The Problem

On September 23, 2014, the District of Columbia Council enacted market-based sourcing provisions for sales of intangibles and services as part of the 2015 Budget Support Act (BSA), as we previously discussed in more detail here.  Most notably the BSA adopts a single sales factor formula for the DC franchise tax, which is applicable for tax years beginning after December 31, 2014.  But the market-based sourcing provisions in the BSA did not align with the rest of the tax legislation.  Specifically, the BSA market-based sourcing provisions were made applicable as of October 1, 2014—creating instant tax implications on 2014 returns.  Absent a legislative fix, this seemingly minor discrepancy will trigger a giant compliance burden that will require a part-year calculation for both taxpayers and the Office of Tax and Revenue (OTR) before the 2014 franchise return deadline on March 15.  For example, taxpayers filing based on the new BSA provisions, as originally enacted in September, will have to use the cost-of-performance approach for the first nine months of the 2014 tax year and the new market-based sourcing approach for the remaining three.

The Fix

Citing to the unintended compliance burden, the Council recently enacted emergency legislation to temporarily fix the unintended compliance burden.  However they have not solved the problem going forward.  On December 17, 2014, Finance and Revenue Committee Chairman Jack Evans introduced identical pieces of legislation that included both a temporary and emergency amendment to quickly fix on the problem (both pieces of legislation share the name “The Market-Based Sourcing Inter Alia Clarification Act of 2014”).  These legislative amendments explicitly make the applicability of market-based sourcing provisions synonymous with the other provisions of the BSA, beginning for tax years after December 31, 2014.  In DC, “emergency” legislation may be enacted without the typical 30-day congressional review period required of all other legislation, but is limited to an effective period of no longer than 90 days.  Because the emergency market-based sourcing legislation was signed by Mayor Muriel Bowser on January 13, it will expire on April 13.  Important to DC franchise taxpayers, this date is before the September 15 deadline for extended filers.

The second piece of legislation was introduced on a “temporary” basis.  Unlike emergency legislation, temporary legislation simply bypasses assignment to a committee but must still undergo a second reading, mayoral review and the 30-day congressional review period.  The review period is 30 days that Congress is in session (not 30 calendar days).  Because the temporary Act is still awaiting Mayor Bowser’s approval at the moment, which is due by this Friday (February 6), it will not become effective until after the 2014 DC Franchise Tax regular filing deadline of March 15—even if it is approved by the Mayor and not subjected to a joint-resolution by Congress.  Neither the House nor Senate is in session the week of February 15, which pushes the 30-day review period to roughly April 1 (assuming it is immediately submitted to Congress).  However, once passed, temporary legislation in the District may remain in effect for up to 225 days.

Practice Note:  Given the apparent intent of the Council to fix this problem, we are confident that a more permanent solution is on the way to correct the disconnect within the BSA provisions.  The Council should act sooner rather than later to ensure taxpayers have a sense of clarity prior to the September filing deadline.  While the Council appears to have their bases temporarily covered, any mishap in the passage of the temporary Act will leave DC taxpayers and the OTR with a significant compliance burden beginning on April 13.  We are closely monitoring the temporary Act, the likely introduction of a permanent fix and the much-anticipated release of market-based sourcing regulations by the OTR (discussed below).  We will update readers with any significant development in this area.

Additional Developments – Regulations Pending

Legislative mishap aside, OTR is nearing completion on a set of market-based sourcing regulations that are modeled off of the recently finalized Massachusetts guidance, but with fewer examples.  The Multistate Tax Commission (MTC) Uniformity Committee is also working to develop model-market sourcing rules and is using the Massachusetts rules as its starting draft.  As with similar uniformity efforts in the past, it will be interesting to see how uniform the DC regulations and MTC model regulations turn out to be.  For example, if the final product in DC substantially conforms to the Massachusetts model, taxpayers may be able to cite to the extended examples provided in the Massachusetts or MTC regulations when taking a tax position.  If history holds true, the one thing that is certain is that the uniformity effort won’t be entirely uniform.

Eric Carstens also contributed to this article.