The University of Phoenix, Inc. v. Indiana Department of State Revenue
FOR PUBLICATION, NOVEMBER 30, 2017 (2017)
Rule of Law:
For adjusted gross income tax purposes, Indiana's service income apportionment statute requires income from services to be sourced based on the geographic location where the taxpayer's income-producing activities occur, as determined by the greater proportion of the costs of performance, not by the market location of the customers.
Facts:
- The University of Phoenix, Inc. (University) is a private, accredited education service provider headquartered in Phoenix, Arizona, offering associate's, bachelor's, master's, and doctoral courses and degrees at its online campus and ground campus locations.
- Online campus students participate in academic activities online, such as class meetings, discussions, online research, accessing course materials, and paying for courses.
- The University's online educational services encompass four main categories: the eCampus platform, online faculty instruction, curriculum development, and graduation assistance.
- The eCampus platform was developed and maintained from locations in Arizona, Washington, and California, with only one individual performing related services from Indiana in 2011.
- During the years at issue (2009-2011), the vast majority of the University's online campus faculty members and graduation team members who assisted online students were located in Arizona, with significantly fewer in Indiana.
- All curriculum development activities for the online courses were performed outside of Indiana, primarily in Arizona.
- The University filed Indiana Corporation Adjusted Gross Income Tax Returns for 2009, 2010, and 2011, sourcing 100% of its receipts attributable to its Indiana ground campus students to Indiana but none of its receipts from its online campus students to Indiana.
Procedural Posture:
- The Indiana Department of State Revenue (Department) conducted an audit of the University of Phoenix, Inc.'s (University) Form IT-20 Indiana Corporation Adjusted Gross Income Tax Returns for the 2009, 2010, and 2011 tax years.
- Upon audit, the Department issued a report stating the University should have sourced all receipts from online students with an Indiana billing address to Indiana, and subsequently issued Proposed Assessments for additional Adjusted Gross Income Tax (AGIT) liabilities, interest, and penalties.
- On June 20, 2013, the University protested the Proposed Assessments.
- On September 11, 2014, the Department denied the University’s protest of the additional AGIT assessments but abated the penalties for each of the years at issue.
- On November 7, 2014, the University filed its original tax appeal against the Department's final determination in the Indiana Tax Court.
- The Indiana Tax Court held a trial from February 28 through March 1, 2017, and heard oral argument on June 22, 2017.
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Issue:
Does Indiana Code § 6-3-2-2(f) require service income to be sourced for adjusted gross income tax purposes based on the location of the taxpayer's income-producing activities, as measured by the costs of performance, or based on the market location of the customers?
Opinions:
Majority - Wentworth, J.
No, Indiana Code § 6-3-2-2(f) requires service income to be sourced for adjusted gross income tax purposes based on the location of the taxpayer's income-producing activities, as measured by the costs of performance, not based on the market location of the customers. The court determined that the Indiana Department of State Revenue's (Department) market-based sourcing method, which attributed revenue to Indiana based on a student's Indiana billing address, was contrary to Indiana Code § 6-3-2-2(f) and its interpretive regulation, 45 IND. ADMIN. CODE 3.1-1-55. The statute and regulation define "income-producing activity" as the acts directly engaged in by the taxpayer (seller) for the purpose of generating income, rather than from the perspective of the buyer or consumer. When income-producing activities are performed both within and without Indiana, service income is sourced to Indiana only if a greater proportion of the costs of performing those activities occur in Indiana compared to any other single state, following an "all-or-nothing" rule that mandates a cost-based analysis. The court accepted the University's identification of its income-producing activities (eCampus platform, classroom instruction, curriculum development, and graduation team) and its cost study as persuasive evidence, particularly since the Department failed to provide probative evidence to rebut the University's claims. The court rejected the Department's argument for a transaction-by-transaction approach to cost analysis, noting that Indiana's regulation defines "income-producing activity" broadly and does not contain language requiring such a granular analysis as found in other states' regulations. Based on the University's cost study, the court found that a greater proportion of its income-producing activities' direct costs were incurred outside of Indiana (primarily in Arizona) for the years at issue, thus vacating the Department's assessments.
Analysis:
This case provides crucial clarification on the interpretation and application of Indiana's service income apportionment statute, Indiana Code § 6-3-2-2(f), definitively rejecting market-based sourcing for services in favor of a cost-of-performance approach. It aligns Indiana's methodology with Section 17 of the Uniform Division of Income for Tax Purposes Act (UDITPA) and differentiates it from states that have statutorily adopted market-based sourcing. The ruling offers vital guidance for multi-state service providers, underscoring the necessity of robust cost accounting to accurately determine the geographic location of income-producing activities. Furthermore, it reinforces that the burden lies with the Department to present compelling evidence to counter a taxpayer's well-supported arguments concerning tax assessments.
