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ADP Lunch & Learn
Course Materials
Tax Reform in New York and Other State
Taxation Issues
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one 1. Tax Reform in New York and Other State
Taxation Issues
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LearningObjectives:
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Field of Study:
RecommendedAccreditation:
RequiredReading(Self-Study):
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VideoTranscript:
Course Level:
CoursePrerequisites:
Advance Preparation:
Expiration Date:
Taxes
August 31, 2017
Work experience in tax planning or tax compliance, or an introductory course in taxation
None
1 hour group live2 hours self-study
Update
“Inside The New York Budget Bill: 2015 – 2016 BudgetLegislation (Excerpts)”From a April 9, 2015 McDermott Will & Emery White PaperBy Maria P. Eberle, Lindsay M. LaCava and Alysse McLoughlinFor additional information, go to: http://www.mwe.com/Inside-the-New-York-Budget-Bill-Corporate-Tax-Reform-Enacted-04-07-2015/
See page 1–13.
See page 1–18.
33 minutes
A year ago, we reported on budget legislation that institutedmajor corporate tax reform in New York State and createdsignificant changes for many corporate taxpayers. In our firstsegment, McDermott Will & Emery attorneys Arthur Rosen,Lindsay LaCava and Mark Yopp provide an update on thedevelopments that have occurred as a result of that tax reformbill, as well as a detailed review of other state taxation issues.They also discuss the implications of some controversial sales tax provisions that were included in this year’s New York budget bill.
Upon successful completion of this segment, you should be able to:● Recognize the impact of qui tam actions and class actions;● Identify the key elements of the Marketplace Fairness Act,
Remote Transaction Parity Act and Business Activity TaxSimplification Act;
● Recognize new developments that have occurred in New Yorksince their 2014 major corporate tax reform;
● Identify the latest issues related to apportionment.
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A. Plaintiff Overpaying Taxes
1. A number of class actions throughoutthe U.S. brought against major sellers
2. Individual lawyers generally get aplaintiff who complains that they’vepaid too much sales tax to a seller
a. Class action bar goes after thesellers for having overcollected
3. Companies have to be concernedabout undercollection
a. Then they’re subject to audit bythe revenue department
B. Immediate Refunds
1. If anybody claims that they paid toomuch sales tax to a seller
a. Buyer has to request an immediaterefund from the seller
2. If the seller gives that refund then it’sall over
a. Can’t be any class action becausethere aren’t any damages
A. Seismic Shift in Business Taxes
1. Businesses used to be primarilyconcerned about revenue departmentauditors and revenue departmentpolicies
2. Now we have “collateral tax”
a. Qui tam actions and class actions
3. Qui tam actions
a. Give individual the right to step inand act on behalf of thegovernment
i. If they don’t think a companyhas been collecting enoughsales tax
B. Tax Vigilantes
1. Incentive for vigilante justice in thetax world
2. Have been cases around the country
a. Notably in Illinois and New York
3. Traditional tax community concernedthat non-tax professionals arebringing these cases for their ownprofit
C. Consider Risks in Tax Decisions
1. In any position a business is going totake business has to consider theserisks
2. Business has to think about theimplications from both sides
a. From revenue department
b. From potential qui tam actions
I. Qui Tam Actions
II. Class Actions
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Outline (continued)
A. Marketplace Fairness Act
1. Passed the Senate last Congress
a. Bill would say there are threecategories of states
2. Members of the Streamlined Salesand Use Tax Governing Board
a. Can require remote sellers tocollect and remit sales tax
i. As long as the streamlinedsales tax agreement maintainscertain minimumsimplification requirements
3. Other states have opportunity tosimplify laws in accordance with theminimum simplification requirements
a. Similarly would be able to requireremote sellers to collect and remit
4. Third category – those who donothing
a. Have to live under the Quill test
i. They cannot require remotesellers to collect and remit
B. Remote Transaction Party Act
1. Expands on Marketplace FairnessAct in certain important ways
2. If seller uses a certified softwareprovider to assist it in sales taxcompliance
a. Buyer and the seller are prettymuch off the hook
“…the RTPA is different (from)Marketplace Fairness…because itnot only carries the carrot thatstates will get to be able torequire remote sales to collect,but also it has a stick.”
- Arthur Rosen
3. Says in the bill that this federallegislation preempts state legislationin this area
a. The Amazon Law would not bevalid
b. Enforcement of any laws otherthan this federal law for remotesellers would be illegal
C. Timeline for New Tax Legislation
1. Optimism that some sales taxlegislation will be enacted
a. Because of some other state taxbills that are also beingconsidered
2. Good possibility for a combination ofthese bills
a. Making two or three of themmove forward together
III. Sales Tax Nexus
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A. Addresses Sales by Remote Businesses
1. BATSA would set forth theguidelines as to when a state couldrequire a remote business to pay thatstate’s direct tax
2. Would say that no state or localitycould impose its direct tax on anybusiness
a. That does not have a physicalpresence in the jurisdiction
b. Physical presence defined ashaving employees or property inthe state or the locality
i. For more than 14 days duringthe taxable year
B. Modernizes Public Law 86-272
1. Bill would also modernize PublicLaw 86-272
a. Which now protects only sellersof tangible personal property
b. All sellers would be covered
i. Whether they sell intellectualproperty or services
2. Other activities would be totallyprotected in addition to solicitation
a. Meeting with suppliers orpotential suppliers
b. Attending a media event
C. Mobile Workforce Act
1. Would say no state could impose anincome or withholding tax on anemployee
a. Unless the employee providedemployment services in the statefor more than 30 days during theyear
2. States officially object to it but moststates would be willing to accept it
a. Understand in today’s mobileeconomy and mobile workforcethis type of legislation is reallyneeded
D. Acts Are Likely to Pass
1. Taxpayer and state frustration hasbeen building too long
2. RTPA, BATSA, Mobile Workforcewill likely move together
IV. Business Activity Tax Simplification Act (BATSA)
A. Review of Reform
1. Last year New York adoptedsignificant corporate tax reform
a. Adopted economic nexusprovisions
b. Significantly altered the tax baseand income classification rules
2. Adopted a new combined reportingregime
3. Also altered the net operating lossprovisions as well as tax rates
B. Two Major Developments
1. Legislature enacted some technicalcorrections to those reformprovisions
2. Legislature adopted conformingprovisions for purposes of New YorkCity’s corporate income tax regime
3. NY State Department of Taxationand Finance has also created a newFrequently Asked Questions sectionon website
a. Department has also issued twotechnical memoranda
i. One addressing transitionalcompliance issues related tocorporate reform
ii. One addressing qualified NewYork manufacturers and thenew benefits available to thosemanufacturers
V. New York State Corporate Tax Reform
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C. Technical Corrections in Bill
1. Touched on many aspects of lastyear’s reform
a. Economic nexus
b. Combined reporting rules
c. Tax base
d. Income classification rules
e. Apportionment
f. Tax credits
g. Net operating losses
h. Tax rates
2. Two of the more notable provisionsrelate to apportionment and theincome classification rules
D. Qualified Financial Instruments
1. QFIs can be apportioned usingeither 8% fixed sourcing rule
a. Or a series of customer-basedsourcing rules
b. Typically instruments that havebeen marked-to-market
2. Taxpayers now allowed to treatcertain types of financialinstruments as QFIs
a. If any instrument of that typehas been marked-to-market
i. By either the taxpayer oranother member of itscombined group
ii. Specific instrument itself didnot necessarily have to havebeen marked to market
3. With respect to marked-to-marketnet gains
a. Gains are included in theapportionment factor
b. Also provided specific allocationrules
i. To determine the portion ofmarked-to-market net gainsthat should be sourced toNew York
E. Income Classification
1. Imposed new requirements thatmust be met for stock
a. Still has to be non-unitary stockto qualify as investment capital
b. Has to qualify as a capital assetunder IRC section 1221
c. Has to have been held forinvestment for at least one year
d. Gain has to qualify as a long-term capital gain or loss underthe IRC
e. Stock purchased on or afterJanuary 1, 2015 can never havebeen held for sale to customersin the regular course of business
f. Taxpayer has to identify thatstock before close of business
i. On the day the stock wasacquired as stock held forinvestment
2. Narrow definition of investmentcapital
a. Less income will qualify asinvestment income to beexcluded from tax base
3. New compliance burdens ontaxpayers
a. Track and conform their federaland New York treatment
b. Adopt new identificationprocedures
4. New cap on taxpayer’s income thatcan be treated as investment income
F. Constitutionality of Cap on InvestmentIncome
1. Raises questions about whetherstate can constitutionally taxincome
a. From a non-unitary stock thatexceeds that 8 percent cap
2. By exceeding that cap
a. Income would be reclassifiedfrom investment income tobusiness income
i. And therefore be taxable
V. New York State Corporate Tax Reform (continued)
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A. NY State vs. NY City Tax
1. NYC tax did not adopt economicnexus provisions that were adoptedat the state level
a. With the exception of certaincredit card banks
2. State will be phasing out thealternative tax on capital
a. NYC tax on capital will not bephased out
3. State apportionment formula was asingle sales factor formula
a. NYC transitioning to a singlesales factor
4. State reduced tax rate applicable tobusiness income base
a. NYC has implemented anincreased rate of 9%
5. NYC will continue to tax S-corporations
a. In the same manner as general C-corporations
b. Will continue to taxunincorporated businesses underthe unincorporated business tax
B. Notable Sales Tax Proposals
1. Sales and use tax exemption forcertain transactions
a. Conducted as a result of aresolution plan adopted under thefederal Dodd-Frank Act
2. Favorable provisions for boats andaircraft
a. General aviation aircraft benefitfrom a sales and use taxexemption
b. Related parties get a sales anduse tax exemption for aircrafttransferred
i. Pursuant to certaincontributions, distributionsand mergers
C. Impact on Out-of-State Businesses
1. Companies without employees orproperty in NY should be concernedabout changes adopted in this year’sbudget bill
a. Might be subject to the economicnexus standard
“… taxpayers should really beconsidering how these reformprovisions affect their tax returnfilings as well as their financialstatements.”
- Lindsay LaCava
2. Reform provisions have electionsthat need to be made
a. With respect to incomeclassification, apportionmentrules, combined reporting
VI. Impact of NY Changes
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A. From Cost-of-Performance to MarketSourcing1. Under cost-of-performance
a. Receipts are sourced based onwhere the income-producingactivity occurs
2. Under marketa. Receipts are sourced based on
where the customer receives thebenefit
3. Cost-of-performance sourcing tendsto put a larger tax burden on in-statecompanies
4. Market sourcing tends to put a largerburden on out-of-state companies
B. Multi-State Compact1. Multi-state compact was enacted by
many states about 50 years agoa. Election allows taxpayers to use a
specific formula to apportiontheir incomei. Based on three factors:
payroll, property, receiptsii. All with equal weight
2. Over time some states have shiftedto two other apportionment formulasa. Single factor based on receiptsb. Three factor but the receipts
factor is double weightedC. Related Court Cases
1. California casea. Lower-level court held that
taxpayers could use the electivemethod
b. State appealed to the stateSupreme Court
c. Case is currently pending2. Michigan
a. State Supreme Court held thattaxpayers could use the electivemethod
b. Michigan legislature retroactivelyrepealed the ability to use thelegislation
c. About 50 cases pending in lowerlevelsi. Challenging whether that
retroactive repeal was validd. Recently a lower-level court held
that the retroactive repeal wasvalid
D. Alternative Apportionment
1. Every state has a provision thatallows the Department of Revenueto use an alternative to the standardmethod
a. Used to create sort of industry-specific apportionment formulas
2. Series of cases in Tennessee, andWisconsin and Mississippi
a. Departments of Revenue havebeen successful in invokingalternative apportionment
3. One thing for people to look out foris whether those alternativeapportionment invocations areconsistent with the overall statutory
E. Keep Up with Legislation andLitigation
1. Get involved on the legislative level
2. Follow the litigation going onaround the states
a. Both on the alternativeapportionment level and on theMTC election level
“Apportionment is a veryimportant issue because at a statelevel, a company’s tax liability isprimarily determined on where itsactivities are occurring.”
- Mark Yopp
3. Companies should be veryconcerned because small changes instatutes could have a big change ontheir tax liability
VII. Taxation Trends at the State Level
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1. Tax Reform in New York and Other State Taxation Issues
● As the Discussion Leader, you shouldintroduce this video segment with wordssimilar to the following:
“In this segment, Arthur Rosen, LindsayLaCava and Mark Yopp provide anupdate on the results of last year’s NewYork State tax reform bill, as well as adetailed review of other state taxationissues.”
● Show Segment 1. The transcript of thisvideo starts on page 1–18 of this guide.
● After playing the video, use thequestions provided or ones you havedeveloped to generate discussion. The answers to our discussion questions are on pages 1–9 and 1–10. Additionalobjective questions are on pages 1–11and 1–12.
● After the discussion, complete theevaluation form on page A–1.
1. What are qui tam and class actions?
2. What are the major elements of theMarketplace Fairness Act, RemoteTransaction Parity Act, and the BusinessActivity Tax Simplification Act?
3. What are the new developments in NewYork state corporate tax reform?
4. What were the technical correctionsrelated to apportionment and incomeclassification?
5. What are the sales tax proposalscontained within the 2015 New YorkBudget Bill?
6. Why should non-New York companiespay attention to New York reforms?
7. How does a cost-of-performance differfrom a market sourcing methodology?Why are states switching to a marketmethodology?
Discussion Questions
You may want to assign these discussion questions to individual participants before viewingthe video segment.
Instructions for Segment
Group Live Optiondi
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s1. What are qui tam and class actions?
● Qui tam actions❖ Statute that gives individual the
right to act on behalf of thegovernment
❖ There are three such casesproceeding now
❖ Traditional tax communityconcerned
● Class actions❖ A number have been brought
against major sellers❖ It goes against the state but can go
against a company in some cases
2. What are the major elements of theMarketplace Fairness Act, RemoteTransaction Parity Act, and the BusinessActivity Tax Simplification Act?● Marketplace Fairness Act: Three
categories of states❖ Members of Streamlined Sales and
Use Tax Governing Board❋ Can require remote sellers to
collect and remit sales tax❖ Other states can simplify their
laws in accordance with minimumsimplification requirements❋ Can require remote sellers to
collect and remit sales tax❖ Those states who do nothing
❋ Cannot require remote sellersto collect and remit sales tax
● Remote transaction parity act❖ Expands Marketplace Fairness Act❖ Adds more simplifications states
would have to enact and STAAwould have to conform to
❖ Use of certified software providertakes buyer/seller off the hook
❖ May lead to more companiesoutsourcing sales tax compliance
❖ Has carrot that would allow statesto collect remote sales tax
❖ But also stick that federalpreempts state legislation
● Business activity tax simplificationact❖ Sets forth guidelines as to when a
state could require a remotebusiness to pay that state’s directtax
❖ No state/locality could imposedirect tax on any business thatdoes not have a physical presencein the jurisdiction
❖ Defines “physical presence” ashaving employees/property in thestate for more than 14 days duringthe taxable year
❖ Modernizes Public Law 86-272:Protects all sellers
❖ Other activities would be totallyprotected
3. What are the new developments in NewYork state corporate tax reform?● New York State corporate tax reform:
New developments❖ Technical corrections❖ Conforming provisions for
purposes of NYC’s corporateincome tax regime
❖ Created a new FAQ part of itswebsite
❖ Issued two technical memoranda❋ Transitional compliance issues❋ New benefits for qualified New
York manufacturers
Suggested Answers to Discussion Questions
1. Tax Reform in New York and Other State Taxation Issues
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4. What were the technical correctionsrelated to apportionment and incomeclassification?● Technical corrections:
Apportionment❖ Broadened definition of qualified
financial instruments❖ Allowed taxpayers to treat
financial instruments that havebeen marked-to-market by thetaxpayer or another member of itscombined group as QFIs
❖ Clarified that marked-to-marketnet gains are included in theapportionment factor
❖ Provided allocation rules fordetermining portion of marked-to-market gains that should besourced to NY
● Technical corrections: Incomeclassification❖ Significantly narrowed the
definition of investment capital❖ Five new requirements for stock❋ Has to qualify as a capital asset
under IRC Code 1221❋ Must be held for investment for
at least one year❋ Upon sale, gain or loss must
qualify as long-term capital gainor loss
❋ Purchased on/after 1/1/15 cannothave been held for sale tocustomers in regular course ofbusiness
❋ Must be identified before close ofbusiness on day stock wasacquired to qualify as investmentcapital
● Adopted new cap on taxpayer’sincome that can be treated asinvestment income
5. What are the sales tax proposalscontained within the 2015 New YorkBudget Bill?● 2015 NY budget bill: Sales tax
proposals❖ Reforms aimed at tax avoidance
structures❋ Accelerated sales and use tax
due on related party leases● Eliminated sales and use tax
exemption for certain related-partytransactions
● Use tax collection obligation onmarketplace providers
6. Why should non-New York companiespay attention to New York reforms?● Why Non-NY companies should pay
attention to NY reforms❖ A corporation is subject to tax in
NY if it has $1 million or more ofreceipts from NY sources
7. How does a cost-of-performance differfrom a market sourcing methodology?Why are states switching to a marketmethodology?● Cost-of-performance vs. market
sourcing❖ Cost-of-performance: Receipts
sourced based on where income-producing activity occurs
❖ Market: Receipts sourced basedon where customer receives thebenefit
● Why states switching to marketmethodology❖ It puts larger burden on out-of-
state companies❖ It helps keep tax revenues flat
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1. With respect to state taxation, businesstaxpayers historically have primarily beenconcerned with issues of:
a) revenue taxation
b) sales taxation
c) estate taxation
d) value added tax
2. Companies have to be concerned with__________ of taxes because they maybe subject to___________.
a) over collection, audits by the state
b) under collection, class action law suits
c) over collection, class action law suits
d) all of the above
3. A key element of the MarketplaceFairness Act is:
a) it discharges liability for those sellersusing certified software
b) it places states into 1 of 3 categorieswith respect to sales tax collectionresponsibilities
c) it preempts state legislatures in thearea of sales tax collections
d) it has a carrot and stick approach
4. Since the 2014 corporate tax reform thattook place in NYS there have been manytechnical corrections concerning all of thefollowing EXCEPT:
a) apportionment
b) physical presence requirements
c) net operating losses
d) combined reporting rules
5. For a stock to qualify as non investmentcapital under the technical corrections: a) that stock has to have been held for
investment for at least 5 years b) upon sale, the gain has to qualify as a
short-term capital gain or loss c) the stock has to qualify as a capital
asset under section 1221 of the IRC d) the taxpayer need not be able to
identify that stock before the close ofbusiness on the day the stock wasacquired as stock held for investment
6. Which of the following sales taxproposals were added to this yearsBudget Bill? a) provisions providing sales and use tax
exemptions for aircraft transferredpursuant to certain contributions,distributions and mergers
b) amendments related to acceleration ofsales and use tax on related partyleases
c) a proposal imposing a use taxcollection obligation on market placeproviders
d) a proposal imposing sales and use taxfor certain transactions conducted as aresult of the Dodd Frank Act
7. The formula used to apportion income aspart of the MCT election is based on allof the following factors EXCEPT: a) property b) number of employees in the
organization c) payroll d) receipts
8. A credit card company is deemed to bedoing business in NY if it has issuedcredit cards to _________ or more NewYorkers. a) 1 b) 1,000 c) 1 million d) 100
You may want to use these objective questions to test knowledge and/or to generate furtherdiscussion; these questions are only for group live purposes. Most of these questions are basedon the video segment; a few may be based on the required reading for self-study that starts onpage 1–13.
Objective Questions1. Tax Reform in New York and Other State Taxation Issues
1–12
9. Which of the following instruments willNOT be considered a qualified financialinstrument under last year’s corporateincome tax reform?
a) federal, state and municipal debt
b) dividends
c) loan secured by real property
d) sales of partnership interests
10. Under current NY tax law the followingelections apply to all members of acombined group EXCEPT:
a) the election to reduce investmentincome or other exempt income by40% in lieu of attributing interestexpenses to that income
b) the election to apportion income andgains from qualifying financialinstruments using the 8% rule
c) the election to waive the netoperating loss carry back period
d) the election to deduct up to 100% ofthe prior year net operating lossconversion subtraction pool over a 5year period
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Self-Study Option
Required Reading (Self-Study)
1. Viewing the video (approximately30–35 minutes). The transcript of thisvideo starts on page 1–18 of this guide.
2. Completing the Required Reading (approximately 25–30 minutes). TheRequired Reading for this segmentstarts below.
3. Completing the online steps (approximately 35–45 minutes). Pleasesee pages iii to v at the beginning ofthis guide for instructions oncompleting these steps.
When taking a CPA Report segment on a self-study basis, an individual earns CPE credit bydoing the following:
Instructions for Segment
INSIDE THE NEW YORK BUDGET BILL: 2015 – 2016BUDGET LEGISLATION (EXCERPTS)
From a April 9, 2015 McDermott Will &Emery White PaperBy Maria P. Eberle, Lindsay M. LaCavaand Alysse McLoughlinFor additional information, go to:http://www.mwe.com/Inside-the-New-York-Budget-Bill-Corporate-Tax-Reform-Enacted-04-07-2015/
A. Economic Nexus The New York Tax Law provides that acorporation is subject to corporate incometax if it is “deriving receipts from activityin [New York].” A corporation is deemed tobe “deriving receipts from activity in [NewYork]” if it has $1 million or more ofreceipts included in the numerator of itsapportionment factor, as determined underthe Tax Law’s apportionment sourcingrules (“New York receipts”). Furthermore,a credit card company is deemed to bedoing business in New York if it has issuedcredit cards to 1,000 or more New Yorkcustomers; has contracts covering at least1,000 merchant locations; or has at least1,000 New York customers plus New York
merchant locations. The Tax Law also hasspecial rules (aggregation rules) forcorporations included in combinedreporting groups. This year’s Budget Billslightly modified those aggregation rules.
Under last year’s corporate income taxreform, if a corporation does not meet the$1 million threshold itself, but has at least$10,000 of New York receipts, the $1million test is to be applied to thatcorporation by aggregating the New Yorkreceipts of all members of the corporation’scombined reporting group having at least$10,000 of New York receipts. Similarly, acredit card corporation that does not meetthe 1,000 customer and/or merchantlocation threshold by itself, but has at least10 New York customers, at least 10 NewYork merchant locations or at least 10 NewYork customers plus merchant locations, issubject to tax in New York if all membersof its combined reporting group with 10such customers and/or merchant locations,on an aggregated basis, have at least 1,000New York customers, 1,000 New York
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merchant locations or 1,000 New Yorkcustomers plus merchant locations.
As a result of this year’s technicalcorrections, the $1 million New Yorkreceipts and 1,000 New Yorkcustomers/merchant locations aggregationtests now apply to a corporation that is partof a unitary group meeting the ownershiptest of Tax Law section 210-C (more than50 percent common ownership measuredby voting power of capital stock), ratherthan a combined reporting group, thuseliminating the application of theseaggregation rules to corporations or creditcard corporations that are members of acombined reporting group solely as a resultof a commonly owned group election.
For example, in determining whether theaggregation test must be applied withrespect to a corporation, the test will beapplied if a corporation has at least $10,000of New York receipts and is part of aunitary group that meets the more-than-50-percent common ownership threshold ofTax Law section 210-C. However, once itis determined that the aggregation test mustbe performed, it is unclear if the unitarygroup is broadened for purposes ofapplying the test. One interpretation of thenew law is that the corporation’s receiptsare aggregated only with corporations thatare unitary with the potential taxpayer andthat meet the more-than-50-percentcommon ownership threshold of Tax Lawsection 210-C. Another interpretation isthat the corporation’s receipts areaggregated with all corporations that areunitary with the potential taxpayer, not justthose that are part of the unitary group andmeet the more-than-50-percent ownershipthreshold. While the first interpretation isthe more logical and likely intended result,the revised provision may require taxpayersto look outside the group of corporationsthat would be required to be included in acombined report under Tax Law section210-C to those corporations that are unitarybut don’t meet the more-than-50-percentownership threshold (although, one canargue that without more than 50 percentownership a unitary relationship cannotexist). Similar changes were made to theaggregation rules applicable to credit cardcorporations.
In revising the aggregation rules, theBudget Bill eliminates corporations that areexcluded by statute from a combined article9-A report from being included in either ofthe aggregation tests. Therefore,corporations taxable (or that would betaxable if subject to tax) under Article 9(certain utilities) or Article 33 (insurancecorporations), REITs or RICs that are notcaptive REITs or captive RICs, New YorkS corporations, and alien corporations thatare not treated as domestic corporationsunder the Internal Revenue Code (IRC) andthat have no effectively connected incomefor the taxable year will not be consideredfor purposes of determining whether theaggregation test applies or when applyingthe aggregation test.
Additional clarifications or technicalcorrections made to the economic nexusprovisions include the following:
● Similar changes to the aggregation testsapplicable to the metropolitancommuter transportation districtsurcharge; and
● A correction to the nexus exclusion forcertain alien (non-U.S.) corporationsrelated to IRC section 864(b) thatmakes it clear that the exclusion forsection 864(b) activities will also applyto the economic nexus standard.
D. Apportionment
1. Treatment of ExcessInvestment Income
As discussed above (Section I.B.2), theBudget Bill includes a “cap” wherebyinvestment income cannot exceed 8 percentof a corporation’s (or a combined group’s)entire net income. A resulting issue is theimpact of that cap and the “excess”investment income that it creates on theapportionment factor that will be applied toa taxpayer’s business income, assumingthat inclusion of the excess investmentincome is constitutional.
As a preliminary matter, the excessinvestment income will not be eligible forthe Tax Law’s 8 percent fixed sourcingelection (i.e., a taxpayer may elect to
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include 8 percent of receipts from qualifiedfinancial instruments (QFI) in the numeratorof its apportionment fraction in lieu of usinga more specific sourcing provision) becausesuch income cannot be considered incomefrom QFIs; a financial instrument thatqualifies as investment capital cannot alsoqualify as a QFI (for a discussion ofchanges to the definition of a QFI seesection I.D.2 below). Even though, throughoperation of the cap, excess investmentincome will be treated as business incomeand not investment income, there is nocorresponding provision in the statutespecifying that the character of theinvestment that gave rise to such excessinvestment income will switch frominvestment capital to business capital. Thus,a taxpayer’s election to use the 8 percentfixed sourcing method will not apply to anyexcess investment income.
Instead, the excess investment income willneed to be sourced under the generalcustomer sourcing rules for financialinstruments. Under those general rules,dividends and net gains from sales of stockare not included in either the numerator ordenominator of the apportionment formula,unless the Commissioner determines thatinclusion is necessary to properly reflect thebusiness income or capital of the taxpayer.The Commissioner’s determination isgoverned by the Tax Law’s generalprovision on alternative apportionment,meaning that the Commissioner can requireor taxpayers can request factorrepresentation to the extent necessary toproperly reflect the taxpayer’s businessincome or capital. Interestingly, in thosecases where the excess investment incomeis properly included in business income,inclusion in the apportionment formulashould be required on constitutional grounds(factors used in an apportionment formulamust reasonably reflect how income isearned).
2. Description of QFI
The rule concerning what will qualify as aQFI for purposes of the 8 percent fixedsourcing percentage election has now beenbroadened. Under last year’s corporateincome tax reform, only financialinstruments that were actually marked tomarket under sections 475 or 1256 could be
treated as QFIs. That definition has beenbroadened to include certain types ofinstruments that are of a type referenced incertain of the financial transactions sourcingrules, as long as the taxpayer (or, if it filesas part of a combined report, any memberof its combined report) has marked tomarket a financial instrument of that sametype in the relevant taxable year. The typesof instruments that are specificallyreferenced in the financial transactionssourcing rules are loans; federal, state andmunicipal debt; asset-backed securities andother government agency debt; corporatebonds; dividends and net gains from sale ofstock or partnership interests; other financialinstruments; and physical commodities.Under last year’s corporate income taxreform, a loan secured by real propertycannot be a QFI; as a result, even though all“loans” are considered one type ofinstrument for purposes of the financialtransactions sourcing rules, if the only loansthat a taxpayer has marked to market areloans secured by real property, then none ofthe taxpayer’s loans shall be consideredQFIs. (The Budget Bill offers clarificationas to when a loan is considered to besecured by real property; thus, under thenew rule, a loan will be considered to besecured by real property if, at the inceptionof the loan, 50 percent or more of the valueof the loan collateral consists of realproperty.)
3. Marked to Market Income
The Budget Bill has also made certainchanges that are applicable when a taxpayerelects the 8 percent fixed sourcing methodfor its income from QFIs. While it is clearfrom last year’s corporate income taxreform that all income, gain or loss fromQFIs is business income once a taxpayerelects the 8 percent fixed sourcing method,the Budget Bill clarifies that the phrase, “allincome, gain or loss,” includes marked tomarket net gains. Thus, when sourcing thenet income from QFIs, 8 percent of allmarked to market net gains should beincluded in the numerator of theapportionment fraction and all marked tomarket net gains should be included in thedenominator of the apportionment fraction.
Furthermore, some of the apportionmentchanges reflect the potential mismatch in
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application of the customer sourcing rulesto marked to market income. As part of thegeneral switch to customer sourcing in lastyear’s corporate income tax reform, incomefrom financial instruments also becamesubject to customer sourcing rules. When afinancial instrument is subject to InternalRevenue Code section 475 or 1256, markedto market income and loss – or the changein value of the financial instrument – isincluded by such taxpayer in computing itsfederal taxable income, and thus incomputing its New York business incometax base. Customer sourcing rules wouldthen require sourcing of such income basedon where the purchaser of the financialinstrument is located. In the case of afinancial instrument that has not been soldby the end of a tax year, it would beimpossible to source the marked to marketincome from that financial instrument tothe purchaser’s location since there wouldnot have been a purchaser. The Budget Billadds some sourcing rules that address thisproblem.
Under the new rules, the amount of markedto market net gains included in thenumerator of the apportionment fraction foreach type of financial instrument isdetermined by multiplying the marked tomarket net gains from that type of financialinstrument by a fraction, the numerator ofwhich is equal to the net gains (usuallyinterest and net gains from sales) includedin the numerator of the apportionmentformula under the customer sourcing rulesfor that type of financial instrument, andthe denominator of which is equal to all ofthe net gains (again, usually interest andnet gains from sales) included in thedenominator from that same type offinancial instrument. All marked to marketnet gains from such financial instrumentswould then be included in the denominatorof the apportionment formula.
If, however, the taxpayer has a net lossfrom that type of financial instrument or ifthe financial instrument is of a type that isnot otherwise sourced by the taxpayerunder the financial instrument customersourcing rules, then the amount of suchotherwise unsourced marked to marketincome will be included in the numeratorof the apportionment fraction bymultiplying such unsourced marked to
market net gains by a fraction, thenumerator of which will include all of thereceipts included in the numerator of thebusiness apportionment formula from thecustomer sourcing rules applicable tofinancial instruments plus all previouslysourced marked to market income that is inthe numerator, and the denominator ofwhich will consist of all receipts includedin the denominator under the customersourcing rules applicable to financialinstruments and previously sourced markedto market income included in thedenominator.
4. Sourcing Hierarchy
In determining the location of a businesscustomer under the financial instrumentsourcing rules, a hierarchy of methods isused. Before passage of the Budget Bill,the first method for determining suchlocation was the location of the treasuryfunction for the business entity. Thatmethod has now been removed due totaxpayers’ complaints that location of acustomer’s treasury function was not amethod that was used by any other stateand was not information that a taxpayerwould usually have for its customers.
5. Treatment of PhysicalCommodities
Under last year’s corporate income taxreform, receipts from sales of tangiblepersonal property and electricity that aretraded as commodities, as such term isdefined under IRC section 475, will besourced, not according to the generalapportionment rules for receipts from salesof tangible personal property, but accordingto the special physical commodities rulesthat are contained in the section of thesourcing rules dealing with income fromfinancial instruments (the “PhysicalCommodities Sourcing Rule”). The BudgetBill clarifies that such physicalcommodities can also be treated as QFIsfor purposes of the 8 percent fixed sourcingmethod election. In describing whatinstruments can qualify as QFIs, theBudget Bill specifically provides that a QFIincludes a financial instrument that “is of atype described” in the PhysicalCommodities Sourcing Rule. Prior to thisreference, it was not clear whether physical
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commodities could be treated as QFIsbecause it was not clear whether (a) theycould be considered “financial instruments”and (b) the direction to use the PhysicalCommodities Sourcing Rule overruled thepossibility that they could qualify for QFItreatment. Since there is now a specificreference that the items that qualify for thePhysical Commodities Sourcing Rule canbe treated as QFIs, any uncertainty in thisarea is resolved.
Furthermore, with respect to the PhysicalCommodities Sourcing Rule, a revision wasmade to clarify that the denominator wouldinclude both receipts from the sale ofphysical commodities actually deliveredwithin and without New York plus, in thecase of those commodities for which noactual delivery occurred, from sales topurchasers located within and without NewYork. Prior to the clarification, the statutecould have been interpreted so that thedenominator would have included onlythose receipts from sales of physicalcommodities actually delivered to pointswithin and without New York State orreceipts from sales to purchasers locatedwithin and without New York.
The Budget Bill also contains certainclarifications and technical corrections tothe apportionment sourcing rules applicableto receipts derived from the operation ofvessels and receipts derived from aviationservices.
E. Combined Reporting
1. Investment Income
Last year’s corporate income tax reformprovisions provided that (1) the election toreduce investment income or other exemptincome by 40 percent in lieu of attributinginterest expenses to that income and (2) theelection to apportion income and gainsfrom qualifying financial instruments usingthe 8 percent rule (discussed in SectionI.D.2. above) apply to all members of acombined group. The Budget Bill providesthat the following elections also apply to allmembers of the combined group: (1) theelection to waive the net operating losscarryback period and (2) the election todeduct up to one-half of the prior year netoperating loss conversion subtraction pool
over a two-year period starting with the taxyear beginning on or after January 1, 2015.
As discussed above, the Budget Bill alsoprovides that the new 8 percent cap oninvestment income applies by comparingthe investment income of the combinedgroup (before the deduction of attributableinterest expenses) to the entire net incomeof the combined group.
2. Designated Agent
Under last year’s corporate income taxreform, each combined group must haveone designated agent, and that designatedagent must be a New York taxpayer (i.e.,must have nexus with New York). TheBudget Bill eliminates the requirement thatthe designated agent be the parentcorporation of the combined group (underlast year’s corporate income tax reformtaxpayers were permitted to choose anotherdesignated agent only if there was no parentcorporation included in the combined groupor the parent was not a taxpayer). Thischange gives combined groups greaterflexibility in selecting the designated agentfor the combined group.
The Budget Bill makes a few additionalclarifying amendments to the combinedreporting provisions:
● When computing the combinedbusiness income base, the apportionedbusiness income of the group is reducedby any prior net operating lossconversion subtraction as well as anynet operating loss deduction (last year’scorporate income tax reform provisionsreferred to only the net operating lossdeduction).
● A combined net operating loss iscomposed of net operating losses thatare carried back or carried forward tothe taxable year (last year’s corporateincome tax reform provisions referredonly to net operating losses carriedforward to the income year).
● The timeliness of the commonly ownedgroup election that must be made on anoriginal return will be determined withregard to extensions.
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SURRAN: Last year we reported on a budget bill that instituted major corporatetax reform in New York and created significant changes for manycorporate taxpayers. Our own Michael Quinlan recently met withattorneys from McDermott Will & Emery to get an update ondevelopments that have occurred related to that reform. He alsoexplores other issues related to state taxation as well as the latest onsome controversial sales tax proposals. Mike started his investigationwith McDermott Will & Emery partner Arthur Rosen.
QUINLAN: Art, I want to welcome you back to the program this month.
ROSEN: Thanks, Mike. It’s good to be here again.
QUINLAN: Art, I understand that for most of American history, business taxpayerswere, in the context of potential tax positions they had taken,concerned only with the various government revenue agencies aroundthe country. I now understand that there has been a seismic shift in thisarea. Can you explain?
ROSEN: It’s true that, as far as state taxation goes, businesses were concernedabout revenue department auditors and revenue department policies.They had to be concerned whenever they took a certain tax positionwhat would happen upon audit when challenged by the stategovernment. But now, we have what I call “collateral tax.” We havequi tam actions and class actions.
Qui tam actions are those where a statute gives an individual the rightto step in and act on behalf of the government. For example, a personcan say, “I don’t think this company has been collecting enough salestax. Therefore, I’m going to step into the shoes of the state and sue thiscompany, the seller, and by the way, I get treble damages and otherfees and costs covered.”
It’s a real incentive for vigilante justice in the tax world, and there havebeen cases around the country. Most notably they’ve been in Illinoisand now in New York; we have at least three cases like that proceedingand the traditional tax community is very concerned that non-taxprofessionals, people outside the government, are bringing these casesfor their own profit and really putting businesses through the ringer,probably inappropriately so.
QUINLAN: So Art, what, if anything, can businesses do to guard against suchattacks?
ROSEN: In planning, in any position a business is going to take, whether it’spart of a major corporate transaction or part of day-to-day business –business has to consider these risks. When making a tax decision,business has to think about the implications from both sides, from therevenue department plus from potential qui tam actions.
QUINLAN: Art, you’ve explained the dangers of businesses perhaps not paying orcollecting tax. Are there any problems on the other side of the coin?
ROSEN: Yes. The other side of the same coin is class actions, and we’ve seen anumber of class actions throughout the United States brought against
Video Transcript
1. Tax Reform in New York and Other State Taxation Issues
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major sellers. Individual lawyers, generally, get a plaintiff whocomplains that they’ve paid too much sales tax to a seller and therefore,the seller has broken a law or committed consumer fraud. By the way,this individual buyer represents an entire class so the class action bargoes after the sellers for having overcollected.
In some states, there’s a valid defense that the seller has turned over allthe excess sales tax it might have collected to the state and therefore ismerely an agent. The class action has to go against the principal–thestate, in this case. However, that’s not the story in all states, and therehave been major cases in 45 states. In one case, the same action wasbrought against a company for collecting too much sales tax.
Again, companies have to be concerned about undercollection becausethen they’re subject to audit by the revenue department. They’re subjectto qui tam actions. They also have to be aware of overcollection, becauseclass actions might ensue.
QUINLAN: Is there anything businesses can do?
ROSEN: There is something that businesses can do to guard against these classactions, which is to become active in some of the legislative activitythat’s occurring in Congress and in a few of the states. That is to prohibitclass actions – well, not technically prohibit, but if anybody claims thatthey paid too much sales tax to a seller, that buyer has to request animmediate refund from the seller.
If the seller gives that refund, then it’s all over. There can’t be any classaction because there aren’t any damages. So those types of fixes arebeing sought to protect businesses who are acting in good faith, and thesales tax law is so complicated in every state, it’s almost impossible tocomply perfectly and collect just the right amount on the right item at theright time.
QUINLAN: Art, let’s switch to another state tax issue. From time to time, there areheadlines in the tax press regarding federal legislation in the state taxarea, especially in terms of sales tax nexus. Can you tell us what’s reallygoing on?
ROSEN: Most of the focus on Washington in the context of state taxation has beenin the various sales tax bills. As you may remember from the 1930s, thestates have been trying to get remote sellers, in those days, catalogsellers – Montgomery Ward, Sears – to collect the state sales tax. In1992, the U.S. Supreme Court in Quill said a state could not force aseller that does not have the physical presence in the state to collect andremit that state sales tax.
States have been going to Congress year after year and now there arethree bills that warrant consideration. We have the Marketplace FairnessAct that passed the Senate last Congress. That bill would say there arethree categories of states. First, those that are members of theStreamlined Sales and Use Tax Governing Board.
Those states can require remote sellers to collect and remit their sales taxas long as the streamlined sales tax agreement maintains certainminimum simplification requirements.
Other states have the opportunity of simplifying their laws in accordancewith the minimum simplification requirements set out in the bill andthose states similarly would be able to require remote sellers to collectand remit.
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The third category of states, those who do nothing, those who have tolive under the Quill test that they cannot require remote sellers to collectand remit.
The second bill that I think people should really focus on is the RemoteTransaction Parity Act. That bill has not yet been introduced, but it’sbeen drafted by Congressman Chaffetz.
That bill starts with Marketplace Fairness, the Senate bill, but expands onit in certain important ways. First, there are more simplifications thatstates would have to enact and that the Streamlined Tax Act Agreementwould have to conform to.
Probably the most important one of those is that if the seller uses acertified software provider to assist it in sales tax compliance, the buyerand the seller are pretty much off the hook. That would be a great reliefto many companies around the country. Certain companies that do salestax compliance in-house now might very well outsource it in order to getthat advantage.
More important than that is that this bill, the RTPA, is different thanMarketplace Fairness, for example, because it not only carries the carrotthat states will get to be able to require remote sellers to collect, but alsoit has a stick. It says in the bill that this federal legislation preempts statelegislation in this area. So laws such as the Amazon Law would not bevalid; could not be enforced in any state. This provision also says thatenforcement of any laws other than this federal law for remote sellerswould be illegal.
So even under current law, if a seller would be subject to remote sales taxcollection responsibility because of a click-through law, the state couldnot collect on that if that bill were enacted. It’s a very good bill that hasthe carrot and the stick and would really encourage, I think everystate–all 45 states and D.C. – that have sales taxes, to conform to theminimum simplification requirements.
QUINLAN: So Art, what do you think is going to happen?
ROSEN: Most people who look at what’s going on in Washington aren’t veryoptimistic about anything going on as far as Congressional activity goes.But assuming that there is some break and things start moving along,there is optimism that some sales tax legislation will be enacted becauseof some other state tax bills that are also being considered.
While certain members of Congress might strongly favor one, othersstrongly favor the other, and there’s a good possibility about acombination of these bills, making two or three of them move forwardtogether.
QUINLAN: I’ve heard about another bill called the BATSA. What is the BATSA?
ROSEN: It is the Business Activity Tax Simplification Act. Just as sales taxlegislation is addressing the nexus issue in connection with when a staterequires a remote seller to collect tax, BATSA would set forth theguidelines as to when a state could require a remote business to pay thatstate’s direct tax. It’s business activity tax – whether that’s income tax, orgross receipts tax, the Ohio CAT, the Texas TMT, the Washington B&Ofor example.
That bill would say that no state or locality could impose its direct tax onany business that does not have a physical presence in the jurisdiction. Itdefines “physical presence” as having employees or property in the stateor the locality for more than 14 days during the taxable year.
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The bill would also modernize Public Law 86-272, which now protectsonly sellers of tangible personal property. Under the bill, all sellerswould be covered, whether they sell intellectual property or services, aswell as sellers of tangible personal property.
Finally, other activities would be totally protected. Solicitation now istotally protected, while under the bill, other activities, such as meetingwith suppliers or potential suppliers, or attending a media event wouldalso be protected activity.
The third bill that warrants attention, I think, is the Mobile WorkforceAct. That bill would say no state could impose an income tax on anemployee or a withholding tax on employer unless the employeeprovided employment services in the state for more than 30 days duringthe year.
That is a very popular bill. Although states officially object to it, moststates would be willing to accept that. They understand in today’s mobileeconomy and mobile workforce, this type of legislation is really needed.
QUINLAN: What do you think is going to happen, Art?
ROSEN: Something’s going to happen in this Congress. This has been building solong, this being taxpayer frustration, as well as state frustration with thestate of affairs in state taxation. My guess is that something like theRemote Transaction Parity Act and BATSA, along with MobileWorkforce, will likely move together.
For businesses that are supportive of one or more of those, it’s soimportant that they get involved. They can get involved to the extreme ofjoining one of the formal coalitions that are working to support thesebills, or by merely letting their congressman and the U.S. senator knowthat they support this.
Without that type of voice being heard from the business community,things will take a long time to move along.
SURRAN: In 2014, Governor Andrew Cuomo signed into law major corporateincome tax reform that resulted in significant changes for manycorporate taxpayers, including changes to traditional nexus standards,combined reporting provisions, composition of tax bases andcomputation of tax, apportionment provisions, net operating losscalculation and tax credits. Next Mike Quinlan met with McDermottWill & Emery partner Lindsay LaCava to get an update on developmentssince last year.
QUINLAN: Okay. So Lindsay, I want to welcome you back to the program again.
LACAVA: Thanks, Mike. It’s great to be back.
QUINLAN: Lindsay, last year you and your colleagues talked about the significantcorporate tax reform adopted by New York State. Can you give us areview of that reform?
LACAVA: To quickly summarize, last year New York adopted significant corporatetax reform that adopted economic nexus provisions. It significantlyaltered the tax base and income classification rules. It adopted a newcombined reporting regime, and it also altered the net operating lossprovisions as well as tax rates.
QUINLAN: So what new developments have occurred with respect to that reformsince last year?
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LACAVA: Since last year, there have really been two major developments that I wantto highlight. First, in this year’s budget bill, the legislature enacted sometechnical corrections to those reform provisions. Secondly, also in thisyear’s budget bill, the legislature adopted conforming provisions forpurposes of New York City’s corporate income tax regime.
In addition to those two major changes, the New York State Departmentof Taxation and Finance has also created a new Frequently AskedQuestions portion of its website where they’ve been posting questions andanswers regarding corporate tax reform, and the department has alsoissued two technical memorandum – one addressing transitionalcompliance issues related to corporate reform and one addressingqualified New York manufacturers and the new benefits available to thosemanufacturers.
QUINLAN: Lindsay, can you describe the technical corrections that were made in thebudget bill?
LACAVA: The technical corrections made as part of this year’s budget bill touchedon many aspects of last year’s reform, including economic nexus, thecombined reporting rules, the tax base and income classification rules,apportionment, tax credits, net operating losses, and tax rates. However,two of the more notable provisions that I want to talk about here todayrelated to apportionment and the income classification rules.
With respect to apportionment, this year’s budget bill made someamendments that broadened the definition of qualified financialinstruments or QFIs. As viewers may recall from last year, qualifiedfinancial instruments can be apportioned using either an 8 percent fixedsourcing rule or a series of customer-based sourcing rules and aretypically instruments that have been marked-to-market.
This year’s budget bill allows taxpayers to treat financial instruments –certain types of financial instruments as qualified financial instruments ifany instrument of that type has been marked-to-market by either thetaxpayer or another member of its combined group, meaning that thespecific instrument itself did not necessarily have to have been marked tomarket.
This year’s budget bill also clarified that with respect to marked-to-marketnet gains, those gains are included in the apportionment factor, and thisyear’s budget bill also provided specific allocation rules for purposes ofdetermining the portion of those marked-to-market net gains that shouldbe sourced to New York.
QUINLAN: And how about income classification?
LACAVA: With respect to the changes that were made to the income classificationrules, these were actually quite significant and were more than just meretechnical corrections.
First, the legislature significantly narrowed the definition of investmentcapital by imposing five new requirements that must be met for stock andit still has to be non-unitary stock to qualify as investment capital.
First, that stock has to qualify as a capital asset under section 1221 of theInternal Revenue Code. Second, that stock has to have been held forinvestment for at least one year. Viewers may recall that the holdingperiod was previously only six months. Third, that stock upon sale, thegain has to qualify as a long-term capital gain or loss under the InternalRevenue Code. Fourth, for stock purchased on or after January 1, 2015,the stock can never have been held for sale to customers in the regular
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course of business. Lastly, for stock to qualify as investment capital, thetaxpayer actually has to identify that stock before the close of businesson the day the stock was acquired as stock held for investment.
These five new requirements taken together really narrow the definitionof investment capital, meaning that less income will qualify asinvestment income to be excluded from the tax base, and also imposenew compliance burdens on taxpayers who now have to track andconform their federal and New York treatment, and also adopt proceduresfor the identification procedures required under the new law.
Also relating to the income classification rules, this year’s budget billadopted a new cap that limits the amount of a taxpayer’s income that canbe treated as investment income.
This cap limits the portion of a taxpayer’s entire net income that can betreated as investment income to 8 percent. This cap is applied before thetaxpayer deducts the interest expenses that are attributable to itsinvestment income or before the taxpayer elects to reduce its income by40 percent.
QUINLAN: Does this new 8 percent cap on investment income raise anyconstitutional concerns?
LACAVA: Mike, that’s a great question. Under the U.S. Constitution, a state can taxonly an apportioned share of income that is from a unitary businessoperation or a unitary asset, meaning that’s unitary with the taxpayer’sin-state business. So this new cap raises questions about whether thestate can constitutionally tax income from a non-unitary stock thatexceeds that 8 percent cap. By exceeding that cap, the income would bereclassified from investment income to business income and therefore betaxable.
Last year’s budget bill attempted to deal with this issue by providing thatif an asset generated income that could not be constitutionallyapportioned, the particular asset, or more specifically, the budget billreferred to securities, would be treated as investment capital.
However, what’s unclear is how this new 8 percent limitation interactswith that savings clause. Taxpayers who have income from a non-unitarystock that exceeds that 8 percent cap should consider resorting toconstitutional challenges if necessary to exclude that income from theirapportionable tax base.
QUINLAN: With respect to New York City’s corporate tax reform, you said that citytax on corporations now largely conforms to the New York State tax. Canyou highlight the differences for our viewers?
LACAVA: Sure, Mike. As I noted, the city tax largely conforms with the reformedstate corporate income tax, but there are a few notable differences.
First, the New York City tax did not adopt, with the exception of certaincredit card banks, the economic nexus provisions that were adopted atthe state level.
Second, viewers may recall that for state purposes, the state will bephasing out the alternative tax on capital. The New York City tax oncapital will not be phased out.
Thirdly, viewers may recall that the state apportionment formula was asingle sales factor formula. New York City, which has been transitioningto a single sales factor, will continue that transition, meaning that payrolland property will still be used for a period of time, and once the single
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sales factor is fully phased in, certain taxpayers can elect to continue touse a three-factor formula.
Fourth, unlike the state that actually reduced the tax rate applicable to thebusiness income base, New York City has retained its 8.85 percent tax rateand in fact has actually implemented an increased rate of 9 percent, whichwill apply to certain large financial corporations.
I also want to point out for viewers that New York City will continue totax S-corporations, which the city taxes in the same manner as general C-corporations, under the former general corporation tax, so not thereformed corporate regime. And it will continue to tax unincorporatedbusinesses under the unincorporated business tax, which has also not beenreformed by these provisions.
Interestingly, the city has set up a working group to explore how S-corporations and pass-through entities should be treated. So we expectfuture reform in that area.
QUINLAN: I understand that this year’s budget bill also contains some controversialsales tax proposals. What is the status of those proposals?
LACAVA: Two of the more controversial proposals in the original budget billincluded a series of reforms targeted at perceived tax avoidance structures.Those amendments would have, for example, accelerated the sales and usetax due on related party leases. They also would have eliminated the salesand use tax exemption that is available for certain related-partytransactions such as contributions, distributions or mergers.
The second controversial proposal would have imposed a use taxcollection obligation on marketplace providers, requiring them to collectsales and use tax on behalf of all of the vendors that sell through theironline marketplace.
Fortunately and to the relief of many taxpayers, none of thosecontroversial proposals were adopted. However, with that said, there weretwo notable sales tax proposals that were adopted in this year’s budgetbill.
First is a proposal that provides a sales and use tax exemption for certaintransactions conducted as a result of a resolution plan adopted under thefederal Dodd-Frank Reform Act.
The second notable sales tax provision included in this year’s bill aresome favorable provisions for boats and aircraft.
For example, general aviation aircraft will now benefit from a sales anduse tax exemption, and related parties will now enjoy a sales and use taxexemption for aircraft transferred pursuant to certain contributions,distributions and mergers.
QUINLAN: Lindsay, why should companies outside of New York State be concernedabout the New York State budget bill?
LACAVA: Well, Mike, as you may recall as part of last year’s reform, New YorkState adopted an economic nexus standard for purposes of its corporateincome tax and under that standard, a corporation is subject to tax in NewYork if it has one million dollars, or more, of receipts from New Yorksources.
So even companies that don’t have any employees or property in NewYork should be concerned about the changes adopted in this year’s budgetbill to the extent they might be subject to that economic nexus standard.
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QUINLAN: Lindsay, as a result of the reforms that were adopted by New York State,what would you suggest our viewers do?
LACAVA: Well, Mike, given that both the state and now the city reform provisionsare effective January 1, 2015, taxpayers should really be considering howthese reform provisions affect their tax return filings as well as theirfinancial statements. For purposes of their tax return filings, corporationsshould be starting to think about important decisions that have to be made.For example, the reform provisions, both last year’s and this year’s, havesome elections that need to be made with respect to income classification,apportionment rules, as well as combined reporting.
Those types of decisions are things taxpayers should be looking at nowand perhaps talking to their advisors to decide what the best path is forthem under the new law.
QUINLAN: Lindsay, thanks for being here again.
LACAVA: Thank you, Mike.
SURRAN: Next Mike Quinlan met with McDermott Will & Emery Associate MarkYopp to hear about the latest developments with regards to state sourcingmethodology and apportionment issues.
QUINLAN: Mark, I want to welcome you to the program.
YOPP: Mike, thanks. It’s great to be here.
QUINLAN: Mark, recently, New York changed its laws to go from a cost-of-performance sourcing methodology to a market sourcing methodology.What are the differences between cost-of-performance sourcing andmarket sourcing?
YOPP: Well, that’s a good question. So cost-of-performance and market sourcingare two methods by which receipts are sourced to states for purposes ofapportioning income.
Under cost-of-performance, receipts are sourced based on where theincome-producing activity occurs. Under market, receipts are sourcedbased on where the customer receives the benefit. That’s the differencebetween the two.
QUINLAN: And was New York’s change an isolated occurrence or part of a largertrend?
YOPP: New York’s change was part of a much larger trend. Over the past fewyears, many states have been switching from cost-of-performance sourcingto market sourcing. One of the reasons they do this is because cost-of-performance sourcing tends to put a larger tax burden on in-statecompanies, whereas market sourcing tends to put a larger burden on out-of-state companies. Many states have done this in order to sort of keeptheir tax revenues flat but make it so that in-state companies are notburdened as much as they have been in the past.
Many states are continuing to review this. For instance, there’s a bill inTennessee that would switch that state from cost-of-performance to marketand many other states are looking at that as well.
QUINLAN: There have been a number of cases in which taxpayers have challengedthe use of the so called “MTC election.” What is the MTC election, andwhy is it being challenged?
YOPP: So the MTC election is part of the multi-state compact, which was enactedby many states about 50 years or so ago. As part of that enactment, there
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is an election, and that election allows taxpayers to use a specific formulato apportion their income.
That formula is based on three factors: payroll, property, and receipts, andall three of those are equally weighted.
Originally, this didn’t make a huge difference because many of thosestates that enacted the compact were already using that formula. Overtime, those states have shifted to two other apportionment formulas.
One is a single factor based on receipts and the other is still the threefactor based on payroll, property and receipts, but in that case, the receiptsfactor is double weighted.
As a result, many taxpayers have filed for refund claims and using theelective three-factor formula, and by doing so, they’ve sort of generated alot of controversy among the states. As a result, the states have gone backand repealed the election and have challenged the taxpayers who are filingthose refund claims.
QUINLAN: So what is the status of those cases?
YOPP: There are two very prominent cases, one in California and one inMichigan. In the California case, a lower-level court held that thetaxpayers could use the elective method. The state then appealed to thestate Supreme Court and the case is currently pending. Oral argumentshave not happened yet, but a decision is expected towards the end of2015.
In Michigan, the state Supreme Court held that taxpayers could use theelective method. Subsequent to that decision, the Michigan legislatureretroactively repealed the ability to use the legislation. As a result, thereare about 50 cases that are pending in lower levels that are challengingwhether that retroactive repeal was valid. Recently, a couple of weeks ago,a lower-level court held that the retroactive repeal was valid.
So it’s likely you’ll continue to see ongoing litigation about whether thatlower-court level decision was accurate. In addition, there are other casesin Texas and Oregon and Minnesota that are still sort of in theintroductory phase and are ongoing.
QUINLAN: So almost every state has some sort of alternative apportionmentprovision. How do those provisions work?
YOPP: Basically, every state has a provision that allows the Department ofRevenue to use an alternative to the standard method, if in thedepartment’s discretion the standard method does not properly reflect theactivities of a taxpayer in the state. For a long time, those provisions wereused to create sort of industry-specific apportionment formulas, fortrucking industries or for financial institutions, things like that.
Recently, the Departments of Revenue have used those provisions tochange the individual taxpayer’s liability as opposed to an industry’sapportionment formula.
QUINLAN: So what are the latest developments with alternative apportionment?
YOPP: So there have been a series of cases in Tennessee, and Wisconsin andMississippi, among some other states, where state Departments ofRevenue have been successful in invoking alternative apportionment withrespect to individual taxpayers. In those cases, one of the concerningthings to look out for is that the invocation of alternative apportionment isnot done to do something that’s consistent with the statutory formula, butslightly different, but rather to adopt an entirely new formula.
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ript For instance, in Tennessee, which has a cost-of-performance sourcing
methodology, the department evoked alternative-apportionment-to-usemarket, which is a completely different theory on how to apportionreceipts, and that case was upheld. It’s currently on appeal. So one thingfor people to look out for is whether those alternative apportionmentinvocations are consistent with the overall statutory.
QUINLAN: So Mark, as a result of the apportionment issues that you discussed, whatwould you suggest our viewers do?
YOPP: Well, I think there are a couple things that they can do. The first is to getinvolved on the legislative level. A lot of these changes are being donespecifically by departments of revenue, sort of outside of the statute. Nowin Tennessee, there’s a pending bill, but in other states there are as welland one of the ways that your viewers can get involved is to make surethat their companies are represented in front of the legislature
So that the way that they’re taxed is consistent with the statutory intentand not the way that the department wants them to be taxed.
The second is to make sure that they follow the litigation that’s going onaround the states, both on the alternative apportionment level and on theMTC election level. Those cases are very important, and if they come outa certain way, then there could be ways in which taxpayers could respond,either by subsequent litigation, or by planning opportunities that couldoccur or again at the legislative level.
QUINLAN: Why is apportionment an important issue for our viewers to know about?
YOPP: Apportionment is a very important issue because at a state level, acompany’s tax liability is primarily determined on where its activities areoccurring. And historically, states had taxed companies based on sort ofhistorical economic models, which is, where is the capital? Where is thelabor? Where are those activities? And that’s where the income washappening.
There’s been a recent trend among the last couple of years to move awayfrom that and to apportion companies based solely on where sales areoccurring, which obviously has a very huge impact on companies becausewhere their capital and labor could be very different from where their salesare occurring. States are typically trying to do this so they can attractbusinesses to come into their state and make sure that the income taxburden is imposed on out-of-state companies rather than in state.
So companies should be very concerned because small changes in statutescould have a big change on their tax liability based solely on how a stateapportions its income.
SURRAN: It’s clear that there are a lot of things going on in the state tax arena with alot of players involved. Viewers will need to stay tuned as to whether andhow Congress and the states legislatures act in the months to come.
