Michigan city income tax apportionment: Sales factor for service providers

On May 18, 2020, the Michigan Supreme Court in Honigman Miller Schwartz and Cohn LLP v. City of Detroit reversed the decision of the Michigan Court of Appeals and held, for purposes of calculating the revenue factor under the Uniform City Income Tax Ordinance (UCITO), that revenue earned for providing services from an office within the city of Detroit is sourced to the location where the service is performed regardless of where those services are delivered to the client.

The taxpayer in this case is a law firm with an office within Detroit that provided legal services to clients located both within and outside of Detroit. The taxpayer computed its Detroit revenue factor at approximately 11% based on where the clients were located, as the law firm deemed that sourcing to be where its services were rendered. The City of Detroit contended that the revenue factor should be based on where the service work was performed which, in this case, would have been almost five times the taxpayer’s calculated amount of Detroit revenue. This would include revenue from services performed in the city such as legal research, document creation, and preparation and arguing of the motions. The Michigan Court of Appeals, which had ruled in favor of the taxpayer, held revenue earned for providing services is sourced to the location where the service is delivered to the client.

The Supreme Court concluded that the Michigan Court of Appeals erred when determining revenue for services rendered in the city is calculated on the basis of where the services were delivered, and that the Tax Tribunal correctly determined the taxpayer must calculate gross revenue on the basis of where services are performed.

The Michigan Supreme Court held the legislature had adopted an origin-based requirement for apportioning services when it used the term “services rendered” for the city income tax revenue factor. The court reasoned that the Merriam-Webster Online Dictionary defines the term “render” as “to do (a service) for another.” Therefore, the revenue factor focuses on where the services are done or carried out, rather than where the services are delivered. The Court also noted that, had the legislature intended to treat services similarly to the sale of goods by looking to the location of delivery, it would have expressed that intention. Specifically, the Court stated the legislature could have provided comparable guidance explaining how services are delivered along with when the delivery should be in-city versus out-of-city, which is what the legislature did for sales of goods.

The revenue factor focuses on where the services are done or carried out, rather than where the services are delivered.

Although this specific case addresses a Detroit apportionment issue, the ruling by the Michigan Supreme Court applies to the sourcing of service revenue for all Michigan cities under the UCITO. Taxpayers should apply this ruling when calculating the Michigan city income tax revenue factor for service revenues. An opportunity to amend city income tax returns to claim a refund may exist if the revenue factor on the originally filed return was prepared using a market-based souring methodology for service revenue due to the previous precedential ruling made by the Michigan Court of Appeals. 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.

If you have any questions about this court ruling and how it may affect you, please reach out to your Plante Moran advisor.