Arkansas enacts market-based sourcing, other revised compact rules

On April 16, 2025, Arkansas Gov. Sarah Huckabee Sanders signed corporate income tax legislation adopting market-based sourcing for sales other than sales of tangible personal property and clarifying the burden of proof for using alternative apportionment, beginning with the 2026 tax year.¹ The legislation generally follows revisions to model allocation and apportionment provisions in the Multistate Tax Compact (Compact) adopted by the Multistate Tax Commission in 2014; however, the Arkansas legislation differs from these provisions by allowing certain telecommunication providers to make an election to continue to use the cost-of-performance apportionment methodology. Also, nonresident corporations or partnerships with no physical presence in Arkansas are not subject to the state’s income tax if their Arkansas receipts do not exceed $250,000.

Updated terminology and definitions

Consistent with the revised version of the Compact, the Arkansas legislation adopts the following terminology: (i) “business income” is changed to “apportionable income;” (ii) “nonbusiness income” is now “nonapportionable income” and (iii) “sales” is changed to “receipts.”²

The law defines “apportionable income” as all income that is apportionable under the U.S. Constitution and is not allocated under Arkansas law, including: (i) income arising from transactions and activity in the regular course of the taxpayer’s trade or business; and (ii) income arising from tangible and intangible property if the acquisition, management, employment, development, or disposition of the property is or was related to the operation of the taxpayer’s trade or business.³ Apportionable income also includes any income that would be allocable to Arkansas under the U.S. Constitution but that is apportioned rather than allocated under Arkansas law.

“Receipts” is defined as all gross receipts that are not allocated and that are received from transactions and activity in the regular course of the taxpayer’s trade or business, but receipts from hedging transactions and from the maturity, redemption, sale, exchange, loan or other disposition of cash or securities are excluded.⁴

Market-based sourcing

Beginning with the 2026 tax year, receipts, other than receipts from the sale of tangible personal property, are sourced to Arkansas if the taxpayer’s market for the sale is in the state.⁵ Receipts from the sale, rental, lease, or license of real property are sourced to the location of the property.⁶ Likewise, receipts from the rental, lease, or license of tangible personal property, are sourced to the location of the property.⁷ For the sale of a service, the receipts are sourced to the location in which the service is delivered.⁸ In the case of intangible property that is rented, leased, or licensed, the receipts are sourced to the location in which the property is used.⁹ Similarly, receipts from intangible property that is sold are sourced to the location where the property is used.¹⁰

If the state or states of assignment cannot be determined under the provisions outlined above, the state or states should be reasonably approximated.¹¹ If the taxpayer is not taxable in a state to which a receipt is assigned,¹² or if the state of assignment cannot be determined or reasonably approximated, the receipt is excluded from the denominator of the receipts factor.¹³

Alternative apportionment

Under existing law, if the statutory allocation and apportionment provisions do not fairly represent the extent of the taxpayer’s business activity in Arkansas, the taxpayer may petition for or the Arkansas Department of Finance and Administration may require, in respect to all or any part of the taxpayer’s business activity, if reasonable: (i) separate accounting; (ii) the inclusion of one or more additional factors that will fairly represent the taxpayer’s business activity in the state; or (iii) the employment of any other method to effectuate an equitable application and apportionment of the taxpayer’s income.¹⁴

Beginning with the 2026 tax year, the legislation clarifies the appropriate burden of proof supporting the use of alternative allocation or apportionment. The party petitioning for or the Department requiring the use of a different method must prove that: (i) the statutory allocation and apportionment methods do not fairly represent the extent of the taxpayer’s business activity and (ii) the alternative provision is reasonable.¹⁵ In general, the same burden of proof applies to the taxpayer and the Department.¹⁶ However, if the Department demonstrates that in any two of the prior five tax years, the taxpayer used an allocation or apportionment method that differs from the method used for the other tax years, the Department does not have the burden of proof.¹⁷ If the Department requires a different allocation or apportionment method, the Department may not impose a civil or criminal penalty for the tax due that is attributable to the taxpayer’s reasonable reliance on the statutory provision.¹⁸ If the taxpayer receives written permission to use an alternative method, the Department cannot revoke permission for the activities that have already occurred unless there has been a material change in or a material misrepresentation of the facts provided by the taxpayer.¹⁹

If the statutory allocation and apportionment provisions do not fairly represent the extent of business activity in Arkansas of taxpayers engaged in a particular industry, transaction, or activity, the Department may establish appropriate rules for determining alternative apportionment.²⁰

Telecommunications provider election

A taxpayer principally engaged in the sale of telecommunications service, mobile telecommunications service, internet access service, cable television service, community antenna television service, or direct-to-home satellite television programming service, or a combination of these services, may elect to use cost-of-performance sourcing for the 2026 through 2035 tax years.²¹ The taxpayer must make the election on its return for the first tax year for which the taxpayer is eligible for the election. Once made, an election cannot be changed for subsequent years without written approval by the Department.

Small business exception from Arkansas income tax

A nonresident corporation or partnership that lacks physical presence in Arkansas through real or personal property, employees, agents, representatives, or otherwise is not subject to Arkansas income tax if its Arkansas receipts do not exceed $250,000 for the current or immediately preceding tax year.²²

Commentary

This legislation modernizes the Arkansas statutes addressing allocation and apportionment by adopting the current terminology and definitions used in the Compact and changing to market-based sourcing for sales other than sales of tangible personal property. The shift from cost-of-performance to market-based sourcing could lead to substantial shifts in the Arkansas sales factor and may be particularly beneficial for service businesses with large amounts of payroll and property in the state that serve a broad multistate market. Also, the legislation follows the Compact by clarifying the burden of proof for alternative apportionment. These rules are intended to provide for more equitable treatment for taxpayers in this area that have used relatively consistent allocation and apportionment methods throughout a five-year period.

The Arkansas legislation differs from the Compact by allowing certain telecommunications companies to elect to continue to use cost-of-performance sourcing. Accordingly, these taxpayers should consider which apportionment methodology would produce the most favorable result based on long-range modeling and expectations regarding the locations of their future operations and market. The legislation also provides some tax relief for nonresident corporations and partnerships without a physical presence in the state that have a small market presence in Arkansas, in which case these entities are not subject to Arkansas income tax. The Department is expected to issue regulations to implement and clarify this legislation.

In Arkansas, there recently has been controversy concerning the determination of whether certain income constitutes allocable nonbusiness income or apportionable business income. In Hudson v. Murphy Oil USA, Inc., the Arkansas Supreme Court held last year that a taxpayer could allocate to Arkansas interest expense from amounts borrowed to fund a corporation reorganization because the income was entitled to nonbusiness income treatment.²³ Earlier this year, an Arkansas trial court followed Murphy Oil and held that capital gains the taxpayer received from selling its fast-food brands and franchises constituted nonbusiness income.²⁴ Perhaps in response to these decisions, the new legislation broadens the concept of “apportionable income.” Specifically, the new legislation replaces the historic “acquisition, management, and disposition of the property constitute integral parts of the taxpayer’s regular trade or business operations” language in the apportionable income definition (commonly termed the functional test) with “acquisition, management, employment, development, or disposition of the property is or was related to the operation of the taxpayer’s trade or business.”