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61st Tulane Tax Institute National Trends in State and Local

Tax

Overview

Nexus Income tax Sales tax

Independent Tax Tribunals Apportionment

Forced Combination Alternative apportionment Procedural Fixes

MTC election Market based sourcing Addback Manufacturing Exemptions Due Process

Penalties Retroactivity

Nexus: Income Tax

Expansion of Physical Presence

Telecommuting Employees

Telebright Corporation, Inc. v. Director, Superior Court of New Jersey, No. A-5096-09T2, March 2, 2012

Appeal of Warwick McKinley, Inc., California State Board of Equalization, No. 489090, Jan 11, 2012

Third Party Servers

Ruling of the Tax Comm’r No. 12-36, Va. Dep’t of Revenue (Mar. 28, 2012) (server owned by taxpayer, but operated by third party, is not a protected activity under P.L. 86-272 and may establish substantial nexus with the state)

Nexus: Income Tax

Economic Nexus

Griffith v. ConAgra Brands, Inc., 728 S.E.2d 74 (W.Va. 2012)

Economic presence rather than physical presence is proper test for state income tax nexus

DPC violation: no purposeful direction where ConAgra did not exercise control over intangibles after licensing

CC violation: no economic presence where activity did not go beyond licensing

Compare: KFC Corp. v. Iowa Dept. of Revenue, 792 N.W.2d 308 (Iowa 2010)

Licensing of intangibles sufficient to establish minimum contacts and substantial nexus

Nexus: Sales and Use Tax

Click through Nexus Litigation:

Amazon.com, LLC v. New York State Department of Taxation and Finance, et al., 913 NYS2d 129 (N.Y. App. Div. 2010)

Statute setting up presumption that click through relationship establishes nexus is facially constitutionally

Performance Marketing Association, Inc. v. Hamer, Ill. Cir. Ct. Cook County, No. 2011-CH-26333 (May 7, 2012)

Failure to require substantial nexus violates commerce clause

Statute is also preempted by Internet Tax Freedom Act moratorium on taxes that discriminate against e-commerce

Nexus: Sales and Use Tax

Click through Nexus Developments: Arkansas Ark. Code. §26-52-117

California Enacted affiliate nexus statute (A. 28) in June 2011 and then temporarily repealed

it

If Congress would have enacted a national solution by July 31, 2012, the repealed law would have been re-enacted on January 1, 2013; because it was not, the statute was re-enacted on September 15, 2012

Connecticut Conn. Gen. Stat. §12-407(a)(12)(L) and §12-407(a)(15)(A)(x)

Georgia Ga. Code Ann. §48-8-2(8)(M)

New York N.Y. Tax Law §1101(b)(8)(iv)

North Carolina N.C. Gen. Stat. §105-164.8(b)

Rhode Island R.I. Gen. Laws §44-18-15(a)(2)

Nexus: Sales and Use Tax

Click through Nexus Developments: South Dakota S.D. Codified Laws §10-63

Tennessee Entered into an agreement with Amazon.com to start collecting use taxes in 2014

(recently enacted by H.B. 2370 (Laws 2012))

Amazon is already notifying taxpayer of obligations to remit the taxes and Tennessee’s tax revenues are already showing it

Texas Governor vetoed H. 2403 affiliate nexus statute but then signed S1 containing the

same provisions (July 19, 2011)

Amazon has settled with Texas and is collecting the tax

Vermont 32 Vt. Stat. Ann. §9701(9)(I)

Illinois (H. 3659)— struck down

Nexus: Sales and Use Tax

Affiliate Nexus

In-state affiliates activities can create nexus for e-retailer entity

New Mexico Tax & Rev. Dept. v. Barnesandnoble.com LLC, No. 31,231 (N.M. Ct. App., April 18, 2012)

Court held affiliate’s activities to promote shared trademark and online retailer created substantial nexus for online retailer

E-retailers with brick and mortar sites must be cautious about cross-promotional activities

Independent Tax Tribunals

Illinois enacted H.B. 5192 establishing independent tax tribunal

Concerns that normal state administrative agencies lack expertise and may not be impartial

“provides taxpayers with a means of resolving controversies that ensures both the appearance and the reality of due process and fundamental fairness”

Growing movement in other states

Georgia enacted H.B. 100 – tax tribunal begins Jan. 1, 2013

Alabama governor pocket vetoed S.B. 549, but enactment is expected in future

Forced Combination: Unitary Group

Taxation through unitary group theory

Costco Wholesale Corp. v. Department of Revenue, Oregon Tax Court, No. TC 4956, July 16, 2012

Court held that retailer’s foreign insurance company subsidiary’s income had to be included in consolidated corporate tax return.

Court recognized it could not tax or impose filing requirement on foreign insurance company, however, income could be included because state has ability to assess tax on the totality of income of a unitary group

Forced Combination: Unitary Group

Expansion of the unitary group concept Clarcor v. Hamer, Appellate Court of Illinois, First District,

No. 1-11-1674, May 11, 2012

Filtration and Packaging subsidiaries were one unitary group because all profits were disbursed to parent, pension plan was shared, and stock option compensation was based on performance of whole group

Appeal of Comcast Cablevision Corp., California State Board of Equalization, No. 424198, February 2, 2012

Board held that contribution or dependency test was an alternative to three unities test.

Board found QVC (channel) was part of unitary group even though it received no preferential treatment from Comcast and was operated independently.

Forced Combination: Penalties

Delhaize America, Inc. v. Lay, N.C. Court of Appeals, No. COA11-868, Aug. 21, 2012

Secretary of Revenue made a determination that returns should have been combined and imposed 25% negligence penalty

TP argued that penalty violated due process because of lack of notice and guidelines to educate taxpayers

Trial court held penalty violated due process

Court of Appeals overturned and upheld penalty

Notice existed due to previous Departmental decisions that demonstrated practice of forced combination

Alternative Apportionment

§18 of UDITPA provides for alternative apportionment

Drafters intended its use in unusual cases to prevent gross distortions

Many states have alternative apportionment statutes modeled after §18

States are increasingly applying §18 to taxpayer dissatisfaction

Alternative Apportionment

General Mills, Inc. v. Franchise Tax Board, No. A131477 (Cal. Ct. App. Aug. 29, 2012) (must consider both the extent of the quantitative distortion of income and qualitative difference in business activity when applying alternative apportionment)

CarMax Auto Superstores West Coast, Inc. v. South Carolina Department of Revenue, No. 4953, (S.C. Ct. App. March 14, 2012) (party seeking alternative apportionment has burden to prove (1) standard formula is not representative and (2) alternative accounting method was reasonable and more fairly representative)

Equifax, Inc. v. Department of Revenue, No. 2010-CA-01857-COA (Miss. Ct. of App. May 1, 2012) (party seeking alternative apportionment has burden of proof)

Alternative Apportionment: Procedural Fixes

Rulemaking June 30, 2011, North Carolina enacted H.B. 619 to amend

prior law and now authorizing Secretary of Revenue to re-determine income or combine returns

North Carolina has been very liberal in applying forced combination and alternative apportionment

North Carolina S.B. 824 would prohibit Secretary from re-determining income or forcing combination prior to rulemaking.

Legislation was enacted over concerns that re-determination guidelines would be implemented with directives rather than rules promulgated pursuant to the Administrative Procedures Act

MTC Election

The Gillette Company et al. v. Franchise Tax Board, 207 Cal.App.4th 1369 (Op. on Rehearing, Oct. 2, 2012) California legislature withdrew from MTC on July 27

Nonetheless, court for the most part reaffirmed July 24 opinion

TPs were entitled to use MTC formula

Statute was unconstitutional for years in issue

Court refused to address validity of repeal

Issue also pending in other states:

International Business Machines, Corp v. Dep’t of Treasury, Docket No. 306618 (Michigan)

Texas Comptroller denies MTC election: SOAH DOCKET NO. 304-12-5984.13

Market Based Sourcing of Services

Growing enactment of market based sourcing California (Cal. Rev. & Tax. Code §25136(b)) Georgia (Ga. Code Ann. §48-7-31(d)(2)(A)(i)) Illinois (35 ILCS 5/304(a)(3)(C-5)(iv)) Iowa (Iowa Admin. Code r. 701-54.6(422)) Maine (Me. Rev. Stat. Ann. tit. 36, §5211(16-A)(A)) Maryland (Md. Regs. Code §03.04.03.08(C)(3)(d)) Michigan (Mich. Comp. Laws §206.665(1)(e)) Minnesota (Minn. Stat. § 290.191(5)(i)) Ohio (Ohio Rev. Code Ann. §5733.05(B)(2)(c)(ii)) Oklahoma (Okla. Admin. Code §710:50-17-71(1)(A)(ii)) Utah (Utah Code Ann. §59-7-319(4)) Wisconsin (Wis. Stat. § 71.25(9)(dh); Wis. Stat. § 71.25(9)(dk))

Market Based Sourcing of Services

Different Approaches

Georgia: proportional to benefit received

Maryland: impetus for sale

Minnesota: cascading rule

Illinois: market-based sourcing plus throw-out rule

Utah: preponderance rule

Addback

Addback: disallowance of the deduction taken for interest and intangible-related expenses between related parties

Alternative: direct taxation of intangible holding company Nexus issues

Novel approach of Tennessee 2012 Tenn. Pub. Law 842, §§ 1-5

TP must file an application with Department of Revenue in order to deduct an intangible expenses paid to affiliate

Easier to administer addback and disallow intangible-related expenses

Addback Exceptions

Common exceptions Foreign treaty exception: recipient is a resident of a nation with a US

tax treaty

Conduit exception: recipient does not qualify as related party

Subject to tax exception: state imposes income tax on recipient

Wendy's International Inc. v. Virginia Dept. of Taxn., CL09-3757 (Va. Cir. Ct., City of Richmond, March 29, 2012) Conduit exception applied because holding company derived over

1/3 of gross revenues to unrelated parties

Company did not directly license to unrelated parties. Court applied pass-through concept to find that 1/3 of gross revenues were indirectly derived from unrelated parties.

Manufacturing Exemptions

States use a variety of standards and definitions

Opportunity for creative arguments Indiana Department of State Revenue Letter of Finding No. 04-

20110559 (May 30, 2012) (asphalt storage tanks eligible for manufacturing exemption because taxpayer used them in manufacturing process)

Virginia Letter Ruling No. 12-48 (April 23, 2012) (department rejected taxpayer argument that applying labels legally necessary for distribution was part of manufacturing process)

Detroit Edison Company v. Dept. of Treasury, No. 10-104-MT, Michigan Ct. of Claims (Mar. 28, 2012) (electricity production process does not cease until delivery to customer so transmission lines are eligible for manufacturing exemption)

Manufacturing Exemptions

Southwest Royalties, Inc. v. Combs, No. D-1-GNU-09-004282, Texas County Court (April 30, 2012)

Texas comptroller has policy of excluding oil and gas extraction equipment from manufacturing exemption

Taxpayer claimed well equipment was entitled to exemption because the equipment directly caused changes to the hydrocarbon products

Trial judge ruled from the bench in favor of taxpayer

Written decision issued on April 30 reversed earlier verbal ruling and rendered judgment for the state

Due Process: Penalties

State penalties have been increasingly draconian Delhaize America, Inc. v. Lay, N.C. Court of Appeals, No. COA11-

868, Aug. 21, 2012

Department assessed deficiency after forced combination of returns and assessed a negligence penalty for failure to combine

Court held no due process violation even though lack of taxpayer knowledge because prior decisions put taxpayer on notice

Marriott International Inc. v. Hamer, No. 09 L 051411 (Ill. App. Ct. Aug. 22, 2012)

Taxpayer filed state amended return after federal income tax audit re-determined income

Court upheld double interest penalty even though taxpayer had no knowledge of increased income tax liability during that period

Decided on statutory interpretation rather than due process grounds

Due Process: Retroactivity

General Motors Corporation v. Department of Treasury, No. 291947 (Mich. Ct. App. October 28, 2010) The Legislature legislated previous appellate decision out of

existence, thus retroactively eliminating GM’s claim for refund

The Appeals Court held that the retroactive application did not violate GM’s right to due process

The Act was related to a legitimate purpose (e.g., preventing unanticipated massive claims for refund that were collected in good faith)

The statutory language covered all taxpayers and GM did not have a vested right to the refund

US Supreme Court denied cert. January 23, 2012

Questions

Doug Sigel

Ryan Law Firm, LLP