Massachusetts Quarterly Update

Welcome to the latest Massachusetts Quarterly Update from Reed Smith. This update for the 2nd Quarter of 2013 includes coverage of a number of corporate excise tax developments, in particular: (i) pending apportionment legislation on Beacon Hill that would impose market sourcing for many types of receipts and institute a throwout rule; and (ii) some recent decisions from the Appellate Tax Board ("ATB") regarding the taxation of securitization entities, SINAA sourcing, and the sham transaction doctrine.

This update also covers a number of sales tax issues, including: (i) pending litigation that could impact the taxation of software as a service (SaaS) and cloud computing services; (ii) recent letter rulings regarding SaaS and cloud computing transactions; (iii) pending legislation expanding the sales tax to certain computer services; and (iv) some recently decided cases involving (a) class action sales tax lawsuits; and (b) bad debt refund claims by vendors in third-party financing transactions.

Corporate Tax

Market sourcing and throwout likely on the way—in 2014

Pending legislation would bring market sourcing to Massachusetts for the 2014 tax year and include a throwout rule when sourcing receipts from sales other than sales of tangible personal property.

The House and Senate have passed legislation replacing Massachusetts' current cost of performance sourcing regime for sales other than sales of tangible personal property with a market-based sourcing rule for tax years starting on or after January 1, 2014. The legislation would also implement a throwout rule for sales other than sales of tangible personal property.1

Governor Patrick has returned the bill to the Legislature and recommended amendments, not because of any objection to the apportionment changes, but because it lacked certain additional revenue provisions (most importantly a provision to increase the gas tax to offset potential lost highway toll revenue). The Democratic legislative leadership has recommended that its members reject the gas tax provision; however, the initial legislation passed with enough votes to override the Governor's veto. As a result, there is still a strong chance the apportionment changes could be enacted in their current form, notwithstanding a potential veto by the Governor.

Takeaways

Effect on Alternative Industry Apportionment Rules: It is unclear how the legislation will affect existing alternative apportionment rules for industries such as airlines and delivery companies. The authority of the Massachusetts Department of Revenue (the "Department") to promulgate alternative apportionment rules for special industries is triggered only if the statutory apportionment rules "are not reasonably adapted to approximate the net income" of a particular industry in Massachusetts. The current industry-specific regulations were arguably permissible because the Department had determined that the statutory apportionment rules, including the cost of performance sourcing rule, did not meet the "reasonable approximation" standard. However, it is less clear that the Department will be able to continue to meet this burden in the case of all industries with alternative apportionment regimes once the statutory apportionment rules are amended to adopt market-based sourcing. Guidance to Follow: While the legislation does not take effect until 2014, we expect the Department to issue guidance implementing the apportionment changes shortly after the legislation is enacted. The Department continues to challenge taxpayer use of the "operational approach" in applying the cost of performance sourcing rule—except in situations where the majority of the taxpayer's operations are in Massachusetts.

At a recent meeting of the Boston Bar Association, David Davenport (Deputy Commissioner and Senior Policy Counsel for the Department) stated that he did not believe that the 2011 ATB decision in AT&T,2 which applied an operational approach to cost of performance sourcing, was broadly applicable. This indicates that the Department will continue to challenge taxpayer attempts to apply an operational approach to source receipts outside of Massachusetts on an "all or nothing basis." Mr. Davenport made clear that his comments were his own and not an official statement of the Department of Revenue, but with more than a dozen cost of performance cases currently pending at the ATB, it is clear that the Department views AT&T as a decision with limited applicability to other out-of-state service providers.

Of course, when the application of an operational approach benefits Massachusetts (e.g., in the case of taxpayers that have a majority of their operations in Massachusetts), we expect the Department to continue to employ an operational approach in applying the cost of performance sourcing rule, citing AT&T, as well as the ATB decisions in Boston Bruins and Interface Group.3 The Department is currently taking this position in several cases pending at the ATB.

Takeaways:

Out-of-state taxpayers that have taken the operational approach to applying the cost of performance sourcing rule should keep a close eye on the cost of performance cases pending at the ATB. Taxpayers that have not yet employed this approach to applying the cost of performance sourcing rule still have time to file refund claims for tax years before the effective date of the pending legislation. Masschusetts-based service providers should...