The Florida Department of Revenue recently released two technical assistance advisements that address the sales factor apportionment treatment of certain receipts. On May 17, the Department held that receipts from the provision of online courses are properly sourced to the students' states of residence, either under a cost of performance approach or as receipts from an "interactive network."1 On May 25, the Department ruled that gross receipts from hedging commodity prices are not true sales, whereas net receipts from "output hedges" (but not "input hedges") are includable in the sales factor of the apportionment formula.2
Online Tuition Receipts
The first ruling addressed the sales factor apportionment treatment of receipts generated by a taxpayer that offered courses through its physical classroom locations as well as through the Internet. With respect to the online courses, students located across the United States typically made their own tuition payments from their state of residency if the expense was not paid by financial aid. These online courses were generally accessed from the students' homes, and the taxpayer had home addresses on file (billing and shipping information) to determine the state of residency for each student.
The taxpayer inquired as to the extent to which its online tuition receipts were required to be sourced to Florida. In the ruling request, the taxpayer requested a ruling that since each student receives value from attending the course and accessing the course materials, and the location where these activities are occurring is the state of each student's residence, such location should control for purposes of sourcing revenues from this activity.
After explaining the general rules for calculating the Florida sales factor and the general definition of sales,3 the Department analyzed how to classify the taxpayer's sales for purposes of apportionment. By looking at its regulation addressing the sourcing of items other than tangible personal property, the Department enumerated three potentially applicable rules relating to the sourcing of sales from personal services, computer-related sales from interactive networks and "other sales."4
The Department ultimately agreed that basing the sourcing on the location of each student's residence was the proper approach, as advocated by the taxpayer. However, in doing so, the Department did not clearly confirm which sourcing rule directly produced this result.
Classification as "Other Sales"
The Department first considered the taxpayer's gross receipts to be the provision of a service to a student, classified as "other sales." Under the "other sales" sourcing rule, sales are sourced to the location in which the income-producing activity giving rise to the receipt takes place.5 An "income producing activity" is defined in the Department's regulation as "the transactions and activity directly engaged in by the taxpayer for the ultimate purpose of obtaining gains or profits."6 The Department considered the income-producing activity to take place in the location where each student took an online course, generally from the student's own residence. Therefore, the online tuition receipts from students who resided in Florida were includable in the numerator of the sales factor for apportionment purposes.
Classification as Computer-Related Sales from Interactive Network
Following this analysis, the Department stated that the online courses could also be deemed a computer-related sale from an interactive network. Pursuant to the Department's regulation, the sale of receipts from an "interactive network" includes the sale of access to database information.7 The Department established that since the taxpayer charged students for online access to materials and courses, which were interactive, the taxpayer's online courses constituted an "interactive network." Under this approach, charges for items such as direct access to databases are sourced based on the customer location.8 As the result under the interactive network sourcing rules was the same as under the "other sales" rule, the Department summarily concluded that tuition receipts from online students who reside in Florida would be sourced to Florida, and included in the sales factor numerator of the apportionment formula.
Commodity Derivative Transaction Receipts
The Department also responded to a taxpayer engaged in a multistate trading and marketing business that used commodity derivatives transactions to hedge business risks.
The taxpayer was part of a federal affiliated group with a parent corporation engaged in the business of selling generated power in regulated and unregulated markets.9
The taxpayer engaged in several types of transactions involving derivative contracts that resulted in the recognition of significant amounts of gross receipts:
- Hedging transactions to manage the cost of inputs needed in the production of electricity sold by its corporate parent ("input hedges");
- Hedging transactions to manage the price of electricity generated by its corporate group ("output hedges"); and
- Hedging transactions employed in chosen markets where no active price risk for electricity then existed ("proprietary trades").
For financial accounting purposes, the net receipts from the input hedges were reflected in the cost of goods sold, regardless of whether gain or loss was realized. The net receipts from both output hedges and proprietary trades were recorded as income from operations. The taxpayer requested guidance from the Department on whether gross receipts or net receipts from the hedging transactions should be included in the Florida sales factor.
Gross Receipts from Hedging Activities
The Department first considered whether the gross receipts from hedging activities truly could be considered "sales" for purposes of the Florida sales factor. While the Department's regulation defines the term "sales" as all gross receipts received in the regular course of business,10 the Department noted that gross receipts from each of the taxpayer's derivatives transactions were not included in financial accounting income because the transactions did not, in fact, represent true sales.11 Including the gross receipts in financial accounting income would allow a company to easily manipulate sales figures. As a result, gross receipts from the hedging activities did not meet the definition of "sales" and could not be included in the Florida sales factor calculation.
Net Receipts from Input Hedges
While the gross receipts from the hedging activities were determined not to represent true sales, the net income from the transactions presented a separate issue. In examining the substance of the input hedges, the Department considered that the activities were conducted to effectively provide insurance and that the purpose was not to make a profit.
Therefore, the Department determined that the net income from input hedges was not includable in the sales factor calculation, as such amounts were not "sales."
Net Receipts from Output Hedges
The net receipts from output hedges, however, were included in the sales factor because they were considered to be part of the actual sale of electricity by the taxpayer, which was the taxpayer's business. Since the taxpayer treated the net receipts as a "sale" on its books and records, and the taxpayer also sourced the output hedges to specific power plants, the net receipts from the output hedges were includible in the Florida sales factor, and attributed to the specific power plant to which each sale related.
Net Receipts from Proprietary Trades
Finally, the Department considered the treatment of net receipts of proprietary trades. While income from the proprietary trades was booked as sales for GAAP purposes, the Department chose to look beyond the GAAP treatment. According to the Department, the underlying purpose of the proprietary trades was to measure markets and as such, was comparable to an expense for market research activities. Therefore, the Department concluded that the net receipts from proprietary trades should not be included in the sales factor.
Commentary
Florida's treatment of sourcing sales of items other than tangible personal property has been characterized as uncertain, with both cost of performance and market-based sourcing concepts potentially in play. The analysis contained in the Department's first ruling reflects that uncertainty. In the first ruling, the Department did not address whether the taxpayer's sales more generally could be classified as personal services. The Department's regulation states that if personal services relating to a single item of income are performed in more than one state, the gross receipts for such services "shall be attributed to [Florida] only if a greater portion of the services were performed in this state, based on costs of performance."12 Under such an analysis, the Department potentially could have concluded that the location of the service provider's costs (for example, the location where the courses or instruction are being conducted, where the course materials are developed, where the instructors reside, and where the web-based learning management systems are housed) controls the sourcing of the taxpayer's receipts from online tuition, rather than the location of each student. Instead, the Department endorsed a market-based sourcing approach in this instance. One question that arises is whether the Department has authority to essentially promote market-based sourcing in parts of its own regulation and rulings, where the statute and even some aspects of its regulation do not support such an application.
As for the second ruling, relating to receipts from hedging transactions, the issue of whether to include gross or net receipts amounts from the sale of securities has become more significant in recent years as companies expand their hedging operations, and has been litigated in California by many businesses with out-of-state treasury departments.13 Some states (including California, which recently amended its statute) specifically exclude from the apportionment formula sales of certain intangible assets.14
Footnotes
1 Florida Technical Assistance Advisement No. 12C1-006, Florida Department of Revenue, May 17, 2012, released July 2012.
2 Florida Technical Assistance Advisement No. 12C1-007, Florida Department of Revenue, May 25, 2012, released July 2012.
3 Florida apportions income using a three-factor formula (property, payroll and double-weighted sales). See FLA. STAT. ANN. § 220.15(1). For purposes of the sales factor, sales generally include all total sales, with exclusion for certain items, including "interest, dividends, rents, royalties, and gross receipts from the sale, exchange, maturity, redemption, or other disposition of securities." FLA. STAT. ANN. § 220.15(5).
4 FLA. ADMIN. CODE ANN. r. 12-C-1.10155(2)(e), (h).5, (l).
5 FLA. ADMIN. CODE ANN. r. 12-C-1.10155(2)(l).
6 Id.
7 FLA. ADMIN. CODE ANN. r. 12-C-1.10155(2)(h).5.
8 Id.
9 Electricity meets the definition of "tangible personal property" contained in FLA. ADMIN. CODE ANN. r. 12- 21.202(7), as stipulated by the taxpayer. Accordingly, sales of electricity are sourced to the location where the property is delivered. FLA. STAT. ANN. § 220.15(5)(b).1.
10 FLA. STAT. ANN. § 220.15(5).
11 In considering whether the transactions constituted true sales for apportionment factor purposes, the Department cited to two Florida cases as relevant guidance, noting that the sales factor cannot be artificially changed by including or excluding transactions that are not true sales. See Department of Revenue v. Anheuser- Busch, 527 So.2d 877 (Fla. Dist. Ct. App. 1988) and Coulter Electronics v. Department of Revenue, 365 So.2d 806 (Fla. Dist. Ct. App. 1978).
12 FLA. ADMIN. CODE ANN. r. 12-C-1.10155(2)(e).
13 See Microsoft Corp. v. Franchise Tax Board, 139 P.3d 1169 (Cal. 2006) and General Motors Corp. v. Franchise Tax Board, 139 P.3d 1183 (Cal. 2006).
14 See CAL. REV. & TAX. CODE § 25120(f)(2)(l); NEB. REV. STAT. § 77-2734.04(20)(b); MONT. ADMIN. R. § 42.26.202(11)(b)(xi).
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