Cost-of-Performance Versus Market-Based Sourcing.

• Author: Yesnowitz, Jamie

The Expert: Jamie Yesnowitz

Calculating how to source sales to determine a company's state corporate income tax sales factor (and overall apportionment factor) drives how much that company ultimately will pay in tax to the states. The basis of the economy has shifted over time from the sale of goods toward the sale of services and intangibles. As a result, sourcing sales of items other than tangible personal property has become crucial. States have developed several different sourcing approaches to account for these sales, including cost-of-performance measures and market-based sourcing methods.

Question: What's the difference between cost-of-performance and market-based sourcing?

Answer: Calculating how to source sales for purposes of determining a company's state corporate income tax sales factor (and overall apportionment factor) drives how much that company ultimately will pay in tax to the states. As the economy has transitioned from primarily selling goods to selling services and intangibles, the methods by which such sales of items other than tangible personal property are sourced have become very important. States have developed several different approaches to locate the sourcing for these sales. Some states source via cost-of-performance measures, whereas others look to market-based sourcing methods.

Cost-of-performance sourcing requires a company to consider its own costs in determining how to source its sales of services. Cost of performance comes in two very different flavors: preponderance (all-or-nothing) cost of performance, in which a sale is sourced only to the state in which a preponderance of the company's costs of performance incurred with respect to its income-producing activities is located, versus pro rata cost of performance, in which a portion of a sale is sourced in line with the proportion of the company's costs. In some cases, a "time spent" or payroll-measurement pro rata approach may be authorized as a means to determine a company's cost of performance.

In contrast, market-based sourcing generally looks to the location of the taxpayer's customers, which may be obtained in a number of ways. Depending on a states rules, sales may be sourced through the location where the customer receives the benefit of the service, the actual delivery location of the service, the customer's ordering or billing address, or even a reasonable approximation in some cases.

Overtaxed? Undertaxed?

Given the lack of conformity among the...