Florida court requires cost of performance method for sourcing service income

In brief

A Florida circuit court on March 1 ruled in Billmatrix Corp. that the Department of Revenue erroneously applied a market-based approach to sourcing taxpayers’ service income. The court determined that the Department’s interpretations contradict the plain language of its sourcing regulation, which requires application of a cost of performance methodology.

Additionally, the court found that the Department’s inconsistent interpretation of its own regulations violates Florida’s Taxpayer Bill of Rights.

Observation: The circuit court’s decision is consistent with the November 28, 2022, appellate court decision in Target Enterprise v. Department of Revenue. Please click here to read our summary of Target.

The takeaway: The circuit court’s decision in Billmatrix is important for several reasons. Most significantly, it indicates that the decision in Target was not an anomaly, that the Florida circuit court is consistently applying the cost of performance rule, and that the Target decision was not unique to that taxpayer’s specific facts. The Target decision discussed alternative apportionment, which raised questions about whether it might be unique to that taxpayer’s facts. By contrast, the court’s opinion in Billmatrix speaks more broadly and addresses the application of cost of performance sourcing in a more general manner. Rulings in Florida that concluded market sourcing was appropriate generally reached this conclusion by asserting that the receipt of the benefit by the customer was the income-producing activity. This logic was not addressed by the court in Target, whereas it was directly rejected in Billmatrix.   

[Billmatrix Corp., et. al v. Florida Department of Revenue, Circuit Court, 2^nd Dist., Leon County, No. 2020 CA 000435 (3/1/23)] 

Facts 

Plaintiffs consist of related out-of-state corporations that provide financial technology services to businesses across the country. For all but one of the Plaintiffs, either the “majority” or the “vast majority” of the costs to provide such services were incurred outside of Florida. 

The court described Plaintiffs as reporting their apportioned income for the 2015 to 2017 tax years “based on the cost of performance method” described in the above Rule. On audit, the Department disagreed with Plaintiffs’ methodology and issued assessments described by the court as “effectively appl[ying] a market-based approach to Plaintiffs’ service income instead of the cost of performance approach . . . .” The Plaintiffs appealed the assessments to a Florida circuit court. 

Florida requires application of the cost of performance methodology 

The circuit court described the “sole dispute” in this case as being “whether the COP Rule requires application of a cost of performance methodology, or a market-based methodology.” The court determined that the “plain language” of the COP Rule “unambiguously directs that the income from Plaintiffs’ sales be determined through the use of the cost of performance method.” 

The court viewed the Department’s audits as imposing varying interpretations of the COP Rule by basing sales factor sourcing on the location of Plaintiffs’ customers. The court found that this approach “contradicts the rule’s plan language.” 

As a result, the court ruled in favor of Plaintiffs, explaining that “each of the tax assessments issued to the Plaintiffs violates the plan language of the COP Rule.”