In Apollo Education Group, Inc. and Subs,¹ the Oregon Tax Court (Court) held an online college's receipts from online course offerings, for purposes of calculating the Oregon sales factor numerator, were calculated using only faculty cost data for the periods ending in 2009 and 2010. The Court found that, under the state's cost-of-performance sourcing method,² the "income-producing activity" of providing online course sections was comprised of faculty, curriculum development and eCampus activities, but only faculty costs were "direct costs."

Background

The taxpayers, the Apollo Education Group and its subsidiary, the University of Phoenix, (collectively, "University") are in the business of providing higher education instruction with courses, related materials and student services delivered over the internet (online campus). At issue in this case is which receipts from the University's online campus, specifically the tuition and fees, should be included in its Oregon sales factor.

For the tax years at issue, Oregon used the cost-of-performance sourcing method for sourcing of sales of nontangible personal property, such as from the sale of the University's educational services.³ In determining whether an item of income arising from the sale of services is includable in the sales factor numerator, the following must be identified: (1) the income-producing activity; (2) the costs of performance of that activity; and (3) the location where those costs of performance were incurred. The item of income from the activity is includible in the sales factor numerator if the costs of performing the activity were greater in Oregon than in any other state. The Court accepted the parties' agreement to treat the gross receipts from individual course sections as items of income.

University's income-producing activity and direct costs

The Court, citing AT&T II,⁴ explained that a taxpayer's "income-producing activity" includes "transactions and activity" that must: (1) be directly engaged in by the taxpayer; (2) be done in the regular course of the University's trade or business; and (3) have the ultimate purpose of obtaining gains or profit. Additionally, the requirement to apply the income-producing activity to "each separate item of income" limits the scope of a company's qualifying activity.⁵ Since the focus is on each transaction, a taxpayer's income-producing activity will consist of the transactions and activity that produce each individual sale.

The Court also found that, although the parties asserted there are multiple income-producing activities (e.g., provision of the eCampus platform, the work of the faculty, curriculum design team, and the Graduation Team) associated with one item of income (i.e., tuition and fees), Ore. Rev. Stat. Section 314.665(4) and the relevant rules refer to a single income-producing activity composed of "transactions and activity."⁶ They do not contemplate multiple income-producing activities associated with one item of income.

Ultimately, the Court concluded that the University's income-producing activity is the provision of a course section, as that is the service the University obliged itself to perform in exchange for tuition and fees, not the Graduation Team's work (i.e., enrollment representative, a financial advisor and an academic counselor). The eCampus platform, the curriculum development team and the faculty are all components of providing the income-producing activity of course sections; the question now becomes, which of these components is a direct cost of providing this activity.

The Court found only the faculty costs were direct costs, accepting the parties' agreement that faculty costs are direct costs. The Court also accepted the accuracy of the University's cost study reporting the amounts and locations of those costs for periods ending in 2009 and 2010. The cost of the curriculum development team's work is not a direct cost of providing a single course section, because developing and updating courses is not an incremental cost⁷ for each course section offered. The Court reasoned that the curriculum development team worked to develop courses rather than course sections. Comparing the sale of course sections rather than courses to a restaurant's sale of individual meals rather than recipes, the Court found that the evidence did not show that the provision of a single course section caused the University to incur an incremental cost for the curriculum development team's work. Additionally, the eCampus costs (those of operating and maintaining the automated network) were not direct costs, except to the extent they increased with each individual sale.

Lastly, the Court did not address the University's alternative apportionment claim because it concluded that the University's requested application of the cost-of-performance statute was correct.

Implications

It is not yet known whether the University will appeal this decision. If appealed, a final outcome could be a few years away. Like AT&T II, this decision offers insight into Oregon's framework for sourcing sales of services and nontangible personal property for tax years in which the cost-of-performance sourcing statute applies (through 2017). Multistate taxpayers selling non-tangible personal property into, or providing services to, Oregon should closely examine their business to determine the actual income-producing activity.

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ENDNOTES

¹ Apollo Education Group, Inc. and Subs. v. Ore. Dept. of Rev., No. TC-MD 150352C (Ore. Tax Ct., Magistrate Div., Aug. 24, 2017).

² Ore. Rev. Stat. Section 314.665(4).

³ Ore. Rev. Stat. Section 314.665(4). However, Oregon adopted market-based sourcing in its 2017 legislative session, applicable to tax years beginning on or after 1 January 2018. Ore. Laws 2017, SB 28, signed by the governor 3 July 2017.

⁴ AT&T Corp. v. Dept. of Rev., 357 Or. 691, 712 (Or. S. Ct. 2015) (AT&T II).

⁵ Id.

⁶ AT&T II, 357 Or. at 715.

⁷ AT&T II, 357 Or. at 716 ("The direct costs of the income-producing activity, each individual phone call or monthly flat-rate billing, are only those incremental costs associated with each individual call or billing, not overall network costs.")