Tennessee Issues Guidance on Franchise and Excise Tax Sourcing for Drop Shipments

Tennessee Revenue Ruling No. 24-12 provides guidance on sourcing sales for franchise and excise tax purposes when the taxpayer, a manufacturer, sells specialty products through third-party merchants ("Merchants") to end users located in Tennessee and other states. Although the Taxpayer is not based in Tennessee, its products are distributed through Merchants, who handle order intake, billing, and regulatory compliance. The Taxpayer contracts with a third-party logistics provider to fulfill orders, and products are shipped from a regulated temperature-controlled facility in Tennessee to end users.

The Taxpayer retains ownership of the products until delivery to the end user, at which point title and risk of loss transfer. The sale from the Taxpayer to the Merchant is recorded once the Taxpayer validates the end user’s order, and a second sale occurs when the Merchant sells the product to the end user. The Taxpayer handles the shipping, including the costs associated with delivering the products from the facility in Tennessee to end users.

The issue addressed in the ruling is how the Taxpayer should source sales of its products to end users for Tennessee franchise and excise tax purposes. The ruling clarifies that sales to end users located in Tennessee should be sourced to Tennessee for tax purposes, while sales to end users outside Tennessee should be sourced outside the state.

The analysis emphasizes the importance of the "receipts factor" in Tennessee’s apportionment formula for franchise and excise taxes. Sales of tangible personal property are sourced to Tennessee if the property is delivered or shipped to a purchaser within the state, regardless of the terms of sale. In the case of drop shipments, the sale is sourced to the ultimate recipient, which means the location of the end user becomes the determining factor for sourcing the sale.

The ruling concludes that for franchise and excise tax purposes, the Taxpayer should include sales to end users in Tennessee in the numerator of the receipts factor. Sales to end users located outside Tennessee should not be included in the numerator for the purpose of calculating the Taxpayer’s franchise and excise tax liability in Tennessee.