Will Virginia Adopt Market-Based Sourcing? The Virginia Department of Taxation is currently conducting a study to determine the “desirability and feasibility” of adopting market-based sourcing. For businesses conducting the bulk of their services in the D.C. Metro area, the adoption of such a rule by Virginia would at least spare them the headache of dealing with Virginia applying a different rule than Maryland and D.C. Currently, Virginia utilizes the costs-of-performance method of sourcing sales from services and intangibles, which assigns such sales to the state where most of a taxpayer’s costs are incurred. On the other hand, a market-based rule sources a sale of a service or intangible to the location of the customer or the delivery location.
Virginia’s adoption of market-based sourcing is in no way a done deal. The study, requested by the Virginia House Finance Committee, has received push back from certain taxpayers in the communications and government contracting industries, respectively. For example, Northrop Grumman, a business that could possibly benefit from Virginia’s adoption of market-based sourcing, said that the change “would disrupt the long-standing stability of the Commonwealth’s tax laws that many businesses find attractive.”
Moreover, in last year’s meeting on the potential change, the Department was very concerned about the difficulties in estimating the revenue impact that might be caused by a change to market-based sourcing. There are options in that regard. For example, North Carolina, which is also considering market-based sourcing, requires larger corporate income taxpayers to file an informational report showing what their tax liability would be if the state were to adopt a market-based sourcing rule.
In recent years, a number of states have adopted a market-based sourcing method. It’s certainly no longer accurate to characterize the shift as a trend, as over 20 states use a market-based method as opposed to a cost-based rule. For tax year 2015 alone, the District of Columbia (D.C.), New York, and Rhode Island will all begin applying a market-based sourcing rule. Virginia should not make the jump to market-based sourcing without considering the impact on its overall method of taxing multi-state businesses. The rule would have multiple implications; for instance, Virginia’s rule for when a business has nexus with the Commonwealth would likely have to be altered, and whether market-based sourcing would apply to pass-through entities as well as corporations will also be up for consideration.
For now, taxpayers are left with Virginia as the outlier in the D.C. Metro area for sourcing of revenue from services and intangibles. For Virginia-based taxpayers, this means the continued aggravation of potentially double counting a significant amount of sales, especially now that D.C. uses a market-based rule.
If you have question about the varying rules used to source multi-state revenue, please contact your Aronson tax advisor or Michael L. Colavito, Jr. at 301.231.6200.