Home - Eversheds Sutherland - Multistate Tax Update New ......tax deduction for ½ the proceeds of sales of stock to ESOPs -Revenue loss estimate = $300 million December 1986: Estate’s

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Multistate Tax Update New Jersey Society of Certified Public Accountants - Multistate Tax Conference

Marc Simonetti, Partner November 29, 2016

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Agenda

Retroactive Laws COP Under Attack Alternative Apportionment Transfer Pricing Challenge Expense Disallowance Nexus Saga False Claims Act & Consumer Fraud Act

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RETROACTIVE LAWS

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Background

Questionable purposes: - From corrective, curative legislation → - To legislation as a litigation tactic or to overturn judicial decisions

Lengthier periods:

- From one to two years/next legislative session → - To whatever period is required to fully reverse the effects of the

statute

Retroactive Tax Legislation Is Evolving

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United States v. Carlton, 512 U.S. 26 (1994)

October 1986: Congress enacted legislation creating an estate tax deduction for ½ the proceeds of sales of stock to ESOPs - Revenue loss estimate = $300 million December 1986: Estate’s executor purchased stock and sold it

to ESOPs to claim the deduction January 1987: IRS stated the deduction was intended to be

limited to stock owned by the decedent prior to death - Revenue loss estimate = $7 billion February 1987: Congress proposed legislation clarifying that the

deduction was limited to stock owned prior to death November 1987: Legislation was enacted, retroactively

The Facts

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United States v. Carlton, 512 U.S. 26 (1994)

Rational Basis Test: Retroactive tax legislation must be “supported by a legitimate legislative purpose furthered by rational means.” - Same test as applied to retroactive economic legislation Requirements:

- (1) Legitimate legislative purposes Purpose must not be “illegitimate” or “arbitrary”

- (2) Prompt action and “modest” period of retroactivity Justice Sandra Day O’Connor’s Concurrence:

- “A period of retroactivity longer than the year preceding the legislative session in which the law was enacted would raise, in my view, serious constitutional questions.”

The Test

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Retroactive Case Files Cert. Petition

The Department narrowed its interpretation of the Direct Seller’s Exemption in 2001 and asserted it did not apply to Dot Foods.

In Dot Foods I (2009), the Department’s interpretation was rejected as being contrary to the statute.

Dot Foods sought a refund of taxes paid from 2005 to 2009 (years outside Dot Foods I).

In 2010, the Legislature retroactively amended the scope of the exemption for periods after the Dot Foods I opinion.

The court held that large and devastating revenue losses are a legitimate purpose and found that the retroactivity period was rationally related to that purpose.

Cert. petition filed on September 9, 2016 (No. 16-308).

Dot Foods Inc. v. Dep't of Revenue, 185 Wash.2d 239 (Wash. 2016)

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Income and Franchise Taxes

The Michigan Supreme Court in 2014 held that IBM could use the

MTC compact apportionment formula for tax year 2008 and remanded the case for entry of judgment.

In response to the IBM decision, Michigan retroactively repealed the compact to avoid paying refunds.

On the remand, the trial court applied the retroactive repeal of the compact to IBM for the tax year IBM won at the state supreme court.

On July 21, the Michigan Court of Appeals reversed the trial court and remanded the case for entry of judgment in favor of IBM.

The Treasury did not appeal that decision, but the Michigan Attorney General is attempting to intervene in order to appeal.

Int’l Bus. Machines v. Dep’t of Treasury, No. 327359, 2016 WL 3941278 (Mich. Ct. App. July 21, 2016)

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Wynne Part 2

In 2015, the U.S. Supreme Court held that Maryland’s statute denying resident taxpayers a full credit against their Maryland income taxes for similar taxes paid to other states violated the dormant Commerce Clause (Wynne 1).

In anticipation of Wynne 1, the Maryland Legislature authorized the Comptroller to pay Wynne 1 refunds, but at a 3% annual interest rate, while refunds generally have a 13% annual interest rate.

On October 17, 2016, the taxpayers contest the retroactive 3% interest rate in Maryland Tax Court asserting violation of the dormant Commerce Clause and the Takings and Due Process Clauses.

Wynne v. Comptroller of the Treasury, pending, No. 16-IN-OO-0216, (Md. Tax Ct.)

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COP UNDER ATTACK

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“Flexible” Costs of Performance

The court found that a satellite television service provider’s income-producing activity was the delivery of its signal into the subscriber’s home and onto the subscriber’s television.

The court reasoned that South Carolina is neither a strict nor pro rata costs of performance state; rather, South Carolina law provides “flexibility” in determining the relative amount of income-producing activities in the state.

Dish DBS Corp. v. S.C. Dep’t. of Revenue, No. 14-ALJ-17-0285-CC (S.C. Admin. Law Ct. May 20, 2016)

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The court held that the taxpayers must source 50% of their credit

card service fees (e.g., late fees, return check fees, over the limit fees, non-sufficient fund fees, and annual fees) to NJ based on NJ’s regulatory 25/50/25 rule. - 25% to where the service originates, - 50% to where the service is performed, and - 25% to where the service terminates

The court’s opinion conflicts with NJ’s statutory rules because NJ has not adopted market-based sourcing. The statute looks to the location of performance.

Bank of America Consumer Card Holdings, et al. v. NJ, Docket No. 0121945-2011, 2016 WL 5899786 (Oct. 6, 2016)

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ALTERNATIVE APPORTIONMENT

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Invoking Alternative Apportionment

Alternative Apportionment Procedure

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Moving Party

Assert Distortion

Yes

No

No Alternative Apportionment

Proposed Alternative Reasonable

Yes

No Alternative Apportionment

Alternative Apportionment

No

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Under the statutory method, the numerator of R-A-C West’s receipts factor

was comprised of the SC receipts from licensing IP and the denominator included all revenue from retails stores and licensing activities.

The DOR argued that including the retail sales in the denominator diluted the receipts factor.

The DOR’s expert opined that including both royalty and retail receipts in the denominator was like putting applies in the numerator and apples and oranges in the denominator.

R-A-C West’s expert countered that this is exactly how an apportionment formula is supposed to work.

The DOR failed to satisfy its burden of showing that the statutory formula did not fairly represent R-A-C West’s business activity in SC.

Rent–A–Center West Inc., v. South Carolina Dep’t of Rev., App. Case. No. 2012-208608 (Oct. 26, 2016)

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Alternative Apportionment

The court upheld the Department’s application of an alternative apportionment method for a wireless communications provider because the statutory COP method did not fairly represent the extent of the taxpayer’s business activity in the state.

The court held that the method employed by the Commissioner, which was similar to a market-based approach, satisfied regulatory standards for the imposition of alternative apportionment.

Vodafone Americas Holdings, Inc. v. Roberts, No. M2013-00947-SC-R11-CV (Tenn. Mar. 23, 2016)

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NJ applied 100% apportionment because the taxpayer

did not have a regular place of business outside of NJ. The three-factor formula would have resulted in

approximately 30% apportionment. The court found three-factor was distortive because most

of Canon’s receipts were outside of NJ. The court remanded for the Division to fashion some form

of apportionment relief (which will have to be somewhere between 30% and 100%).

Canon Financial Services, Inc. v. NJ, Docket No. 000404-2014, 2016 WL 6068247 (Oct. 13, 2016) (unpublished)

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TRANSFER PRICING CHALLENGES

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Transfer Pricing

The Indiana Tax Court rejected combination as an alternative apportionment methodology.

The court rejected the Department's claim that R-A-C’s income would be distorted unless it filed a combined return with two affiliates.

The court relied in part on an IRC § 482 transfer pricing study and the parties’ stipulation of valid business purposes.

The Indiana Supreme Court denied review on March 2, 2016.

Rent-A-Center East Inc., v. Indiana Dep't of State Revenue, 42 N.E.3d 1043 (Ind. T.C. 2015)

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Transfer Pricing

Indiana Tax Court concluded that because Columbia’s transfer pricing studies demonstrated that its intercompany transactions were conducted at arm’s length rates, its Indiana income was fairly reflected for purposes of Indiana’s transfer pricing statute.

Columbia Sportswear USA Corp., v. Ind. Dep’t of Revenue, No. 49T10-1104-TA-00032 (Ind. Tax Ct. Dec. 18, 2015)

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Authority Limited by IRS Regulations

The court held that the Utah State Tax Commission abused its discretion by denying a taxpayer a full deduction for royalty expenses paid to a related party when the transfer was supported by a transfer pricing study.

The court found that the Commission’s authority to reallocate income was limited by the regulations under I.R.C. § 482 because the state law is virtually identical to I.R.C. § 482 and there is nothing in the statutory scheme to indicate that guidance comes from anywhere other than the I.R.C. § 482 regulations.

The state filed its appeal on November 3, 2016.

See’s Candies, Inc. v. Auditing Div. of the Utah State Tax Comm'n, No. 140401556 (Utah Dist. Ct. 2016)

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Debt Versus Equity

Deferred subscription arrangements (DSAs) among related entities to sell and repurchase shares of stock; designed to look like debt for U.S. purposes and equity for U.K. purposes. Massachusetts Appeals Court agreed that the DSAs did

not constitute debt because the company failed to prove that there was an unqualified obligation to repurchase shares (and thus repay the funds).

Nat’l Grid Holdings, Inc. v. Comm'r of Revenue, 89 Mass. App. Ct. 506 (2016)

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EXPENSE DISALLOWANCE

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Royalty Addback Exception

Royalties paid to related members must be added back to a taxpayer’s federal taxable income unless such payments “are subject to a tax based on or measured by net income or capital.” Virginia trial court said that even where royalties are

reported by related members to other states, royalty payments do not qualify for the addback exception unless those other states actually tax them. The Virginia Supreme Court granted review on October

31, 2016.

Kohl’s Dep’t Stores, Inc. v. Va. Dep’t of Taxation, No. CL12-1774 (Va. 13th Jud. Cir. Ct. 2016)

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Interest Addback Exception

Parent corporation took on third-party debt and allocated it to the operating company, Kraft Foods Global.

The Division asserted that the interest payments made to the parent were subject to addback.

Kraft Foods Global countered that the debt issued by its parent was essentially Kraft Foods Global’s debt and that the interest payments were a legitimate business expense.

The New Jersey Tax Court determined that the Division correctly required the taxpayer to add back related party interest payments, holding that the taxpayer did not prove by clear and convincing evidence that addback was unreasonable.

Kraft Foods Global, Inc. v. Div’n of Tax’n, 29 N.J.Tax 224 (N.J. Tax Ct. 2016)

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An intangible holding company was not required to “throw out” any of its “nowhere receipts” from an affiliate in computing the denominator of its receipts factor. New Jersey’s economic nexus standard under Lanco

must be applied to determine whether a corporation is “subject to tax” in other jurisdictions. The New Jersey Supreme Court denied certification on

June 17, 2016.

Lorillard Licensing Co., LLC v. Div’n of Tax’n, 29 N.J.Tax 275 (App. Div., Dec. 4, 2015)

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Dividends Received Deduction

The Mississippi Supreme Court affirmed that the Mississippi provision allowing an income tax exemption for dividends received from AT&T’s Mississippi subsidiaries while denying an exemption to similarly situated non-Mississippi subsidiaries was discriminatory in violation of the dormant Commerce Clause.

Miss. Dep’t of Revenue v. AT&T Corp., No. 2015-CA-00600-SCT (Miss. 2016)

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NEXUS SAGA

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Background

The nexus standard set by the U.S. Supreme Court in Quill still applies.

In order for a state to impose a sales and use tax collection obligation on an out-of-state seller, the U.S. Supreme Court has held that a physical presence in the state is required. Quill Corp. v. North Dakota, 504 U.S. 298 (1992).

The physical presence must be more than de minimis.

What is the Nexus Standard?

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Background

The U.S. Supreme Court has not accepted a nexus case since Quill.

Federal legislation addressing state sales tax collection is caught up in political wrangling.

States have taken action to overturn Quill. – Aggressive nexus positions

– Anti-Quill legislation

– Anti-Quill legislation that allows for immediate review by state courts

– Use tax reporting

Shifting Nexus Landscape

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Background

In Direct Mktg. Ass’n v. Brohl, 135 S. Ct. 1124 (2015), Justice Anthony Kennedy went out of his way to invite reconsideration of Quill. - “Given these changes in technology and consumer sophistication, it is

unwise to delay any longer a reconsideration of the Court’s holding in Quill. A case questionable even when decided, Quill now harms States to a degree far greater than could have been anticipated earlier….It should be left in place only if a powerful showing can be made that its rationale is still correct.”

In response, states have taken legislative efforts to force remote vendors to collect sales tax.

Justice Kennedy’s Concurrence

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Direct Marketing Part 2

Colorado’s notice and reporting requirements did not violate the Commerce Clause because such requirements neither discriminated against nor unduly burdened interstate commerce.

The court found Quill applies narrowly to sales and use tax collection. - “Even though the Supreme Court has not overruled Quill, it has not

extended the physical presence rule beyond the realm of sales and use tax collection.”

- “We cannot identify any good reasons to sua sponte extend the bright-line rule of Quill.”

Direct Marketing Ass'n v. Brohl, 814 F.3d 1129 (10th Cir. 2016)

“sua sponte” = “on its own motion”

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Direct Marketing Part 2 (cont’d)

On August 29, 2016, DMA filed a petition for writ of certiorari with the Supreme Court (No. 16-267). On October 3, 2016, the state filed a “conditional cross-

petition for writ of certiorari” to address whether a state law to enforce its use tax in light of the Quill restrictions is constitutional (No. 16-458). - Colorado states: “Quill is the only reason that the States treat in-

state and out-of-state retailers differently; without it, Colorado and other States will treat retailers alike, regardless of their in-state or out-of-state location.”

Direct Marketing Ass'n v. Brohl, 814 F.3d 1129 (10th Cir. 2016)

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Nexus - Alabama

The Alabama Department of Revenue promulgated regulation 810-6-2-.90.03, effective Jan. 1, 2016, imposing sales and use tax reporting and collecting obligations on an out-of-state retailer without physical presence in Alabama if such retailer had at least $250,000 in retail sales of tangible personal property the prior calendar year.

On June 8, 2016, Newegg filed suit in the Alabama Tax Tribunal challenging an assessment based on the new regulation.

Newegg contends that the Department’s attempt to apply its regulation is unconstitutional and violates U.S. Supreme Court precedent. Newegg also argues that the regulation conflicts with Alabama’s statutes.

Newegg Inc. v. Ala. Dep’t of Revenue, No. S 16-613 (Ala. Tax Tribunal)

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Nexus – South Dakota

On March 22, 2016, South Dakota enacted S.B. 106, which imposes sales and use tax reporting and collection on out-of-state retailers without physical presence in South Dakota if: - $100,000 in gross revenue from sales into South Dakota; or - 200 separate transactions involving delivery into South Dakota.

S.B. 106 permits the state to bring a declaratory judgment action in

any South Dakota Circuit Court against “any person [that South Dakota] believes meets the criteria of section 1 of [S.B. 106] to establish that the obligation to remit sales tax is applicable and valid under state and federal law.”

South Dakota v. Wayfair, Inc., et al., Hughes County Circuit Court Docket No. 32CIV16-00092

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Nexus – South Dakota

South Dakota brought suit against Wayfair, Inc., Systemax, Inc., Overstock.com, Inc., and Newegg Inc. on April 28, 2016 in state court. - Defendants filed a Notice of Removal to Federal Court and a

motion for summary judgment. Trade associations also filed a separate constitutional challenge to

S.B. 106 in state court in Am. Catalog Mailers Ass’n v. Gerlach, No. 32CIV16-___ (6th Judicial Cir., S.D.).

South Dakota v. Wayfair, Inc., et al. (cont’d)

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Nexus - Florida

The Company had a business location in Florida. All sales of flowers and other TPP were initiated online. Sales orders were filled by local florists. The Department assessed sales tax on sales delivered

outside of Florida by local florists, consistent with the Florida statute. No violation of Complete Auto or Due Process. Cert. petition filed on October 24, 2016 (No. 16-567).

- Suggests that this case presents an opportunity to reexamine Quill.

Florida Dep’t of Revenue v. American Business USA Corp., 191 So.3d 906 (Fl. 2016)

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Nexus - Ohio

Ohio adopted factor nexus provision for CAT purposes. The Department claimed the CAT is not governed by Quill

because it is not a sales and use tax. On November 17, 2016, the Ohio Supreme Court upheld the

factor nexus provision because the Quill physical presence nexus standard does not extend to business-privilege taxes such as the CAT. The court distinguishes that physical presence is a sufficient condition to impose a business-privilege tax, but not a necessary one.

Crutchfield, Inc., et al. v. Testa, Nos. 15-0386, 15-0483, 15-0794 (Ohio Nov. 17, 2016)

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Proposed Economic Nexus

Tennessee: On June 16, 2016, the Tennessee Department of Revenue proposed regulation 1320-05-01-.129 imposing sales and use tax reporting and collecting obligations on out-of-state retailers without physical presence in Tennessee if such retailer had at least $500,000 in retail sales of tangible personal property during the calendar year

Illinois: On April 15, 2016, the Illinois General Assembly proposed SB 1041 to amend Illinois sales tax law to provide that a retailer is also presumed to be “maintaining a place of business in this State” if the retailer’s total gross receipts from sales occurring in Illinois in the previous calendar year is $1,000,000 or more

Minnesota: On April 1, 2016, the Minnesota Legislature proposed HB 3787 that would require a remote seller that does not have physical presence in the state to collect and remit Minnesota sales tax if the seller:

– Engaged in one of several specified activities that do not require an in-state physical presence; and

– Makes taxable sales to 20 or more Minnesota purchasers that aggregate to more than $200,000 or makes 200 or more taxable in-state sales

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FALSE CLAIMS ACT & CONSUMER FRAUD ACT

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False Claims Act Litigation

New York Attorney General took over a whistleblower lawsuit that alleged that Sprint Nextel had failed to collect $100 million in telecommunications sales taxes after unbundling its wireless services.

On February 27, 2014, the appellate court affirmed a 2013 trial court ruling denying Sprint Nextel’s motion to dismiss the complaint.

On October 20, 2015, the appellate court denied Sprint Nextel’s motion to dismiss, finding that the complaint sufficiently pleaded a cause of action under New York’s False Claims Act that Sprint knowingly filed false tax records with the state.

People of the State of New York, et al. v. Sprint Nextel Corp, et al., 26 N.Y.3d 98 (N.Y., Oct. 20, 2015)

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False Claims Act

Lush (Ill. Cir. Ct. May 10, 2016; on appeal) – Retailer Win - No attributional nexus based on in-state affiliate with brick-and-mortar retail

stores; and - No scienter violation where company relied on expert advice in an area

that is “far from clear.” Relax the Back (Ill. App. Div. (1st) Oct. 17, 2016) – Retailer Win

- Defendant did not act with reckless disregard in determining that it did not have a duty to collect use tax on its catalog and Internet sales.

Nat’l Bus. Furniture (Ill. App. Div. (1st) Aug. 1, 2016) – Retailer Win - Defendant did not act with reckless disregard; and - A knowing violation of the Act cannot occur when the pertinent area of the

law is unclear and specific factual analysis must be completed to determine a retailer’s use tax liability.

Illinois Cases

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Consumer Fraud Act Litigation

The plaintiff brought a $15 million consumer fraud class action alleging that Verizon overcharged 911 fees. The court held that New Jersey’s State Uniform Tax

Procedure Law, as incorporated into the 911 statute, provides the exclusive remedy to seek a refund of the 911 fees. Each customer must file a refund claim with New Jersey

and class actions are not permitted.

Frank Greek & Son, Inc. v. Verizon New Jersey, Inc., No. A-1928-14T4 (N.J. Super. Ct. App. Div. Aug. 26, 2016)

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Class Action Litigation

Plaintiffs commenced a class action lawsuit claiming that Dunkin’ Donuts improperly collected sales tax on prepackaged coffee. The court dismissed the complaint based on a lack of

subject matter jurisdiction because plaintiffs failed to follow New York’s statutory law, which provides an administrative procedure for seeking a refund that is the exclusive remedy.

Estler, et al., v. Dunkin Brands, Inc., et al., S.D.N.Y. Docket No. 16 Civ. 932 (Oct. 3, 2016)

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Questions?

Marc Simonetti Sutherland Asbill & Brennan LLP

212.389.5015 [email protected]

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This communication cannot be used for the purpose of avoiding any penalties that may be imposed under federal, state or local tax law.

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Home - Eversheds Sutherland - Multistate Tax Update New ......tax deduction for ½ the proceeds of sales of stock to ESOPs -Revenue loss estimate = $300 million December 1986: Estate’s