The Utah State Tax Commission recently released a private letter ruling clarifying the appropriate apportionment methodology for freight forwarders. In this ruling, the Commission held that the taxpayer requesting the ruling was not eligible to use a single sales factor for purposes of apportionment, and was required to source its revenue stream from freight forwarding to the location of its direct customers.1 The direct customer approach taken by the Commission with respect to sourcing revenue is distinctive from other states that often look to the ultimate destination of a transaction.
Freight Forwarding and Typical Apportionment Treatment
A broker or forwarder arranges for the transportation of freight from the origination to destination point. However, unlike trucking companies who transport goods using their own trucks and personnel, forwarders arrange for the movement of the freight by rail, air, water and/or truck by another company. This makes the process of sourcing receipts based on mileage unavailable in most states. Instead, due to the nature of their logistics activities, forwarders come under the general application of the cost of performance or market-based sourcing methodologies required to source sales of services.
Background and Rulings Requested
The taxpayer, which is engaged in the acquisition and resale of transportation and shipping services performed by unrelated third-party common carriers, sells its services to end users, as well as the taxpayer's own franchisees (who then resell these services to their customers). In doing so, the taxpayer contracts for and arranges the shipping, then pays the carrier and then invoices the customer or franchisee.
In its ruling request, the taxpayer requested that the Commission: (i) conclude that the taxpayer was required to apportion based on a single factor as a "sales factor weighted taxpayer" (SFWT); and (ii) clarify whether the sales of the taxpayer's services should be sourced on a market basis to the billing address, state of origination or state of destination.
SFWT Designation Denied
Utah applies a single sales factor apportionment factor for SFWTs, which are defined as corporations that derive more than 50 percent of their total sales from activities not explicitly excluded under state law.2 These activities that are explicitly excluded are determined using the North American Industry Classification System (NAICS) code of the taxpayer.
In the letter ruling, the taxpayer had a NAICS code of 488510, or Freight Transportation Arrangement (freight forwarding). NAICS codes that begin with 48 or 49 (which are described within the transportation and warehousing business sector) have been specifically excluded from SFWT.3 Therefore, the Commission summarily precluded the taxpayer from SFWT treatment. Instead, the taxpayer could elect to use either equally weighted payroll, property and sales apportionment factors or a payroll, property and double-weighted sales factor.4
Sourcing Rules for Freight Forwarder Sales Clarified
The Commission began its analysis on the sourcing issue by citing the Utah statute that sources receipts from the performance of a service to Utah if the purchaser receives a greater benefit of the service in Utah than in any other state.5 The Commissioner is authorized to prescribe the circumstances under which a purchaser is considered to receive a greater benefit of the service in Utah than in any other state.6 Pursuant to that authority, a Utah regulation interpreting the statute provides that in general "...the greater benefit of the service is typically received in the state in which the market for the service exists and where the purchaser is located"7 (emphasis added).
The Commissioner interpreted Utah's market based approach to consider where the benefits of the taxpayer's services are received by the taxpayer's direct customers, and source according to the location of the direct customers. In the taxpayer's fact pattern, the direct customers were the taxpayer's franchisees and the direct end-user shippers. The direct customers did not include the franchisees' customers. The Commissioner distinguished the taxpayer's fact pattern from an example in the Utah regulation relating to a moving company that sourced its moving services to the state to which the purchaser was moving.8 In the example, the purchaser was the moving company's direct customer, and so the moving services were located in the "destination" state. In this letter ruling, the taxpayer's services were to direct customers that were not necessarily in the location where the goods were being shipped. Finally, the Commission noted that the taxpayer was not subject to a special regulation applicable to trucking companies because the taxpayer was in the business of arranging for the movement of the goods, not directly transporting goods.9
Commentary
The Commission's regulation interpreting how to determine where benefits are received by a purchaser took center stage in this letter ruling. Under the Commission's regulation, two conditions are paramount. A market for the service must exist in the state, and the purchaser must be located in the state. This two-part test, when applied to freight forwarders, does not necessarily cohere with the sourcing result in many other states that utilize market-based sourcing. Rather than focusing on the location of the direct customer like Utah, other states have taken the position that a sale of this nature should be sourced to the ultimate destination of the freight, regardless of where the direct customer is located. The different approaches are especially important to consider in the freight forwarding context, as each shipment often consists of four parties: (i) the forwarder; (ii) the party hired to transport the shipment; (iii) the customer; and (iv) the customer's customer. The direct customer in this letter ruling is the party that directly hired the forwarder to move the shipment.
Interestingly, the Commission's ruling did not explicitly analyze significant parts of its own regulation that were actually cited by the taxpayer in the ruling request. Pursuant to the regulation, the Commission has claimed that the benefit from performing a service is in Utah if any of several separate conditions are met. If the service relates to tangible personal property, the benefit of the service is in Utah if the service is performed at a purchaser's location in the state, or the property is delivered by the service provider to a purchaser in the state after the service is performed.10 Services provided to individuals physically present in the state at the time the service is received are also sourced to Utah.11 In addition, services provided to purchasers either exclusively engaged in a Utah trade or business where such services relate to such business, or present in the state where such services relate to their activities in the state are sourced to Utah.12 In addition to these rules, the regulation provides for a tiered approach to sourcing a service receipt when the benefit of the service is received in more than one state. The first step in this situation is to use "reasonable and consistent methods of analysis" to figure out where the greatest benefit is received.13 If the benefit of the service cannot be determined by this rule, the following tiering rules apply: (i) ordering location; (ii) billing location if order location cannot be determined; and (iii) automatic sourcing to Utah if the billing address cannot be determined.14 Perhaps the Commission felt that its sourcing determination with respect to the taxpayer at issue in the ruling could be made without resorting to the more intricate sourcing rules in its regulation.
Due to the language in the statute and the interpretation of the Commission, the revenue of arranging for the transportation of goods will not always be the destination of the freight. Accordingly, there may be instances in which a nowhere sale may occur, or a sale reported in the numerators of two different jurisdictions may result. The following example may be instructive with respect to a nowhere sale. Assume that a taxpayer's customer is in state B and that customer's customer is in Utah. State B uses market-based sourcing with a pure benefits received test, regardless of the location of the customer. While the sale would be included in the denominator of both Utah and state B's sales factors, neither Utah nor state B would include this sale in their own state's numerator. Of course, if the taxpayer's customer is in Utah and that customer's customer is in state B, both Utah and state B would claim the sale.
Footnotes
1 Utah State Tax Commission, Private Letter Ruling 15-003, April 22, 2015.
2 UTAH CODE ANN. § 59-7-302(1)(k).
3 UTAH CODE ANN. § 59-7-302(1)(k)(i)(D).
4 UTAH CODE ANN. § 59-7-311(c), (d).
5 UTAH CODE ANN. § 59-7-319(3)(a).
6 UTAH CODE ANN. § 59-7-319(3)(b).
7 UTAH ADMIN. CODE R865-6F-8(10)(g)(i).
8 See UTAH ADMIN. CODE R865-6F-8(10)(g)(viii)(H).
9 See UTAH ADMIN. CODE R865-6F-19.
10 UTAH ADMIN. CODE R865-6F-8(10)(g)(iii)(A), (B).
11 UTAH ADMIN. CODE R865-6F-8(10)(g)(iii)(C).
12 UTAH ADMIN. CODE R865-6F-8(10)(g)(iii)(D), (E).
13 UTAH ADMIN. CODE R865-6F-8(10)(g)(iv).
14 UTAH ADMIN. CODE R865-6F-8(10)(g)(iv)(A)-(C).
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