Michigan Supreme Court Adopts Origin Based Test To Source The Sale Of Services For City Income Tax Purposes
Summary
On May 18, 2020, the Michigan Supreme Court issued an opinion in Honigman, Miller, Schwartz and Cohen LLP v City of Detroit, and ruled in favor of the city of Detroit. The court determined that services are sourced using an “origin-based” test when calculating the sales apportionment factor for Michigan city income tax purposes. The Michigan Supreme Court’s opinion reversed the Court of Appeal’s published opinion from January of 2018, which had ruled in favor of the Honigman law firm (taxpayer). As a result, taxpayers may be required to file amended returns for any open tax periods if they relied on the Court of Appeal’s published opinion.
Details
For city income tax purposes in Michigan, the Uniform City Income Tax Ordinance applies to each city that imposes an income tax. Unlike the apportionment formula for state income tax that uses a single-sales factor, the apportionment formula for city income tax still uses an equally weighted three-factor apportionment formula, consisting of payroll, property, and revenue (i.e., sales). The relevant statute at issue, MCL 141.623, indicates that the numerator of the revenue factor includes the “gross revenue of the taxpayer derived from sales made and services rendered in the city.”
The issue here was whether the phrase “services rendered in the city” includes legal services performed within the city of Detroit, but delivered to clients located outside the city of Detroit, when calculating the sales factor. Essentially, the court was interpreting whether Michigan had adopted the market-based approach for sourcing the sale of services for income apportionment purposes.
In this case, the taxpayer is a law firm with offices located throughout the state of Michigan, with one of its main offices located within Detroit. For Detroit city income tax purposes, most of its legal services were performed by attorneys working at the office within the city of Detroit. However, many of the law firm’s clients were located outside the city of Detroit. When calculating its Detroit sales factor, the law firm argued that its legal services should be sourced to where the service is delivered, effectively using the market-based approach. Detroit, on the other hand, argued that the legal services should be sourced to where the services were performed, regardless of the client’s location or the place of delivery.
In the taxpayer’s initial petition, the Michigan Tax Tribunal agreed with Detroit and ruled in the city’s favor. The Michigan Court of Appeals then reversed the lower court’s decision in January of 2018, ruling in favor of the taxpayer. In its published opinion, the Court of Appeals concluded that sourcing occurs where the service is delivered, not where the attorney performs the service. Finally, the Michigan Supreme Court reversed the Court of Appeals judgment and ruled in favor of the city of Detroit.
Interpreting the relevant statute, the court concluded that “services rendered” under the revenue factor encompasses revenue for all services performed, i.e., done or carried out within the city, even when those services were performed for out-of-city clients. Therefore, Michigan has effectively adopted an “origin test” for services under the revenue factor, rather than a destination or market-based test, for purposes of sourcing services receipts for Michigan city income tax purposes.
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