Connecticut Adopts Market-Based Sourcing Rule

    The Connecticut Department of Revenue Service (“DRS”) issued guidance on the recent apportionment changes applicable to corporations as of 1/1/16 and individuals as of 1/1/17. Special Notice 2017(1) provides guidance regarding CT’s market-based sourcing rule, as well as the exclusion of certain receipts from the sales factor and other general apportionment rules.

    The market-based sourcing guidance addresses the sourcing of receipts from the sale of services and the rental, lease or license of intangible property. Generally, under the market-based sourcing rules, receipts are sourced to CT to the extent the service or intangible is used in the state. For both services and intangibles, the sourcing rules vary depending on the type of customer (business customer vs. individual customer).

    Sourcing Rules for Services & Intangibles to Business Customers

    Receipts from the sale of services and the rental, lease or license of intangible property to business customers are sourced to CT based on a tiered approach, under which a taxpayer utilizes the first usable sourcing methodology, starting from the top tier. The four methods for determining the location(s) from which a service/intangible is used follow:

    • Books and Records: Source the sale to Connecticut if the customer contract or taxpayer’s books and records kept in the normal course of business reflect that the service was used in the state;
    • Reasonable Approximation: If sourcing cannot be determined using the first test, taxpayers can reasonably approximate the location(s) where the service is used;
    • Order From: Next source the sale to the location from which the customer placed the order; or
    • Bill To: If no other test is able to be used, source the revenue to the customer’s billing address

    Sourcing Rules for Services & Intangibles to Individual Customers

    Determining the place from which services to individual customers are used is based on the type of service provided. Receipts from services related to real or tangible personal property are sourced to CT if the property is located in or delivered to CT. Receipts from services that require the physical presence of the customer (examples provided in the Special Notice are haircuts and physical therapy) are sourced to CT if the service is performed in CT.

    Receipts from all other services, as well as receipts from the rental, lease or license of intangible property, to individual customers, are presumed used in CT if the customer’s billing address is in CT (“bill to”).  However, subject to DRS scrutiny, a taxpayer may use the sourcing method specified in a customer contract or as reported in the taxpayer’s books and records, instead of the “bill to” method, if such method reasonably reflects where the service/intangible is used.

    Other Apportionment Rules

    Taxpayers required to use industry-specific apportionment rules (i.e., air carriers, financial service companies and securities brokerage services) must continue using the industry-specific apportionment rules and are not affected by the new market-based sourcing rules.

    For both corporate and individual taxpayers, receipts from real property, tangible personal property, and intangible property are excluded from the sales factor if the property is not held by the taxpayer for sale in the ordinary course of business. Whether gain or loss from these items is included in apportionable net income or allocated depends on the type of taxpayer and use of the property. 

    As a reminder, under CT’s new apportionment rules, corporate taxpayers are required to use a single-sales factor apportionment formula as well as the apportionment rules discussed above for tax years beginning on or after January 1, 2016, while the aforementioned rules apply to individual taxpayers for tax years beginning on or after January 1, 2017.  

    What Does CohnReznick Think?

    Connecticut has joined a number of other states in adopting a market-based sourcing rule. Service providers, those located both inside and outside Connecticut, should notice a change in their Connecticut apportionment factor in the first year of the new rule (2016 for corporations and 2017 for individuals). Many service providers located outside Connecticut will be required to source receipts to Connecticut for the first time under the new rule.


    For more information, please contact Matthew Nick, Director, State and Local Tax Services, at [email protected] or 860-271-7933 or Cynthia Galamgam, Senior Manager, State and Local Tax Services, at [email protected] or 959-200-7239.

    Any advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues. Nor is it sufficient to avoid tax-related penalties. This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.