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SALT TALK: Ruling on Market Based Sourcing Dispenses with Traditional Doctrine - My Customer’s Customers are Not My Customers

Posted by Wayne K. Berkowitz CPA, J.D., LL.M. on Apr 11, 2016 7:00:00 AM
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While the issue of whether the enemy of my enemy is my friend has always been controversial, the California Franchise Tax Board (FTB) ended all discourse concerning whether or not your customer’s customers are your customers.

As readers recall, market based sourcing (MBS) endeavors to source the revenue and tax base to the location of the taxpayer’s customers or market base. To help “locate” your customers, some states, such as California, have provided detailed regulations, while other states are just getting up to speed. This is a warning to marketing departments everywhere. Apparently state tax departments can now serve as the primary source of customer location.

All kidding aside, determining customer location can get complicated and comes down to where the customer receives the benefit of the service provided. A recent FTB Chief Counsel Ruling intends to fill a gap in the Regulations, addressing a taxpayer’s sale of services to customers, which in turn are used by or enhance the value of services provided to the customer’s customers.

The taxpayer provided financial data and analytical tools to its customers. In turn, these customers use the data and analytical tools to provide products and services to their own customers. The challenge for the taxpayer: Does my tax base follow the location of my customers or the location of my customer’s customers? The Ruling held “[f]or purposes of assigning sales of non-marketing services . . . [the taxpayer] shall assign the sales of its services to this state to the extent its customers and not its customer’s customers receive the benefit of the service in this state.”

The linchpin of this ruling hinges on the parallel the FTB makes to the existing regulations which do make a distinction between marketing and non-marketing intangibles[1]. Marketing intangibles are defined as those used in promoting a product or service. Non-marketing intangibles are those used in a manufacturing or other non-marketing process. So, were I to license a manufacturing process I invented to a customer located exclusively in California, the Golden State would be the source of all my income. However, were that same customer to license my likeness for use in its latest clothing line, I would need to figure out where their customers were sporting my image?

As you can see, this can get complicated. The first step we take at Berdon is to gain an intimate understanding of what our clients actually do. Only then can we apply the rules to help tailor the best result.

If you have concerns or questions about the application of market based sourcing to your business, contact me at or your Berdon Advisor.

[1] Just to add another complication, I’m not so certain that the taxpayer was providing a service as compared to an intangible in this case, or whether that would have even made a difference.

Wayne Berkowitz, a tax partner and head of the State and Local Tax Group at Berdon LLP, New York Accountants, advises on the unique requirements of governments and municipalities across the nation.


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