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Hawaii Adopts Market Sourcing for Services, Intangibles

Posted on June 14, 2019

Hawaii Gov. David Ige (D) has approved legislation applying market-based sourcing to sales of services and intangibles.

S.B. 394, which Ige signed June 7, establishes that for tax years beginning after December 31, 2019, sales of services and intangibles are sourced to Hawaii to the extent that:

  • the intangible property is used in the state; and

  • the service is used or consumed in the state.

According to March written testimony by the state Department of Taxation, Hawaii already applies market-based sourcing to sales of tangible personal property, but “sales of services and intangibles have been sourced using the place of performance of services or place of production of intangibles.”

The proportion of sales sourced to Hawaii is one of three factors used to determine how much of a business’s taxable income can be apportioned to the state and subjected to corporate income tax. The other two factors involve the proportion of payroll and property that a business has in the state.

Over time, “products that were traditionally delivered as tangible personal property are becoming consumable in intangible form, and services that were previously performable only locally are now performed remotely,” according to the department's testimony. “As this has happened, the tax base has become distorted as the sourcing rules” for sales “no longer reflect the nature of the economy. For this reason, the Department thinks it is appropriate to update the sales factor to better reflect the modern economy."

Market-based sourcing means more sales by out-of-state sellers could be attributed to Hawaii. The department argued that the change in sourcing rules makes sense, since the current sales factor for intangibles and services “is duplicative of the property and payroll factors” used by the state’s three-factor test for apportionment of taxable income.

The department also contended that market-based sourcing of sales matches “the sourcing law and rules applicable under Hawaii’s general excise tax,” which would ease the burden of administering and complying with the state's income and general excise taxes.

S.B. 394 at one point also included a provision to shift the state to single-sales-factor apportionment, under which only the sales factor would be used to apportion businesses’ income for income tax purposes. However, the department argued in opposition to that transition in its March testimony, and the provision was removed.

“The Department believes single sales factor apportionment will not properly reflect taxpayers’ activity in the State whereas the equally weighted three-factor formula will,” the testimony said.

Other states have moved toward market-based sourcing and single-sales-factor apportionment. Oregon — a single-sales-factor state — in 2017 adopted market-based sourcing for sales of services and intangibles. Like Hawaii, Oregon already used market-based sourcing for sales of tangible goods.

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