On November 8, 2019, a new tax law was enacted in North Carolina changing the rules for sourcing sales to North Carolina for income tax apportionment purposes. These new rules are effective for taxable years beginning on or after January 1, 2020.
Taxpayers that have business operations in multiple states are required to apportion their income between the states in which they operate. Each state has a formula in place that is used to determine the taxable income that is subject to tax within that state. The general formula in North Carolina requires a taxpayer’s sales within North Carolina be compared to the taxpayer’s total sales. The resulting percentage is then multiplied by the taxpayer’s total taxable income to determine the amount of income taxable in North Carolina. Therefore, the determination of whether a taxpayer’s sales are “within North Carolina” has a significant impact on the outcome of this formula and the resulting tax due within the state.
The recently enacted law clarifies and changes the definition of when sales are “within North Carolina” for apportionment purposes. The most significant change within this definition relates to when receipts from the sale of services are considered sales “within North Carolina.” Prior to the effective date of the new law, receipts for services are deemed to be “within North Carolina” if the income producing activities of the taxpayer occur within the state (i.e., cost-of-performance based sourcing). For example, if the taxpayer’s employees perform services outside of North Carolina for a customer located within North Carolina, the sales would not be sourced to North Carolina because the taxpayer’s activities are being performed outside of North Carolina. Under the new law, receipts for services will be sourced to North Carolina based on where the customer is located regardless of where the taxpayer’s employees are performing these services (i.e., market-based sourcing). So, using our previous example, under the new law, the receipts for the sale of services will be sourced to North Carolina based on the fact that the customer is located within the state regardless of the fact that the employees are performing those services outside of North Carolina.
The following is an excerpt from the recently enacted new law that provides an overview of when receipts will be considered “within North Carolina” for income tax apportionment purposes:
- In the case of sale, rental, lease, or license of real property, if and to the extent the property is located in North Carolina;
- In the case of rental, lease, or license of tangible personal property, if and to the extent the property is located in North Carolina;
- In the case of sale of tangible personal property, if and to the extent the property is received in North Carolina by the purchaser. In the case of delivery of goods by common carrier or by other means of transportation, including transportation by the purchaser, the place at which the goods are ultimately received after all transportation has been completed is considered the place at which the goods are received by the purchaser;
- In the case of sale of a service, if and to the extent the service is delivered to a location in North Carolina;
- In the case of intangible property that is rented, leased, or licensed, if and to the extent the property is used in North Carolina.
In addition to the changes made to the general definition, the new legislation also enacts special apportionment rules for banks, wholesale content distributors, and electric power companies as well as modifies the rules for pipeline companies.
It is important to analyze and understand the impact that these changes will have on your entities’ North Carolina taxable income for tax years beginning on or after January 1, 2020. If you have any questions or wish to discuss how these changes may impact your specific tax situation, we encourage you to reach out to your tax advisor.