When a Tennessee manufacturer drop-ships goods for an affiliated buyer, which sales count toward its Tennessee franchise & excise tax — does title passing in Tennessee control, or the final delivery destination?

Plain-English summary

A company that will manufacture products at a Tennessee plant — and store them in its own Tennessee warehouse — asked the Department a franchise & excise (F&E) tax apportionment question. It plans to sell everything to an affiliated sales company ("SalesCo") in arm's-length transactions. SalesCo takes title to the goods in Tennessee but never takes physical possession of them there. The manufacturer wanted to know which of those sales it has to count as Tennessee sales when it figures its Tennessee apportionment ratio.

Background on apportionment. A business that operates in more than one state doesn't owe Tennessee F&E tax on all of its income and net worth — it apportions, using a three-factor formula (property, payroll, and a double-weighted receipts factor). The receipts factor is a fraction: Tennessee receipts on top (the numerator), receipts everywhere on the bottom (the denominator). A bigger Tennessee numerator means more Tennessee tax. So the practical question is: which receipts go in the Tennessee numerator?

For sales of tangible personal property, Tennessee uses a destination rule: a sale counts as a Tennessee sale when the goods are "delivered or shipped" to a "purchaser within this state" (§ 67-4-2012(h)(1) for excise; § 67-4-2111(h)(1) for franchise). The Department's regulation, Rule 1320-06-01-.33, explains how that plays out in different shipping arrangements. Two parts mattered here:

• Drop shipments (Rule 33(1)(d)): when the buyer tells the seller to ship straight to a third party, "purchaser within this state" includes the ultimate recipient. So the destination of that final shipment controls — and it doesn't matter that title first passed to an out-of-state buyer, or which party booked the carrier.
• Delivery to an in-state purchaser (Rule 33(1)(c)): goods delivered to a purchaser in Tennessee are Tennessee sales even if the purchaser later reships them out of state; the flip side is that goods delivered to a purchaser outside Tennessee are not Tennessee sales.

How the three scenarios came out:

• Drop shipment to SalesCo's out-of-state customer — NOT a Tennessee sale. Excluded from the numerator.
• Drop shipment to SalesCo's Tennessee customer — IS a Tennessee sale. Included in the numerator.
• Direct sale shipped to SalesCo's out-of-state warehouse — NOT a Tennessee sale. Excluded from the numerator.

In every scenario the Department stressed two things that do not change the answer: it's irrelevant that title passed to SalesCo (an out-of-state buyer) while the goods were still in Tennessee, and it's irrelevant whether the manufacturer or SalesCo arranges the common-carrier shipment. What controls is where the goods ultimately come to rest. (The Department pointed to its earlier Revenue Ruling 04-12, which reached the same result for a manufacturer drop-shipping to an in-state affiliate's out-of-state customers.)

One important assumption: the ruling assumes the taxpayer actually has the right to apportion because it does business in more than one state (§§ 67-4-2010(a), 67-4-2110(a)). If it didn't, these conclusions wouldn't apply.

What this means for you

Tennessee manufacturers selling through an affiliate

If you make goods in Tennessee but sell them through a related sales company, you don't automatically have a Tennessee receipt just because the goods start here or because your affiliate takes title here. For apportionment, follow the goods to their final destination. Drop-shipping straight to an out-of-state end customer keeps that receipt out of your Tennessee numerator; shipping to a Tennessee end customer (or to a purchaser located in Tennessee) puts it in.

Anyone structuring drop-shipment or warehouse flows

The destination of the actual shipment is what matters — not where title transfers and not who books the freight. Engineering an in-state title transfer won't, by itself, move a sale into or out of the Tennessee numerator. Conversely, shipping to a buyer's Tennessee warehouse makes it a Tennessee sale even if the buyer immediately reships the goods to other states.

Accountants and tax professionals

This is a receipts-factor sourcing question for the three-factor F&E formula (§§ 67-4-2012(a), 67-4-2111(a); receipts factor §§ 67-4-2012(g), 67-4-2111(g)(1)). TPP receipts are destination-sourced under §§ 67-4-2012(h)(1) / 67-4-2111(h)(1) and Rule 1320-06-01-.33(1)(a)-(d). Drop shipments turn on Rule 33(1)(d)'s "ultimate recipient" gloss on "purchaser within this state"; straight deliveries turn on Rule 33(1)(c). Title passage and which party arranges carriage are both non-determinative. Remember the ruling assumes a right to apportion under §§ 67-4-2010(a) / 67-4-2110(a). Compare Revenue Ruling 04-12 (Apr. 26, 2004).

Common questions

Q: For Tennessee franchise & excise tax, what makes a sale of goods a "Tennessee sale"?
A: Destination. A sale of tangible personal property is sourced to Tennessee when the goods are "delivered or shipped" to a purchaser within Tennessee (§ 67-4-2012(h)(1)). In drop-shipment cases, "purchaser within this state" includes the ultimate recipient, so the final delivery point controls.

Q: Our affiliate takes title to the goods in Tennessee — does that make it a Tennessee sale?
A: No, not by itself. The Department said it is irrelevant that title passed to the out-of-state buyer while the goods were in Tennessee. What matters is where the goods are ultimately delivered.

Q: Does it matter whether we or our customer arranges the shipping?
A: No. The ruling repeatedly states that it is irrelevant which party arranges for the common-carrier shipment.

Q: We ship to our buyer's Tennessee warehouse, but they reship to other states — is that a Tennessee sale?
A: Yes. Under Rule 33(1)(c), goods delivered to a purchaser in Tennessee are Tennessee sales even if the purchaser later transfers them to another state for resale.

Q: Is this the same as sales-tax sourcing?
A: No. This ruling is about franchise & excise tax apportionment — which receipts go in your Tennessee numerator — not about whether sales tax is due on a transaction. They use different rules.

Q: Can I rely on this letter ruling?
A: No. A Tennessee letter ruling binds the Department only as to the specific taxpayer and facts, and this one also assumes the taxpayer qualifies to apportion in the first place. Confirm your own facts with a tax professional.

Citations and references

Tennessee franchise & excise tax statutes (Tenn. Code Ann., Title 67, Chapter 4):

• § 67-4-2007(a) (excise tax — 6.5% of net earnings); § 67-4-2004(38) (definition of "person," includes corporations and LLCs)
• § 67-4-2105(a) (franchise tax — $0.25 per $100 of net worth); § 67-4-2106(a) (franchise tax measured by net worth)
• § 67-4-2010(a) (apportion net earnings — taxpayers doing business inside and outside Tennessee); § 67-4-2110(a) (apportion net worth)
• § 67-4-2012(a) (three-factor apportionment formula, double-weighted receipts — excise); § 67-4-2111(a) (same — franchise); § 67-4-2012(g) / § 67-4-2111(g)(1) (receipts factor)
• § 67-4-2012(h)(1) (TPP receipts sourced to Tennessee by destination — excise); § 67-4-2111(h)(1) (same — franchise)

Regulation:

• Tenn. Comp. R. & Regs. 1320-06-01-.33(1)(a)-(d) (1984) (destination sourcing of TPP sales; (1)(c) delivery to an in-state purchaser who reships; (1)(d) drop-shipment "ultimate recipient" rule)

Related Department guidance cited by the ruling:

• Revenue Ruling 04-12 (Apr. 26, 2004) (a manufacturer's receipts from goods shipped directly to an in-state affiliate's out-of-state customers are excluded from the Tennessee apportionment numerator)

Source

• Landing page: https://www.tn.gov/revenue/tax-resources/legal-resources/tax-rulings.html
• Original PDF: https://www.tn.gov/content/dam/tn/revenue/documents/rulings/fae/13-14fe.pdf

Original ruling text

TENNESSEE DEPARTMENT OF REVENUE
LETTER RULING # 13-14

Letter rulings are binding on the Department only with respect to the individual taxpayer
being addressed in the ruling. This ruling is based on the particular facts and
circumstances presented, and is an interpretation of the law at a specific point in time. The
law may have changed since this ruling was issued, possibly rendering it obsolete. The
presentation of this ruling in a redacted form is provided solely for informational purposes,
and is not intended as a statement of Departmental policy. Taxpayers should consult with a
tax professional before relying on any aspect of this ruling.
SUBJECT
The sourcing of sales of tangible personal property for Tennessee franchise and excise tax
apportionment purposes.
SCOPE
This letter ruling is an interpretation and application of the tax law as it relates to a specific set of
existing facts furnished to the Department by the taxpayer. The rulings herein are binding upon
the Department, and are applicable only to the individual taxpayer being addressed.
This letter ruling may be revoked or modified by the Commissioner at any time. Such revocation
or modification shall be effective retroactively unless the following conditions are met, in which
case the revocation shall be prospective only:
(A) The taxpayer must not have misstated or omitted material facts involved in
the transaction;
(B) Facts that develop later must not be materially different from the facts upon
which the ruling was based;
(C) The applicable law must not have been changed or amended;
(D) The ruling must have been issued originally with respect to a prospective or
proposed transaction; and
(E) The taxpayer directly involved must have acted in good faith in relying upon
the ruling; and a retroactive revocation of the ruling must inure to the taxpayer’s
detriment.
FACTS
[TAXPAYER] (the “Taxpayer”) [REDACTED] will manufacture items of tangible personal
property (the “Products”) at [ITS] Tennessee manufacturing facility. The Taxpayer will store the
Products in a warehouse that is owned and operated by the Taxpayer [REDACTED].
The Taxpayer will sell the Products to [AFFILIATED ENTITY] (“SalesCo”) in an arm’s length
transaction. [REDACTED]. The structure of these sales transactions is set forth under the
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following scenarios whereby SalesCo takes title to, but not possession of, the Products in
Tennessee:
1) Drop Shipment Transaction. The Taxpayer receives an order from SalesCo for the
purchase of Products. SalesCo directs the Taxpayer to ship the Products directly to a
third-party customer. SalesCo’s third-party customers are located inside and outside of
Tennessee. Title to the Products passes from the Taxpayer to SalesCo when placed in the
hands of a common carrier, and then from SalesCo to the Customer. The Taxpayer may
arrange for the shipment of the Products to SalesCo’s customer via common carrier.
Alternatively, SalesCo may arrange for the shipment of the Products to its customer via
common carrier.
2) Direct Sale Transaction. The Taxpayer receives an order from SalesCo for the
purchase of Products, directing the Taxpayer to ship goods directly to a SalesCo
warehouse outside of Tennessee. SalesCo does not take possession of the Products in
Tennessee. The Taxpayer may arrange for the shipment of the Products to SalesCo via
common carrier. Alternatively, SalesCo may arrange for the shipment of the Products via
common carrier.
This letter ruling assumes that the Taxpayer will have activities in more than one state, such that
it will be entitled to apportion its net earnings or loss and its net worth in accordance with TENN.
CODE ANN. §§ 67-4-2010(a) and 2110(a) (2013). 1
RULINGS
1.
In a Drop Shipment Transaction, is the Taxpayer required to include receipts from sales
of Products shipped to SalesCo’s out-of-state customers in the numerator of its apportionment
formula, for purposes of determining its Tennessee franchise and excise tax apportionment ratio
under TENN. CODE ANN. §§ 67-4-2012(a) (2013) and 67-4-2111(a) (2013)?
Ruling: No. For purposes of determining its Tennessee franchise and excise tax
apportionment ratio under TENN. CODE ANN. §§ 67-4-2012(a) (2013) and 67-4-2111(a)
(2013), the Taxpayer will exclude from the numerator of the apportionment ratio all
receipts from sales of Products in a Drop Shipment Transaction that are shipped or
delivered by the Taxpayer directly to an ultimate recipient outside Tennessee at the
direction of SalesCo. It is irrelevant which party arranges for the shipment of the
Products to SalesCo’s customer via common carrier.
2.
In a Drop Shipment Transaction, is the Taxpayer required to include receipts from sales
of Products ultimately shipped to SalesCo’s Tennessee customers in the numerator of its
apportionment formula, for purposes of determining its Tennessee franchise and excise tax
apportionment ratio under TENN. CODE ANN. §§ 67-4-2012(a) (2013) and 67-4-2111(a) (2013)?

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Note that the rulings contained herein are inapplicable if the Taxpayer does not have the right apportion under
these provisions.

2

Ruling: Yes. For purposes of determining its Tennessee franchise and excise tax
apportionment ratio under TENN. CODE ANN. §§ 67-4-2012(a) (2013) and 67-4-2111(a)
(2013), the Taxpayer will include in the numerator of the apportionment formula only
those receipts from sales of Products in a Drop Shipment Transaction that are shipped or
delivered by the Taxpayer directly to an ultimate recipient in Tennessee at the direction
of SalesCo. It is irrelevant which party arranges for the shipment of the Products to
SalesCo’s customer via common carrier.
3.
In a Direct Sale Transaction, is the Taxpayer required to include receipts from sales of
Products shipped to SalesCo’s out-of-state warehouses in the numerator of its apportionment
formula, for purposes of determining its Tennessee franchise and excise tax apportionment ratio
under TENN. CODE ANN. §§ 67-4-2012(a) (2013) and 67-4-2111(a) (2013)?
Ruling: No. For purposes of determining its Tennessee franchise and excise tax
apportionment ratio under TENN. CODE ANN. §§ 67-4-2012(a) (2013) and 67-4-2111(a)
(2013), the Taxpayer will exclude from the numerator of the apportionment formula all
receipts from sales of Products in a Direct Sale Transaction that are shipped or delivered
by the Taxpayer to SalesCo’s warehouse outside Tennessee. It is irrelevant which party
arranges for the shipment of the Products to SalesCo’s warehouse via common carrier.
ANALYSIS
Tennessee imposes an excise tax at the rate of 6.5% on the net earnings of all persons, as defined
under TENN. CODE ANN. § 67-4-2004(38) (2013), doing business within Tennessee. 2 Tennessee
also imposes a franchise tax at the rate of $0.25 per $100, or major fraction thereof, on the net
worth of a person doing business in Tennessee, pursuant to TENN. CODE ANN. §§ 67-4-2105(a)
and 2106(a) (2013). Persons subject to the Tennessee franchise and excise taxes include, but are
not limited to, corporations and limited liability companies. 3
TENN. CODE ANN. § 67-4-2010(a) (2013) provides that a taxpayer that has business activities
taxable both inside and outside the state of Tennessee shall allocate or apportion its net earnings
or losses for Tennessee excise tax purposes. Similarly, TENN. CODE ANN. § 67-4-2110(a) (2013)
provides that a taxpayer that has business activities taxable both inside and outside the state of
Tennessee shall allocate or apportion its net worth for Tennessee franchise tax purposes. Unless
it is a financial institution or a common carrier, a taxpayer must use the three-factor
apportionment formula set forth under TENN. CODE ANN. §§ 67-4-2012(a) and 67-4-2111(a),
which utilizes a property factor, a payroll factor, and a double-weighted receipts factor. The
receipts factor “is a fraction, the numerator of which is the total receipts of the taxpayer in
[Tennessee] during the tax period, and the denominator of which is the total receipts of the
taxpayer everywhere during the tax period.” 4 Receipts are sourced to Tennessee based on
whether such receipts derive from sales of tangible personal property or from sales other than
sales of tangible personal property.
2

TENN. CODE ANN. § 67-4-2007(a) (2013).

3

TENN. CODE ANN. § 67-4-2004(38) (2013).

4

TENN. CODE ANN. §§ 67-4-2012(g) and 67-4-2111(g)(1).

3

The Taxpayer has represented that it will have business activities both inside and outside the
state of Tennessee. Because the Taxpayer is not a financial institution or a common carrier, it
must use the three-factor apportionment formula, with a double-weighted receipts factor, set
forth under TENN. CODE ANN. §§ 67-4-2012(a) and 67-4-2111(a).
The facts indicate that the Taxpayer makes sales of tangible personal property, which are sourced
in accordance with TENN. CODE ANN. §§ 67-4-2012(h) and 67-4-2111(h). Generally, when the
purchaser is not the United States government, such sales are sourced to Tennessee whenever the
tangible personal property is “delivered or shipped” to a “purchaser . . . within this state”
regardless of the other conditions of the sale. 5 The destination of the taxpayer’s shipment or
delivery is determinative for the sourcing of the taxpayer’s sales. Thus, when property is shipped
by the taxpayer to a purchaser in Tennessee, the sale is sourced to this state even if the property
is ordered from outside the state 6 or the purchaser subsequently moves the property out of state. 7
1-2.

Drop Shipment Transactions

TENN. CODE ANN. §§ 67-4-2012(h)(1) and 67-4-2111(h)(1) provide that when the purchaser is
not the United States government, such sales are sourced to Tennessee whenever the tangible
personal property is “delivered or shipped” to a “purchaser . . . within this state” regardless of the
other conditions of the sale.
TENN. COMP. R. & REGS. 1320-06-01-.33(1)(d) (1984) (“Rule 33(1)(d)”) addresses the type of
transaction commonly described as a “drop shipment,” whereby the purchaser instructs the
taxpayer to ship a product directly to a third party, without the purchaser taking possession of the
product. Rule 33(1)(d) defines the phrase “purchaser within this state” for purposes of TENN.
CODE ANN. § 67-4-2012(h) to include the “ultimate recipient of the property if the taxpayer in
this state, at the designation of the purchaser, delivers to or has the property shipped to the
ultimate recipient within this state.” 8 The fact that title was transferred to the out-of-state
purchaser prior to the shipment is not determinative for purposes of sourcing the taxpayer’s
sales. It is also irrelevant which party arranges for the shipment of the products to the ultimate
recipient via common carrier.
Thus, a sale of tangible personal property will be sourced to Tennessee if the taxpayer delivers or
has the products shipped directly to an ultimate recipient in Tennessee at the direction of a
purchaser who does not take possession of the property, regardless of where the purchaser is
located. The corollary to the drop shipment rule under Rule 33(1)(d) is that sales made to an instate purchaser but shipped by the taxpayer directly to an out-of-state ultimate recipient are not

5

TENN. CODE ANN. §§ 67-4-2012(h)(1) and 67-4-2111(h)(1). See also TENN. COMP. R. & REGS. 1320-06-01.33(1)(a) (1984).
6

TENN. COMP. R. & REGS. 1320-06-01-.33(1)(b).

7

TENN. COMP. R. & REGS. 1320-06-01-.33(1)(c).

8

TENN. COMP. R. & REGS. 1320-06-01-.33(1)(d).

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sourced to Tennessee. 9 Thus, a sale of tangible personal property will not be sourced to
Tennessee if the taxpayer delivers or has the property shipped directly to an ultimate recipient
outside Tennessee at the direction of a purchaser who does not take possession of the property,
regardless of where the purchaser is located.
Here, the Taxpayer is located in Tennessee. When SalesCo submits an order for a Product,
SalesCo directs the Taxpayer to ship the Products directly to a third-party customer. Title to the
Products passes from the Taxpayer to SalesCo when placed in the hands of a common carrier,
and then from SalesCo to the customer. SalesCo never takes possession or delivery of the
Products. The ultimate recipient may be in Tennessee or may be outside of Tennessee. In
accordance with Rule 33(1)(d), a sale of Products will be sourced to Tennessee if the Taxpayer
delivers or has the products shipped directly to an ultimate recipient in Tennessee at the direction
of SalesCo. Conversely, a sale of Products will not be sourced to Tennessee if the Taxpayer
delivers or has the products shipped directly to an ultimate recipient outside Tennessee at the
direction of SalesCo.
For purposes of determining its Tennessee franchise and excise tax apportionment ratio under
TENN. CODE ANN. §§ 67-4-2012(a) and 67-4-2111(a), the Taxpayer will therefore include in the
numerator of the apportionment formula only those receipts from sales of Products in a Drop
Shipment Transaction that are shipped or delivered by the Taxpayer directly to an ultimate
recipient in Tennessee at the direction of SalesCo. The Taxpayer will exclude from the
numerator of the apportionment ratio all receipts from sales of Products in a Drop Shipment
Transaction that are shipped or delivered by the Taxpayer directly to an ultimate recipient
outside Tennessee at the direction of SalesCo.
3.

Direct Sale Transaction

TENN. CODE ANN. §§ 67-4-2012(h)(1) and 67-4-2111(h)(1) provide that when the purchaser is
not the United States government, sales of tangible personal property are sourced to Tennessee
whenever the tangible personal property is “delivered or shipped” to a “purchaser . . . within this
state” regardless of the other conditions of the sale.
TENN. COMP. R. & REGS. 1320-06-01-.33(1)(c) (1984) (“Rule 33(1)(c)”) addresses sales
transactions in which property is delivered or shipped to a purchaser within Tennessee, where the
property is subsequently transferred by the purchaser to another state for resale. Rule 33(1)(c)
provides as an example a taxpayer that makes a sale to a purchaser who maintains a central
warehouse in Tennessee, where all merchandise purchases are received. In the example, the
purchaser then reships the goods to its branch stores in other states for sale. Rule 33(1)(c) states
that all of taxpayer’s products shipped to the purchaser’s warehouse in Tennessee are considered
property “delivered or shipped to a purchaser within this state.” It is irrelevant which party
arranges for the shipment of the products via common carrier.

9

See, e.g., Revenue Ruling 04-12 (April 26, 2004) (ruling that receipts from sales of products shipped by a
manufacturer directly to an in-state affiliate’s out-of-state customers are excluded from the numerator of the
manufacturer’s Tennessee apportionment formula).

5

Thus, in accordance with Rule 33(1)(c), a sale of tangible personal property will be sourced to
Tennessee if the taxpayer delivers or has the products shipped to a purchaser in Tennessee, even
if the products are subsequently transferred by the purchaser to another state for resale. The
corollary to the rule under Rule 33(1)(c) is that a sale of tangible personal property will not be
sourced to Tennessee if the taxpayer delivers or has the products shipped to a purchaser outside
Tennessee.
Here, the Taxpayer is located in Tennessee. Upon submitting an order for Products, SalesCo
directs the Taxpayer to ship or deliver the Products to SalesCo’s warehouse outside Tennessee.
SalesCo never takes possession of the Products in Tennessee. In accordance with Rule 33(1)(c),
such sales of Products will not be sourced to Tennessee. For purposes of determining its
Tennessee franchise and excise tax apportionment ratio under TENN. CODE ANN. §§ 67-42012(a) and 67-4-2111(a), the Taxpayer will therefore exclude from the numerator of the
apportionment formula all receipts from sales of Products in a Direct Sale Transaction that are
shipped or delivered by the Taxpayer to SalesCo’s warehouse outside Tennessee.

Kristin Husat
General Counsel

APPROVED:

Richard H. Roberts
Commissioner

DATE:

October 11, 2013

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