As a result of the enactment of House Bill 259 (S.L. 2015-268), the North Carolina Revenue Laws Study Committee (RLSC) will be evaluating the effect of market-based sourcing on state revenues. To assist the RLSC in its evaluation, every corporate taxpayer that meets certain criteria is required to file an informational report (Form CD-400 MS, Market-Based Sourcing Informational Report) by April 15, 2016, for the tax year beginning in 2014 with the North Carolina Department of Revenue (the Department). The report requires taxpayers to apportion income and the capital stock base using four different methodologies:

1. The 2014 North Carolina apportionment factor (i.e., as originally reported). For most corporations, this will be the standard, three-factor formula with a double-weighted sales factor.

2. The 2014 North Carolina sales factor only, computed in accordance with N.C.G.S. Section 105-130.4(I).¹ This requirement reflects the fact that North Carolina is phasing in a sales-only apportionment factor, with a full phase-in effective for tax years beginning on or after January 1, 2018.

3. The 2014 North Carolina apportionment factor with the sales factor computed in accordance with market-based sourcing guidelines.

4. The 2014 North Carolina sales factor only, computed in accordance with market-based sourcing guidelines.

The Department has published two documents explaining the market-based sourcing guidelines to be used for purposes of completing Form CD-400 MS.² The documents, along with Form CD-400 MS, are available on the Department's website. The first document issued by the Department, "Guidelines for Computing the Sales Factor Based on Market-Based Sourcing — Introduction and Summary," discusses the market-based sourcing principles and includes tables for how to source receipts from various services and intangibles, including:

— In-person services, other than professional services (directly/indirectly provided by the taxpayer)

— Professional services

— Non-in-person and non-professional services delivered to the customer on behalf of the customer or delivered electronically through the customer

— License or lease of intangible property

— Sale of intangible property

— Special rules

The second document, Guidelines for Computing the Sales Factor Based on Market-Based Sourcing, is a detailed notice that includes numerous examples intended to assist taxpayers in understanding the provisions of market-based sourcing. The guidelines are generally based on the Multistate Tax Commission's model market-based sourcing regulations.³ The North Carolina guidelines, however, do not include a throw-out provision, and the sourcing of receipts from the sale of real or tangible property does not differ.

Criteria and due date

Every corporate taxpayer (i.e., a taxpayer required to file Form CD-405, C Corporation Tax Return, or Form CD-401S, S Corporation Tax Return) that meets ALL of the following criteria based on the tax year beginning in 2014 is required to file Form CD-400 MS:

1. The taxpayer had apportionable income greater than $10 million.

2. The taxpayer had a North Carolina apportionment percentage less than 100%.

3. The taxpayer was subject to apportionment of income based in whole or in part on the sales factor as determined under N.C.G.S. Section105-130.4(l).

For combined filers, the principal member of the group for tax year 2014 must complete all lines of the Form CD-400 MS. All other members of the group must complete lines 6 through 8 only. Lines 6 through 8 relate to the computation of capital stock, surplus and undivided profits.

The report is due by April 15, 2016, and is not subject to an extension. The due date applies to both fiscal-year filers and calendar-year filers. Fiscal-year filers that do not have final data available may have to estimate their 2014 apportionment factors. A penalty of $5,000 will be imposed on corporations that fail to timely file the informational report. There are no penalties for filing inaccurate reports. The form must be printed and paper-filed with the Department.

Implications

The informational report results from recent legislation mandating that the RLSC analyze the fiscal impact of market-based sourcing for the introduction of legislation during the next legislative session for a move to market-based sourcing in conjunction with the single sales factor phase-in that was enacted in 2015.

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ENDNOTES

¹ Under N.C.G.S. Section 105-130.4(I)(3), North Carolina requires receipts from services to be sourced based on the location of income-producing activities. Receipts from intangible property are sourced to North Carolina if the source of the receipts is in North Carolina.

² See Guidelines for Computing the Sales Factor Based on Market-Based Sourcing, N.C. Dept. of Rev., Jan. 26, 2016; and Guidelines for Computing the Sales Factor Based on Market-Based Sourcing — Introduction and Summary, N.C. Dept. of Rev., Jan. 29, 2016.

³ A working draft of the Multistate Tax Commission's UDITPA Section 17 market-based sourcing regulations (as of Nov. 17, 2015) is available on the Commission's website (last accessed on Feb. 2, 2016).