Proposed Regulations for Market-Based Sourcing in Kentucky
Earlier in 2018, Kentucky Legislation passed House Bill 487 which brought substantial reform to the Kentucky Tax Laws. Among these changes were two specific adjustments that were made to move to a Single Sales Factor apportionment method and adapt to a Market-based sourcing approach. Proposed regulations submitted by Kentucky Legislators in November 2018 look to update and expand the Kentucky tax code to incorporate these changes effective for tax years beginning on or after January 1, 2018.
A Market-Based sourcing approach defines that receipts from sales, other than tangible personal property, are considered to be within Kentucky if the taxpayer’s market for these sales are located within the state’s borders. The proposed regulations give guidance for concluding whether the Market for a sale is in Kentucky or otherwise. Additional rules are outlined for reasonably approximating sales to be assigned to Kentucky in the instance that the location of the Market cannot be determined. These assignment rules must be determined with good faith and in a reasonable effort using state-to-state and year-to-year consistencies in the allocation determinations. Records must be well maintained in order to explain the allocations which are made.
The new regulations specifically expand guidance on gross receipts derived from Service activities. They explain that, in general, receipts from services must be assigned to Kentucky if they were delivered to a location within the state. This is in reference to the location of the market of the service, not necessarily the location of employees or property. “In-person” services will be assigned to Kentucky if the service was received in the State. A few examples provided of “In-person” services are those related to:
- The Customer’s body (such as a haircut or X-ray).
- The Customer’s physical presence, including live entertainment or athletic performances.
- The Customer’s real estate.
- The Customer’s tangible personal property at their residence or that is in the customer’s possession.
- The Customer’s tangible personal property that is shipped or delivered to the customer in the state.
Professional services provided to an individual customer must be assigned to Kentucky if the customer’s primary residence or billing residence is in the state. Professional services provided to a business customer must be assigned to Kentucky if the contract of sale is principally managed by the customer in the state, the customer placed the order in the state, or the customer’s billing address is in the state.
Receipts generated from the license or sale of intangible property used in the state must be sourced to Kentucky, though the assignment varies depending on the type and nature of property sold. Specific sourcing rules are provided for
- Marketing intangibles;
- Production intangibles;
- Broadcasting intangibles;
- Mixed intangibles;
- Contract rights or government licenses;
- Software transactions;
- Digital goods or services;
- Transactions that resemble the sale of goods or services.
Safe Harbor Rule
There is also a safe harbor rule for large volume transactions which allows qualifying taxpayers to assign receipts from services based upon the customers billing address. In order to qualify a taxpayer must not derive more than 5% of all service receipts from that customer and engages in substantially similar service transactions with greater than 250 customers. Special guidelines apply to:
- Taxpayers who derive greater than 5% of all service sales from a single customer
- Services delivered physically or electronically for or through a customer
- Architectural and engineering services
- Financial services
- Broadcast advertising services
- Services sold to related members that own or control the taxpayer
Throw Out Rule
A special rule which is outlined is the “Throw-out Rule”. A taxpayer can exclude receipts other than those derived from tangible personal property if the taxpayer is not taxable in the state where it assigns the receipts or if a source state cannot be determined or reasonably approximated.
Kentucky is set to hold a public hearing for the proposed regulations on December 21, 2018. If you are unable to attend the hearing, written comments will be accepted through December 31, 2018.
Please contact us here or call 513-241-8313 to speak with a member of the Barnes Dennig team for any questions regarding the new Kentucky Tax Laws, Market-based sourcing, or any other State and Local Tax matters.