This Week in State Tax

The Minnesota Tax Court recently addressed whether a taxpayer’s income from the provision of pharmacy benefits management services were sourced to Minnesota (i.e., the location of the Plan members). The case focused on contracts between two members of a combined group—an insurance provider (HIC) that offers medical and drug insurance products to plan members, and a pharmacy benefits manager (HPS) that provides various services related to HIC’s plan members. Among the services provided by HPS were maintaining the formulary (i.e., covered drugs), recruiting and maintaining a network of pharmacies, and claims adjudication. Minnesota law attributes receipts from the performance of services to “the state where the services are received.” If the location of where services are received is not readily determinable, Minnesota applies a cascading set of sourcing rules that looks to the ordering location or billing address of the customer.

The taxpayer first argued that the plain language of the sourcing rule required a determination of where the taxpayer’s “direct customer” received the services, not where the customer’s customer received the services. Further, in the taxpayer’s view, reading the sourcing statute, as a whole, the third and fourth rules (i.e., the location of the ordering office or billing office), foreclose the possibility of sourcing by looking to where the customer’s customer (i.e., Plan member) received the services. The Commissioner of Revenue argued that the services of HPS were received by the subscribers to the various plans offered by HIC. The tax court disagreed with the taxpayer, holding that under the cascading rule, the plain language of the statute requires a determination of where the services are received, and a taxpayer may only apply the cascading rules if the location of receipt is not readily determinable. The court further held that nothing in the services sourcing rule limited the sourcing determination to the “direct recipient” or “direct customer” of the taxpayer. There is nothing in the statute that specified any required relationship between the taxpayer and the recipient of the services. Further, the definitions of received do not specify who needs, orders, or is offered the service in any particular context.

The taxpayer also pointed to a Minnesota Supreme Court decision in Lutheran Brotherhood Research Corp, in which the court rejected a look-through approach for sourcing services provided by a mutual fund service provider to a family of funds. However, the court noted that Lutheran Brotherhood decision did not establish an absolute rule that receipts from services should be sourced to the taxpayer’s “direct customers.” Rather the sourcing determination was a “plain language” determination based on the factual record.

Based on the facts presented in this matter, the court held the taxpayer failed to support its claims that any portion of the receipts at issue should be sourced to a location outside of Minnesota where HIC, as the insurance provider, received the taxpayer’s services. In the court’s view, the facts presented by the taxpayer pertained entirely to how HPS performed its responsibilities to HIC and how a provider fee was paid. As it was previously stipulated that all disputed fees should be sourced together, the facts offered by the taxpayer did not provide sufficient evidence to dispute the Commissioner’s determination that the receipts should be sourced to Minnesota. Contact Matthew Saunders for questions about Humana MarketPoint, Inc. v. Commissioner of Revenue.

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The Ohio Supreme Court ruled that a dialysis service is performed entirely at the location where a patient receives treatment for purposes of the Ohio Commercial Activity Tax. The taxpayer treated patients out of various physical offices, some of which were in Ohio; it also performed related activities, such as laboratory testing and administrative services, at various locations outside Ohio. The taxpayer initially sourced to Ohio all receipts earned at its Ohio locations. It later filed refund claims based on the position that a share of the revenue should be sourced to the states where the lab and administrative activities occurred. Both the Tax Commissioner (Commissioner) and the Board of Tax Appeals rejected the refund requests, and the taxpayer appealed the matter to the state supreme court.

Under Ohio law, receipts from the sale of services are sitused to Ohio “in the proportion that the purchaser’s benefit in this state with respect to what was purchased bears to the purchaser’s benefit everywhere with respect to what was purchased.” In making this determination, “the physical location where the purchaser ultimately uses or receives the benefit of what was purchased shall be paramount.” Regulations further specify that “If a healthcare service is provided partly in this state and outside this state, a reasonable allocation for the services performed in Ohio must be made.” The taxpayer argued that the Commissioner was (a) bound by its own reasonable interpretation of the statute, (b) the service was provided “partly in this state and outside this state,” and (c) a reasonable allocation for the services performed in Ohio would permit situsing services performed at out-of-state labs or administrative offices to those states. The court rejected this argument, noting that the statute clearly points to the location where the purchaser benefited from the purchased service, not to where the service was performed. Although the regulation considers where the service was performed, it does so only if the service was provided both within and without the state; here, the service was dialysis, and it was provided entirely within Ohio. Contact Brandon Erwine for questions about Total Renal Care, Inc. v. Harris.

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A Texas district court judge recently issued a permanent injunction preventing the Comptroller of Public Accounts from enforcing certain provisions of a revised rule promulgated in July 2024 for determining what constitutes a “place of business” of a seller and where a sale is “consummated” for purposes of sourcing transactions for local sales and use tax purposes. The provisions struck down in this proceeding reflected further consultation, proceedings, and amendments made by the Comptroller after an initial proposed rule was rejected by the same judge in 2021.

The crux of the issue involves the sourcing of online orders placed by Texas residents with Texas retailers. Under current law, some retailers have established a sales office or fulfillment center in a jurisdiction and sourced all intrastate online sales to that jurisdiction. They have also entered into sales tax sharing agreements with the locality for a portion of the tax emanating from the online orders; it was several cities with such agreements that brought the current action. Comptroller Hegar has argued this is inequitable to the localities in which the purchasers actually live. The proposed regulations that were challenged attempted to put some further parameters around what constitutes a place of business for purposes of consummating an intrastate online sale.

In her order pertaining to the latest proposed rule, the judge found that it specifically contravened the current “detailed statutory scheme for determining where a sale ... is ‘consummated’.” She also found that the proposed rule contravened the statutory definition of place of business and that the Comptroller did not substantially comply with certain requirements of the state Administrative Procedures Act. It is not known at this time whether the Comptroller will appeal the ruling and or further attempt to revise the rule. For further information on City of Round Rock, Texas v. Hegar, please contact Karey Barton.

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The Washington Department of Revenue released a new Excise Tax Advisory providing guidance on the application of sales and use tax and business and occupation (B&O) tax to transactions involving non-fungible tokens (NFTs).  The Advisory updates and replaces an interim statement on NFTs released in July 2022.

The Department generally explains that NFTs typically grant ownership of, or a right to, something of value.  To assess the tax treatment of an NFT transaction, according to the Department, taxpayers should consider (1) the nature of the underlying product, (2) whether the transaction involves only one product or more than one product, (3) the tax treatment of the underlying product, and (4) the identity of the parties to the transaction.  If an NFT represents only one product, the sales tax and B&O tax treatment is determined by the nature of the underlying product.  If the NFT represents two or more distinct and identifiable products for one nonitemized price, the transaction is a bundled transaction, and Washington’s bundled transaction rules apply. In Washington, the general rule for bundled transactions is that the entire bundled transaction is subject to retail sales tax and retailing B&O tax if any component of the transaction is subject to tax.  There is an exception for certain transactions involving the sale of digital codes that may be used to acquire one or more digital products or services; in such cases, the taxability and B&O classification can be disaggregated if the seller has adequate books and records to substantiate the separate treatment.

The Department also addresses NFT marketplaces and explains that persons operating such marketplaces generally meet Washington’s definition of a “marketplace facilitator.”  Marketplace facilitators are required to register and report their gross income from NFT sales made on behalf of marketplace sellers under the retailing B&O tax classification but are also eligible to claim a deduction.  Marketplace facilitators are also required to collect and remit sales tax on retail sales sourced to Washington and must provide their NFT marketplace sellers with access to a written report showing the marketplace sellers’ monthly gross Washington sales.  Marketplace sellers do not need to collect retail sales tax on NFTs when marketplace facilitators collect the tax, but the sellers must report their gross revenue from sales of NFTs under the retailing B&O tax classification.

The Advisory provides detailed examples on various tax issues as applied to NFTs, including determining the selling price of an NFT, sourcing an NFT, application of use tax to NFTs, bundled transactions, and purchase of NFTs under a resale exemption. It also addresses other miscellaneous NFT-related activities, including royalties, minting, and the burning of NFTs.  For questions regarding Excise Tax Advisory 3241, please contact Michele Baisler.

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