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Service Apportionment Opportunities for Washington Based Businesses

Posted Wednesday, June 16, 2010 by Michael A. Larson

alt textOne of the biggest changes adopted by the Washington Legislature in 2010 is the requirement for “receipts factor” sourcing for businesses earning gross income from certain “apportionable activities.” Prior to the new law, businesses only apportioned gross income from services and the method used for such apportionment was based loosely on where the taxpayer’s costs of doing business were incurred.

Under the new law, taxpayers that are not taxable in another state (see explanation below) will continue to pay B&O tax on 100% of their gross income from these apportionable activities. However, the B&O tax liability for out of state businesses that engage in apportionable activities with Washington based customers is likely to increase dramatically. On the other hand, the B&O tax liability of Washington based businesses that engage in apportionable activities and are “taxable in another state” could be reduced substantially.

What are Apportionable Activities?

Apportionable activities are a specifically enumerated set of activities that include:

  • Real estate brokers
  • Nonprofit corporations and associations engaging in R&D
  • Travel agents and tour operators
  • International steamship agents, international customs house brokers, etc.
  • Stevedoring and associated activities
  • Low-level waste disposal
  • Insurance producers, title insurance agents and surplus line brokers
  • Hospitals
  • Inspecting, testing, labeling and storing canned salmon
  • Independent resident managing general fire or casualty insurance agents
  • Contests of chance and horse races
  • International investment management services
  • Aerospace product development for hire
  • Royalties from granting intangible rights
  • Boarding home room and domiciliary care
  • Certain radioactive waste cleanup activities
  • Newspaper and printer/publisher advertising

In addition, apportionable activities also include any activities that are taxable as “service and other activities” under the catchall provision at RCW 82.04.290 for business activities not otherwise specifically included in any other classification. Most of these “apportionable activities” would fall into a service activity, but this category does not include retail service activities such as, repair and installation services, abstract services, title insurance, escrow services and credit bureau services.

What is Receipts Factor Sourcing?

Receipts factor sourcing is a method for apportioning gross income from business activities that sources gross income to Washington using a ratio of Washington gross income over gross income from everywhere. The resulting percentage is applied to gross income from everywhere to determine the gross income that must be reported for Washington excise tax purposes. Those persons who have a basic grasp of algebra will immediately see that this results in essence in a tax on 100% of Washington gross income.

In many cases, the single sales factor sourcing will simply result in a tax on the Washington gross income. However, Washington also adopted a “throwout” rule that must be used in computing gross income from everywhere for purposes of the denominator of the receipts factor. The throwout rule requires that the denominator of the receipts factor be reduced by the amount of gross income sourced to a state in which the taxpayer is not taxable if any part of the activity to earn the gross income is performed in Washington. This can result in businesses paying B&O tax on gross income in excess of the Washington gross income.

When is a Taxpayer Taxable in another State?

A taxpayer is taxable in another state when a taxpayer is actually subject to a business activities tax by another state on its income received from engaging in apportionable activities. A business activities tax would appear to include state and local income taxes as well as gross receipts taxes like the Ohio CAT and Michigan MBT and taxes based partially on gross income, such as the Texas Margins tax. It is unclear if business activities taxes will include hybrid sales tax systems like the New Mexico Gross Receipts tax or the Hawaii General Excise Tax, for while these taxes are measured in whole or in part on gross income or receipts, the law specifically excludes from the definition sales and use taxes and similar transaction taxes.

A taxpayer is also treated as taxable in another state if the taxpayer is not subject to a business activities tax but the state would have jurisdiction to subject the taxpayer to a business activities tax under the economic nexus standards recently adopted by Washington.

Planning Opportunities

Washington based businesses should examine their apportionment methodologies for service income to determine if the new rules will reduce their liability for Washington B&O taxes. Businesses with service operations in WA, but substantial customers outside of Washington could benefit dramatically. Financial institutions based in Washington should especially pay attention to the recent law changes as similar changes have been devised for financial institutions that previously paid tax under the three factor formula required by WAC 458-20-14601.

A Note of Caution

Should the economic nexus provisions of the new law be successfully challenged as unconstitutional, the receipts factor sourcing will be automatically be voided. This could result in a requirement to repay taxes saved by reason of the receipts factor apportionment. While this result is clearly speculative, it may be prudent to establish reserves for this possibility.

For more information, please contact Ron Bueing at 206-340-2008.

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