FL – Taxpayer properly applied cost-of-performance rule to its income producing activities

An out of state subsidiary (taxpayer) of a nationwide online and brick-and-mortar retailer (retailer) properly sourced its service revenue under the state’s cost-of-performance (COP) rule, for Florida corporate income tax purposes.

In this matter, the retailer and its subsidiary (taxpayer) entered into a Retail Operating Services Agreement (ROSA). Under ROSA, the taxpayer provided merchandising, marketing, and strategy and management consulting services to the retailer. The subsidiary owned no real or tangible personal property in Florida during the tax years at issue. However, it had a small amount of payroll attributed to Florida.

The Florida Department of Revenue (department) conducted an audit to determine the taxpayer’s compliance with the state income tax laws. Subsequently, the department proposed adjustments to the taxpayer’s corporate income tax liability contending that the taxpayer was required to attribute its service receipts to Florida based on a fraction the numerator of which was the retail square footage of the retailer’s stores across the country.

The taxpayer countered the adjustment and stated that the department’s rule required that its sales receipts must be attributed to Florida based on the location of the income producing activity directly engaged in by the taxpayer, which is determined based on the location of the costs to perform those services. Since the location of the costs to perform services under the ROSA were those of the taxpayer’s employees residing outside Florida, the taxpayer argued that the department’s administrative rule attributed none of the taxpayer’s sales receipts to Florida.

Generally, under the COP rule, service revenue is attributable to Florida if the “income producing activity” responsible for generating the sales revenue is performed by the taxpayer in Florida. If the “income producing activity” is not conducted solely in Florida, the COP rule states that the sales revenue is attributable to Florida if the “greater proportion of the income producing activity is performed in Florida, based on costs of performance.”

The department argued that the taxpayer failed to provide sufficient documentation to support the use of the COP apportionment method. However, the taxpayer asserted that it provided state-by-state payroll, property and sales apportionment work-papers, and working trail balance information to the auditors. Moreover, in response to the department’s request, the taxpayer provided its payroll apportionment worksheet and related supporting document to substantiate its use of the COP apportionment method.

Upon review, the circuit court noted that the taxpayer provided sufficient documentation to the department. The court also noted that the COP rule operates in two steps:

(1)
determining the taxpayer’s income producing activity; and

(2)
balancing of the costs incurred to perform that activity.

If the greater proportion of the costs to perform the activity are incurred outside Florida, as the court noted, none of the receipts are apportioned to Florida. In this matter, the taxpayer’s income producing activities were performing services under the ROSA and the greater proportion of the costs to perform the taxpayer’s services were incurred outside Florida.

Accordingly, the taxpayer properly apportioned its income under COP rules and therefore the taxpayer’s protest was sustained. Target Enterprise, Inc. v. Florida Department of Revenue, Circuit Court, 2nd Judicial Circuit (Florida), No. 2021-CA-002158, November 28, 2022