On June 2, 2016, Governor Dannel Malloy signed SB 502, the state's 2016-17 budget implementer bill (the Bill) that includes various tax law changes. The most notable tax law changes contained in the Bill are the establishment of market-based sourcing for sales of non-tangible property and services for corporate and individual income tax purposes and the use of single-sales factor apportionment for individual income tax purposes.

Corporate income tax receipts sourcing

Effective for tax years beginning on or after January 1, 2016, gross receipts, for corporate income tax purposes, are sourced as follows:

— Gross receipts from sales of tangible personal property are assignable to Connecticut if the property is delivered or shipped to a purchaser within the state, other than a company that qualifies as, and has made a valid election to be treated as, a Domestic International Sales Corporation under IRC Section 992, regardless of the FOB point or other conditions of the sale.

— Gross receipts from services are assignable to Connecticut if the market for services is in Connecticut, which occurs if and to the extent the service is used in a location in Connecticut. This departs from current Connecticut provisions, which require origin-based sourcing (i.e., based on where services are performed), not destination-based sourcing, for sales of services.

— Gross receipts from the rental, lease or license of real or tangible personal property are assignable to Connecticut to the extent the property is situated within Connecticut. Note that this is not a change from the current law.

— Gross receipts from the rental, lease or license of intangible property are assignable to Connecticut if and to the extent the property is used in Connecticut. While this is not a change from current law, the Bill specifies that intangible property used in marketing a good or service to a consumer is used in Connecticut if that good or service is purchased by a consumer in Connecticut.

— Gross receipts from interests managed or controlled within Connecticut are assignable to Connecticut. This is not a change from the current law.

— Gross receipts from the sale or other disposition of real property, tangible personal property or intangible property are excluded from the apportionment fraction calculation if the property is not held by the taxpayer primarily for sale to customers in the ordinary course of the taxpayer's trade or business. Under current law, net gains from the sale or disposition of intangible assets managed or controlled within Connecticut and net gains from the sale or disposition of tangible assets situated within the state are assignable to Connecticut.

— Gross receipts not specifically enumerated above are assignable to Connecticut to the extent the taxpayer's market for the sales is in the state. Under current law, all other receipts earned in Connecticut are sourced to the state.

Personal income tax receipts sourcing

Effective for and applicable to income years beginning on or after January 1, 2017, gross receipts, for personal income tax purposes (including nonresident non-corporate pass-through entity owners), are sourced as follows:

— Gross receipts from sales of tangible personal property are considered to be earned within Connecticut when the property is delivered or shipped to a purchaser within Connecticut, regardless of FOB point or other conditions of the sale. This is not a change from the current law.

— Gross receipts from services are earned in Connecticut if the market for services is in Connecticut, which occurs if and to the extent the service is used in a location in Connecticut. This is a major departure from the current provisions, which provide that Connecticut gross receipts from sales of services are earned in the state when performed by an employee, agent, agency or independent contractor chiefly situated at, connected by contract or otherwise, with or sent out from, offices or branches of the business, trade, profession, or occupation or other agencies or locations situated within the state.

— Gross receipts from the rental, lease or license of real or tangible personal property are earned in Connecticut to the extent the property is situated within Connecticut. Under current regulations, rental income from tangible personal property in Connecticut or any interest in it is attributed to Connecticut.

— Gross receipts from the rental, lease or license of real or intangible personal property are earned in Connecticut to the extent the property is used within Connecticut. Intangible property used in marketing a good or service to a consumer is used in Connecticut if a consumer in Connecticut purchases that good or service.

— Gross receipts from the sale or other disposition of tangible personal property or intangible property are excluded from the gross income percentage if the property is not held by the taxpayer primarily for sale to customers in the ordinary course of the taxpayer's trade or business.

— Gross receipts from the sale, rental, lease or license of real property are excluded from the gross income percentage.

— Gross receipts not specifically enumerated above are assignable to Connecticut to the extent the taxpayer's market for the sales is in the state.

Alternative apportionment requests

Under both the corporate and personal income tax provisions, if a taxpayer cannot reasonably determine the assignment of its receipts in accordance with the new sourcing provisions, the taxpayer may petition the Commissioner to use a methodology that reasonably approximates the assignment of the receipts. Such petition must be submitted no later than 60 days before the due date of the return for the first income year to which the petition applies, determined with regard to any filing extensions. The Commissioner must grant or deny the petition before the due date.

Single sales factor apportionment for personal income tax

Effective for and applicable to income years beginning on and after January 1, 2017, the Bill implements single sales factor apportionment for personal income tax purposes. Under current law, businesses calculate their Connecticut apportionment fraction using an equally weighted formula including property, payroll and sales. The apportionment fraction will now be computed by dividing the gross receipts from sales earned within Connecticut by gross receipts everywhere.

The portion of a nonresident partner's distributive share of partnership income, a nonresident shareholder's pro rata share of S corporation income, and a nonresident beneficiary's share of trust or estate income that is derived from or connected with sources within Connecticut is determined under the amended market-based sourcing provisions.

Implications

Connecticut's adoption of market-based sourcing was expected by many after the state adopted single-sales factor apportionment as part of the corporate tax reform effective for tax years beginning on or after January 1, 2016. Connecticut may be unique, however, in adopting market-based sourcing provisions, as well as single sales factor provisions for personal income tax purposes. The corporate and personal income tax sourcing provisions, which currently vary widely, will be uniform (although the implementation dates vary — 2016 for corporations and 2017 for individuals). The personal income tax provisions in the Bill, which also apply to nonresident non-corporate pass-through entity owners, provide much needed clarity around sourcing of receipts other than sales of tangible personal property, particularly as applied to Connecticut businesses.

Corporate taxpayers will need to consider this change when calculating their estimated tax payments for the 2016 tax year and consider the impact of this change for financial accounting purposes. As with market sourcing rules in other states, there will likely be some degree of ambiguity in determining the location of the market for certain services. We will provide additional Alerts in the event that the state releases more specific guidance.

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