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Royalties received by out-of-state manufacturers not sourced to Wisconsin

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November 2019


A Wisconsin appellate court on October 31 held that Microsoft’s royalties received from licensing its software to out-of-state original equipment manufacturers (OEMs) were not sourced to Wisconsin for corporate income tax purposes. Such revenue generally is sourced based on the location of income-producing activity, which was not in dispute as being outside of Wisconsin. At issue was an exception for a licensee’s in-state use. 

The Wisconsin Department of Revenue argued that Wisconsin ultimate customers (end-users) were licensees of Microsoft and, therefore, OEM royalties related to Wisconsin customers were sourced to Wisconsin. The appellate court disagreed, holding that ultimate customers were not ‘licensees’ for purposes of the exception. Accordingly, out-of-state OEM royalties paid to Microsoft were not sourced to Wisconsin because no income-producing activities were performed in Wisconsin.

The takeaway

Wisconsin applied a cost of performance regime for sourcing from the use of intangibles during the years at issue in this case.  For tax years beginning on or after January 1, 2009, Wisconsin applies a market sourcing regime; however, the statute still has the exception for the license of software sourcing. 

The state historically has provided little guidance related to how market-based sourcing should be applied to sales of other than tangible personal property, but generally on audit has tried to apply a ‘look through’ approach.  The Microsoft case has provided some much-needed guidance related to the Court’s view of Wisconsin sourcing statutes, even though decided under the old cost of performance rules.  Taxpayers should, in light of the Microsoft case, evaluate their current sourcing methods to determine if alternative methods should be considered.

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Peter Michalowski

Peter Michalowski

State and Local Tax Leader, PwC US

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