Indiana: where market-based sourcing and income-producing activity collide.

• Author: Kirkell, Brian J.

Over the past several years, service providers have been swept up in a legislative sea change in relation to their apportionment sales factors, as states have shifted from sourcing sales of services using an income-producing-activity approach to market-based sourcing. Conceptually, these approaches to sourcing sales of services are diametrically opposed. The income-producing-activity test focuses on where the service is performed, as measured by costs of performance, time spent, or other methods, while market-based sourcing focuses on where the benefit of the service is received, as measured by customer location, customer billing address, or geographic target. However, the Indiana Department of Revenue has blurred the edges of these two approaches through the quasi-regulatory ruling process, creating a potential trap for the unwary, opportunity for the savvy, and fertile ground for litigation.

Indiana clearly derived its statutory framework and administrative guidance regarding sourcing sales of services from Art. IV, Section 17 of the Multistate Tax Compact (MTC) (previous to the adoption of amendments to the MTC on July 30,2014) and Reg. IV.17.(2) of the MTC Allocation and Apportionment Regulations. Mirroring the pre-amendment MTC Art. IV, Section 17, Indiana Code Section 6-3-2-2(f) provides that receipts from sales of services are sourced 100% to Indiana if (1) the income-producing activity is performed entirely in Indiana, or (2) the income-producing activity is performed both within and without Indiana and a greater proportion of the income-producing activity is performed in Indiana than in any other state, based on costs of performance. Similarly, following the lead of Reg. IV. 17. (2), 45 Indiana Administrative Code Section 3.1-1-55 provides that income-producing activity for the purposes of Indiana Code Section 6-3-2-2(f) includes the "rendering of personal services by employees or the utilization of tangible and intangible property by the taxpayer in performing a service" and that such activity is deemed to be entirely performed in Indiana if "the act or acts directly engaged in by the taxpayer for the ultimate purpose of obtaining gains or profit" occur solely in Indiana.

In applying these rules, an out-of-state service provider used to dealing with the MTC's income-producing-activity rules in other states would expect that its sales of services to Indiana customers would be sourced outside Indiana under Indiana Code Section...