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Florida court rules that service revenue sourced under state COP rule
December 2022
In brief
The Florida second circuit court ruled that the taxpayer, a Target corporation subsidiary (TEI), properly sourced its service revenue under the state’s cost-of-performance (COP) rule. The court rejected the Department of Revenue’s attempt to source such revenue based on a formula that considered the square footage of Target stores located in the state.
The takeaway: Although the decision fundamentally concerns the court rejecting the Department’s assertion of alternative apportionment due to the taxpayer’s purported lack of documentary support, the court’s summary of the state’s COP rule may provide Florida taxpayers with guidance on how to source service revenue. In supporting the taxpayer’s use of COP, the court stated that “[f]or provision of the services at issue, the most relevant cost of performance is payroll” and that “the best evidence of the costs to perform these services” was the taxpayer’s apportionment workpapers.
[Target Enterprise, Inc., v. Department of Revenue, Fla. Cir. Ct (2nd), No. 2021-CA-002158, 11/28/22]
In detail
Facts
Target Enterprise, Inc. (TEI or the taxpayer) is a subsidiary of Target Corporation (Target). During the 2017 to 2019 tax years at issue, the taxpayer, under an intercompany services agreement, provided a variety of services (e.g., merchandising, marketing, consulting) to its parent. Intercompany payments made pursuant to the agreement were supported by a third-party transfer pricing study. The taxpayer owned no real or tangible personal property in Florida and had a small amount of Florida payroll during the years at issue. The taxpayer sourced its service revenue by measuring its COP using payroll data.
The Department on audit used its equitable adjustment authority to modify the taxpayer’s sales factor and sourced the taxpayer’s service revenue based on the retail square footage of Target stores in Florida compared to stores across the country. The taxpayer countered that under the Department’s own rules, sales are 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. The taxpayer appealed the resulting assessment.
The Department’s COP Rule
Under the Department’s 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.”
Department invokes alternative apportionment methodology
The Department argued that the taxpayer failed to provide sufficient documentation to support the use of COP. Accordingly, the Department maintained that it was entitled to use its equitable authority to craft a new methodology for the taxpayer’s sales factor.
The Department asserted 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 Target stores in Florida and the denominator of which was the retail square footage of Target stores across the country.
Court supports taxpayer’s use of COP
The court rejected the Department’s claim that the taxpayer failed to supply sufficient documentation to support the use of the COP rule. The taxpayer provided state-by-state payroll, property, and sales apportionment workpapers and working trial balance information to the auditor for review and, therefore, complied with its duty to make any and all books and records "available for inspection" by the Department.
In supporting the taxpayer’s use of COP, the court stated that “[f]or provision of the services at issue, the most relevant cost of performance is payroll.” The court provided that there was “no question” the taxpayer’s income producing activity was performing services under the contracts and that “the best evidence of the costs to perform these services” was the taxpayer’s apportionment workpapers.
The court found that such workpapers made “abundantly clear that the greater proportion of the costs to perform the taxpayer’s services were incurred outside Florida. “Because the overwhelming portion of [the taxpayer’s] payroll costs were incurred outside Florida, none of the receipts from the sale of [the taxpayer’s] services should be considered” a Florida sale, the court stated.
Department’s alternative methodology not reflective of taxpayer’s Florida activity
The court added that even if it were reasonable to invoke the Department’s adjustment authority, the court rejected the Department’s proposed formula as it “bears no relevant relationship” to the taxpayer’s business activity in the state. The taxpayer does not provide services to individual Target retail locations; it provides services to Target. “How – or if – Target chooses to use these services in its retail stores in no way impacts [the taxpayer’s] entitlement to receive compensation” under the service agreement.
The court stated that the Department’s proposed formula “conflates Target’s business activity in Florida with [the taxpayer’s] business activity. [The taxpayer] is a distinct legal entity separate and apart from Target” (emphasis added).
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