Ohio rejects proposed CAT revenue sourcing method

The Supreme Court of Ohio recently ruled that a taxpayer’s gross receipts received from broadcast, media, licensing and sponsorship revenue could not be sourced to Ohio for purposes of the state’s Commercial Activity Tax (CAT).¹ In reversing a determination of the Ohio Board of Tax Appeals (Board) affirming a CAT assessment against NASCAR Holdings, Inc. (NASCAR), the Court found that the Ohio Department of Taxation improperly followed Ohio law in sourcing receipts from broadcast, media, licensing and sponsorship agreements to Ohio based on television ratings and population data as a basis of measurement of the audience located in Ohio. Finding that NASCAR’s agreements were not based on the right to use NASCAR’s intellectual property (IP) in the state, the Court determined that Ohio lacked the statutory authority to assess CAT on the revenues at issue.

Background

The CAT is a privilege tax that generally applies to taxable gross receipts in Ohio received on or after July 1, 2005.² ”Gross receipts” are defined as the total amount realized, without deduction for the cost of goods sold or other expenses incurred, from activities that contribute to the production of gross income.³ Since taxable gross receipts include only “gross receipts sitused to this state,” sourcing rules often have significant impact on a taxpayer’s overall CAT liability.⁴ The sourcing statutes provide general sourcing rules for certain receipts, including proceeds from the sales of real property, tangible personal property, intangible property and delineated services.⁵ Gross receipts from the right to use IP are sourced to Ohio based on the amount of use of the property in the state.⁶ However, if the receipts are based on the right to use the property, and the payor has the right to use the property in Ohio, such receipts are sourced to Ohio to the extent that the receipts are based on the right to use the property in the state.⁷ Under a catch-all sourcing provision, receipts that are not otherwise described in the sourcing statute are sourced by applying the proportion that the purchaser’s benefit in Ohio bears to the purchaser’s benefit everywhere with respect to what was purchased.⁸

NASCAR is the reporting member of a combined group that includes the National Association for Stock Car Auto Racing. The company is headquartered in Daytona Beach, Fla., and sanctions races at tracks in approximately 39 states in addition to international locations. NASCAR’s revenue streams are separated into several categories, including broadcast revenue, media revenue from sponsors, license fees, sponsor fees, sanction fees and membership revenue.

NASCAR followed a receipts sourcing methodology that apportioned virtually no revenue to Ohio, except for revenue from sanction agreements for events held in Ohio. NASCAR sourced all other revenues to Florida, the company’s headquarters and state of domicile. NASCAR did not file Ohio CAT returns for the 2005-2010 tax years, resulting in an audit by the Department for that period.

Following the audit, the Department assessed tax, interest and penalties related to sourcing of the different revenue streams, noting that revenue was realized both within and outside Ohio. With respect to broadcast and media revenues, the auditor sought to source a portion of NASCAR’s broadcast revenues to Ohio based on the portion of the audience located in Ohio, ether via Nielsen ratings or U.S. Census population data.

At the conclusion of the audit, NASCAR petitioned for reassessment, challenging the Department’s rejection of its sourcing methodology and requesting abatement of penalties. After a hearing, the Department issued a final determination affirming the assessment, resulting in approximately $550,000 in tax, penalty and interest. NASCAR appealed the assessment to the Board.

Board of Tax Appeals decision 

Upon review, the Board affirmed the assessment, agreeing with the Department’s proposed sourcing methodology.⁹ Although the Board agreed with NASCAR that the IP sourcing statute applied to the revenue streams at issue instead of the catch-all provision, the Board nonetheless concluded that the assessment would have been the same under either provision. The Board observed that NASCAR’s broadcasting revenue should be sourced based on the purchaser’s use of, or right to use, the IP in Ohio. The Board rejected NASCAR’s proposed methodology to source broadcasting revenues to Florida because it ignored the fact that Ohio was included in the territory described in the agreements, and that the purchasers of these rights obtained the right to use the IP in Ohio.

The Board also rejected NASCAR’s argument that a recent Ohio Supreme Court decision in Defender Security Co v. McClain¹⁰ should be considered in this case. In Defender Security, the Court held that a company’s gross receipts from the sale of security monitoring services contracts should be sourced to the location where purchasers received the benefit from purchasing the intangible contract rights. Reasoning that the Court’s analysis in that decision was controlled by the catch-all sourcing provision, the Board found that Defender Security did not apply to NASCAR’s facts, which focused on the use of or right to use intangible assets. Accordingly, the Board affirmed the Department’s assessment. NASCAR filed a direct appeal with the Ohio Supreme Court, which heard oral arguments in January 2022.

Supreme Court decision

On appeal, the Court first rejected NASCAR’s argument that the Board may not affirm the assessment on a different statutory provision than the one relied on by the Department. In reaching this conclusion, the Court noted that Ohio law provides the Board with explicit statutory authority to modify a final determination of the Department.¹¹

Turning to NASCAR’s substantive arguments, the Court next considered NASCAR’s statutory argument that broadcast, media, licensing and sponsorship revenues were incorrectly sourced to the state under Ohio law. At issue was the sourcing of NASCAR’s revenue streams to Ohio under the second part of the IP sourcing statute, which provides that gross receipts from the sale, exchange, disposition or other grant of the right to use IP are sourced to Ohio “to the extent the receipts are based on the right to use the property in this state.” The Court noted that the NASCAR’s sample agreements with its customers provided for fixed sums for the right to use NASCAR’s IP.

Reviewing each of the sample contracts related to NASCAR’s revenue streams, the Court observed that none of the contracts tied payments to the right to use the property in Ohio. Instead, the agreements granted broad rights to use NASCAR’s IP over large geographic areas that included Ohio. Accordingly, the Court concluded that Ohio law does not authorize the sourcing of revenues to Ohio because NASCAR was not paid based on the right to use the property in Ohio. In reaching this conclusion, the Court rejected the Department’s proposed sourcing methodology for the broadcast revenue based on general principles underlying the CAT to source receipts based on where the market for the sale is located. Declining to adopt a sourcing methodology that stretched the statutory language, the Court noted that its job is to “apply the plain language of the statute.” The Court added that “[t]o the extent that the commissioner believes that the statutory language fails to adequately reflect the policies underlying the CAT, he is free to take up that matter with the Legislature.”

The Court reached similar conclusions for the sourcing of the media revenue, licensing fees and sponsorship fees, noting that although NASCAR’s licensing fees vary based on sales of the merchandising company, they were not tied to the use of NASCAR’s marks in any particular location. Concluding that the assessment for the broadcast revenue, media revenue, sponsorship fees and licensing fees exceeded the Department’s authority under Ohio law, the Court reversed the Board’s decision upholding the assessments. Although NASCAR also argued that the CAT assessment was unconstitutional as applied, the Court found it unnecessary to address these arguments since it agreed with NASCAR on the statutory argument.

Finally, the Court declined to address NASCAR’s request for penalty abatement, instead remanding that issue to the Department to determine whether NASCAR would still have nexus and a CAT filing obligation based on the state’s bright-line presence threshold of $500,000 in taxable gross receipts.¹² The Court noted that its decision reduced NASCAR’s taxable gross receipts from nearly $186.6 million to $499,400 over the tax periods at issue. The Court remanded the case to the Department to re-calculate the CAT assessment on the remaining fees that were not challenged, noting that NASCAR may appeal the re-assessed penalties at that time.

Concurring and dissenting opinion

Three of the Court’s seven justices joined in a concurring and dissenting opinion that provided a somewhat different take on how to source NASCAR’s revenues. While this opinion concurred with the majority that NASCAR’s receipts from broadcast revenue, media revenue and sponsorship fees were not properly sourced to the state under Ohio law, receipts from NASCAR licensing fees should have been subject to the CAT. This opinion referenced the first part of the IP sourcing statute, which requires that gross receipts be sourced to Ohio to the extent that the licensee/payor uses the licensed intangible property in Ohio. Since NASCAR’s licensing fees are based on a percentage of the licensee’s net sales, such arrangement required that the receipts be sitused to Ohio “to the extent that a reasonable allocation method can be found.”¹³

Commentary

In the NASCAR decision, the Ohio Supreme Court soundly rejected the Department’s proposed sourcing method for intangible receipts based on general market sourcing principles, instead looking to the statutory language providing for specific sourcing rules. Focusing on the language in NASCAR’s broadcast, media, licensing and sponsorship agreements and analyzing how the fees were earned, the Court determined that none of the contracts predicated payment on the right to use NASCAR’s IP in Ohio. Applying the statutory language to the contracts at issue, the Court determined that the Department lacked the necessary statutory authority to assess CAT on a market basis. The Court’s decision is significant given the general trend of states to source sales of intangible property based on market sourcing principles even without the requisite statutory authority.

In reversing the Board of Tax Appeals, the Court looked to the construction of the applicable intangible sourcing provisions instead of deferring to the legal analysis of the Board or the Department’s policy to apply “general principles” underlying the CAT. The Court’s decision comes at a time when other state courts are grappling with the amount of deference that should be given to state taxing authorities in interpreting tax statutes and divining legislative intent. The issue of administrative deference is front and center in Synthes USA HQ v. Commonwealth, a service receipts sourcing case currently before the Pennsylvania Supreme Court.¹⁴ In Synthes, a Pennsylvania appellate court most recently upheld a Pennsylvania Department of Revenue policy following a benefits-received sourcing analysis for sales of services under the state’s pre-2014 receipts sourcing statute for corporate net income tax purposes.¹⁵ One of the issues before the Pennsylvania Supreme Court is whether the appellate court should have deferred to the Pennsylvania Department’s interpretation of the statute via unofficial policy.

In the near term, the NASCAR decision provides additional certainty for companies operating in Ohio and generating receipts from similar types of intangible property such as broadcast or media revenue. That being the case, the decision should also serve as a reminder that the specific language within the contracts providing for the use of IP is paramount in determining how to source these types of receipts. Although the NASCAR contracts did not provide for payments tied to use in the state, contracts with varying language may lead to very different sourcing outcomes depending on the specific facts and circumstances.

1 NASCAR Holdings, Inc. v. McClain, Slip Opinion No. 2022-Ohio-4131, Supreme Court of Ohio, Nov. 22, 2022.
2 Ohio Rev. Code Ann. § 5751.02.
3 Ohio Rev. Code Ann. § 5751.01(F).
4 Ohio Rev. Code Ann. § 5751.01(G).
5 Ohio Rev. Code Ann. § 5751.033.
6 Ohio. Rev. Code Ann. § 5751.033(F).
7 Id.
8 Ohio Rev. Code Ann. § 5751.033(I).
9 For further discussion of the Ohio Board of Tax Appeals decision, see GT SALT Alert: Ruling OKs Ohio CAT revenue sourcing for media.
10 165 N.E.3d 1236 (Ohio 2020).
11 Citing Ohio Rev. Code Ann. § 5717.03(F).
12 Entities may create substantial nexus with Ohio if they establish a bright-line presence in Ohio by having taxable gross receipts of at least $500,000 in a calendar year. Ohio. Rev. Code Ann. § 5751.01(H), (I)(3).
13 The concurring and dissenting opinion noted that a contractual arrangement tying the amount of payment for the right to use IP to a percentage of the payor’s activity should be presumed to constitute use under Ohio law, and that because NASCAR did not rebut the Department’s findings, the Department’s method of sourcing the licensing fees should also be upheld. In response to the concurring and dissenting opinion, the majority noted that the Department assessed tax based on the right to use the NASCAR logo in Ohio, rather than the actual use of the IP. The majority stated that “[w]e will steer clear of new theories of taxability that were neither relied on by the [Department] nor argued by the parties.”
14 No. 11 MAP 2021, Pennsylvania Supreme Court.
15 236 A.3d 1190 (Pa. Commw. Ct. 2020).