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For corporate income tax purposes, explain why many states are adopting market based sourcing for services?

For corporate income tax purposes, explain why many states are adopting market based sourcing for services?

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For corporate income tax purposes, explain why many states are adopting market based sourcing for services:-

More states will likely be adopting market-based sourcing in 2017 to determine which companies should pay what in income taxes, though criticism of the approach lingers.

Under market-based sourcing, generally speaking, a state taxing authority looks to the consumer of a business’s service. If the customer is within the state or if the benefit of a service is received within the state, then the company must pay income taxes to that state in a proportional amount.

But exactly how market-based sourcing applies to certain financial industries could be clearer, according to those who counsel such businesses and states. A model statute created by the Multistate Tax Commission (MTC) is in the final drafting stages and may lead to an improved way of addressing dividends and interest that may be less prone to litigation.

The impact of the market-based sourcing is twofold.For states that have adopted market-based sourcing, they are now able to tax out-of-state service providers, as mentioned previously. In essence, states are eliminating the loophole of the all or nothing scenario that occurs with cost of performance and ensuring themselves a portion of any service revenue generated from customers within their state. In addition, since the sales factor within the home state drops as a result of market-based sourcing methods, in-state companies enjoy smaller tax burdens within their home state.States lose out on income tax revenue from in-state companies due to the lower apportionment figures, but the states generate more income tax revenue from out-of-state companies performing services within their boundaries. These states could also become more attractive for companies looking to establish branches or offices within a new state. States also expect their tax revenues to increase since the pool of taxable sales increases with market-based sourcing.

The companies (or individuals) providing the service are also impacted by the change.Companies will have lower taxable income in their home state since service revenue is no longer entirely assigned to their home state. Depending on the tax rate of the home state relative to destination states, this shift could be either an advantage or a disadvantage for the company.On the other hand, the out-of-state tax burdens will likely increase.

When coupled with the continued presence of cost of performance regulations, market-based sourcing’s emergence has made tax treatment of service revenue more complex.It is important to note nexus must be established before market-based sourcing rules may be applied by a particular state. The combination of both sourcing methods has the potential to produce to both tax-free and double-tax transactions. Slight variations in each state’s specific market-based sourcing rule can produce double taxation among market-based sourcing states. In addition, the type of service and how it’s delivered to the customers can impact the treatment of the service revenue.These possibilities have made it paramount to develop a sourcing strategy in order to avoid double taxation.Since market-based sourcing generally lowers home-state tax revenues, states have become more aggressive in sourcing revenue from out-of-state service providers, especially when it yields additional tax revenues.


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