United States: Market vs. Place-Of-Performance: Recent NJ Tax Court Decisions Give Options To Taxpayers

Last Updated: September 16 2018
Article by David J. Gutowski and Matthew L. Setzer

In its ruling this week concerning Xpedite Systems, Inc. v. Director, Division of Taxation,1 the Tax Court of New Jersey addressed how receipts from information services are sourced for corporation business tax ("CBT") purposes. Rather than apply the market-sourcing method advocated by the taxpayer or the place-of-performance method advocated by the Division of Taxation ("Division"), the court ruled that the receipts could be sourced using a hybrid approach that combines both methods. The court's decision reflects the flexibility of New Jersey's sales-fraction sourcing rules and may provide potential opportunities or exposures for service providers depending on where their employees, equipment, and customers are located.

Background and summary of decision

Xpedite's business involves mass-marketing services. A customer provides Xpedite with an advertising message, which Xpedite then forwards to a list of targeted fax numbers provided by the customer. Although Xpedite's customers were located both within and without New Jersey, Xpedite was based in the state. New Jersey was where Xpedite performed its services and where the tangible and intangible property used to perform its services was primarily located.

During the period at issue, the New Jersey statute provided that services receipts are sourced to New Jersey if the underlying service is "performed within the State."2 (As a result of recent legislative amendments, services receipts will be sourced based on market beginning in 2019. For prior coverage, please see our alert.) Despite this clear place-of-performance rule, the Division's regulations provide alternative sourcing methods that account for the taxpayer's market. These alternative methods include the following:

  • Pure market sourcing. The regulation provides that receipts from long distance telecommunications services are sourced based on where the calls originate.3
  • Hybrid method. Receipts from certain services, including Internet access and ATM processing, are sourced using the so-called "25:50:25 rule." Under this approach, 25% of the receipts are sourced to where the transaction originates; 50% of the receipts are sourced to where the service is performed; and 25% of receipts are sourced to where the transaction terminates.4

Xpedite took the position that it was engaged in a telecommunications business. In fact, for sales and use tax purposes, the Division treats Xpedite as a telecommunications provider and requires it to collect tax on its sales as such. Accordingly, Xpedite asserted that its receipts should be sourced for CBT purposes based on the special market-sourcing rule that applies to telecommunications providers. Under this market-sourcing approach, no more than 7% of its receipts were sourced to New Jersey. On audit, however, the Division re-sourced Xpedite's receipts using the 25:50:25 rule, which resulted in 76% of its receipts being included in the sales-fraction numerator. After the taxpayer appealed, the Division argued that up to 100% of Xpedite's receipts should be sourced to New Jersey based on where Xpedite performed its services and maintained its equipment.

The Tax Court upheld the Division's assessment. The court reasoned that:

  • The Division's assessments are presumptively correct, and that to overcome an assessment, a taxpayer must provide clear, competent, and cogent evidence. To prevail, the taxpayer must show that the Division relied on an "aberrant methodology."5
  • Xpedite failed to meet this standard; rather, it merely pointed to an alternative sourcing method set forth in the regulation. The court further noted that Xpedite's proposed method applied only to long distance telephone providers. Because Xpedite's business was providing "mass messaging services via fax, e-mail and voice," the court concluded that the taxpayer's proposed alternative didn't apply.

Significance and takeaways

No clear guidance on when 25:50:25 rule applies. The court concluded that the 25:50:25 rule was not limited to the two examples (Internet access and ATM processing) set forth in the Division's regulation. As a result, the court upheld the application of this hybrid approach to Xpedite's messaging business. But the court did not provide any guidance on other types of services that might also be within the scope of the 25:50:25 rule.

Under a broad reading of the court's decision, the 25:50:25 rule could apply to any taxpayer that performs services at a location apart from where its customers are located. For a taxpayer that performs services outside New Jersey, this would result in at least some receipts being included in the numerator despite a clear statutory rule that includes these receipts only in the denominator. On the other hand, the 25:50:25 rule can benefit an in-state taxpayer by enabling it to source a portion of its receipts outside New Jersey.

The Xpedite decision illustrates just how flexible New Jersey's sourcing rules can be. In other recent decisions, the Tax Court has vacillated between market sourcing and place-of-performance. For example, in Bank of America Consumer Card Holdings v. Director, Division of Taxation,6 the court showed a clear preference for sourcing intangible-type services to where the benefit was received (which happened to be in New Jersey). By contrast, in United Parcel Serv. Gen. Servs. Co. v. Director, Division of Taxation,7 the court sourced services receipts based on the location of the equipment used to perform the service (not surprisingly, the equipment at issue was located in New Jersey).

New Jersey taxpayers should use this flexibility to their advantage. If your company performs services outside the state, apply the statutory rule and exclude your receipts from the numerator. Alternatively, if your company performs services from within the state, consider filing a refund claim based on the 25:50:25 rule or market sourcing.

Inconsistency between corporate income and sales tax. For sales tax purposes, the Division treated Xpedite as a telecommunications provider. But neither the Division nor the court treated Xpedite this same way for CBT purposes. Although this inconsistency hurt Xpedite, other taxpayers can potentially benefit from such disparate treatment. For example, for sales tax purposes, a taxpayer may want to characterize itself as a manufacturer engaged in the production and sale of tangible personal property so that it can qualify for certain exemptions. But for CBT purposes, the same taxpayer may want to characterize itself as also engaged in services activities so that it can take advantage of more favorable sourcing methods. Importantly, where a taxpayer receives a lump-sum payment for tangible property and related services, the Division's policy is to permit the taxpayer to allocate its receipts between property and services using any reasonable method.


  1. See Docket No. 018847–2010 (N.J. Tax Sept. 5, 2018).
  2. See N.J.S.A. 54:10A–6(B)(4).
  3. See N.J.A.C. 18:7–8.10(a), Example 2.
  4. See N.J.A.C. 18:7–8.10(c).
  5. See Yilmaz, Inc. v. Director, Division of Taxation, 22 N.J. Tax 204, 236 (N.J. Tax 2005) (finding that an "aberrant methodology [for an assessment] will overcome the presumption of correctness . . . [but an] imperfect methodology will not").
  6. 29 N.J. Tax 427, 471 (N.J. Tax 2016).
  7. 25 N.J. Tax 1 (N.J. Tax 2009), aff'd 430 N.J. Super. 1 (N.J. Super. Ct. App. Div. 2013), aff'd 220 N.J. 90 (N.J. 2014).

This article is presented for informational purposes only and is not intended to constitute legal advice.

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