- The Minnesota Tax Court looked through the related company and used sourcing rules based upon where the related company’s customers were located
- May create exposure in certain cases for those companies that are selling through a conduit company located outside Minnesota to the ultimate customer in Minnesota
- Conversely, companies selling through a conduit company based in Minnesota may have overstated their sales factor and may be entitled to a refund, since apportionment should reflect the location of the ultimate customer
Background
A recent decision by the Minnesota Tax Court, Humana MarketPoint, Inc. v. Commissioner of Revenue, 2024 BL 445996, Minn. T.C., 9570-R, (Nov. 21, 2024), required the taxpayer, an affiliate of an insurance company, to source revenue for sales factor apportionment purposes based upon the location of the insurance company’s customers rather than the domicile of the insurance company itself.
Insight from Forvis Mazars: This is a relatively unique situation in that these sales would typically eliminate in consolidation on Minnesota’s tax return in most instances and, therefore, not be reflected in the sales factor. However, insurance companies are not subject to corporate income tax in Minnesota and, therefore, not included in the unitary group. Nonetheless, nothing in the tax court’s reasoning suggests that the logic of the decision would not apply to other related and unrelated party transactions.
Facts
The corporate structure involved is simple. Humana, Inc. (Humana) is the parent company of Humana MarketPoint, Inc. (MarketPoint), Humana Pharmacy Solutions, Inc. (HPS), and Humana Insurance Company (HIC). Humana filed a unitary Minnesota corporate return including MarketPoint and HPS; HIC, as an insurance company, is exempt from corporate income tax and was therefore excluded from the return.
HIC provides traditional health insurance products for its insurance plan members. It contracted with HPS, a pharmacy benefit management company, to provide pharmacy benefit management services with respect to Medicare.
On the returns at issue, Humana filed returns sourcing receipts from services performed by HPS for HIC to Minnesota if HIC’s plan member was located in Minnesota at the time they purchased a plan from HIC. Humana subsequently amended the return to reduce the amount of these receipts in the Minnesota sales factor to zero, since HIC was commercially domiciled in Wisconsin, and argued that the receipts from HIC were properly sourced to Wisconsin. The commissioner denied this refund request, and the claim was litigated in tax court.
The Statute at Issue
Minnesota Statute Section 290.191, subdivision 2(a) dictates Minnesota apportionment based upon sales; that is, the ratio of Minnesota sales to everywhere sales is multiplied by the Minnesota tax rate, which is then multiplied by taxable apportionable income to arrive at Minnesota tax due. Minnesota is a “market state” with respect to services—Minn. Stat. §290.191, subd. 5(a) provides that receipts are attributed to the numerator of the Minnesota apportionment factor based upon the state where the services are received. Services provided to a corporation, under the statute, may only be attributed to a state where the corporation has a fixed place of doing business. However, if this cannot be readily determined (or the corporation does not have a fixed place of doing business), services are deemed received at the location from which the customer ordered the services. If the order location cannot be determined, the customer’s billing address is the location where the services are deemed to be received.
The Tax Court’s Construction of the Statute
The opinion centers upon the court’s construction of the apportionment statute’s dictate that receipts are attributed to Minnesota if the state is where the services are received. Since the rise of market sourcing, this is an issue that has arisen among a number of industries, including—but not limited to—asset management services provided to hedge and private equity funds. Typically, the funds are partnerships or limited liability companies with little to no substance other than the ownership of the investments. Management services are provided to the funds, and the issue tends to be whether the service is received at the nominal location of the funds (which is typically the location of the related management companies), or whether you look through the funds to the ultimate owners of the funds.
Indeed, as the court notes, the only other time the statute has been the subject of litigation was in the context of management services provided to Minnesota-based mutual funds. In interpreting the 1988 version of the statute in Lutheran Brotherhood Research Corp. v. Commissioner of Revenue, 656 N.W.2d 375 (Minn. 2003), the Minnesota Supreme Court did not “look through” the mutual fund and source the receipts to the location of the mutual fund investors as it was determined that the mutual fund contracted, was billed for, and paid for the services and, therefore, was the beneficial consumer of the services under the statute. The Minnesota Legislature amended the statute at issue in 1995, changing the language that required sourcing to the place where benefits are consumed to the place where benefits are received. In 2008, the legislature again amended the statute to explicitly provide for “pass-through” sourcing for services provided to mutual funds.
In the instant case, Humana argued that Minnesota law did not allow for services to be sourced to the location of the indirect customers, the plan members. It argued that the plain language of the statute required sourcing to “direct customers,” and that the waterfall provisions of the statute that provide sequential sourcing rules required sourcing to direct customers. It also argued that the holding of the Minnesota Supreme Court in Lutheran Brotherhood requires sourcing to direct recipients of the contractual services and precludes look-through. The commissioner countered by arguing that the plain meaning of the statute does not require that the person paying for the service (HIC) and the persons receiving the service (the plan members) be the same, and that Humana’s interpretation of the statute adds language to the statute.
The court found that its interpretation of the first of the sequential rules contained in the statute—the location where the service is received—was dispositive. Since the statute did not specify that this first rule only applied to direct customers, the court declined to add this requirement to the statute as the plain meaning was unambiguous. The court also noted that in arguing that only direct customers could receive or be provided a service, Humana confuses the legal act of contracting with the practical fact of receiving a service and is a preference for form over substance. The court also declined to make a negative inference from the legislature’s 2008 amendment of the statute as applied to mutual funds as otherwise barring look-through sourcing for other businesses, noting that if the legislature wanted to amend the main sourcing provision, it could have.
Insight from Forvis Mazars: Although the facts in this case involve a unitary return and related parties, it is not limited to this context. It is easy to imagine other contexts where this could arise, whereby the payor for a service is not the ultimate recipient of the service. For example, consider a bank that contracts with a travel service provider to provide services to its credit card holders. While the contract might be between the bank and the travel service provider, customers likely receive the services nationwide. Depending on the facts and circumstances of particular taxpayers, it may create an additional Minnesota tax liability or provide an opportunity for a Minnesota refund.
How Forvis Mazars Can Help
We can work with you to consider critical contractual arrangements, whether intercompany or third party, to gauge whether these arrangements create risks or opportunities for your sales sourcing methodologies, both in Minnesota and elsewhere. If you have any questions or need assistance, please reach out to a professional at Forvis Mazars.