The Virginia General Assembly has enacted legislation requiring the Department of Taxation to adopt regulations consistent with recently issued guidance pertaining to the Local Business License Tax (BPOL) deduction for receipts attributable to other states. This development does not change the state of the applicable law, as the Virginia Supreme Court addressed the particular issue in 2015. However, having a regulation will hopefully give taxpayers clear guidance in a single source instead of having the rules spread out over a lengthy court decision, and multiple Department letter rulings. Additional background on the out-of-state deduction can be found here.
The legislation itself (HB 1961) is brief and to the point. It simply states that the Department must adopt regulations regarding the methodology for determining deductible gross receipts attributable to business conducted in another state consistent with the holding in The Nielsen Company v. County Board of Arlington County and rulings issued by the Department. Assuming the regulation will merely address the particular application of the out-of-state deduction at issue in Nielsen, taxpayers can expect the regulation to provide guidance on how to determine the allowable deduction when the BPOL tax base is computed using the payroll apportionment method.
Essentially, a taxpayer that uses payroll apportionment in initially computing its gross receipts attributable to the locality must be able to provide evidence that employees in the locality earn, or participate in earning, receipts attributable to customers in other states where the taxpayer filed an income tax return. If the taxpayer can provide such evidence, the taxpayer can claim a deduction from the tax base that is determined by multiplying the payroll factor percentage for the locality by the amount of gross receipts assigned to the states where the taxpayer filed an income tax return. Initially, this methodology was proposed and applied by the Department in a handful of rulings, and was affirmed as a reasonable approach by the court in the Nielsen ruling.
The more telling aspect of the developments on this issue is that they further support that the out-of-state deduction is not based on income tax apportionment rules. This is a common position taken by Virginia localities on audit or when deciding if a taxpayer is due a refund. Granted, the ability to claim the deduction is contingent upon a taxpayer filing an income tax return in the jurisdiction for which the deduction of the receipts is based. However, multiple Virginia rulings as well as the Nielsen decision make it clear that the amount of the deduction is not somehow tied to the amount of a taxpayer’s sales sourced to that state on its income tax returns. Indeed, such a requirement could result in similarly situated taxpayers ending up with different deduction amounts merely because the deduction is claimed with respect to states that have different sales factor sourcing rules for income tax purposes.
Whether a particular taxpayer has the ability to reduce their BPOL tax liability using the out-of-state deduction depends on how a taxpayer provides its services to its customers. Thus, the facts in each case become very important in assessing whether a taxpayer has been over reporting its BPOL tax. The best approach for any Virginia service provider is to seek out an experienced tax practitioner before filing that first BPOL tax return so the reporting is correct from the start. While refund claims can be great, the localities typically put up a fight even in the clearest cases. Taxpayers are typically required to provide extensive substantiation to support the claim. Still, many taxpayers overstate their BPOL tax base by such a large amount that the refund is substantial enough to endure dealing with a locality that is understandably reluctant to accept such a drastic change in the tax base without sufficient substantiation.
If you have concerns about whether your business is overpaying its BPOL tax, please contact your Aronson tax advisor or Michael L. Colavito, Jr. at 301.231.6200.
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.