New Jersey Division Of Taxation Issues Proposed Market-Based Sourcing Regulation

On April 15, 2013, the New Jersey Division of Taxation published a proposed regulation in the New Jersey Register that, if adopted, would change the way in which New Jersey determines whether receipts from services are included in the numerator of the Corporation Business Tax ("CBT") allocation factor sales fraction. Under the new regulation, service receipts will be apportioned based upon a market-based sourcing approach, rather than sourcing according to the service provider's cost of performance. If adopted, the new regulation would become effective for tax periods beginning on or after January 1, 2014.1

Background

New Jersey receipts are simply defined in the CBT statute and current regulations as receipts from services performed in New Jersey.2 Under the current regulation, receipts from most services performed both within and outside New Jersey are apportioned according to the cost of performance incurred in New Jersey, the amount of time spent in performing the services in New Jersey or by some other reasonable method.3 For "certain service fees" (i.e., electronic transactions) receipts are currently allocated 25 percent to the state of origination, 50 percent to the state in which the service is performed and 25 percent to the state in which the transaction terminates.4

The Proposed Regulation

The proposed regulation redefines New Jersey receipts as "receipts derived from customers within [the] State" effective for tax periods beginning on or after January 1, 2014.5 A customer is within the state if it is engaged in a trade or business and maintains a regular place of business in New Jersey or is not engaged in a trade or business but has a New Jersey billing address.6 For these purposes, a regular place of business in New Jersey may include any office, factory, warehouse, or other business location in the state where the customer conducts business or maintains property or employees.7 A regular place of business is not limited to a principal place of business.8 A billing address is the address where notices, statements, or bills relating to the customer's account or services provided to the customer are mailed.9

The general intent of the proposed regulation is to attribute receipts from sales of services to New Jersey to the extent the customer receives the benefit of the service in the state.10 Thus, if the customer receives the benefit of the service within and outside New Jersey (i.e., multistate services), the proposed regulation allows a taxpayer to use the terms of the service contract and its books and records, or can consider the nature of the taxpayer's or recipient's business or the service at issue, to determine the extent the benefit of the service is received in the state.11 If these methods do not provide the information necessary to determine how much benefit of the service is received in the state, a reasonable approximation may be made.12

The proposed regulation provides ten examples that show how this new sourcing regulation would operate in practice. Among the examples that are likely to have the widest application to service providers are the following:

Revenues from engineering services would be attributable to New Jersey if the services relate to a building located in New Jersey.13 An out-of-state computer software developer would attribute revenues derived from developing custom software to New Jersey if the software would only be used in the customer's office in New Jersey.14 However, if the customer also uses the...