The Streamlined Sales Tax Project (“SSTP”) Governing Board voted unanimously on December 12, 2007, to amend the Streamlined Sales and Use Tax Agreement (the “Agreement”) to allow member states to elect an origin sourcing rule to source intrastate sales (i.e., sales occurring entirely within a state). The Agreement previously required its member states and their local tax jurisdictions to source transactions on a destination basis for both inter- and intrastate sales. Pressure from both non-SSTP states (e.g., Texas, Virginia, Missouri, and Illinois) and SSTP states (e.g., Ohio, Tennessee and Utah), coupled with pressure by representatives of local tax jurisdictions, resulted in a unanimous Governing Board vote for a dramatic change to the Agreement’s long-standing destination sourcing rule. The amendment permits states to elect to retain (or adopt) origin sourcing for sourcing of intrastate sales under a uniform methodology.
The Streamlined Sales Tax Project has been meeting for approximately seven years and has produced a robust sales tax regime. The centerpiece of this regime is an extensive set of sourcing rules, which dictate the state (and locality) that is entitled to tax a particular transaction. The general sourcing rules, contained in section 310 of the Agreement, apply a destination test; i.e., tax is imposed based on the destination of the goods or services. Nearly every state has historically applied the destination test for interstate sales, but several states have allowed localities to impose tax based on origin.
The origin rule has permitted localities to impose tax on all of a seller’s sales regardless of where the sales are shipped to within the state. Further, some businesses, such as pizza delivery stores, prefer origin sourcing because it allows them to deal with only one taxing locality and not every locality to which the store may deliver a pizza Because some local governments and small businesses prefer origin sourcing, some states have been unwilling or unable to adopt destination sourcing for intrastate sales. The SSTP Governing Board, which authorizes changes to the Agreement, has come under pressure to abandon destination sourcing of intrastate sales under the theory that foregoing destination sourcing will allow more states to become full members of SSTP.
General Applicability of the Newly Adopted Origin Sourcing Rule
The amendment to the Agreement allows states with local jurisdictions to elect to source intrastate sales of tangible personal property and digital goods to the “location where the order is received by the seller.” It is expected that some, but not all, SSTP states will choose to make this election. Those states that do not elect will retain destination sourcing for intrastate sales – thus, there will not be one set of uniform sourcing rules in SSTP full member states. However, all interstate sales must be sourced using a destination test (i.e., the interstate sourcing rules are unchanged).
Origin sourcing only applies to the sale of tangible personal property and digital products; it does not apply to leases or rentals. Further, origin sourcing does not apply to sale of taxable services.
Importantly, the origin sourcing rule applies only if the “recordkeeping system of the seller used to calculate the proper amount of sales or use tax to be imposed captures the location where the order is received.” In other words, if a seller’s recordkeeping system does not capture the origin location information, a default rule applies and the sale must be sourced on a destination basis. States adopting this origin sourcing regime are not allowed to require sellers to utilize recordkeeping systems that capture location information.
Sutherland Observation: As a result of the rule defaulting to destination and the prohibition against states requiring sellers to capture location information, businesses choosing to not source intrastate sales on an origin basis may be able to ensure that they are not subject to the new rule by failing to capture origin information in the “recordkeeping system … used to calculate the proper amount of sales or use tax.” Also, origin sourcing of intrastate sales has been constitutionally suspect because it can result in different tax rates being applied to intrastate sales versus interstate sales, in violation of the dormant Commerce Clause. SSTP’s adoption of an origin sourcing alternative, while likely to bring additional states to the effort, raises the specter of a constitutional challenge.
What is the “Origin” of a Transaction?
“Origin” is determined based on the location where the order is received, which is defined to include physical locations of the seller (or a third party on behalf of the seller). Relevant locations include outlets, offices, call centers and server locations, including those hosted by third parties. Sellers attempting to determine the location where the order is received are directed to focus on where the order is initially received, not where the order is subsequently accepted, completed or fulfilled. An order is considered received when all of the information necessary to make the determination as to whether the order can be accepted has been received by, or on behalf of, the seller. The rule provides that the location from which an order is shipped cannot be used to determine where the order is received.
Sutherland Observation: A seller that receives orders at a server location or at a call center would source the sale to the locality where the server or call center is located (provided the seller’s sale and use tax recordkeeping system captures the location where the order was received). Thus, to the extent a seller has flexibility in deciding where it is locating its servers or call centers within a state, a seller can “select” a local tax rate for all of its intrastate sales.
The origin sourcing amendment allows states to join the Governing Board as Associate Members if they have adopted the alternative origin sourcing rules (and otherwise substantially comply with the Agreement). These states are not eligible for full membership unless a “trigger” requirement is met: five states (that are not already full member states) must adopt the origin sourcing regime before the origin states can become full members. This trigger mechanism is intended to ensure that a sufficient number of origin states are “recruited” to join the SSTP before the benefit of full membership is extended to the origin members. The Business Advisory Council (which is led by Steve Kranz of Sutherland and represents the voice of the business community) advocated for raising the minimum number of “trigger” states to seven, but the proposal was defeated by the Governing Board. The trigger also provides that the origin states may not become full members before January 1, 2010.
Sutherland Observation: While Texas, Virginia, Utah, Tennessee, Ohio, Missouri, and Illinois all indicated that they would attempt to participate in SSTP as a result of the new origin sourcing rule, each of these states face challenges (other than sourcing) in adopting the Agreement. These challenges could prevent some or all of these states from joining, regardless of the Governing Board’s adoption of the intrastate origin sourcing election.
Direct Pay Authority
The provision requires that states participating under the alternative sourcing regime must provide direct pay permit authority. Purchasers who remit tax under such a permit must remit at the rate in effect for the location where receipt of the product occurs or where the product is first used. States may not limit direct pay permits to manufacturers or businesses that do not know the ultimate use of the product at the time of purchase.
Sutherland Observation: This expansion of the Agreement’s direct pay authority is intended to ensure that purchasers holding a direct pay permit are able to remit use tax on a destination basis, thus eliminating the need for purchasers to obtain origin information from their vendors.
Sales of Tangible Personal Property and Services
As stated above, the newly adopted origin sourcing regime only applies to sales of tangible personal property and digital products, and not to sales of taxable services. If a seller sells both tangible personal property and services pursuant to a single contract (and billed on a single statement), the provision requires states (as opposed to sellers) to elect to treat the entire sale (i.e., both the tangible property and taxable service) on either an origin or destination basis. Such a sale would then be sourced to a single location rather than having an origin rule for the tangible personal property and a destination rule for the taxable service.
Sutherland Observation: The provision applicable to combined sales was an attempt to address concerns raised by businesses that sell both taxable tangible personal property and taxable services. These businesses were concerned that under the origin sourcing alternative, they would be required to apply dual sales tax systems on a single invoice. The Governing Board acknowledged that the provision addresses only limited sales of taxable tangible personal property and services (i.e., those included on the same contract.
and billed on the same invoice) and that further work is needed to address other combined sale scenarios.
Some participants at the SSTP meeting expressed significant concerns over the adoption of the elective origin sourcing rule. For instance, several states, including Washington State, have recently replaced intrastate origin sourcing in favor of destination sourcing. These states will now face pressure from some localities and small businesses to “roll back” these tax reform efforts in favor of origin sourcing. Further, most state officials on the Governing Board acknowledged that origin sourcing does not represent good tax policy or tax simplification, but that its adoption was politically necessary to entice a greater number of states to become full members.