How should a debt-collection company that buys charged-off receivables apportion its income when it fits none of Colorado's standard receipt categories?

Plain-English summary

A company buys charged-off (defaulted) receivables at a deep discount and collects on them, mostly through a national network of affiliated law-firm "branch offices." It is commercially domiciled in Colorado but operates in many states. The problem: its collection revenue fits none of Colorado's standard receipt categories, and it had been apportioning nearly 100% of its income to Colorado (building up large Colorado net operating losses) by treating its revenue like gain on intangibles or interest — both of which source to commercial domicile. It asked how it should really apportion.

The Department worked through the options:

• Not a financial institution. Special Regulation 7A's industry rules don't apply. The company doesn't handle financial transactions or provide financial services; it merely buys and collects loans others originated. It's also not a registered bank/thrift, not organized for foreign banking, not a production credit association, and doesn't get more than 50% of gross income from finance leases. (And even if it qualified, 7A has no sourcing rule that fits its income.)
• Not gain from the sale of intangibles. Yes, the company bought an intangible (the receivables), but the income comes from the debtor performing its payment obligation — not from the company selling the receivable.
• Not interest income. Interest is pay for the time value of money; here the majority of collections is repayment of principal, not interest. (Any genuine interest piece would source to commercial domicile, but the Department assumed that's a small share.)
• It's most like a service provider. Even though a service provider normally sells services to a third party, and here the company "consumes" its own collection service, its activity is closest to a service. So it should apportion gross receipts by the cost of performance — where the cost to perform the service is incurred — which reflects its multi-state operations far better than commercial domicile.

Because the company lacked cost records for prior years, the Department allowed it to use current-year cost-of-performance results to revalue the proportionate Colorado NOLs, if it represents that its operations haven't substantially changed. A footnote flags that the Department intended to amend the service-provider rule (or create a debt-collection special regulation); if adopted, the company must follow it prospectively. As a PLR, this binds the Department only for this company.

For other corporate apportionment rulings, see [[plr-17-009-treatment-of-gain-realized-from-the-sale-of-ownership-interest-in-an-l]] and the mixed-method combined-group analysis in [[plr-17-001-apportionment-of-income-on-a-combined-report]].

What this means for you

Debt buyers and collection businesses

If your revenue comes from collecting purchased receivables, Colorado likely treats you as a service provider, not a financial institution — and cost-of-performance sourcing, not commercial domicile, governs. That can dramatically cut the share of income apportioned to your home state if your collection work happens elsewhere.

Companies that don't fit a standard receipt category

When your receipts aren't a clear sale of TPP, interest, or gain on intangibles, Colorado looks for the closest analog. Don't default to commercial-domicile sourcing just because it's simplest — that can over-apportion income to your home state (and the resulting "benefit" of big home-state NOLs may be wrong).

Accountants and tax professionals

The ruling rejects financial-institution treatment (Special Reg 7A definition unmet), rejects gain-on-intangible and interest characterizations, and lands on service-provider / cost-of-performance sourcing. Watch for the rule change the Department signaled (service-provider rule amendment or a debt-collection special reg), which would apply prospectively. Current-year cost data can revalue prior NOLs only if operations are unchanged.

Common questions

Q: Is a company that buys and collects charged-off debt a "financial institution" for Colorado apportionment?
A: No. It doesn't handle financial transactions or provide financial services, isn't a registered bank, and doesn't earn over 50% from finance leases, so the financial-institution rules don't apply.

Q: Is collection revenue interest income or gain on selling an intangible?
A: Neither. The income comes from debtors paying (mostly principal), not from selling the receivable, and it's mostly principal rather than interest.

Q: How should the company apportion, then?
A: As a service provider — sourcing gross receipts by the cost of performing the service, not by commercial domicile.

Q: Can my company rely on this ruling?
A: No. A private letter ruling binds the Department only for the taxpayer and facts it was issued to and cannot be relied upon by anyone else.

Citations and references

Statutes and rules:
- § 39-22-303.5, C.R.S. (single-sales-factor apportionment; general sourcing); (4) (classes of receipts); (7)(a) (special industry rules)
- 1 CCR 201-2, Rule 39-22-303.5.4(C) (sourcing rules)
- 1 CCR 201-3, Special Regulation 7A (financial institutions — definition not met)
- 1 CCR 201-1, Rule 24-35-103.5 (private letter ruling procedure)

Source

• Landing page: https://tax.colorado.gov/all-letter-rulings
• Original PDF: https://tax.colorado.gov/sites/tax/files/documents/PLR-15-006.pdf

Original ruling text

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

PLR-15-006
June 8, 2015
XXXXXXXXXX
Attn: XXXXXX
XXXXXXXXXX
XXXXXXXXXX
Re: Apportionment of Corporate Income Tax
Dear XXXXXXXXX
You submitted on behalf of XXXXXXXXXXXXXXXXXXX ("Company") a request for a
private letter ruling to the Colorado Department of Revenue ("Department") pursuant to
Department Rule 24-35-103.5. This letter is the Department's private letter ruling.
Issue
How should Company apportion their income when it does not squarely fit into existing
apportionment methodologies?
Conclusion
Company should consider itself a service provider and apportion its gross receipts based
upon where the cost to perform the service is incurred.
Background
Company has its commercial domicile in Colorado. Its primary business is the acquisition,
management, and collection of charged-off consumer and commercial accounts
receivable, which are purchased from other financial institutions, finance and leasing
companies, and other issuers. Charged-off accounts receivable are defaulted accounts
receivable that credit issuers have charged-off as bad debt, but that remain subject to
collection. Typically, Company buys entire groups of accounts, or debt portfolios, in order
to mitigate risk within its business model. Fresh charged-off credit card and consumer loan
receivables are generally 180-210 days past due at the time of purchase and typically
have not been subject to previous collection attempts by a third-party collection agency.
The act of charging-off an account is an action required by banking regulations and is an
accounting action that does not release the obligor on the account from his or her
responsibility to pay amounts due on the account.

Because the credit issuer was unable or unwilling to collect the charged-off receivables
that Company purchases, Company is able to acquire the debt portfolios at a substantial
discount to their face value. Company's primary source of revenue is recognized on the
portfolio base of purchased debt assets which are driven primarily by cash proceeds from
voluntary, judicial and nonjudicial collections.
Once the charged-off receivables are acquired, the accounts are placed for collection with
one of Company's affiliated but independently-owned third-party law firms, to which
Company refers as its "branch offices". The branch offices are located across the country
and have agreed to work exclusively for Company to collect upon the accounts that are
placed with them. Each branch office has an executed detailed agreement that provides
the legal structure for the relationship with Company, including its right to use Company's
integrated account management system software used to maintain and collect upon
accounts. To a much lesser extent, Company also utilizes specialized non-affiliated third­
party collection firms throughout the United States. It also employs a small number of
collectors focused exclusively on commercial collections. Under the terms of Company's
contractual arrangements, the branch offices license Company's proprietary technology
and perform recovery work on Company's behalf in accordance with its required policies.
Company is under no obligation to provide accounts to any branch office. It pays its
branch offices a fee, which varies based upon their performance against Company's return
assumptions and is subject to adjustment based upon the performance against its
operational standards. Accounts are allocated to branch offices based on the capacity,
geographic coverage, their performance against return expectations, and adherence to the
aforementioned operational requirements.
Effective January 2, 2013, the Consumer Financial Protection Bureau ("CFPB") has
assumed direct regulatory oversight of the debt-purchasing and collection industry
including supervisory jurisdiction over large market participants, defined as having over
$10 million in annual receipts. The CFPB specifically supervises banks, credit unions, and
other financial companies and also enforces federal consumer financial laws. Company is
subject to regulatory oversight by the CFPB. In 2013, the CFPB exercised its regulatory
authority over Company by conducting and on-site examination at Company's headquarter
location.
Company has historically apportioned one hundred percent of its operating revenue to
Colorado. Company's filing treatment has been based on the conclusion that while its
collection revenues do not fall with any of the enumerated classes of receipts in section
39-22-303.5(4), C.R.S., Company is most akin to either gains from sales of intangible
property or interest income. Thus, Company has apportioned its "sales" based on
commercial domicile (Colorado), which is the sourcing standard for both classes of
revenue. This treatment resulted in the build-up of significant Colorado net operating
losses, computed using a near one hundred percent Colorado apportionment factor.
Company has reviewed its apportionment methodology and concluded that it is not correct
because it operates in many states. Company does not believe the collection of revenue
constitutes either interest income or gains from the sale of intangible property, and, thus,
does not squarely fall within any of the enumerated categories of receipts under the
standard taxpayer apportionment provisions. For these reasons, Company believes the
most logical approach to apportioning Company's collection revenue is through the use of
the special apportionment regulation applicable to financial institutions.
2

OR 4010A (06/11/14)

Discussion
If a legal entity has sources of income from both inside and outside Colorado, the entity
must allocate and apportion its income among the relevant states. Colorado has adopted
the single-sales factor apportionment methodology to apportion business income.1 This
methodology uses general sourcing rules for various types of income.2 However, Colorado
recognizes that these sourcing rules may not be suited for certain types of business3 and,
therefore, the Department adopts by regulation apportionment and allocation rules for
certain industries, including financial institutions.4
We first consider whether Company is a financial institution. Financial institutions are
commonly understood to be institutions that handle financial transactions and provide
financial services such as investments, loans, and deposits. Company does not handle
financial transactions nor does it provide financial services. Rather, Company purchases
charged-off financial services (loans) originated by a financial institution and strives to
collect on such purchased loans. The fact that financial institutions can and do collect on
loans and credit card receivables does not automatically qualify Company as a financial
institution. Company appears not to be a financial institution because it does not handle
financial transactions and does not provide financial services to customers.
Moreover, Company is not registered under state or federal law as a bank, saving
association or thrift institution; Company is neither organized for the purpose of engaging
in international or foreign banking or other international or foreign financial operations nor
an agency or branch of a foreign depository; Company is not a production credit
association; and Company does not derive more than fifty percent of its total gross income
from finance leases; thus, Company does not meet the definition of a financial institution in
1 CCR 201-3 Special Regulation 7A, is not considered to be a financial institution, and is
unable to allocate and apportion its income based upon the financial institution sourcing
rules.5
We next turn to the general sourcing rules. There are three sourcing rules that must be
considered, 1) gain or loss from the sale of intangibles, 2) interest income, and 3) revenue
from services performed in Colorado. The Department agrees that Company should not
apportion its income as gains or losses from the sale of intangible property. Gain from the
sale of intangibles arises when the asset is sold to a third party. Although Company
bought an intangible (i.e., accounts receivables), the income is not generated from the
sale of the intangible property. Instead, the income is generated from the performance by
the debtor of its payment obligations.
Moreover, this income is not interest income. Interest income is income paid for the time­
value of money. The majority of Company's income is generated from the payment of the
principal on debt obligations. Although some of the payments to the Company may reflect
1
2

§ 39-22-303.5, C.R.S.

§ 39-22-303.5, C.R.S. and 1 CCR 201-2, 39-22-303.5.4(C).
§ 39-22-303.5(7)(a), C.R.S.
4
1 CCR 201-3, Special Regulation 1A- SA
3

5

3

Even if Company were to meet the definition of a financial institution, there are no sourcing
rules within the financial institutions special regulation that are specifically applicable to
Company's income.
DR 4010A (06/11/14)

interest6, the majority of income is the repayment of the principal debt. Thus, neither of
these two sourcing rules apply to Company.
The third sourcing rule we consider is that relating to services rendered in Colorado.
Revenue from services is sourced to the place where the service is performed. Company
engages law firms and other similar service-related industries to generate income from
delinquent debt. Company also has staff in its headquarters who perform services that
generate the income. The Department acknowledges that characterizing Company as a
service provider is unusual because a service provider typically generates income by
selling its services to a third-party7 Here, Company is engaging in a service that it
consumes. However, the activities engaged by Company are most closely related to a
service provider. The service rule reflects Company's gross receipts better than other rules
available because it is based on the proportionate cost of performance rather than solely
where Company's commercial domicile is located. Finally, although attenuated, there is a
service being performed by Company to the sellers of the charged-off debt in the form of
creating a market for the underlying debt to be purchased if the debt is charged-off by the
seller. For these reasons, we rule that Company should use the rules relating to service
providers when apportioning its income.
If Company does not have cost records for previous tax years to substantiate where
Company's cost of performance took place, Company may use its current cost of
performance results to determine the proportionate Colorado net operating losses. In order
to use the current year's cost of performance results, Company must represent that the
operating facts of Company's business have not substantially changed from the periods
for which Company will revalue the net operating losses.
Miscellaneous
This ruling is premised on the assumption that Company has completely and accurately
disclosed all material facts. The Department reserves the right, among others, to
independently evaluate Company's representations. The ruling is null and void if any such
representation is incorrect and has a material bearing on the conclusions reached in this
ruling and is subject to modification or revocation in accordance to Department Regulation
24-35-103.5.
This ruling is binding on the Department to the extent set forth in Department Regulation
24-35-103.5. It cannot be relied upon by any taxpayer other than the taxpayer to whom the
ruling is made.
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.

6

To the extent Company's income does reflect interest income, such income should be sourced
under the interest income sourcing rules (commercial domicile); however, the Department
assumes that most of Company's income is not from such source.
7
The Department intends to propose a modification to the service provider rule to make clear
that the service provider sourcing rule can include entities whose services generate income or
create a special regulation for the debt collection industry. If such amendment or new regulation
is adopted, Company must prospectively follow the guidance adopted by the Department in
regulation for the tax year in which the regulation becomes effective.

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DR 4010A (06/11/14)

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,

Office of Tax Policy
Colorado Department of Revenue

5

DR 4010A (06/11/14)