The Washington Court of Appeals recently issued a split (2-1) decision in a case involving Washington’s “benefits received” test for the distribution of service income. The Court ruled that the “benefits” of the services of an aircraft design firm were received in Washington, where the taxpayer’s direct customer, Boeing, manufactured the planes incorporating the taxpayer’s aircraft designs, rather than in the states where Boeing ultimately delivered the planes to its customers, individual airlines such as Delta, United, and American.
The taxpayer in Walter Dorwin Teague Associates, Inc. v. Washington State Department. revenues, n ° 54959-0-II (Teague), was an industrial design firm based in Seattle, Washington (Teague). Teague specializes in the design of the interiors of passenger planes, including seating arrangement, geometry and brand placement. Boeing, one of Teague’s major customers, hired Teague in fiscal years 2011-2014 to design interiors of planes Boeing would manufacture in Washington. After manufacture, Boeing delivered the aircraft to customer airlines at their respective sites. Claiming that the revenue for his design services should have come from where the airlines are located, and not from Washington where Boeing is located, Teague filed for a refund of the Washington business and professional tax. (B&O).
Washington imposes a B&O tax on an allocated portion of a service provider’s income, determined using a single revenue factor formula, the numerator of which is the gross taxpayer income attributable to Washington and the denominator of the gross taxpayer income all over. Washing revision code § 82.04.462. Since 2010, service revenues have come from Washington (that is to say, included in the numerator of the apportionment formula) if the “customer benefited from the taxpayer’s service” in Washington. Wash. Rev. Code § 82.04.462 (3) (a).
The question before the Court of Appeal in Teague was whether the “benefit” for the taxpayer’s services was received at the location of his customer, Boeing, or at the location of individual airlines, which were Boeing’s customers. Majority and dissenting opinions turned to a ministry rule to resolve this issue. Washing. Admin. Code § 458-20-19402 (Rule 19402). This regulation provides that when the taxpayer’s service relates to tangible personal property, “the benefit is received where the tangible personal property is located or is deemed / is deemed to be located”, which the rule in turn defines as being the “main place of use of the property. “The rule further provides that in the case of” tangible personal property [that] will be created or delivered in the future, the primary place of use is the place where it is expected to be used or delivered.
Applying the rule, the majority determined that the “benefits” of Teague’s services were “received” in Washington because “the airline interiors were to be used by Boeing during the manufacturing process in Washington.” The majority rejected Teague’s argument that the place of use should instead be where the airlines “have used or received delivery of the interiors of the aircraft” because he “ignores[d] the key legal investigation, where the client benefited from the taxpayer’s service. Since Teague’s customer was Boeing, and not the individual airlines, the majority concluded that it was “wrong” to research the place of use or delivery by anyone other than Teague’s direct customer, that is to say, Boeing.
A dissenting opinion disagreed, believing the tax law to be at least ambiguous, which under Washington rules would require the case to be resolved in favor of the taxpayer. The dissent said there was another reasonable interpretation of the legal provisions (which Teague had put forward): “The majority conclude that Boeing benefited from the design services of Teague in Washington, where Boeing used the design to manufacture interiors. aircraft for its commercial aircraft. But another reasonable interpretation is that Boeing benefited from Teague’s design services when Boeing sold the completed planes to foreign airlines. It was certainly at this time that Boeing received the financial benefit from the design services of Teague. The dissent raised a particular problem with the majority’s application of the relevant regulation, Rule 19402, because that regulation does “not refer to the clients place of use or even contain the word “customer”. And it was “equally reasonable” to conclude that the “primary place of use is where the airlines purchasing the planes containing the interiors are located”.
Teague is an example of the “benefits received” test applied on the basis of the location of the taxpayer’s direct customer, rather than on a “see-through” basis that looks at the location of an end user. The search for sources of supply can be beneficial or detrimental to a taxpayer depending on the location of their customers. In Teague, the transparency would have benefited the taxpayer because its direct customer was in Washington and the end-users were outside of Washington. But in other cases – for example, where the taxpayer’s direct customer is out-of-state and end users are in-state – a go-through approach would be detrimental. Barring another appeal to the Washington Supreme Court, the case should prevent Washington from applying a transparent procurement method to the detriment of a taxpayer in similar circumstances in the future.
Walter Dorwin Teague Assocs., Inc. v. Dep’t of Revenue, 2021 Wash. App. LEXIS 2983 (Dec 14, 2021).