T +1 513 345 4578
T +1 513 345 4529
T +1 513 345 4573
Jamie C. Yesnowitz
T +1 202 521 1504
T +1 312 602 8517
T +1 513 345 4540
The Kentucky Department of Revenue recently amended corporate income tax regulations to address the sourcing of receipts for apportionment purposes1
and the computation of net operating losses (NOLs).2
In response to the major tax reform legislation that Kentucky enacted last year, the sales factor apportionment regulation is amended and greatly expanded to reflect the adoption of market-based sourcing for sales of items other than tangible personal property.3
Because the new regulation provides special rules for certain industries, many apportionment regulations concerning specific industries are repealed.4
The tax reform legislation enacted last year also requires combined reporting for members of a unitary business group that do not elect to file a consolidated return. The NOL regulation is amended to clarify the computation of NOLs for taxpayers that file combined returns, nexus consolidated returns or elective consolidated returns. The amendments to both regulations apply to tax years beginning on or after Jan. 1, 2018.
Sourcing of receipts for apportionment
For taxable years beginning on or after Jan. 1, 2018, Kentucky is requiring most taxpayers to use a single sales factor apportionment formula.5
Also, sales other than sales of tangible personal property are sourced to Kentucky if the taxpayer’s market for the sales is in the state.6
Most of the amendments to the apportionment regulation are consistent with the Model General Allocation and Apportionment Regulations adopted by the Multistate Tax Commission (MTC). The major provisions of the amended Kentucky regulation and notable differences from the MTC’s model regulations are discussed below.
Definitions and additional principles
The amended Kentucky regulation adopts the following definitions from the MTC model regulation: billing address, business customer, individual customer, intangible property, place of order, population, and state where a contract of sale is principally managed by the customer.7
Also, the Kentucky regulation includes additional principles from the model regulation such as year-to-year and state-to-state consistency (which if not followed, may require taxpayer disclosures to that effect), and items included in the denominator and numerator of the sales factor.8
However, the Kentucky regulation also defines additional terms that are primarily related to specific industries, including: advertising services, barrel mile, broadcaster, financial institution, platform distribution company, public service company and qualified air freight forwarder.9
Sales of tangible personal property
Similar to the model regulation, the Kentucky regulation contains provisions on sales of tangible personal property in the state.10
In general, gross receipts from sales of tangible personal property are in Kentucky if the property is delivered or shipped to a purchaser within the state regardless of the freight on board (FOB) point or other conditions of sale. Kentucky largely adopts the model regulations for sourcing sales of tangible personal property, including the model examples, but Kentucky does not throw back sales shipped from Kentucky if the taxpayer is not taxable in the state of the purchaser. Also, Kentucky adopts the MTC model regulations for generally sourcing sales of tangible personal property to the U.S. government via location of origin rather than destination.11
Sales other than sales of tangible personal property
The Kentucky regulation addresses sales other than sales of tangible personal property at great length, generally requiring sourcing to the taxpayer’s market for the sales.12
The regulation establishes uniform rules for: (i) determining whether and to what extent the market for the sale is in the state; (ii) reasonably approximating the state or states of assignment if the state or states cannot be determined; (iii) excluding certain receipts from the sale of intangible property from the numerator and denominator of the sales factor; and (iv) excluding receipts from the denominator if the state of assignment cannot be determined or reasonably approximated, or if the taxpayer is not taxable in the state to which the receipts are assigned.13
Furthermore, the Kentucky regulation adopts the model regulations concerning: (i) contemporaneous records; (ii) reasonable approximation; (iii) the exclusion of receipts from the receipts factor; (iv) the sale, rental, lease or license of real property; and (v) the rental, lease or license of tangible personal property.14
Sourcing sales of a service.
The Kentucky regulation largely follows the model regulations for sourcing sales of a service.15
In general, the receipts from the sale of a service are in Kentucky if and to the extent the service is delivered to a location in the state. Similar to the model regulations, the Kentucky regulation discusses the sourcing of receipts from in-person services.16
If the service provided by a taxpayer is an in-person service, the service is delivered to the location where the service is received. If the state or states where a service is actually received cannot be determined, the taxpayer should reasonably approximate the state or states. The Kentucky regulation includes the same examples as provided in the model regulations.
Similar to the model regulations, the Kentucky regulation includes a detailed discussion regarding the treatment receipts for services delivered to the customer, or on behalf of the customer, or delivered electronically through the customer.17
If the service is not an in-person or professional service, and the service is delivered to or on behalf of the customer, or delivered electronically through the customer, the receipts from a sale are in Kentucky if and to the extent the service is delivered in the state.18
The assignment of receipts to a state or states from this type of service depends upon the method of delivery of the service and the nature of the customer.19
Separate rules of assignment apply to services delivered by physical means and services delivered by electronic transmission. The Kentucky regulation follows the model regulations and covers: (i) delivery to or on behalf of a customer by physical means whether to an individual or business customer; (ii) the rule of determination; and (iii) the rule of reasonable approximation. Also, the Kentucky regulation adopts the model regulations’ examples. The Kentucky regulation also adopts the model regulations’ detailed discussion of delivery to a customer by electronic transmission.20
Similar to the model regulations, the Kentucky regulation covers: (i) services delivered by electronic transmission to an individual customer; (ii) services delivered by electronic transmission to a business customer; and (iii) services delivered electronically through or “on behalf of” an individual or business customer.
Sourcing sales of a service.
In adopting most of the model regulations’ provisions, the Kentucky regulation also includes a very detailed section on sourcing receipts from professional services.21
Because the location of delivery of a professional service is not susceptible to a general rule, the location of delivery must be reasonably approximated. Comparable to the model regulations, the Kentucky regulation covers: (i) overlap with other categories of services; (ii) professional services delivered to individual customers; (iii) professional services delivered to business customers; and (iv) a safe harbor for a large volume of transactions. Also, the regulation follows the model regulations by discussing: (i) architectural and engineering services with respect to real or tangible personal property; (ii) services provided by financial organizations and institutions; and (iii) related member transactions.22
The Kentucky regulation adopts the numerous examples provided by the model regulations.
License or lease of intangible property.
The Kentucky regulation generally adopts the license or lease of intangible property provisions from the model regulations.23
Receipts from the licensing of intangible property are in Kentucky if and to the extent the intangible property is used in the state. The Kentucky regulations address licenses of: (i) marketing intangibles; (ii) production intangibles; (iii) mixed intangibles; and (iv) intangibles if the substance of the transaction resembles a sale of goods or services.24
The Kentucky regulation generally adopts the numerous examples in the model regulations.
Sourcing sales of intangible property.
Finally, the Kentucky regulation adopts the model regulations’ provisions for sourcing sales of intangible property.25
The assignment of receipts from the sale or exchange of intangible property depends upon the nature of the intangible sold. The Kentucky regulation follows the model regulations by covering the sourcing of receipts in the following types of transactions: (i) a contract right or government license that authorizes business activity in a specific geographic area; (ii) a sale that resembles a license; and (iii) a sale that resembles a sale of goods and services. The regulation also addresses excluded receipts and provides the numerous examples from the model regulations. Similar to the model regulations, the Kentucky regulation also provides special rules for software transactions and sales or licenses of digital goods or services.
In a departure from the model regulations, the Kentucky regulations also provide special sourcing rules for: (i) bank holding companies; (ii) barge lines; (iii) bus lines; (iv) passenger airlines; (v) pipelines; (vi) public service companies; (vii) qualified air freight forwarders; (viii) railroads; (ix) regulated investment companies; (x) securities brokerage services; and (xi) truck lines.26
Net operating losses
For tax years beginning on or after Jan. 1, 2019, Kentucky is implementing mandatory combined reporting for members of a unitary business group, except for groups which elect to file a consolidated return with all members of the affiliated group.27
Each member of the group is responsible for tax based on its taxable income or loss apportioned or allocated to the state, which includes its NOL carryover.28
Kentucky recently enacted legislation allowing a member to share its NOL carryover with other members of the group in certain situations, which is not reflected in this regulation.29
Kentucky has amended its NOL regulation to provide guidance for combined group filers, elective consolidated filers, nexus consolidated filers30
and separate filers.31
The Kentucky regulation first provides a general rule for combined group filers, elective consolidated filers and separate filers, confirming that the NOL is first apportioned, and such apportioned NOL is available for carryforward to future years.32
With respect to transitional provisions, an elective consolidated filer having an NOL carryforward on the last elective consolidated return may carry that loss forward to combined group returns or separate returns.33
If a nexus consolidated filer ceases to exist or a member leaves the group and a consolidated NOL carryforward exists, the NOL carryforward may be carried forward to the combined group return, elective consolidated return or separate returns.34
The regulation includes detailed examples that illustrate the computation of NOLs when: (i) a member leaves the nexus consolidated group; (ii) the remaining nexus consolidated group dissolves; (iii) a member leaves the elective consolidated group; and (iv) the remaining elective consolidated group dissolves.35
As amended, the regulation provides an NOL limitation.36
Losses generated in tax years beginning on or after Jan. 1, 2018, are limited to 80% of the taxable net income as allowed by IRC Sec. 172.37
The regulation also addresses NOLs by corporations included in a combined group return.38
As provided in the regulation, NOLs generated by corporations included in a combined group may not be used to offset income of other corporations included in the combined group (though presumably, this provision will need to be amended to reflect the recent legislation allowing group members to share NOLs). NOLs may only be used if the corporation that generated the loss has taxable net income in subsequent years. All NOL carryforwards must be used on a first-in-first-out basis. Finally, no prior year NOL carryforward is available to separate entities that were not doing business in Kentucky prior to becoming part of a combined group return.
Kentucky substantially amended the sales factor apportionment regulation to reflect the change to market-based sourcing that was enacted last year. The regulation is very extensive and generally adopts the MTC model apportionment regulations. Due to the frequently complex nature of sourcing receipts from services or intangibles, this regulation should assist taxpayers in determining reasonable positions in how to source these types of receipts. Also, the regulation includes many examples that are useful in determining the application of the various sourcing provisions.
The NOL regulation also was amended to reflect the major tax reform legislation that Kentucky enacted last year. As amended, the regulation reflects the state’s change to unitary combined reporting. The NOL regulation provides guidance on computing NOLs for combined filers, elective consolidated filers, nexus consolidated filers and separate filers. As discussed above, however, some of these provisions may be further amended to reflect recent legislation.
This content supports Grant Thornton LLP’s marketing of professional services and is not written tax advice directed at the particular facts and circumstances of any person. If you are interested in the topics presented herein, we encourage you to contact us or an independent tax professional to discuss their potential application to your particular situation. Nothing herein shall be construed as imposing a limitation on any person from disclosing the tax treatment or tax structure of any matter addressed herein. To the extent this content may be considered to contain written tax advice, any written advice contained in, forwarded with or attached to this content is not intended by Grant Thornton LLP to be used, and cannot be used, by any person for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.
The information contained herein is general in nature and is based on authorities that are subject to change. It is not, and should not be construed as, accounting, legal or tax advice provided by Grant Thornton LLP to the reader. This material may not be applicable to, or suitable for, the reader’s specific circumstances or needs and may require consideration of tax and nontax factors not described herein. Contact Grant Thornton LLP or other tax professionals prior to taking any action based upon this information. Changes in tax laws or other factors could affect, on a prospective or retroactive basis, the information contained herein; Grant Thornton LLP assumes no obligation to inform the reader of any such changes. All references to “Section,” “Sec.,” or “§” refer to the Internal Revenue Code of 1986, as amended.