The Impact of Market-Based Sourcing on Idaho R&D Tax Credit Compliance: Analyzing Idaho Code § 63-3027(q) and (r)

Idaho Code § 63-3027(q) and (r) mandate that multi-state corporations utilize Market-Based Sourcing (MBS) for receipts derived from services and intangible property in their corporate income tax apportionment formulas. This is a critical requirement because the calculation of the Idaho R&D tax credit base relies exclusively on gross receipts that are successfully sourced to Idaho under these specific MBS rules.

This requirement fundamentally connects a company’s sales geography to its R&D tax benefit eligibility. The subsections govern how Idaho corporate taxpayers, particularly those engaged in multistate R&D activities, must determine which portion of their service and licensing revenue is attributed to Idaho for tax purposes. Prior to changes enacted in 2022, Idaho utilized the Cost of Performance (COP) method for sourcing non-tangible sales, often favoring companies with large production footprints, such as R&D centers, regardless of where their customers resided.1 The transition to MBS shifts the tax burden to the market location, requiring sophisticated data collection and analysis to ensure accurate tax reporting and R&D credit compliance.1

I. Statutory and Legislative Mandate: The Adoption of Market-Based Sourcing

Idaho Code § 63-3027 governs how multistate or unitary corporations compute their Idaho taxable income, establishing rules for the allocation and apportionment of business income.3 The state’s recent legislative action significantly altered the method by which receipts are sourced, directly impacting the calculation of the R&D credit base.

I.A. The Foundation of Corporate Apportionment in Idaho

Historically, Idaho, like many states, followed a multi-factor formula, which included property, payroll, and sales factors (often with sales double-weighted).1 Effective retroactively to tax years beginning on or after January 1, 2022, Idaho adopted a Single Sales Factor (SSF) apportionment formula for most corporate taxpayers.1 This change makes the sales factor, or receipts factor, the default and often sole component determining the percentage of a corporation’s overall business income that is taxable in Idaho.6

The term “receipts” includes all gross receipts, net of returns and allowances, derived from transactions and activity conducted in the regular course of the taxpayer’s trade or business (apportionable income).5 This definition is central to the R&D credit base calculation. Taxpayers may elect to use the three-factor method only if they are electrical, telephone, and communications corporations, or if they are subject to specific Multistate Tax Commission (MTC) special industry regulations (e.g., construction contractors, airlines, financial institutions).6

I.B. Legislative Shift: H.B. 563 and the Role of (q) and (r)

House Bill 563 (H.B. 563), signed into law in March 2022, implemented the transition to both SSF and Market-Based Sourcing (MBS).1 The adoption of MBS replaces the older Cost of Performance (COP) standard for sourcing sales other than tangible personal property.1

While the full text of subsections (q) and (r) is often summarized in public guidance, these provisions fundamentally require that receipts derived from services and intangible property be sourced based on market principles. Receipts from the sale of a service are sourced to Idaho if and to the extent the service is delivered to a location in this state.8 Similarly, receipts from the rental, licensing, or leasing of intangible personal property are sourced to Idaho to the extent that the property is used within the state.5

The combined implementation of SSF and MBS by Idaho represents a calculated policy strategy. By eliminating the property and payroll factors in the apportionment calculation, the state minimizes the benefit a company receives for maintaining significant in-state production activity, such as substantial R&D operations. Simultaneously, the adoption of MBS for services and intangibles ensures that a company’s tax liability is now driven primarily by its customer base and market penetration within Idaho. For R&D-intensive companies based in Idaho but servicing national or global markets, this policy shift can increase their effective Idaho apportionment factor compared to the pre-2022 COP regime, where their production costs in Idaho would have driven up the numerator of the COP factor.1 This structural change confirms that Idaho’s tax policy prioritizes taxing sales market presence over taxing production presence.

II. Nexus to the Idaho R&D Tax Credit Calculation

The mandatory sourcing rules established under Idaho Code § 63-3027(q) and (r) are explicitly woven into the calculation mechanism for the Idaho R&D Tax Credit (I.C. § 63-3029G).

II.A. R&D Credit Structure and Base Calculation

The Idaho R&D tax credit is calculated as 5% of Qualified Research Expenditures (QREs) that exceed a calculated base amount, plus an additional 5% credit for basic research payments in excess of the base period amount (for corporations only).9 The computation closely aligns with the federal IRC § 41 methodology but is limited to Idaho-sourced activities and calculations.9

The credit calculation hinges on the determination of the Base Amount, which is computed using the following formula 9:

$$\text{Base Amount} = \text{Fixed-Base Percentage} \times \text{Average Annual Gross Receipts (AAGR)}$$

The AAGR is derived from the average of the taxpayer’s gross receipts for the four tax years immediately preceding the current tax year.9 A crucial limitation exists: the calculated Base Amount cannot be less than 50% of the current year’s Idaho QREs.9 Taxpayers may also elect to be treated as a start-up company, which allows them to use a specific fixed-base percentage (capped at 16%) regardless of whether they meet the specific requirements of IRC § 41(c)(3)(B).9

II.B. The Mandate for Idaho-Sourced Receipts in the Base

The statutes unequivocally require that the “gross receipts” used in the AAGR calculation must include only those receipts attributable to sources within Idaho, as strictly determined by Idaho Code § 63-3027(q) and (r).9

This requirement creates a historical discontinuity for R&D taxpayers. When calculating the AAGR for the current credit year, the taxpayer must apply the former Cost of Performance (COP) rules for tax years prior to 2022, and must rigorously apply the new Market-Based Sourcing (MBS) rules of § 63-3027(q) and (r) for 2022 and subsequent years.1 This methodological change means that if a company primarily conducts R&D in Idaho but sells its resulting services or licensed IP predominantly to customers outside the state, the application of MBS will result in significantly lower Idaho Gross Receipts reported in the AAGR for the post-2022 period.

This application mechanism can function to constrain the R&D credit benefit for companies that successfully service national or global markets from an Idaho R&D center. If the historical Fixed-Base Percentage (FBP, the ratio of QREs to gross receipts) is high due to a large R&D spend relative to Idaho sales, this high FBP, when multiplied by a lower AAGR (resulting from MBS pushing sales out of Idaho), may still result in a calculated base that is below the mandatory minimum base (50% of current QREs). Conversely, a high FBP combined with rapidly growing Idaho sales under MBS could significantly increase the Base Amount, thereby decreasing the pool of incremental QREs eligible for the 5% credit.9 Therefore, the proper application of the sourcing methodology is not merely a compliance issue but an integral factor in credit maximization.

Table 1 summarizes the impact of these sourcing rules on the R&D credit components.

Table 1: Idaho R&D Credit Base Calculation Components and Sourcing Impact

III. Idaho State Tax Commission Guidance: Detailed Application of Market-Based Sourcing (IDAPA)

The practical application of I.C. § 63-3027(q) and (r) is managed through the Idaho Administrative Code (IDAPA). The Idaho State Tax Commission publishes rules that provide detailed methods for assigning receipts, particularly concerning services (Rule 548) and intangible property (Rules 549 and 550).

III.A. Sourcing Receipts from Services (IDAPA Rule 548)

Rule 548 governs the sales factor sourcing for services under I.C. § 63-3027(13)(c). The fundamental general rule is that receipts from the sale of a service are sourced to Idaho to the extent that the service is delivered to a location in this state.7 The location of delivery is interpreted as the location of the taxpayer’s market, which is generally distinct from the location of the taxpayer’s employees or property.7

III.A.1. Professional Services Sourcing

Rule 548.04 specifically addresses professional services, defined as services of an intellectual or intangible nature, such as software development consulting, legal, financial, and accounting services—activities often central to R&D companies.7

The rule acknowledges the difficulty in characterizing the location of delivery for such services, requiring the location of delivery to be determined by reasonable approximation.7 The rules distinguish between customer types:

1. Individual Customers (B2C): Receipts are assigned to Idaho if the customer’s primary residence is known to be in Idaho. If the residence is not known, the customer’s billing address is used.7
2. Business Customers (B2B): For business customers, receipts are assigned based on the location of the customer’s operations to which the service primarily relates. If the service relates to the general operations of the customer, the receipts are sourced to the state(s) in which the related party has employees, proportional to the customer’s payroll in those states.7

For related party transactions involving professional services, the assignment relies on a strict hierarchy: if the service relates to specific operations in one or more locations, assignment is proportional to the related party’s payroll at those specific locations. If it relates generally to the entire business, the assignment is proportional to the related party’s total payroll in all states where they have employees.7

The administrative guidance explicitly states that when dealing with related-party customers, information relevant to the sourcing of receipts is imputed to the taxpayer, meaning the taxpayer is presumed to know where the related party receives the benefit, unless the taxpayer can demonstrate that such imputation of knowledge is unreasonable.7 This requirement places a significant data management burden on R&D contractors, necessitating that they secure or reasonably approximate detailed knowledge of their business customer’s operational structure (specifically employee location and payroll data). The failure to obtain verifiable external data required by Rule 548 poses a measurable audit risk related to the accuracy of the Idaho-sourced receipts used in the R&D AAGR base calculation.

III.B. Sourcing Receipts from Intangible Property (IDAPA Rules 549 & 550)

Receipts from intangible property, often generated by R&D activities, fall under two categories: licenses/leases (contingent payments) and outright sales (non-contingent payments).

III.B.1. License or Lease of Intangible Property (Rule 549)

If intangible property (such as software, patents, or trademarks) is licensed or leased, the gross receipts are assigned to Idaho to the extent that the property is used within the state.5

• Marketing Intangibles: Licensing fees for marketing intangibles (e.g., trademarks, franchises) are sourced to Idaho to the extent they are attributable to goods or services purchased by consumers located in Idaho.5
• Contingent Sales: Crucially for R&D firms with royalty streams, a sale of intangible property is treated as a license under Rule 549 if the receipts are contingent on the productivity, use, or disposition of the property.5

III.B.2. Sale or Exchange of Intangible Property (Rule 550)

Rule 550 covers sales where the transaction is treated as a sale of all substantial rights and the receipts are not contingent on productivity or use.5

• Geographic Intangibles: For contract rights or government licenses that authorize business activity in a specific geographic area, receipts are sourced to Idaho to the extent that the intangible property is authorized for use in the state.5
• Non-Contingent, Non-Geographic Sales (The Exclusion Rule): Sales of intangible property that are not contingent on productivity or use, and which do not relate to specific geographic authorization, are explicitly excluded from both the numerator and the denominator of the receipts factor.8 This exclusion is significant for companies that sell patents or other technology rights for a non-contingent lump sum. Excluding large, non-recurring lump-sum IP sales from the denominator of historical Gross Receipts can affect the Fixed-Base Percentage (FBP). Excluding such receipts results in a lower denominator for the FBP ratio (Historical QREs/Historical Gross Receipts), leading to a higher FBP. This calculation adjustment, dictated by I.C. § 63-3027 sourcing rules, significantly influences the calculated Base Amount and, thus, the incremental R&D credit availability.

Table 2: Idaho Market-Based Sourcing Summary for Non-Tangible Receipts

IV. Practical Example: Calculating the R&D Base Under Market Sourcing

The following example illustrates the consequence of applying the sourcing rules under I.C. § 63-3027(q) and (r) when determining the R&D credit base.

IV.A. Hypothetical R&D Scenario: InnovateSoft Corp.

InnovateSoft Corp. is an Idaho-based C-corporation whose primary business is selling software subscriptions, which are sourced as services/licenses under Rules 548/549. All of the corporation’s current QREs of $1,500,000 are performed exclusively in Idaho.9

IV.B. Sourcing Receipts Under the Two Methodologies

To determine the AAGR, InnovateSoft must correctly source the gross receipts for the four preceding tax years (2020 through 2023), applying COP for pre-2022 years and MBS (I.C. § 63-3027(q) and (r)) for 2022 and 2023.

IV.C. Calculating the Base Amount and Tax Credit

Step 1: Calculate Average Annual Gross Receipts (AAGR)

$$\text{AAGR} = \frac{\$18,400,000}{4} = \$4,600,000$$

Step 2: Calculate the Base Amount

$$\text{Calculated Base Amount} = \text{FBP (10.00\%)} \times \text{AAGR (\$4,600,000)} = \$460,000$$

Step 3: Apply the Minimum Base Check

The minimum base amount is 50% of the current year’s QREs 9:

$$\text{Minimum Base} = 50\% \times \$1,500,000 = \$750,000$$

Since the Minimum Base Amount $(\$750,000)$ is greater than the Calculated Base Amount $(\$460,000)$, the Final Base Amount used is $\$750,000$.

Step 4: Calculate the Idaho R&D Tax Credit

$$\text{Excess QREs} = \text{Current QREs (\$1,500,000)} – \text{Final Base Amount (\$750,000)} = \$750,000$$

$$\text{Idaho R\&D Tax Credit} = 5\% \times \text{Excess QREs (\$750,000)} = \$37,500$$

The transition to Market-Based Sourcing, which significantly reduced the Idaho-sourced AAGR, resulted in the minimum base requirement controlling the credit calculation in this instance. Had the company mistakenly used the old COP methodology for all four years (yielding an AAGR of $\$8,000,000$ and a calculated base of $\$800,000$), the resulting credit would have been lower $(\$35,000)$, demonstrating that accurate MBS application is essential for maximizing the credit benefit, even when the minimum base applies.

V. Strategic Implications for Multistate Corporations

The implementation of Idaho Code § 63-3027(q) and (r) creates significant compliance and strategic planning considerations for multistate companies, particularly those with substantial R&D investments in Idaho.

V.A. Data Management and Compliance Requirements

The switch to MBS mandates a rigorous, data-driven approach to sourcing. R&D-intensive companies can no longer rely on simple cost allocation methods. They must invest in or leverage infrastructure capable of granularly tracking where services are consumed and where licensed intangible property is used.7

For professional services rendered to business customers, the rules effectively require the taxpayer to map the benefit of the service to the customer’s internal operations, often requiring payroll data as a proxy for market location.7 This means the taxpayer must possess, or be able to defensibly approximate, detailed information about the customer’s operational footprint to accurately source receipts for the AAGR base. Without meticulous documentation justifying the market location for every non-tangible receipt, the accuracy and defensibility of the entire R&D credit base calculation are exposed to audit challenge.

V.B. Planning for Intangible Property Sales

The specific IDAPA rules concerning intangible property sales and licensing offer a unique planning dimension. The statutory exclusion of non-contingent, non-geographic IP sales from both the numerator and the denominator of the sales factor requires careful verification.8 For transactions completed in prior base years (2022 onward), this exclusion can alter the calculated historical FBP, which in turn affects the current year’s Base Amount. Companies must review their historical IP sales to ensure they have properly excluded non-apportionable receipts when calculating the denominator of the FBP, thereby ensuring the R&D credit mechanism functions as intended under the new sourcing regime.

V.C. Conclusion

Idaho Code § 63-3027(q) and (r) establish Market-Based Sourcing as the definitive methodology for determining Idaho-sourced gross receipts derived from services and intangible property. This requirement forces R&D taxpayers to integrate complex, customer-centric sourcing data into the historically sensitive calculation of the Average Annual Gross Receipts base, which underpins the Idaho R&D tax credit.

Compliance necessitates abandoning historical production-based sourcing assumptions and embracing robust data collection to verify the location of customer benefit and IP use. For R&D corporations, the proper application of MBS rules is crucial, as the sourcing outcome directly dictates the magnitude of the AAGR, potentially minimizing the incremental QREs eligible for the state credit or, in specific scenarios, forcing the reliance on the minimum base threshold. Consequently, multistate corporations must perform specialized analysis to ensure that both their apportionment factor and R&D credit calculation conform precisely to Idaho’s updated market-based requirements.

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