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The Ongoing Struggle with Market State Sourcing in Washington

Tax Development Dec 30, 2021

The Ongoing Struggle with Market State Sourcing in Washington

As states continue to struggle with where the benefit of a service is received, Washington State has issued two recent rulings dealing with this issue: the Thurston County Superior Court’s order in AT&T Services, Inc. v. Department of Revenue (AT&T) and the Washington Court of Appeals decision in Walter Dorwin Teague Associates Inc. v. Department of Revenue (Teague).


In AT&T, the taxpayer challenged the Department of Revenue’s (DOR’s) Rule 19402, which interpreted former RCW 82.04.462(3)(b) (2010). The statute adopted a single factor receipts apportionment formula, effective June 1, 2010. The statute specified that service receipts should be sourced to where the customer received the benefit of the taxpayer’s service. If the customer received the benefit of the service in more than one jurisdiction, the receipts should be sourced to where the benefit of the service was primarily received. However, the DOR’s rule specified that if the taxpayer received the benefit of the service in multiple states, and the taxpayer can reasonably determine the proportion of the benefit of the services received, the amount reasonably determined to be received in Washington must be apportioned to Washington. Effective June 12, 2014, the Washington Legislature amended RCW 82.04.462(3)(b)(i) by specifically adding the proportional attribution rule. The Thurston County Superior Court agreed with AT&T and ruled that for periods before June 12, 2014, the DOR exceeded its authority by issuing Rule 19402, as it did not appropriately reflect the plain meaning of the statute.

On December 20, 2021, the DOR issued guidance with respect to this decision. It will not challenge the court’s order and will review any refund requests for periods prior to June 12, 2014 under the proportional attribution rule. The guidance notes that “it may be in some taxpayers’ interest to submit refund applications by December 31, 2021, in situations where they believe they made an overpayment during calendar year 2017, for a pre-June 12, 2014 tax period.”


The Court of Appeals struggles with the question as to where the benefit of a service is received in Teague. Teague is a design firm that contracted with Boeing to design airplane interiors. Boeing used the designs to build its planes in Washington. As Boeing sells a plane to a particular airline, Teague customized the interior design for each airline’s specification and needs. The question at issue in this case is whether Teague should source its receipts to its customer’s location, Boeing, or to the ultimate beneficiary of the design, the airline. Teague argued that the real beneficiary of its design service was the airline and that the revenue should be sourced to the location of the airline. This is an issue that many states have struggled with—is it where the customer receives the benefit or where the customer’s customer receives the benefit? The Court adopted a plain reading of the statute. Because the statute specified where the customer received the benefit, and Boeing is the customer, the receipts should be sourced to Washington. 

The question of whether to source the receipts generated from the sale of services to the customer’s location or to the customer’s customer location has been interpreted differently by many states. On the west coast notably, California and Oregon differ on the sourcing methodology. 

California has a tiering system that looks first to the contract between the taxpayer and customer to indicate the location where the benefit of the service is received. If the contract does not indicate a location, then the second tier would look to see if the location(s) could be determined by reasonable approximation. If unable to approximate, the third tier looks to where the contract was placed. The final tier is the customer’s billing location. In addition, Chief Counsel Ruling 2015-03, (12/31/15) (Ruling), Tax Counsel to the Franchise Tax Board, also looked to the rules for determining the sale of intangibles to determine the location of benefit of a service. Under California Revenue and Taxation Code section 25136 and California Code of Regulations section 25136-2, nonmarketing intangibles are sourced to the location where the customer receives the benefit, while the sale of marketing intangibles is sourced to the location where the customer’s customers receive the benefit. In the Ruling, the services were financial information services, which were used by both the customer of the taxpayer and the customer’s customers. While the factual situation does not involve the sale of intangibles, the author of the ruling analogizes the sale of the services to the sale of nonmarketing intangibles and sources the receipts to where the taxpayer’s customer received the benefit. Under this analysis, Teague would receive the same treatment in California as it does in Washington. 

Oregon’s sourcing rules for the sale of services are quite different but lead to the same result. Oregon does not discuss the issue of a sale to a customer or a customer’s customer. The general rules are pretty straightforward. Sales are considered as Oregon receipts if the market for the sale is in Oregon. Services are sourced to Oregon to the extent the service is delivered to a location in Oregon. Of course, the nuance is the application of these general rules to a specific fact pattern. Oregon’s first cut is to determine if the services are in-person services. Those services are sourced to location where the customer’s property is located. The next category of classification is for services that are not in-person services, professional services, services delivered to or on behalf of the customer, or delivered electronically through the customer. Services that fall outside of the scope of the aforementioned four categories are sourced to the extent the service is delivered in Oregon. This determination involves another set of sourcing rules. Under the fact pattern in Teague, Oregon would consider these services engineering and architectural services. Engineering services are assigned to the state(s) based on where the property associated with the services is located. The rules never discuss ultimate destination. One could argue that because the ultimate destination of the property is the airline’s location, that location would control the sourcing of the receipts. More likely, because the engineering drawings and plans are put to use at the Boeing location, the receipts would be sourced to that location, which is similar to the conclusion of Washington and California. 


As indicated in this discussion, a review of the laws and rules of just these three west coast states results in a complex analysis. Our Ryan state and local income tax team is here to help guide and support sourcing determinations for sales under market-sourcing regimes. We will continue to analyze and monitor additional developments as they occur. 


Mark L. Nachbar

Greg Rottjakob

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