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Washington simplifies municipal B&O tax apportionment

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Contacts:

Patrick Shine
Seattle
T +1 206 398 2485

Jamie C. Yesnowitz
Washington, D.C.
T +1 202 521 1504

Chuck Jones
Chicago
T +1 312 302 8617

Lori Stolly
Cincinnati
T +1 513 345 4540

Patrick Skeehan
Philadelphia
T +1 215 814 1743
On April 23, 2019, Gov. Jay Inslee signed Substitute House Bill 1403 into law, simplifying Washington’s apportionment formula for municipal business and occupation (B&O) taxes.1 The newly enacted law amends the local service income apportionment rules to adopt a market-based sourcing model, includes a “throw-out” provision for nontaxable service income, and adopts consistent rules for both taxpayers and local tax administrators requesting alternative allocation and apportionment of receipts.

Background In addition to the state-levied B&O tax, 49 Washington cities are permitted to levy local B&O taxes, which are imposed at a percentage rate on the gross receipts of a business having nexus with a given city.2 Similar to the state B&O tax regime, businesses are classified depending on the type of business activity in which they are engaged, including manufacturing, wholesaling, retailing or services.3 The applicable gross receipts tax rate varies among business classifications.

In order to avoid multiple local B&O taxation on the same receipts, businesses are permitted to apportion taxable income between taxing jurisdictions in which they are engaged in business.4 With respect to businesses deriving income from activities taxed as services, Washington municipalities currently are required to apply a standard two-factor apportionment formula to source such income for B&O tax purposes. The two-factor formula consists of measuring city-to-everywhere ratios of service income and payroll.5 Service income is defined as gross income of the business subject to the B&O tax under either the service or royalty classification.6

For purposes of the local B&O tax service-income factor, service income is currently sourced to the customer location based on the physical contacts of the business with the customer.7 If the income-producing activity is performed in more than one location, service income is sourced to the location where the greater proportion of the income-producing activity is performed by the business, based on costs of performance.8

Local B&O tax apportionment simplified for service businesses Effective Jan. 1, 2020, the new law adopts a market-based sourcing model for businesses apportioning service income for local B&O tax purposes. Instead of requiring the business to keep track of its physical contacts with the customer, the new rules redefine the term “customer location” based on whether or not the customer is engaged in business. For customers not engaged in business, if the service requires the customer to be physically present, service income will be sourced to the location where the service is performed.9 On the other hand, if the non-business customer is not required to be physically present, service income is sourced to: (i) the customer’s residence; or (ii) the customer’s billing or mailing address, if the customer’s residence is unknown.10

For customers engaged in business, the customer location is determined based on a specific sourcing hierarchy: (i) the location where the services are ordered from; (ii) the customer’s billing or mailing address, if the location from where the services are ordered is unknown; or (iii) the customer’s commercial domicile, if none of the above are known.11

For purposes of calculating the service-income factor, the legislation provides for the inclusion of a “throw-out” provision for service income attributed to a location where the taxpayer is not subject to tax. Specifically, the gross income of a business engaging in an apportionable activity may be excluded from the denominator of the service factor if at least some of the activity is performed in the city, and the gross income is attributable to a jurisdiction where the taxpayer is not taxable.12

Finally, the new law adopts consistent rules for parties seeking an alternative method of allocating or apportioning income. A taxpayer petitioning for, or a tax administrator requiring, the use of an alternative allocation or apportionment method must prove that: (i) the allocation and apportionment provisions do not fairly represent the extent of the taxpayer’s business activity in the locality; and (ii) the proposed alternative method is reasonable.13 The same burden of proof applies regardless of whether the taxpayer petitions for, or the tax administrator requires, an alternative method to achieve an equitable allocation or apportionment of income.14

Commentary With the objective of providing consistency for multistate service businesses, the legislation brings the local B&O tax service income sourcing rules in line with existing market-based rules for state B&O tax purposes.15 Further, the new “throw-out” rule allows service income attributable to a location where the business is not taxable to be excluded from the local B&O tax apportionment calculation. Finally, the amended apportionment statute establishes a consistent burden of proof for both taxpayers and tax administrators seeking to use an alternative apportionment method.

The revised municipal B&O tax apportionment rules come after efforts by several task forces formed to recommend a simpler apportionment formula for the local taxation of service activities. Generally, the task forces found that the historic two-factor formula presented administrative difficulties for both Washington cities and businesses.16 They also recognized that many state and local taxing jurisdictions are adopting market-based sourcing apportionment formulas in response to technological advances in a growing service-based economy. As a result, it was recommended that the legislature update Washington’s local B&O tax apportionment rules to reflect a market-based model, based on where the service is delivered or received, instead of an increasingly outdated production model.

The amended service income sourcing rules may have a significant impact on taxpayers operating in Washington cities. For example, a Seattle-based service business with a majority of its customers located outside Washington currently is more likely to have a high apportionment factor for Seattle B&O tax purposes where most of its employees are based in Seattle and performing services remotely from the company’s office. Under the new market-based rules, that business may have an appreciably lower service-income factor more closely aligned to its Washington state B&O service apportionment factor, given that the company’s services are delivered to a marketplace predominantly outside Washington.


 
1 Sub. H.B. 1403, Laws 2019.
2 WASH. REV. CODE §§ 35.22.280; 35.23.440; 35.27.370; 35.102.050.
3 WASH. REV. CODE § 35.102.120.
4 WASH. REV. CODE § 35.102.130.
5 WASH. REV. CODE § 35.102.130(3).
6 WASH. REV. CODE § 35.102.130(4).
7 WASH. REV. CODE § 35.102.130(3)(b)(i), (4)(d).
8 WASH. REV. CODE § 35.102.130(3)(b)(ii).
9 Subs. H.B. 1403, Sec. 1, amending WASH. REV. CODE § 35.102.130(4)(f)(i), effective Jan. 1, 2020.
10 Sec. 1, amending WASH. REV. CODE § 35.102.130(4)(f)(ii).
11 Sec. 1, amending WASH. REV. CODE § 35.102.130(4)(f)(iii).
12 Sec. 1, amending WASH. REV. CODE § 35.102.130(3)(c). “Not taxable” means that the taxpayer is not subject to a business activities tax by that U.S. city or county or by a foreign country, except that a taxpayer is taxable in a U.S. city or county or in a foreign country where it has substantial nexus, regardless of whether the jurisdiction imposes such a tax.
13 Sec. 1, amending WASH. REV. CODE § 35.102.130(3)(e). The burden of proof is based on a preponderance of the evidence standard.
14 Sec. 1, amending WASH. REV. CODE § 35.102.130(3)(e).
15 Washington replaced cost of performance apportionment with a single factor, market-based apportionment formula for state B&O tax purposes in 2010.
16 See EHB 2005 Local B&O Tax Apportionment Task Force Report to the Washington State Legislature, Washington Local B&O Tax Apportionment Task Force, Oct. 31, 2018.



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