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Economic Presence Nexus Regulations Moving Forward

Posted Thursday, July 28, 2011 by Michael A. Larson

alt textYesterday I attended the Washington Department of Revenue hearing on proposed WAC 458-20-19401 (Rule 19401) and WAC 458-20-19404 (Rule 19402). Rule 19401 covers the minimum nexus threshold for apportionable activities in Washington. Although the concept of applying economic presence nexus rules to service businesses remains controversial, the Department of Revenue’s interpretation of the 2010 statute garnered scant comment as the proposed Rule 19401 language appears to be a fair interpretation of the statute adopted by the Washington legislature.

Also in 2010 the Washington legislature adopted single sales factor apportionment for service businesses, including banks. The Washington apportionment scheme for banks has long been patterned after the MTC Apportionment and Allocation Rules for Financial Institutions. The 2010 legislation continued this practice with respect to financial institution apportionment with two primary changes: replacement of the three factor formula (receipts, property and payroll) with a single sales receipt factor; and explicit authority to treat the definition of “financial institution” as advisory only.

The Department of Revenue had a problem with the standard MTC apportionment scheme. Nonfinancial service income of banks was to be allocated to the numerator of the receipts formula using a greater cost of performance rule. Subsidiaries of financial institutions are treated as financial institutions under the MTC rules. Thus, a service-based business owned by a financial institution would allocate its nonfinancial service receipts according to the greater cost of performance rule, while similar service businesses that were not owned by financial institutions would be required to allocate service receipts to the place where the benefit of the service is received.

To remedy this problem the Department of Revenue chose to narrow the definition of financial institution to a specific group of regulated financial institutions. While this rule provides symmetry between service businesses regardless of their ownership, it creates significant problems for certain special-purpose entities that are used by regulated financial institutions to engage in certain securitization transactions. As such, a request was made by the Washington banking industry to broaden the definition of “financial institution,” but to change the allocation rule for gross receipts from nonfinancial service activities.

Interestingly, many taxpayers that had previously been subject to the financial institution apportionment rules of WAC 458-20-14601 will not be subject to the provisions of Rule 19404, but instead will be subject to WAC 458-20-19402. This will primarily affect these companies by eliminating the ability to use the greater cost of performance rule to allocate nonfinancial service income for purposes of the computing the receipts denominator. For some companies this could result in significant changes to their Washington B&O tax liability.

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