In Quest Diagnostics Clinical Laboratories, Inc. v. T.A. “Tim” Barfield, Jr., Secretary, Department of Revenue, State of Louisiana; and the State of Louisiana, Louisiana Court of Appeal, First Circuit, Docket No. 2015-CA-0926 (September 9, 2016), the Louisiana Court of Appeal, First Circuit recently confirmed that Louisiana was a “location-of-performance” state when sourcing service-based receipts for corporate income tax apportionment purposes. We say “was” because the Louisiana Legislature amended the underlying statute this summer to expressly adopt market sourcing, in Act No. 8 of the Second Extraordinary Session. This decision, however, may present refund opportunities for numerous taxpayers who prior to 2016 may have sourced to Louisiana a wide range of receipts – perhaps not limited to services alone – based on a market-sourcing method.
Hurricanes Scramble Tax Returns, Too
Prior to Hurricane Katrina, Quest Diagnostics Clinical Laboratories, Inc. (“Quest”) performed medical diagnostic testing services such as blood testing and screening at a regional laboratory near New Orleans. Because its patients and the laboratory servicing them were both within the state, its Louisiana sales factor essentially would have been the same under either a traditional cost-of-performance or market-sourcing scheme. Thus, there was no need to make such a distinction when gathering its apportionment data.
After Katrina destroyed the Louisiana lab in August 2005, the company relocated its operations and most of its employees to another facility in Texas, and it began processing the specimens from its Louisiana patients at that lab. Following Katrina, however, the company did not immediately update its apportionment data collection practices to account for the fact that the services were no longer being performed in the same location as the patients.
As a result of this oversight, for the latter part of 2005 and all of 2006 it mistakenly attributed to Louisiana considerable revenue for services which in fact were performed in Texas. Quest realized its data collection error during a subsequent audit, and filed amended returns solely to correct its sales numerator to reflect the out-of-state performance of those services. The Department refused to process the amended returns, effectively denying the refunds generated by this apportionment change.
The “Quest” for Sourcing Certainty
Prior to the extensive legislative amendments enacted this summer, service enterprises apportioned their income based on a two-factor payroll and sales ratio under La. R.S. 47.287.95(D), which explicitly sourced to Louisiana “the revenue from services performed in this state.” That subsection, however, defined “service enterprises” only to include those service businesses “in which the use of property is not a substantial income producing factor.” The immateriality of property in generating these service enterprises’ income was the basis for using a two-factor rather than a three-factor formula. In the Court’s words, “[t]hat the legislature would do this makes perfect sense.”
The Department successfully argued that Quest’s reliance upon highly-specialized technical equipment in rendering its diagnostic testing services removed it from Subsection (D), forcing it instead to use the catch-all three-factor formula set forth in Subsection (F). That subsection applied to any taxpayers not covered by the industry-specific provisions of Subsections (A) through (D), including service providers for whom property is a substantial income producing factor. Subsection (F) sourced to Louisiana all “net sales made in the regular course of business” as well as “other gross apportionable income attributable to this state.” It did not, however, directly cross-reference the location-specific sourcing rule under Subsection (D) or contain its own guidance in this regard.
The Department first argued that Quest’s services were “net sales made in the regular course of business” and sourced to Louisiana, but the Court rejected this position based on the Department’s own regulation that clearly limited that phrase to sales of tangible property, not sales of intangible items such as service.
The Department then argued that the phrase “other gross apportionable income attributable this state” as used under Subsection (F) required sourcing based on the patient’s location (market sourcing), even though the virtually identical phrase used in Subsection (D) clearly required sourcing based on the “location of performance.” The Court rejected this argument, stating that it could find “absolutely no indication” that the Legislature intended to source services differently under Subsections (D) and (F) when the only difference between those provisions was whether to include or exclude a property factor from the apportionment formula.
“Indeed, we can conceive of no plausible reason why the sourcing of income for the
revenue factor in Subsection (F) would be different from that in Subsection (D).”
Because Subsection (D) unambiguously required use of a “location-of-performance” sourcing method, that same method must be used under Subsection (F). Quest argued, and the Court agreed, that absent a statutory amendment by the Legislature, the Department had no authority to source these Texas-based receipts to the state, and the Court awarded Quest the refund requested on the amended returns.
Refund Claims May Exist
For periods prior to 2016, the Quest decision confirms that Louisiana has always been a location-of-performance state in sourcing service based receipts. To the extent any taxpayers reported those receipts to the state on a market-sourcing method when a location-of-performance method would have produced a lesser tax liability, those taxpayers should investigate their data to determine if refund claims may exist. Refund claims for the 2012 income tax year will generally prescribe on December 31 of this year.