What’s the opposite of market sourcing?

Market-based sourcing refers to the method of determining where sales or revenues are attributed for tax purposes based on where the customer receives the benefit of the service. In this method, income is taxed in the state or jurisdiction where the service is consumed, rather than where the service is performed. This approach is commonly used in state income tax apportionment, especially in industries like consulting, software, and digital services, where customers and service providers are often located in different region.

Market-based sourcing is used primarily by state tax authorities and businesses in the context of tax apportionment. Many U.S. states, especially those dealing with digital services, remote work, or e-commerce, have adopted market-based sourcing to determine where companies should pay taxes based on where their customers are located or where services are consumed. Industries like software, consulting, and digital marketing, where services are delivered across state lines, commonly follow this approach for tax purposes to allocate revenue more fairly across jurisdictions.

Market-based sourcing is primarily a tax apportionment method used by the public sector (states and tax authorities) to determine where businesses should pay taxes based on where their customers are located. However, it indirectly affects private sector businesses, especially those operating in multiple states or providing services remotely, as they need to comply with state tax laws. While private companies don’t use market-based sourcing for their internal operations, they must follow it for tax compliance and reporting to various state tax authorities.

The downside of market-based sourcing lies in its complexity and potential unfairness for certain businesses. It can be difficult to determine where the “benefit” of a service is received, especially in cases involving multi-state transactions or digital services. This ambiguity can lead to disputes between states over tax jurisdiction, resulting in potential double taxation or under-taxation. Additionally, the method may favor states with larger customer bases, disadvantaging smaller states where services are actually performed but not taxed as heavily.

The opposite of market-based sourcing is cost-of-performance sourcing. In this method, revenue is allocated to the state or jurisdiction where the service was performed, regardless of where the customer is located or where the benefit of the service is received. In cost-of-performance sourcing, the focus is on where the work or service provider is physically located, and revenue is taxed based on the provider’s location rather than the customer’s. This method is commonly used in industries with more localized services.

The downsides of cost-of-performance sourcing include its complexity and lack of fairness in a digital economy. Since this method taxes revenue based on where the service provider is located, it can create discrepancies, especially when services are consumed in different states or globally. This can lead to tax avoidance strategies, where businesses relocate to low-tax jurisdictions despite serving customers elsewhere. Additionally, it may under-tax businesses that provide remote or digital services, causing states to lose revenue from services consumed by their residents.