Michigan City Income Tax Act (CITA) apportionment: Sales factor for service providers
The taxpayer in this case is a law firm with an office within the city of Detroit who provides legal services to clients located both within and outside of Detroit. The taxpayer computed its Detroit sales factor based on where its client received the service. The City of Detroit contended that the sales factor should be based on where the service work was performed which, in this case, would have been from the law firm’s Detroit office.
The court looked to the meaning of “sales made in the city” and in particular examples provided in the CITA related to the sales of goods. The court noted that the destination of the goods is the relevant factor, not the location of the taxpayer. The court reasoned that services cannot be “delivered” in the same manner as a tangible item; however, this does not mean that services cannot be delivered. For example, a lawyer’s time and advice may result in the drafting of a will or contract, and those items may be delivered to the client in a different location than where the lawyer performs the drafting. A lawyer may also have a telephone conversation with a client outside the city, and in that case, the lawyer’s advice is delivered to the client outside of the city. The court concluded that, for purposes of the CITA, service revenue should be included in the sales factor where the service is delivered to the client, not where the service is performed. Thus, where a service is provided to a client outside the city of Detroit, it is to be considered an “out-of-city” service while services provided to a client located within the city of Detroit is to be considered an “in-city” service.
Although this specific case addresses a Detroit apportionment issue, the holding by the Michigan Court of Appeals applies to the sourcing of services for all Michigan cities under the CITA. Taxpayers should consider this case when calculating the Michigan city income tax sales factor for service revenues. An opportunity to amend city income tax returns to claim a refund may exist if the sales factor on the originally filed returns was prepared using a performance location souring methodology for service revenue. The refund opportunity is limited to those years still open under the statute of limitations, which is generally four years from the later of the date the payment was made or due date of the original return including extensions. The statute of limitations could extend beyond four years if there was a previous agreement with the city to extend the limitations period.