State and Local Tax Update

Walter Doggett – E* TRADE Financial CorporationMichelle Zahler – EY, ChicagoMichael Johnson – EY, Charlotte

Agenda

New York state corporate tax reform• New York City conformity

State tax audit and controversy trends

Tax data, process and technology trends

Multistate legislative, administrative and judicial developments

New York State reform

New York State corporate reform – major provisions

Repeals Article 32 and merges it into a substantially modified Article 9-A (generally as of January 1, 2015)

Expands the economic nexus provisions Modifies the combined reporting rules Revises tax bases and rates Eliminates subsidiary capital tax and related modifications Modifies net operating loss rules Adopts increased customer based apportionment rules and 8%

Qualified Financial Instruments (“QFI”) election Modifies the Metropolitan Business Tax Surcharge No New York City conformity (to date) but GLBA transitional

provisions extended

New York corporate tax reform – tax bases and rates Business Income Tax base and rates

• Business income is ENI less investment income and other exempt income• ENI starting point for domestic corporations and alien corporations treated as

domestic is federal taxable income• ENI starting point for other alien corporations is ECI with no treaty modifications• 7.1% rate for general corporations reduced to 6.5% for tax years beginning on or

after 1-1-16

Capital Tax base rate• 0.15% rate for general corporations phased down to 0% for tax years beginning on

or after 1-1-21• Cap for general corporations is $5M

Fixed Dollar Minimum Tax base rate• Amount increased based on New York receipts, with maximum of $200,000 if New

York receipts exceed $1B

Subsidiary Capital Tax is repealed

New York corporate tax reform - combined reporting More than 50% direct or indirect ownership and unitary tests

• Includes domestic corporations, alien corporations treated as domestic corporations, alien corporations with effectively connected income (ECI), captive real estate investment trusts (REITs) and captive regulated investment companies (RICs) not included under Article 33 and combinable captive insurance companies

Excludes corporations taxable under other articles and non-captive REITs and RICs Commonly-owned group election Designated agent Calendar/fiscal year members

New York corporate tax reform - “investment income” and “other exempt income” Investment income is generally income and net capital gains from stock

of non-unitary corporations held for more than six consecutive months, other than stock held for sale to customers in the regular course of business

Investment income is reduced by interest expense and hedging losses attributed thereto

Other exempt income is the sum of exempt CFC income and exempt unitary corporation dividends

Other exempt income is reduced by interest expense attributed thereto

Investment income and other exempt income could be treated as taxable business income if from a qualified financial instrument (“QFI”) and fixed percentage method of apportionment election is made

New York corporate tax reform - thrift/ qualified community bank modification

Qualified residential loan subtraction modification (“r” modification)

Qualified Community Bank/Small Thrift subtraction modification (“s” modification)

Qualified Community Bank/Small Thrift Institution REIT subtraction modification (“t” modification)

The taxpayer can utilize only one of the modifications but the taxpayer cannot utilize the “r” or “s” modification in any tax year in which it maintains the REIT that qualifies the taxpayer for the “t” modification

New York corporate tax reform - net operating losses (“NOLs”) Pre-Corporate Tax Reform NOLs: Prior NOL Conversion Subtraction

• NOL subtraction conversion pool is determined by multiplying unabsorbed NOLs at the end of the base year by the BAP for the base year and by 7.1% for general corporate taxpayers. This amount is then divided by 6.5% for general corporate taxpayers

• The subtraction reduces allocated business income to the higher of the tax on the capital base or the fixed dollar minimum

• The allowable annual subtraction can only equal 1/10 of the total pool plus prior year carryforwards. The subtraction can be carried forward until tax years beginning on or after 1-1-36

• Alternatively, taxpayer can elect to utilize not more than 50% of the pool in 2015 and not more than 50% in 2016 with no carryforwards after 2016

• Special rules apply where pre-corporate tax reform NOLs reside in separate companies or different combined groups than the combined group that will exist post-corporate tax reform

New York corporate tax reform – NOLs (continued) Post-Corporate Tax Reform NOLs

• Post apportioned business loss

• The amount that reduces a taxpayer’s allocated business income is limited to the higher of the tax on its business capital base or its fixed dollar minimum

• No longer limited to federal NOL deduction or subject to federal tracing rule

• Twenty year carryforward and three year carryback (but not prior to 2015)

New York corporate tax reform- apportionment

Single sales factor with customer based sourcing

Financial transactions• Financial instruments that are QFIs - Customer sourcing v. fixed

percentage • Financial instruments that are non-QFIs - Customer sourcing• Other receipts from broker or dealer activities• Receipts from credit card and similar activities• Receipts from certain services to investment companies• Hierarchy for determining “commercial domicile” of business customer

Receipts from other services and other business receipts• Inclusion in the numerator is determined by a hierarchy

New York Corporate Tax Reform –Tax Department Implementation

Regulations and TSB-Ms• Key areas identified to date

FAQs on website

Forms and instructions

What are taxpayers considering in light of New York State Tax Reform?

2014 Filings, especially in light of NOL conversion subtraction Modeling of new tax Expense Attribution Receipts Sourcing and Data Gathering Elections

• QFI• Consolidated Election• Safe Harbors

New York City conformity

NYC conformity – what to expect?

Goal to conform to NYS Corporate Tax Reform – expectation for draft proposal in Fall 2014;

• Aim to ensure revenue neutrality with certain provisions being considered including:• Keeping capital base tax – no phase out• Conforming to ENI base including economic nexus, market-based sourcing,

and new unitary rule• Imposing a surcharge on banks and financials• Commissioner believes economic nexus and unitary rules will offset a

portion of revenue loss to the City• Conformity likely to be retroactive 1/1/2015

S Corps and Unincorporated Business Tax • May be exempted from reform provisions

* Information within this presentation deck is based on 15 September 2014; more recent updates will be discussed

Audit controversy trends

Recent audit experiences – Tales from the trenches

Overview of state audit divisions and composition of these groups

Key considerations in managing the audit process• Pre-audit communication• Statute of Limitations - Requests for extensions

Information Documents Requests• Detail and volume of the requests• Managing the Process and timing• Requests that require information from outside of the tax department

Proposed assessments• Review of proposed assessments and additional documentation• Penalties• Review of Supervisor• Appeal procedures• Litigation

Tax data, process and technology trends

Today’s state and local tax landscape

In today’s tax departments, data and technology needs/ challenges monopolize the greatest majority of a state and local tax professional’s time• Data sourcing

• Gross/net, SINAA, COP, market, modifications, ad hoc audit requests• Data reconciliation

• Loan systems to G/L, FTI, I/C eliminations, ad hoc audit requests• Data models

• SINAA, COP, depreciation, addbacks, elections (e.g. NY reform)• Technology enablement

• Provision, compliance and apportionment systems, workflow, document management• Technology training

• New technology, upgrades/updates, law changes, upstream technology changes• Technology issues

• Outages/maintenance, overrides, consolidation, efile

Page 21

Record Gather & Analyse Report

ERP

Transactional

Data

Other

(e.g., Payroll)SSC

Excel

or CSV

Tax Data

Warehouse

Filings

Mgmt

Reports

Analysis

Exception

Reporting

Compliance

Software

Work-

papers

Workflow & Information Management

eFiling

Retention

& Archiving

Business Units

Data - collection, management and reporting approach

State and local tax data, process and technology trends Apportionment

• Addressing previous decisions to determine if the methodology/proxy being used in data models complies with the current laws

• Capturing additional information beyond available finance data• Gross receipts• SINAA• COP• Customer related information (commercial domicile, where contracted)• Associate information

• Establishing more comprehensive models to support apportionment decisions and establish a stronger audit trail

• Migration to apportionment technology that can efficiently link into provision and compliance technology

State and local tax data, process and technology trends Indirect taxes

• Continued movement to automated determination interfaced with upstream transactional and financial data• Often connected to other finance initiatives

• Development of a single source of reporting data for future controversy needs

• Use of workflow management with scheduled automated data sourcing and associated document management programs to manage and track compliance

• Modification/remediation of data in upstream systems versus maintaining a separate set of tax “books”• Personal property tax• VAT/GST/PST

Dimension Reactive Established Leading practice

Data ► Extensive manipulation► Lack of communication

between legacy data systems

► Ad hoc enhancements built to deal with regulatory changes as they happen e.g., NY reform

► Lack of flexibility to provide reporting to various stakeholders in the organization and vendors in desired format

► Lack of maintenance of tax entity trial balances.

► Significant time spent by internal tax team to prep data for vendors to start compliance process

► Formal workplan and tools such as tax calendars and/or close plan are not centrally maintained.

► Electronic updates for key data needs

► Tax function has formal workplans for core tax processes and critical activities, but individual responsibilities, interdependencies and integration points are not clearly defined.

► Specific data sources have been scheduled with business unit/finance to obtain ad hoc tax data files.

► Policies to manage the retention of tax data have been developed, but not actively maintained.

► Tax needs at right level within source systems (e.g., legal entity, jurisdiction)

► Automated data collection across multiple sources

► Validation and mapping of disparate data into consistent format and single tax processing point

► Data retention to support tax audit and clear audit trail

► Tax function utilizes workflow management system to effectively manage all major activities with clear visibility over individual responsibilities, interdependencies and integration points.

► Tax has developed standard policies which comprehensively address the management of data retention for tax audits and are aligned with the requirements set forth in Revenue Proc.98-25. Policies are annually re-evaluated.

Maturity model - data

Dimension Reactive Established Leading practice

Processes and controls

► Limited formality► Limited standardization► Lack of integration is

indicated by static tax processes and functional and geographic silos. Tax process owners focus only on their own work and communication across tax processes, functions or geographies is mostly informal

► Some standardization ► Formalized processes for

local country compliance► Tax participates in regular

meetings with deal professionals and finance to discuss significant transactions

► Tax department is process-focused and considers the tax life cycle (provision, compliance, controversy and planning) in its start to finish

► Tax processes are global in reach and embedded in underlying financial processes

► Tax has a limited footprint regarding routine processes

► Key person risk minimized by documented policies

► Processes are challenged for continuous improvement

► Tax trial balance is maintained by finance

► Documented policies/procedures on roles, responsibilities and expectations for each organizational tier

► Tax process integration goes beyond tax department and includes processes impacting tax across the extended organization. Key tax processes flow seamlessly across "firewalls" or business functions

Maturity model - processes

Dimension Reactive Established Leading practice

Technology ► Limited use of technology ► Spreadsheets► Manual entry for select

information needs► Automated interfaces

between tax reporting and source systems do not exist, requiring manual intervention and reconciliation

► Dedicated tax technology with limited sophistication and automation

► Electronic updates for select key information needs

► Major tax processes (compliance, provision) have an automated interface between tax reporting systems and source systems

► Extensive automation from data collection of underlying inputs

► Real time monitoring and reporting of tax workflow and risk

► Real time information sharing between tax, finance, deal professionals, legal and accounting as needed

► Tax represented in key technology decisions

► Partnership with IT to continually improve processes

► Major tax processes (compliance, provision) have an automated interface between tax reporting systems and source systems. Manual interventions are minimal and automation leveraged for processes to the maximum extent possible. Adjustments made in source systems are available to tax on a real time basis. Tax journal entries are automatically posted to general ledgers

Maturity model - technology

Other recent state developments

Legislative Developments

2014 state income/franchise tax legislative scorecard (as of September 15, 2014)

Rate decreases

► Corporate income: AZ, DC, ID, IL, IN, IA, MD, MO, NE, NM, NY, RI, VA, WV► Personal income tax: DC, MO, NE, OH, OK, SC, WI► Personal income  tax from pass‐through entities: MO, OH► Business entity fees: FL, IL► Repeal: Business entity tax: CT; Corporate net worth tax: GA; Phase‐out corporate income tax 

MS, MO; Repeal corporate minimum tax: RI

Rate increases

► Corporate income tax: IL► Personal income: IL, NYC► Pass‐through Entity Fees: DE► Increased income tax exemption: FL► Corporate surcharge: NJ 

Allocation and Apportionment

► Market sourcing: DC, KY, NM, NY, RI, SD► Single sales factor: DC, KY, MO (amendments), NY, RI► Discretionary Authority: MS, MO

Filing options ► Combined reporting: KY,MD, NM (banks only), NY, RI► Consolidated Returns: VT

Tax base► Nexus: NY► Amend NOL provisions: ID, NJ, NY, NC,WI ► Increase income tax exemption: FL

Controversy ► Amnesty program: LA, MA, MS, MO► Independent tax court: AL, KS (modified), LA (modified)

Miscellaneous► Loophole closures: NJ► Tax Haven: ME,MA, RI, WV,WI► Defer FAS 109 deduction: MA

Key: Green – enacted; Red – dead; Purple – Vetoed; Black – proposed 

District of Columbia

New law (B20-849), an emergency bill, makes a number of changes to the District of Columbia's tax code effective for tax years beginning after 12/31/2014 • Bill adopt a single sales factor apportionment formula• Market-based sourcing for services• Unincorporated Business and Business franchise tax rate will be reduced from

9.975% to 9.4%. • Upon certain revenue thresholds are met, the rate will be reduced as follows:

9.4% to 9.2% to 9.0% to 8.75% to 8.5% to 8.25%. On July 14, 2014, the DC Council overrode the mayor's veto of B20-849.

Note: B20-849 is an emergency bill and as such, is effective for a 90-day period.

These changes also are contained in a permanent bill (B20-750), which requires approval by the mayor and Congress.

Rhode Island - H7133

Requires unitary reporting for domestic and foreign corporations that have more than 20% apportionment in the US• Entities with common ownership greater than 50% can be included in a unitary group• Unitary business is intended to be construed to the broadest extent allowable• Special rules relate to foreign corporations and certain income/expenses may be

excluded if protected under federal treaty and the foreign corporation is not in a “tax haven”

An election is permitted for federal affiliated groups to file as an affiliated group rather than following a unitary group analysis

Single sales factor apportionment with market based apportionment for services

Reduces corporate income tax rate from 9% to 7% Repeals annual franchise tax, related party intangible and interest expense

add-back provisions Effective January 1, 2015

Michigan – MTC Challenge

On September 11, 2014, the Michigan Governor Rick Synder signed legislation (SB 156) that expressly repeals the Multistate Tax Compact (MTC), retroactively effective beginning January 1, 2008• The direct object of this Michigan legislation is to prevent any refunds from

being paid in light of the Michigan Supreme Court’s July 14, 2014 decision in IBM.

• Case held that taxpayer was allowed to use the Multistate Tax Compact's equally weighted three-factor apportionment formula to determine tax liability under the since-repealed Michigan Business Tax.

Refund requests in excess of $1 billion submitted for the tax years 2008 through 2010.

Other Income/Franchise Tax Legislative Developments North Carolina – H.B. 1050

• Repeals long-standing net economic loss deduction and replaces it with a state net loss deduction that more closely resembles the federal NOL deduction

• No longer requires an offset to the net loss by non-taxable income• Loss must be allocated and apportioned to North Carolina in the year of

the loss• Losses may be carried forward for 15 years; no carryback• Effective for tax years beginning on or after January 1, 2015

Other Income/Franchise Tax Legislative Developments (continued) Mississippi – S.B. 2065

• Amends the computation of the corporation franchise tax to:• Exclude deferred gains and deferred income from the computation of capital,

paid-in capital, surplus and retained earnings; and• Reduces capital by the cost of treasury stock

• Effective July 1, 2014

Mississippi – HB 799 • Equifax “fix” legislation modernizes of alternative apportionment; clarifies

who bears the burden of proof

Internet Tax Freedom Act (“IFTA”)

Originally enacted in 1998, Act is set to expire on November 1, 2014 • Bars federal, state and local governments from imposing a tax on internet

access and imposing “multiple and discriminatory taxes on electronic commerce,” such as bit taxes bandwidth taxes and email taxes

Congress is currently considering and is expected to be renewed with recent momentum around aligning the IFTA with such the Marketplace Fairness Act and the Mobile Workforce State Income Simplification Act• Key considerations include what if any provisions will be included to

grandfather those state provisions that impose a tax on internet access (Hawaii, New Mexico, North Dakota, Ohio, South Dakota, Texas, Washington and Wisconsin)

Update will be provided

Administrative Developments

Multistate Tax Commission developments

Launches state tax transfer pricing study group – August 2014

Model act to adopt market state sourcing – May 2014• Includes the modification of Reg.IV.17

• Now services and receipts from intangibles are sourced based upon where the service is received

• Launches Market based sourcing draft regulations

Model Uniform Financial Institution Apportionment Rules

Adopts changes to the Model formula for the Apportionment and Allocation of Net Income of Financial Institutions• Adopts changes to sourcing of receipts

• ATM Fees – location of machine• Merchant Discount – merchant location if available, credit card receivables if

not available• Receipts from Investment and Trading Activity on behalf of third parties –

Market sourcing or as an alternative Greater cost of performant• Other Services – Market • Receipts from Investment and Trading Activity – location where activity

conducted but requires asset to be reflected on financial statement of taxpayer • Property Factor

• After significant discussion and debate no changes proposed Financial Institution definition

• No change recommended

Other administrative developments

Colorado – PLR-13-001, 1/24/2013 – S&L holding company allowed to use an alternative apportionment formula to assign investment receipts to its Colorado receipts factor numerator.

Indiana – LOF 02-20130134 – Finnegan does not apply to corporations filing consolidated returns, it only applies to corporations filing a unitary combined tax return

Indiana – Revenue Ruling 2013-03 IT – Company’s storage of its out-of-state clients’ catalogs at its Indiana facilities prior to distribution did not establish a substantial nexus for its clients sufficient to create an Indiana filing obligation

Pennsylvania

Pennsylvania Department of Revenue Information Notice Corporation Taxes 2014-0X (issued June 16, 2014)• Draft guidance on sourcing sales of services under the new market-based sourcing

provisions:• Sales of services are sourced to PA if the services are delivered to a location in the state• “Delivery” means occurring at a location where a person or entity may use the service

• Passage of service from provider to user = delivery• Passage of service from provider to intermediate party = no delivery• If third party is used to complete final delivery to customer, service provider will source receipts to

customer’s location of use• Delivery to electronic address, service deemed to be delivered in PA if the user of the electronic service is

in the state• Service is delivered in the state according to the relative proportion of use of the service in PA as

compared to other states• Service income should be apportioned by a “reasonable and consistent method”• If a receipt is for an intangible and a service, receipt should be sourced according to the rules

for sourcing services• Income from intangibles will continue to be apportioned to PA if the income producing activity

is performed in the state; COP rule applies if activity occurs in multiple states

California

California FTB, Legal Ruling 2014-01, 7/22/2014• Multi-member limited liability companies (LLCs) classified as partnerships for tax

purposes are required to file a CA return and pay applicable taxes and fees in the following situations:• 1) LLC only registered to do business in CA• 2) LLC only organized in CA• 3) LLC commercially domiciled in CA• 4) LLC “doing business” in CA• 5) “Manager-managed” LLC “doing business” in CA• 6) CA sales exceed the sales amount of $500k or 25% of taxpayer’s total sales

• “Doing business” threshold values for 2014 are sales of $529,562 and property and payroll of $52,956; only one threshold needs to be met to be considered doing business

• Situations 1) and 2) are not attributable to LLC members, therefore no filing requirement for LLC members

• Business entities that have a membership interest in the LLC have a filing obligation in situations 3) through 6) as the activities are attributable to LLC members and constitute “doing business”

California

California Third Interested Party Meetings• Discussion of California Code of Regulations (CCR), title 18, section 25136-2

• Possible amendments for market-based sourcing rules for sales other than sales of tangible personal property

• Address certain issues in connection with sales of services and intangible property that were not addressed previously

• Includes definitions and examples of:• “Benefit of a service is received”• “Intangible property”• “Marketable securities”• “Reasonably approximated”• “Service”• “The use of intangible property in this state”

• Discussion of sales from services assigned to this state to the extent the customer of the taxpayer receives the benefit of the service in this state

Other administrative developments (continued)

Massachusetts – Department of Revenue issues draft market based sales factor sourcing regulation for public comment

Missouri – Southwestern Bell Telephone – Nexus not created for out-of-state company whose only asset in the state is its interest in a pass-through entity

New York – Sungard Capital Corp. and IT USA Inc. – Decisions to allow and not allow taxpayers to file combined returns under prior law

Virginia – PD 13-193 – Add-back exception for taxes paid to another state allowed for the portion of royalties and interest that correspond with the portion of the intangible holding company’s income subject to tax in other states

Judicial Developments

US Supreme Court to Consider Three State Tax Cases

The U.S. Supreme Court on September 4 scheduled three state tax cases –• Comptroller of the Treasury v. Wynne• Direct Marketing Association v. Brohl• CSX Transportation Inc. v. Department of Revenue

All cases were accepted for the October 2014 term to be argued on November 12, December 8, and December 9.

Multistate Tax Commission –MTC three factor elections Current cases to watch;

• California - Gillette• Michigan – IBM and Anheuser-Busch• Minnesota - Kimberly-Clark• Oregon - Healthnet • Texas - Graphic Packaging

Michigan

IBM v. Department of Treasury, Michigan Supreme Court• MI Supreme Court ruled that IBM was permitted to use the Multistate Tax

Compact (MTC) equally weighted, three factor apportionment formula to determine tax liability under the Michigan Business Tax (MBT)• Court concluded MTC election and MBT apportionment provisions contain the

common purpose of setting forth apportionment methods for a multistate taxpayer’s business income and could be harmonized

• Court determined MBT gross receipts tax was based on gross receipts less a variety of exclusions/deductions and the MTC election could be used to calculate the MBT gross receipts tax

• Additional litigation is expected to determine if the MTC election can be used in 2011 and later periods

• To the extent the case is not repealed, MI will need to process outstanding refunds/ credits for 2008 to 2010

• The MI Office of Attorney General filed a motion for reconsideration on the case with the MI Supreme Court on August 4th

Kentucky Nexus Combined Return

Kentucky apportionment factors of a South Carolina parent corporation, which had realized a net operating loss, were de minimis and therefore, the parent corporation was not an includible corporation in an affiliated group within the meaning of Ky. Rev. Stat. Ann. § 141.200(9)(e) and could not file a consolidated tax return with its wholly owned subsidiary in Kentucky• The parent corporation had only one employee, an auditor, performing services in

Kentucky. The auditor was a Tennessee resident who also performed the majority of her services in that state and received her assignments from corporate headquarters in South Carolina.

• The BTA ruled that the DOR properly sourced all of the employee's compensation to Tennessee and the payroll factor numerator for Kentucky was zero. The parent corporation's only sales in Kentucky was a management fee charged to the subsidiary. Since the management fee was for accounting and administrative services, which were mostly performed in South Carolina, the DOR correctly sourced the management fee to South Carolina and the parent had a zero sales factor. • (World Acceptance Corp., et al. v. Kentucky Finance and Administration Cabinet DOR, Ky.

BTA, File No. K13-R-18, 08/29/2014.)

Missouri – Sales Tax Bad Debt Claim

The Missouri Supreme Court, two retailers in a consolidated case were ineligible for refunds of amounts written off as bad debts by banks under contract with them to operate private label credit cards.

Retailers did not themselves write off the bad debts. Only the retailers are legally obligated to remit the tax and eligible to apply for a refund if they suffered a loss; however, only the banks sustained bad debt write off losses.

(Circuit City Stores, Inc. v. Director of Revenue, Mo. S Ct., Dkt. No. SC93687, 07/29/2014.)

Other significant judicial developments

California – ComCon Production – Trial court finds in favor of taxpayer in nonunitary claim but agrees with FTB that gain from liquidated damage was business income

Maryland – Gore Enterprises – State’s highest court upholds corporate income tax on out-of-state subsidiaries; clarifies Maryland “unitary” nexus standard from SYL, Inc. case, alternative apportionment

New Jersey – Lorillard Licensing Co. – Division of Taxation not allowed to use dual nexus standards for purposes of determining whether sales made to another state should be thrown-out of the NJ sales factor denominator

Other judicial developments (continued)

Alaska – Tesoro Corp. – Use of an alternative apportionment formula to determine the taxable income of an oil company and its pipeline subsidiary was reasonable and appropriate

Arizona – Home Depot – Wholly owned intangible holding company included in corporation’s unitary business group because entities operations were substantially interrelated

Arizona – Harris Corp. and First Data Corp. – Income is business income if it meets either the transactional or functional tests

Illinois – Witte Brothers – Pass-through miles of an interstate trucking company are Illinois revenue miles includable in the numerator of the special Illinois apportionment factor for the transportation industry

Illinois – Wendy’s International – Out-of-state captive insurance company is a bona fide insurance company that cannot be a member of the same unitary business group as non-insurance company parent and affiliates

Other judicial developments (continued)

New Jersey – Village Super Market – PA corporate limited partner of NJ LP has nexus because the partnership and the partner are not discreet and independent entities, distinguishes BIS, Ltd. ruling

New York – Caprio – the appellate court disallowed retroactive application of tax on gain resulting from liquidations

New York City – McGraw Hill – A publishing/information services company is allowed to compute its NYC General Corporation Tax using an alternative apportionment formula

Oklahoma – CDR Systems – State supreme court upholds capital gains deduction for in-state companies on constitutional grounds

Tennessee – Vodafone – State allowed to require market-based sourcing rather than statutory cost of performance method

Addendum

New York State corporate tax reform

A. 8559D and S.6359D (enacted 31 March 2014) Key components

• Repeal the bank franchise tax (Article 32) and merge it into a substantially modified general corporation franchise tax (Article 9-A)

• Adopt economic nexus and market-based receipts sourcing• Eliminate subsidiary capital tax and related modifications• Reduce tax rates and modify the Metropolitan Transit Authority (MTA)

surcharge• Modify New York State net operating loss (NOLs) rules and combined

reporting rules• Adopt tax benefit for certain manufacturers• Repeal license/maintenance fees (Tax Law §§180 and 181)• Changes are generally effective 1 January 2015, with notable exceptions

Corporate tax reform specificsNexus Expansion of the economic nexus standard already in place for credit

card companies Tax on any corporation (domestic or foreign) that derives receipts

from activities in New York, including:• Taxpayer receives $1 million or more from New York State sources, or• Taxpayer has at least $10,000 in receipts from New York State sources

and is a member of a combined group (group member must have at least $10,000 of receipts from New York State sources and in aggregate members must meet the $1 million threshold); or

• Taxpayer issues credits cards to 1,000 or more customers with mailing addresses in New York State, or has merchant customer contracts; or

• Has at least 10 customers, locations, or customers and locations and is part of a combined reporting group (similar aggregate rules apply as stated in (2) above).

Corporate tax reform specificsNexus (cont.) Corporate partner

• Any corporate partner doing business, employing capital, owning or leasing property in New York, maintaining an office in the state or deriving receipts from activity in the state is subject to corporate franchise tax “as described in the regulations”

Alien corporation• Will not be deemed to be doing business, employing capital, owning or

leasing property, or maintaining an office in New York if its activities are limited to:• Investing in stocks and securities for its own account, or • Investing or trading in commodities for its own account, or• Any combination of (a) and (b)

• Alien corporations, not otherwise treated as domestic corporations, with no effectively connected income (ECI) will not be subject to tax

Repeal of fulfillment services exemption provision under 209.2(f)

Corporate tax reform specificsTax base and tax rates Article 9-A taxpayers taxed on the greater of their

• Business income base (formerly “entire net income base”) • Tax rate - effective 1 January 2016 the corporate tax rate is reduced to 6.5% from

7.1% (qualified NY manufacturers subject to 0% tax rate effective 1 January 2014); or• Business capital base (formerly business and investment capital base)

• Tax capped at $350,000 for qualified NY manufacturers and $5 million for all other taxpayers

• Phased out through reduction in rate through 2020• Fixed dollar minimum (rates have changed)

MTA surcharge becomes permanent • For tax years beginning on and after 1 January 2015 the rate is 1.82% • Applied to tax before credits• Commissioner required to review, may adjust the surcharge rate on annual

basis Other alternative tax bases that are repealed include subsidiary capital

tax, minimum taxable income base, and the Article 32 alternative base

Corporate tax reform specificsNet income base Business income base specifics

• Definition: entire net income minus “investment income” and “other exempt income” • Remains linked to federal taxable income• Most of the current Article 9-A modifications are retained, including the

IRC §78 dividend subtraction• Starting point for alien corporation not otherwise treated as domestic

• Effectively connected income with the conduct of a US trade or business as determined under IRC §882, even if otherwise exempt from federal taxable income under any US treaty obligation

• Eliminated from current entire net income (ENI) base modifications:• Subtraction for income from subsidiary capital • Subtraction for 50% of dividends other than dividends from subsidiaries or

dividends treated as business income• Addition for expenses attributable to subsidiary capital• Addition for taxes paid to foreign countries

Corporate tax reform specificsNet income base (cont.) Investment income

• Continues to be income from investment capital• Investment capital is defined to include investments in stock held by

taxpayers for more than six consecutive months, but not held for the sale to customers in the regular course of business • Does not include: stock of unitary corporations, stock in a corporation that is included in

a combined report under the commonly controlled group election, bonds, other corporate or governmental securities; nor cash election

• Presumption that less than 20% direct/indirect ownership of voting power is not unitary• Net of interest deductions: direct or indirect tracing or alternative election to

use 40% safe harbor provisions. Other exempt income

• Definition: sum of exempt controlled foreign corporation (CFC) income (IRC §951(a)) and exempt unitary corporation dividends

• Net of interest expense: direct or indirect tracing or 40% safe harbor Safe harbors must be elected for both investment income and other exempt

income Investment income and other exempt income may never exceed ENI; deductions

exceeding investment or other exempt income must be added back to ENI

Corporate tax reform specificsCombined reporting Combined reporting – eliminates the substantial intercorporate

transaction (SIT) test• New requirements

• Ownership test: a more than 50% stock direct/indirect ownership test, and• Unitary business (no definition)

• Combined group includes all unitary corporations• Domestic corporations meeting the ownership test• Alien corporations meeting the ownership test and deemed domestic• Alien corporations with ECI and that meet the ownership test• Captive insurers, captive real estate investment trusts (REITs) and captive

regulated investment companies (RICs)• Combined group does not include: cross article companies (i.e., Articles 9

or 33); non-captive REITs and RICs; S corporations; and certain corporate limited partners

• Irrevocable election can be made – seven years, automatically renewed

Corporate tax reform specificsCombined reporting (cont.)

Computation of combined business income• Intercorporate dividends are eliminated• Other intercorporate transactions deferred – IRC §1502 federal

consolidated return regulations apply Computation of combined capital base

• Intercorporate items are eliminated Single sales factor – applies including corporations required to use a

different apportionment methodology NOLs

• Effect of change in group members a result of the 50% ownership test:• Additional members included in the group • Entities no longer a member of the group

Corporate tax reform specificsNOLs

Post-2014 NOL + Pre-2015 NOL Conversion Subtraction• Post-2014 NOL

• The amount that reduces a taxpayer’s allocated business income is limited to the higher of the tax on its business capital base or its fixed dollar minimum

• NOL deduction (NOLD) allowed for losses incurred in tax years beginning on or after tax year 2015

• Not limited to federal NOLD (IRC §382) and federal tracing rules appear inapplicable

• NOL sustained in a year in which the taxpayer was not subject to corporate franchise tax is still disallowed

• 20 year carryforward and three year carryback (not prior to 2015)• If filing a NYS return on separate basis and a consolidated federal return then

must compute NOLD as if filing on separate basis

Corporate tax reform specificsNOLs (cont.) Post-2014 Net Operating Loss + Pre-2015 NOL Conversion

Subtraction• Pre-2015 Losses – NOL Conversion Subtraction

• Any loss incurred prior to 2015 is converted into a subtraction, which expires on or after 2035

• The conversion subtraction can only offset tax on business income• Calculation of “NOL Conversion Subtraction Pool”

• Multiply the base year (2014) pre-apportioned NY NOL carryforward (unabsorbed NOLs) by the base year (2014) Business Allocation Percentage (BAP) and base year (2014) tax rate, then divide by 6.5% (5.7% if qualified NY manufacturer)

• The allowable annual subtraction can only equal 1/10 of total amount of the subtraction before 2036 (exception for small business owners)• BUT, carryover from prior year 1/10 may be aggregated and added to the

1/10 amount• Election to utilize not more than 50% of the conversion subtraction in 2015 and 50% in

2016• Any remaining carryover is forfeited

Corporate tax reform specificsApportionment

Single Sales Factor• Receipts generally sourced to the location where the benefit of the sale is

received (generally the customer location)• Sales of tangible personal property continue to be sourced where

shipments are made or property is received• Receipts from sales of digital products sourced to New York if used in New

York – must consider hierarchy• Customer’s primary use location of the digital product• Location where the digital product is received by the customer• Apportionment fraction determined for the preceding tax year for the product• Apportionment fraction in the current taxable year for those digital products that

can be sourced using the hierarchy method

Corporate tax reform specificsApportionment (cont.)

Single Sales Factor• Receipts from services or other business receipts sourced based on

location of the customer – must consider hierarchy• The benefit is received in the state• Delivery destination• Apportionment fraction for such receipts within the state determined for the

preceding taxable year• Apportionment fraction in the current taxable year for those receipts that can be

sourced using the hierarchy method• Sourcing is based on a “hierarchy of sourcing methods”

• Taxpayers must exercise due diligence under each prescribed sourcing method before proceeding to the next sourcing method

• Taxpayer must base its determination on information known to it or information known upon reasonable inquiry

Corporate tax reform specificsApportionment (cont.)

New rules for Qualified Financial Instruments (QFIs) • Customer sourcing or 8% method: taxpayer can use either the customer

sourcing rules or elect to apportion to NY 8% of the net income from QFIs. If elected all income from QFIs is treated as business income and apportioned at 8%.

Sourcing rules for QFIs and non-QFIs

Type of income Numerator of the receipts factor

Dividends and sale of stock Not included in numerator or denominator

Net gains from sale of partnership interests Not included in numerator or denominator

Sourcing rules for QFIs and non‐QFIsType of income Numerator of the receipts factor

Interest income from loans Allocate 100% to property’s location if secured by real property orborrower’s location if not secured (100% in the denominator)

Federal, State and Municipal debt

Neither interest income nor net gains included (100% or 50% included in the denominator depending on the issuer)

Income from asset‐backed securities issued by government agencies

Allocate 8% of interest income and net gains to New York (includes GNMA, FNMA, FHLMC mortgage backed securities). (100% in the denominator)

Net income from federal fundsAllocate 8% of net income to New York State

Income from other financial instruments

Allocate 100% interest income and net gains to payor’s location

Net income from reverse reposand stock borrows

8% of net interest income is included (100% in the denominator)

Corporate tax reform specificsApportionment (continued)

Corporate tax reform specificsApportionment (continued)

Sourcing rules for QFIs and non‐QFIsType of Income Numerator of the receipts factor

Interest income from corporate bonds

Allocate 100% of interest income to issuing corporation’s commercial domicile.

Sales of loans secured or not secured by real property

Allocate net gains from sale of loans by applying a fraction (numerator is amount of gross proceeds within NY and denominator is gross proceeds within and without NY.)

Net gains from sale of corporatebonds

Similar rule as above – However, if sold through registered broker/dealer then 8%.

Net gains from sale of other asset backed securities

Similar rule as above – However, if sold through registered broker/dealer then 8%.

Net income from sale of physicalcommodities

Included by multiplying net income by a fraction (numerator is amount of receipts from sales of physical commodities delivered to points within NY, and denominator is amount of receipts from those delivered to points within and without NY). Special rule if no actual delivery.

Corporate tax reformOther

Other noteworthy items• Financial Services Investment Tax Credit retained• New York City conformity pending, but the Gramm-Leach-Bliley transitional

provisions extended for two years• Governor Cuomo signed legislation on 31 March 2014 making this a Q1

event for calendar year taxpayers

Thank You

Walter Doggett – (703) 236-8778 walter.doggett@etrade.com

Michelle Zahler – (312) 879-4340michelle.zahler @ey.com

Michael Johnson – (704) 331-1836 michael.johnson@ey.com