Opinion ID: 4535167
Heading Depth: 3
Heading Rank: 2

Heading: sale of services

Text: In an analogous context of our state’s business taxation laws, “the Legislature has always required a multistate taxpayer with business income or activity both within and without the state to apportion its tax base.” Int’l Business Machines Corp v Dep’t of Treasury, 496 Mich 642, 650; 852 NW2d 865 (2014) (IBM Corp) (opinion by 7 For purposes of the UCITO, we conclude that “performed” under the payroll factor means “to carry out an action . . . ,” Merriam-Webster’s Collegiate Dictionary (11th ed), and accordingly, as the parties do not dispute, that compensation for “services performed within the city” is calculated on the basis of the location at which the employee has carried out the service for compensation. 10 VIVIANO, J.).8 As with the UCITO, which was adopted in 1964, our early business-income tax laws did not provide a detailed explanation of how receipts from the sale of services should be apportioned.9 At least by 1955, however, when the Legislature first adopted a multifactor apportionment formula, it was clear that our state followed “the traditional rule of assigning services to the state in which they are performed.”10 See MCL 205.553(b)(1)(C)(2) and (3), as amended by 1955 PA 282 (apportioning receipts from services by dividing the taxpayer’s gross receipts from “[s]ervices performed within this state” by the total amount of the taxpayer’s gross receipts from “services performed . . . both within and without the state”).11 8 Although our business taxation laws concern the apportionment of income between Michigan and other states, reviewing their apportionment provisions is useful because these show the historical development of formula-based apportionment rules for receipts from services in Michigan and offer insight as to the apportionment of in-city and out-ofcity income under the UCITO. 9 See MCL 205.553(2), as adopted in 1953 PA 150; MCL 205.553(b)(1), as amended by 1954 PA 17; and MCL 205.553(b)(1)(C), as amended by 1955 PA 282. The last of these acts is noteworthy because it appears to be the first time the Legislature adopted a multifactor formula to determine the adjusted receipts of a taxpayer to be deemed attributable to Michigan. See MCL 205.553(b), as amended by 1955 PA 282. 10 See 1 Hellerstein, Hellerstein & Swain, State Taxation (3d ed), ¶ 9.18[3][a], p 9-372. See also 1964 HR Rep No 1480, p 188 (“Among those States which provide specific rules for the assignment of particular types of receipts, other than those from the sale of tangible personalty, there is considerable uniformity in their attribution provisions. Receipts from services are assigned to the State where the service is performed.”). 11 Because these were enacted in an era when significantly fewer services were remotely consumed (see infra note 16 and accompanying text), the prior versions of the statute likely would have been viewed the same way even though these employed the phrase at issue here, “services rendered.” See MCL 205.553(2), as adopted in 1953 PA 150 (apportioning receipts from “the rendition of services” by multiplying the total adjusted gross receipts “by a fraction the numerator of which is gross receipts from services rendered in Michigan 11 However, that changed in 1965 when the Legislature incorporated language from the Uniform Division of Income for Tax Purposes Act (UDITPA) into our income tax statute. MCL 205.553(c)(3)(b), as amended by 1965 PA 186, specified that revenue from the sale of services should be included in the sales factor if: (i) The income-producing activity is performed in this state; or (ii) The income-producing activity is performed both in and outside this state and a greater proportion of the income-producing activity is performed in this state than in any other state, based on costs of performance.[12] and the denominator gross receipts from services rendered everywhere”); MCL 205.553(b)(1), as amended by 1954 PA 17 (same). 12 This provision is almost identical to art IV, § 17 of the UDITPA. In the same public act, our Legislature adopted a destination test for the sale of tangible personal property by incorporating language from art IV, § 16 of the UDITPA into our income tax statute. See MCL 205.553(c)(3)(a), as amended by 1965 PA 186. Notably, during the debate over whether to adopt a destination or an origin test as the fundamental rule of attribution for sales of tangible personal property in the UDITPA, [w]hile acknowledging that an origin test would have been the preferred choice of the manufacturing states, the National Conference of Commissioners on Uniform State Laws “was of the opinion that [a sales factor with an origin test] would merely duplicate the property and payroll factors which emphasize the activity of the manufacturing state.” [Hellerstein, Construing the Uniform Division of Income for Tax Purposes Act: Reflections on the Illinois Supreme Court’s Reading of the “Throwback” Rule, 45 U Chi L Rev 768, 773-774 (1978) (second alteration in original).] Furthermore, as Professor Hellerstein noted, “the adoption of the destination test [was] so widespread as to render academic any question of its acceptability.” Id. at 774. But despite that criticism, the Uniform Law Commissioners adopted an origin test for the sale of services. See id. at 772 (noting that with respect to the sale of services, “UDITPA attributes receipts to the state in which ‘the income-producing activity is performed’ or, if it is performed in more than one state, to the state in which a ‘greater proportion of the income- 12 The Legislature maintained this language when it repealed our initial income tax statute and replaced it with the Income Tax Act of 1967. See MCL 206.123, as adopted in 1967 PA 281.13 And it employed similar language several years later in 1975 in adopting the Single Business Tax Act (SBTA).14 In recent years, a different trend-- toward “market-based sourcing” rules-- has emerged.15 This trend has been fueled by the growth of the service sector of the economy producing activity is performed . . . based on costs of performance’ ”). And our Legislature followed suit, incorporating this language into our income tax statute in 1965. 13 Michigan formally adopted the UDITPA and joined the Multistate Tax Compact in 1969. See 1969 PA 343. The Legislature later reversed course after this Court’s decision in IBM Corp, 496 Mich 642. See 2014 PA 282. 14 See MCL 208.53, as adopted by 1975 PA 228: Sales, other than sales of tangible personal property, are in this state if: (a) The business activity is performed in this state. (b) The business activity is performed both in and outside this state and, based on costs of performance, a greater proportion of the business activity is performed in this state than is performed outside this state. (c) Receipts derived from services performed for planning, design, or construction activities within this state shall be deemed Michigan receipts. 15 See Schadewald, Apportioning Income from Sales of Services: The Rules Have Changed, The CPA J (Oct 2016), available at (accessed March 18, 2020) (“In 2000, only a handful of states . . . used market-based sourcing rules for sales of services,” but “[i]n recent years, many states have replaced the cost of performance rule with market-based sourcing rules for sales of services.”). See also Hellerstein, Hellerstein & Swain, ¶ 9.18[3], at 9-368 (“Before the widespread adoption of UDITPA and similar statutes that attributed sales of services based on a catch-all ‘incomeproducing activity’/‘cost of performance’ test for attributing receipts from all sales other than sales of tangible personal property, and the more recent and equally widespread 13 and the development of new technologies that allow for more services to be provided remotely.16 Michigan followed the trend toward market-based sourcing in 2007 when our Legislature adopted the Michigan Business Tax Act (MBTA), 2007 PA 36, shortly after repealing the SBTA. See 2006 PA 325. Under the MBTA’s approach, revenue from the sale of services is attributed to the specific market in which the benefit of the services is received.17 And the Legislature preserved this language in adopting a new corporate replacement of the UDITPA approach with a ‘market-state’ approach to attribution of receipts from the sale of services, states typically included receipts from services in the numerator of the receipts factor to the extent that the services were performed in the state.”) (citations omitted). 16 In an influential article pointing out the weaknesses in UDITPA’s treatment of services, Professor Swain explained that “when UDITPA was first promulgated in 1957, it was much more reasonable to assume that customer location would correlate with the place of the performance. Thus, place of performance may have been an acceptable proxy for the market state.” Swain, Reforming the State Corporate Income Tax: A Market State Approach to the Sourcing of Service Receipts, 83 Tul L Rev 285, 300 (2008). However, in light of the growth of remotely consumed services, this was no longer the case: A product of its day, UDITPA was written against the backdrop of an economy dominated by mercantile and manufacturing enterprises . . . . The U.S. economy, however, has changed dramatically since that time. Production has shifted steadily from goods to services and intangibles, and the forces of globalization, spurred by the revolution in communications technology, now allow many more goods and services to be supplied remotely. This puts tremendous pressure on division of income rules that were developed in another era. [Id. at 287.] 17 Under MCL 208.1305(2): Sales from the performance of services are in this state and attributable to this state as follows: (a) Except as otherwise provided in this section, all receipts from the performance of services are included in the numerator of the apportionment factor if the recipient of the services receives all of the benefit of the services in this state. If the recipient of the services receives some of the benefit of 14 income tax in 2011. See MCL 206.665(2)(a), as adopted in 2011 PA 38.18 Although the UDITPA has not been amended, in 2015, the Multistate Tax Commission revised Article IV of the Multistate Tax Compact to encompass market-based sourcing for the sale of services and other intangibles.19 In other words, the language of each of these provisions the services in this state, the receipts are included in the numerator of the apportionment factor in proportion to the extent that the recipient receives benefit of the services in this state. 18 Under MCL 206.665(2): Sales from the performance of services are in this state and attributable to this state as follows: (a) Except as otherwise provided in this section, all receipts from the performance of services are included in the numerator of the apportionment factor if the recipient of the services receives all of the benefit of the services in this state. If the recipient of the services receives some of the benefit of the services in this state, the receipts are included in the numerator of the apportionment factor in proportion to the extent that the recipient receives benefit of the services in this state. 19 See Model Multistate Tax Compact (as revised by the Multistate Tax Commission, July 29, 2015), art 4, § 17 (“Receipts, other than receipts described in Section 16, are in this State if the taxpayer’s market for the sales is in this state. The taxpayer’s market for sales is in this state: . . . (3) in the case of sale of a service, if and to the extent the service is delivered to a location in this state[.]”) (paragraph structure omitted). Changing to market- based sourcing for the sale of services and other intangibles was intended to mirror the destination principle used for assigning the receipts of tangible personal property. See Pomp, Report of the Hearing Officer: Multistate Tax Compact Article IV [UDITPA] Proposed Amendments (October 25, 2013), p 57, available at (accessed March 19, 2020). In his report, Professor Richard Pomp noted that “[t]he destination principle . . . is hard to mimic in the case of services,” and that “[s]ervices (and intangible property) present different—and more difficult considerations.” Id. at 62. He outlined a number of problems that could arise depending on how the concept of “delivery” is defined: 15 requires that the sale of services and other intangibles be calculated on the basis of where the recipient receives the benefit, either in state or out of state. And this approach reflects an evolution of tax policy from an origin-based approach to a market-based sourcing approach. In light of this brief historical context underlying the sale of services in the realm [S]uppose an architectural firm performs its design services in State A, for a corporate client based in State B, involving a project in State C. The firm sends drawings to the corporate contact as an e‐mail attachment. Where does delivery take place if the client downloads the attachment while on a plane, at home, or at a hotel? What if the architectural firm makes the drawings available at its web site, located on a server in State D, which is accessed by the client while in State E? In which state did delivery take place and how would the firm know? What if the drawings are delivered in hard copy to the client’s office in State B, or handed to the client when she visits the firm in State A? Does it matter that the project is in State C? For a rule on delivery to be workable it cannot require information unknown to the provider. A sound rule must also not be easily manipulated. A sound definition of “delivery” should not allow the firm’s receipts (its fees) to be assigned to a state under tenuous, fortuitous, or serendipitous circumstances, having little to do with any reasonable policy considerations underlying how income should be apportioned. Moreover, any rule for assigning sales should not be easily susceptible to manipulation by the taxpayer. If the scenarios above can result in assigning the service fee to different states, the place of delivery could become elective. Digital services could be delivered to low‐tax jurisdictions and retransmitted. To be sure, this same possibility exists under the destination principle in Act Art. IV.16, (especially with boats and planes) but in the case of services, there are fewer transaction costs and constraints on the place of delivery, which facilitates tax planning. It is tempting to use the customer’s billing address as an acceptable proxy for “delivery,” at least in the case of individuals who have less opportunity to change it in cooperation with the service provider and the regulations should address this possibility. [Id. at 63-64.] 16 of multistate-business taxation, we turn again to the UCITO, in particular its calculation of the revenue factor.