How does a prepaid debit card company apportion its Colorado income from card sales and transaction fees — by cost of performance or by market?

Plain-English summary

A nationwide marketer and processor of prepaid debit cards (general-purpose reloadable cards, gift cards, hybrids — all carrying Visa or MasterCard marks, issued through third-party banks) asked how to apportion its Colorado income. Its money comes from a small fulfillment fee when a card is sold, plus a large volume of transaction fees: interchange fees, monthly service fees, account-maintenance fees, lost/stolen-card fees, balance-inquiry fees, transfer fees, and check fees. Its headquarters, employees, and proprietary processing systems are outside Colorado.

The key question was which apportionment regime applies. The default for service income is cost of performance — sourcing income to where the company incurs the costs of performing the service, which here would point mostly out of state. But Colorado, like most states, gives financial institutions a different, market-based rule (§ 39-22-303.5(7)(a)): their income is apportioned to where the market is, not where the work is done. For credit-card operations that means sourcing to the cardholder's billing address or the merchant's location, not the company's infrastructure.

The Department concluded the company is a financial institution. Even though it isn't a bank, it fits the catch-all in the Financial Institution Regulation, subsection (h)(10): a business that derives more than 50% of its gross income from activities a financial institution is authorized to transact. The company's debit-card operations and fee structure are "substantially the same" as a bank's credit-card operations (interchange, account fees, etc.). The Department acknowledged the regulation doesn't specifically mention debit/prepaid cards and that they differ slightly from credit cards (the cardholder's own funds are on deposit), but found those differences didn't justify a different method — and noted other states source debit/prepaid card income the same way as credit-card income.

How each fee is sourced:

• Fulfillment fees → the state where the card was sold to the cardholder.
• Interchange fees → the state where the merchant is located at the time of the cardholder's purchase.
• Service, account-maintenance, lost/stolen-card, balance-inquiry, account-to-account transfer, and check fees → the state of the cardholder's billing address.

This market-sourcing approach for financial institutions runs through the Department's later FI rulings — see [[plr-13-001]] (a financial institution granted a deposits-factor market proxy) — and contrasts with [[plr-15-006-apportionment-of-corporate-income-tax]], where a debt buyer was held not to be a financial institution and so was sourced as an ordinary service provider.

What this means for you

Card programs, payment processors, and fintech companies

If more than half your gross income comes from activities a financial institution is authorized to transact, Colorado may treat you as a financial institution regardless of whether you're a chartered bank — which flips your apportionment from cost-of-performance to market sourcing. For card businesses, that means your Colorado income tracks where your cardholders and the merchants are, not where your headquarters and servers sit. That can substantially raise or lower your Colorado tax depending on your customer geography.

Practical sourcing of card revenue

Build systems that can tie each fee type to the right market location: card-sale location for fulfillment fees, merchant location for interchange, and cardholder billing address for the recurring account/service fees. The company here couldn't yet track transactional fees state-by-state — that data gap is the practical compliance burden this ruling creates.

Accountants and tax professionals

The gating test is the >50% gross-income catch-all in the Financial Institution Regulation subsection (h)(10), § 39-22-303.5(7)(a). Once met, apply market sourcing by fee type as above. Watch the timing: this ruling spans the 2009 shift to single-factor apportionment, and the Department was then still using the FI regulation's receipts-factor method in the interim. Contrast the "not an FI" outcome in [[plr-15-006-apportionment-of-corporate-income-tax]].

Common questions

Q: Is a prepaid/debit card company a 'financial institution' for Colorado apportionment? A: It can be. The Department found this one qualified under the catch-all for businesses earning more than 50% of gross income from activities a financial institution is authorized to transact, because its card operations work like a bank's credit-card operations.

Q: Why does that classification matter?
A: It changes apportionment from cost-of-performance (where the work is done) to market sourcing (where the customers and merchants are). For an out-of-state card company, that can shift a lot of income into or out of Colorado.

Q: Where is each fee sourced?
A: Fulfillment fees to where the card was sold; interchange fees to the merchant's location at purchase; and service, maintenance, lost/stolen, balance-inquiry, transfer, and check fees to the cardholder's billing address.

Q: Can other taxpayers rely on this ruling?
A: No. A private letter ruling binds the Department only as to the specific taxpayer and facts to which it was issued.

Citations and references

Statutes and rules:

• § 39-22-303.5, C.R.S. (single-factor apportionment; cost-of-performance sourcing of services)
• § 39-22-303.5(7)(a), C.R.S. (special apportionment for financial institutions)
• 1 CCR 201-3, Financial Institution Regulation, subsection (I)(2)(h)(10) (>50% of income from financial-institution activities)
• § 39-22-303 and § 24-60-1301, C.R.S. (pre-2009 two/three-factor election)

Related rulings:

• [[plr-13-001]] — financial institution granted a deposits-factor market proxy for investment receipts
• [[plr-15-006-apportionment-of-corporate-income-tax]] — debt buyer held NOT a financial institution; sourced as a service provider

Source

• Landing page: Colorado All Letter Rulings
• Original PDF: PLR-09-002.pdf

Original ruling text

Office of Tax Policy
P.O. Box 17087
Denver, CO 80217-0087
[email protected]

PLR-09-002
March 25, 2009

XXXXXXXXXXXXXXXX
Attn: XXXXXXXXXXXX
XXXXXXXXXXXXXXXX
XXXXXXXXXXXXXXX
Re: XXXXXXXXXXX
Dear XXXXXXXXXXX,
You submitted a request for a private letter ruling on behalf of your client, XXXXXXXXX Corporation (“Company”). This letter constitutes the Department ruling. Issue How should the Company apportion its income that is derived from various sales revenues and transactional fees generated in connection with prepaid debit cards? Background The Company is a marketer and processor of prepaid debit cards and prepaid debit card services throughout the United States. The Company’s network includes more than XXXXXXX retailers, check cashing locations and supermarkets. Independent agency agreements are executed between the Company and its retailers / distributors. The Company uses a combination of proprietary digital processing, new account representatives and customer service representatives to deliver services to customers. All debit cards are issued by third party banks, with the Company acting as an authorized independent sales organization of these banks. The Company’s core products include general purpose reloadable cards (GPR”), gift cards, and XXXXXXXXX [brand name] cards. GPRs operate like bank debit products. Money can be deposited onto the card by direct deposit, at a terminal or retail location, through a personto-person payment, or online. Gift cards hold a pre-configured amount of money and cannot be reloaded. XXXXXXX [brand name] cards are a hybrid between GPR and gift cards; they can only be reloaded up to three times. All cards carry the Visa or MasterCard acceptance marks.

The Company derives income from a variety of fees charged in connection with the issuance and subsequent use of the prepaid cards. The card is issued for a set amount, otherwise known as a fulfillment fee. Once money is loaded onto the card, various transaction fees are collected. These transactional fees include interchange fees, (signature fees and PIN purchase fees), monthly service fees, account maintenance fees, lost or stolen card fees, convenience fees, and balance inquiry fees. The Company’s transactional fees account for a majority of total revenues whereas the fulfillment fees account for a relatively small portion of total revenue. The Company tracks card sales (e.g., fulfillment fees) on a state-by-state basis according to the location of the transaction. The company’s transactional fees are not currently tracked on a state-by-state basis because the systems have not been created to allow for such tracking. The Company’s corporate offices and headquarters are based in XXXXXXXX [a state other than Colorado]. The majority of the company’s employees are stationed at the company’s headquarters. In addition, the Company maintains an inventory of its debit cards throughout the United States. These debit cards are manufactured by various vendors and shipped to the Company’s main distribution warehouses. The cards are stored in the warehouses until they are needed and shipped to retailers throughout the country. The Company holds legal titled to the inventory during the entire distribution process. The Company employs regional account managers, located in XXXXXXXX states, who solicit business from new distributors and maintain relationships with existing distributors. The account managers educate and train distributor’s employees, set sales goals for distributors, ensure that the distributors have the correct point of sales, and assist the distributor with the marketing of the Company’s cards. The Company generates revenue from the following transactions in the ordinary course of business:

1. Sale of debit cards. (GPR cards, gift cards, XXXXXXXXXXX [brand name] Cards, etc.).
   The card is issued for a set amount, otherwise known as the fulfillment fee.
2. Transactional Revenue.
   a. Interchange Fees. (“Signature fees” and “PIN purchase fees”). These fees are charged by the issuing bank to the merchant’s bank for processing the cardholder’s purchase transaction. The purchase transactions are processed by third-party processors (e.g., XXXXXXX). These third party processors are located in various states and perform the processing services in various locations. The Company receives a portion of this interchange fee from the issuing bank pursuant to a revenue sharing agreement. b. Service Revenue. The maintenance of the cardholder’s account is controlled by the Company’s proprietary digital processing intellectual property and the Company’s employees who are located in XXXXXXXXXX[a state other than Colorado]. The Company charges cardholders various service fees associated with the maintenance and use of outstanding cards. The typical service fees include the following: i. Service Fee (per transaction or monthly) – charged each time the card is used. Alternatively, the customer can pay a monthly service fee that 2

allows for multiple transactions (rather than paying a fee on a per transaction basis). ii. Account Maintenance fees – charged for each reloadable card with an inactive balance exceeding 90 days. Gift card accounts are charge an account maintenance fee for inactive account balances exceeding 6 months. iii. Lost or stolen card fees – charged for replacing a lost or stolen card. iv. Balance inquiry fee –charged for inquiring into the balance of their account. v. Account-to-account transfer fee –charged for transferring funds from one Company cardholder account to another. vi. Check fee –charged for issuing a check to close an account.

Discussion.
For tax years beginning on or after January 1, 2009, a corporation that derives income from sources within and outside Colorado must allocate and apportion its income pursuant to the single factor apportionment methodology set forth in §39-22-303.5, C.R.S. In general, this methodology apportions business income based on the source of the corporation’s sales.1 Income derived from services is sourced between and among the state(s) in proportion to the amount of costs incurred in each state where the services are performed. There are certain exceptions to this general “cost of performance” rule. Colorado, as is true of many other states, has special apportionment and allocation rules for certain industries. One such exception is for financial institutions.2 Income generated by financial institutions is apportioned based on the location of the market exploited by the taxpayer and not where the costs of performance are incurred. More specifically, income generated by credit card operations of financial institutions is apportioned between and among states based on the billing address of the cardholder or the commercial domicile of the merchant, and not on the

1 For tax years beginning before January 1, 2009, a corporation had an election to apportion and allocate

income using either a two-factor (revenues and property factors) or three factor (receipts, payroll, and property) methodology. §39-22-303, C.R.S. and §24-60-1301, C.R.S. 2 Colorado, as is true of most other states, adopted the Multi-state Tax Commission’s financial institution regulation that uses the “market” approach to apportioning income for financial institutions. Colo. Code Regs. 1 CCR 201-3, p. 37 Financial Institution regulation. This regulation uses the familiar three factor (receipts, payroll, and property) methodology and applies to tax years beginning before January 1, 2009. As noted above, Colorado recently enacted a single factor apportionment approach for tax years beginning on or after January 1, 2009. The department is in the process of modifying the current financial institution regulation to be consistent with the new single factor methodology. In the interim, the department uses the receipts factor methodology of the current regulation for apportioning income of financial institutions.

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location of the infrastructure and labor costs incurred by the taxpayer to provide those credit card services.3 The principal issued raised by your request is whether the Company fairly falls within the regulation governing financial institutions. Financial institutions are, among other entities, banks and thrift institutions, savings and loans associations, corporations that generate fifty percent or more of their income from finance leases, and, importantly, “[a]ny other person or business entity, other than an insurance company taxable under C.R.S. 10-3-209, which derives more than fifty percent (50%) of its gross income from activities that a person described in subsections (2) through (7) and (9) above is authorized to transact.” Department regulation 1 CCR 201-3(I)(2)(h)(10); § 39-22-303.5(7)(a), C.R.S. Most banks engage in credit and debit card operations and those operations include a variety of services and related charges, including:

1. Reimbursement fees to a merchant’s bank because one of the persons to whom the
   taxpayer bank has issued a credit card has charged merchandise or services to the credit card.
2. Interest and fees or penalties in the nature of interest from credit card receivables and
   receipts from fees charged to card holders, such as annual fees.
3. Net gains from the sale of credit card receivables.
4. Receipts from merchant discounts, which are the fees (or negotiated discount) charged
   to a merchant by the taxpayer bank for the privilege of participating in a program whereby a credit card is accepted in payment for merchandise or services sold to the card holder. The Company’s debit card operates and generates fees in substantially the same manner as credit card operations. The Company issues debit cards, which carry either the Visa or MasterCard acceptance marks. Cardholders use these cards to purchase goods and services from merchants. A merchant extends credit to a cardholder subject to the purchase clearing through the various financial institutions. The merchant’s financial institution issues the merchant a credit to its account. The merchant’s financial institution, in turn, is reimbursed by the issuing financial institution with which the Company has an agreement. The issuing financial institution charges the merchant’s bank an “interchange fee” for processing the cardholder’s purchase. The Company is paid a percentage of the interchange fee. The Company’s debit card operations are substantially the same as the operations of a credit cards operation of other financial institutions. Moreover, the fees the Company charges cardholders are similar to the fees typically charged to credit cardholders. Financial institutions that issue credit cards often receive interest 3 A number of states treat credit card service operations as operations of a financial institution.

Hellerstein & Hellerstein: State Taxation, Part IV, Chapter 10, ¶10.06. Compare, Conn. Gen. Stat. § 12218(j) (credit card fees apportioned based on billing address of cardholder); Ind. Code §6-5.5-4-8 (apportioned to billing address of cardholder); Kan. Stat. Ann. § 79-1130; Utah Department of Revenue Regulation R8656F-32B and 32C; Va. Code § 58.1-418 (financial corporation is an entity that receives fees, commissions, and other compensation for financial services, including credit card operations); Wis. Admin. Code Tax 2.49(4)(g)-(j) (substantially same rule as Colorado regulation for apportionment of income for financial institutions). 4

revenue from the cardholders based on the amount of credit extended, charge annual membership fees, charge fees for issuing checks on closed accounts, charge for transfers of funds between accounts, and charge fees for a variety of related services. The Company charges fees that are substantially the same as those of other financial institutions. For these reasons, the Company fairly falls within subsection (h)(10) of the financial institution regulation.4 We acknowledge that the existing financial institution regulation does not specifically address debit card or prepaid card operations. We also acknowledge that debit and prepaid cards operate somewhat differently than credit cards.5 However, the differences do not suggest that a fundamentally different apportionment methodology is warranted. We also note that it appears that the few states which have specifically addressed apportionment of income from debit or pre-paid card operations have apportioned this income in the same manner as income from credit card operations.6 Turning to the various fees outlined in your request, income from these fees should be sourced as follows:

1. Fulfillment fees are sourced to the states in which the sale of the card to the cardholder
   occurred.
2. Interchange fees are sourced to the states where the merchant is located at the time of
   the purchase by the cardholder.
3. Service fees, account maintenance fees, lost or stolen card fees, balance inquiry fees,
   account-to-account transfer fees, and check fees are sourced to the states in which the cardholders’ billing addresses are located.

Miscellaneous
This ruling is premised on the assumption that the Company has completely and accurately disclosed all material facts. The department reserves the right, among others, to independently evaluate the Company’s representations. This ruling is null and void if any such representation is incorrect or incomplete and has a material bearing on the conclusions reached in this ruling. Enclosed is a redacted version of this ruling. Pursuant to statute and regulation, this redacted version of the ruling will be made public within 60 days of the date of this letter. Please let me know in writing within that 60 day period whether you have any suggestions or concerns about this redacted version of the ruling. Sincerely,

4 Compare, Indiana Letter of Finding No. 04-0430, 10/01/2005 (company that provided marketing, data processing, and administrative services related to credit cards is a financial institution for purposes of apportionment of income regulation. 5 Unlike credit cards, a debit and pre-paid cardholder has funds on deposit with a financial institution and from which the cardholder’s purchase is debited. 6 Indiana Commissioner’s Directive 14, 08/20/1990; Wis. Admin. Code Tax 2.49(2)(d) Apportionment of apportionable income of interstate financial institutions.

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Office of Tax Policy
Colorado Department of Revenue

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