Ernst & Young's State and Local Tax Weekly newsletter for January 15 is now available. Prepared by Ernst & Young's State and Local Taxation group, this weekly update summarizes important news, cases, and other developments in U.S. state and local taxation.

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Top Stories

Michigan Department of Treasury will retroactively apply Auto-Owners Insurance decision regarding characterization of certain prewritten computer software transactions — potential refund opportunity

On Jan. 6, 2016, the Michigan Department of Treasury (Department) issued a notice indicating a significant change in its policy regarding the use tax treatment of remote accessed computer software transactions resulting from the decision by the Michigan Court of Appeals (Court) in Auto-Owners Insurance Co. The Notice communicates the Department's intention to give the Court's decision full retroactive effect and outlines the procedures by which taxpayers may file refund claims.

In Auto Owners Insurance, the Court held that prewritten computer software programs that did not include the delivery of "code that enabled the vendor's system to operate" were exempt from Michigan's use tax. The Court concluded that this category of software did not satisfy Michigan's criteria that prewritten computer software must be delivered, in any manner, because there was no proof that software code was electronically delivered to the taxpayer or that the taxpayer had exercised any incidence of ownership over the vendor's code.

Additionally, the Court held that a certain category of remotely accessed prewritten software programs involved the electronic delivery of a "local client" or "desktop agent" and were sufficient to constitute an "ownership-type right" over the software; however, when applying the "incidental-to-service" test outlined in the Catalina Marketing Sales Corp., the downloaded software is only incidental to the vendor providing or "rendering a professional service" and, therefore, is excluded from use tax. The Notice indicates that the "incidental-to-service" test will apply to determine whether a transaction constitutes the rendition of a non-taxable service rather than the sale of tangible personal property "if only a portion of a remotely accessed software program is electronically delivered to a customer." If, however, a software program is electronically downloaded in its entirety, it will be taxable.

Portions of Michigan's Revenue Administrative Bulletin (RAB) 1999-5 suggesting that access to software over the internet without the delivery of either "the code that enables the program" to operate or a "desk top client" no longer represent the Department's policy as they are inconsistent with the ruling in Auto-Owners Insurance.

Taxpayers seeking refunds of self-accrued use tax under the Auto-Owners Insurance ruling must file a written refund request with the Department within the appropriate statute of limitations, which is four years after the date set for filing the original return. Taxpayers requesting a refund of tax collected by a vendor must request a refund directly from the vendor. For additional information on this development, see Tax Alert 2016-99.

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Income/Franchise

All States: The Income/Franchise quarterly newsletter, which provides a summary of the legislative, administrative, and judicial updates that occurred during the fourth quarter of 2015, is now available. Highlights include: (1) a summary of legislative developments in Connecticut and District of Columbia; (2) a summary of judicial developments in California, Indiana, Kentucky, Maryland, Massachusetts, Michigan, New Jersey, Oregon, Pennsylvania and Vermont; (3) a summary of administrative developments in California, Idaho, Illinois, Massachusetts, Michigan, Minnesota, Nebraska, New York, New York City and Rhode Island; (4) a discussion of state and local tax items to watch in New Jersey, New York, Oregon, Rhode Island and Texas. Click here for a copy of the newsletter.

California: The Franchise Tax Board (FTB) has determined that the payment of the revised Texas franchise tax (i.e., Margin Tax) is not eligible for California's other state tax credit (OSTC). Under California law, a credit is allowed for "net income taxes" paid to another state. The FTB determined that the Margin Tax "is not a 'net income tax' under California law because it is a tax on, or measured by, gross receipts." The FTB indicated that it will issue a more detailed legal ruling on credits and deductions for taxes paid to other states sometime before the third quarter of this year. Cal. FTB, Technical Advice Memorandum 2016-01 (Jan. 12, 2016).

Illinois: An international specialty phosphates manufacturer (manufacturer) is required to include throwback sales in its sales factor numerator for the 2009 and 2010 tax years because the addition of throwback sales is automatic under the state's standard apportionment statute (35 ILCS 5/304(a)(3)(B)(ii)) and nothing in a 2013 amendment to an alternative apportionment statute (35 ILCS 5/304(f)) changed that requirement. In reaching this conclusion, the Illinois Independent Tax Tribunal (Tribunal) rejected the manufacturer's arguments that the amendment to the alternative apportionment statute cannot be reconciled with the standard apportionment statute's automatic inclusion of throwback sales under a "harmonious reconciliation" of those statutes, and that adding throwback sales results in inflating the Illinois market by the addition of non-Illinois sales to the sales factor numerator. Rather, the Tribunal found that the two statutes can be read in harmony — the standard apportionment statute includes throwback sales as sales within Illinois and the 2013 amendment to the alternative apportionment statute looks to the Illinois market for a fair representation of a taxpayer's business. The Tribunal further held that the burden of proof does not shift to the Illinois Department of Revenue when it adds throwback sales into a taxpayer's sales formula, because throwback is applied under the standard apportionment statute, not the alternative apportionment rule. Lastly, the Tribunal rejected the manufacturer's alternative argument that it was effectively denied due process because the retroactive effect of the 2013 amendment (effective for tax years ending on or after Dec. 31, 2008) to Illinois' alternative apportionment statute made it impossible for the manufacturer to have requested alternative apportionment at the time it filed its original returns for tax years 2009 and 2010. The Tribunal reasoned that since throwback sales were properly includible by statute both before and after the 2013 amendment, the manufacturer was eligible to file for alternative apportionment but failed to timely do so. Innophos Holdings, Inc. v. Ill. Dept. of Rev., No. 14 TT 214 (Ill. Indep. Tax Trib. Nov. 17, 2015).

Missouri: Individual partners of a limited liability partnership (LLP) are allowed to claim a credit on their Missouri individual income tax returns for their proportionate share of the LLP's directly paid Texas Margin Tax but not the Washington Business and Occupation (B&O) Tax. The Missouri Department of Revenue (Department) found the Margin Tax is an income tax for purposes of Missouri law because it is based solely on various types of income reported on the federal income tax return, and it essentially operates as an income tax since a corporation must pay the Margin Tax due even if the corporation ceases doing business in the state (as opposed to a franchise tax, which is payable in advance for the privilege of exercising the right to do business in the future). The Department found the B&O tax is a gross receipts tax rather than an income tax as it is a not based on federal taxable income (federal income less deductions) and instead is based on gross income or gross receipts of businesses that operate in Washington. In addition, the "object" of the B&O tax is to assess operating businesses for "privilege of doing business" in Washington. Mo. Dept. of Rev., PLR 7665 (Nov. 24, 2015).

New York: On Dec. 31, 2015, the New York State Department of Taxation and Finance (Department) issued Technical Services Bulletin TSB-M-15(8)C, 7(I) (TSB), addressing how Article 9-A taxpayers must attribute interest expense deductions to "investment income" and "other exempt income" under the corporate tax reform legislation. This TSB supersedes TSB-M-88(5)C and TSB-M-95(2)C, which discussed attribution of expense deductions, but does retain some of the language and concepts used in these prior TSBs for direct attribution. While the rules for attribution of interest deductions contained within New York City's (NYC) Administrative Code are identical to the NYS Tax Law provisions, the NYC Department of Finance (DOF) has not yet provided guidance on this topic or indicated whether it will follow this TSB. That said, the DOF has previously indicated that it will follow guidance issued by the Department when the state's and city's respective corporate tax reform statutes are the same. For additional information on this development, see Tax Alert 2016-71.

New York: The New York State Department of Taxation and Finance (Department) issued TSB-M-15(7)C, (6)I (the Memo) to explain the impact New York corporate tax reform, which included changes to the income apportionment rules, will have on nonresident or a part-year resident shareholders of a New York S Corporation. The Memo discusses how the new rules apply when computing a New York S Corporation's shareholder's New York source income for tax years beginning after December 31, 2014. For additional information on this development, see Tax Alert 2016-135.

New York: The New York Department of Taxation and Finance enacted an emergency regulation to change the MTA surcharge rate. Under the emergency regulation, the MTA surcharge is increased from 25.6% to 28% for taxable years beginning on or after Jan. 1, 2016 and before Jan. 1, 2017. The 28% rate will remain in effect for succeeding tax years unless the Commissioner determines a new rate. N.Y. Dept. of Taxn. & Fin., Emer. Reg. 20 NYCRR Part 9 (released Dec. 31, 2015).

Pennsylvania: Governor Tom Wolf announced that the Pennsylvania capital stock and foreign franchise tax has been phased-out, effective Jan. 1, 2016. The Governor indicated that the Department of Revenue will be providing additional guidance on filing the final 2015 return. PA Gov., Press Release (Jan. 4, 2016).

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Sales & Use

Massachusetts: An unapportioned motor vehicle use tax imposed on a freight company's interstate fleet of vehicles does not violate the Commerce Clause because the tax meets the four-pronged test developed in Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977). In reaching this conclusion, the Massachusetts Supreme Judicial Court (Court) found the tax to be fairly apportioned as it is both internally and externally consistent. The tax is internally consistent since any potential for multiple taxation (i.e., use tax paid to other jurisdictions) under Mass. Regs. § 64H.25.1(7)(g) is averted by the catchall exemption of Mass. Regs. §64H.25.1(7)(h). The tax is externally consistent because the freight company's tax liability reasonably reflects the in-state activity being taxed — such as the freight company's use of all of the tractors and trailers in its fleet in Massachusetts, and at least partial storage and maintenance of its fleet there. The tax is not discriminatory because it is imposed on the privilege of using and storing tractors and trailers in Massachusetts, rather than solely on the freight company's use of roads. Discrimination, the Court noted, occurs when a state subjects taxpayers doing business outside the state to disparate tax treatment from those based inside the state, not when Massachusetts subjects all taxpayers to tax on a transaction that other states might exempt. The tax is fairly related to state services based on the nature and extent of the freight company's Massachusetts activities and the benefits the freight company receives because the freight company is incorporated and headquartered in Massachusetts, the majority of its workforce is employed there, and it uses, stores, and maintains its vehicles there. In regard to nexus, the Court noted that this was not at issue as the parties previously agreed that the freight company's activities constitute substantial nexus with Massachusetts. Regency Transp., Inc. v. Mass. Comm'r of Rev., Slip Op. No. SJC-11873 (Mass. Sup. Jud. Ct. Jan. 6, 2016).

Michigan: New laws (SB 616 and SB 617) provide sales and use tax exemptions for data center equipment, or the storage, use, or consumption of data center equipment, sold to the owner or operator of a qualified data center or a co-located business for use or consumption in the operations of the data center. The exemptions apply from Jan. 1, 2016 to Dec. 31, 2021, and they will continue to apply through Dec. 31, 2035 if certain job creation criteria are met. Data center equipment includes computers, servers, routers, switches, peripheral computer devices, racks, shelving, cabling, wiring, storage batteries, back-up generators, uninterrupted power supply units, environmental control equipment, other redundant power supply equipment, and prewritten computer software used in operating, managing, or maintaining the qualified data center or the business of the qualified data center or a co-located business. It also includes any construction materials used or assembled under the qualified data center's proprietary method, but excludes any equipment owned by a third party used to supply the qualified data center's primary power. Mich. Laws 2015, PA 251 (SB616) and PA 252 (SB 617), each signed by the governor on Dec. 23, 2015.

Missouri: An out-of-state supplier's sales of original and optional business management software and network and software maintenance services are not subject to sales or use tax, because all of the sales of software are optional and are delivered over the internet (nontaxable) and not on a tangible medium (taxable). In addition, the supplier's software maintenance, security services and networking solution services are all optional and are not tied to the sale of software on a tangible medium, and none of the services that the supplier provides, by itself or through a third party, are specifically enumerated taxable services. Mo. Dept. of Rev., PLR 7635 (Nov. 24, 2015).

Nevada: The U.S. Supreme Court will not review a Nevada Supreme Court (court) ruling that a power company was not entitled to a refund of use tax even though the tax statute denying it an exemption was found to violate the Commerce Clause. Rather than strike the offending provision and allow all mine proceeds to be exempt, the court ruled that the entire statute must be struck because the legislative intent was to protect local mines, not to exempt all mine and mineral proceeds. Sierra Pac. Power Co. and Nevada Power Co. v. Dep't of Taxation, No. 61193 (Nev. Sup. Ct. Dec. 4, 2014), cert. denied, Dkt. No. 15-25 (U.S. Sup. Ct. Jan. 11, 2016).

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Business Incentives

Federal: In Notice 2016-5, the IRS delivers rules for making one-time claims of the retroactively extended incentives for biodiesel mixtures and alternative fuels that were sold or used during 2015. The Notice also gives guidance for claiming other retroactively extended credits for 2015, including the alternative fuel mixture excise tax credit. For additional information on this development, see Tax Alert 2016-116.

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Controversy

Massachusetts: A two month tax amnesty program will run April 1, 2016 through May 31, 2016. Amnesty applies to business and individual taxpayers that are not currently registered with the Department of Revenue (Department), have not filed a tax return, or have not reported the full amount of tax owed on a previously field return for any tax return due on or before Dec. 31, 2015 (with some exceptions). Amnesty applies to all taxes administered by the Department except the Preferred Provider excise and those covered under the International Fuels Tax Agreement. In exchange for participating in the amnesty program, the Department of Revenue will waive otherwise applicable penalties and interest, and apply a three-year lookback period. Amnesty is not available to taxpayers that have been the subject of a tax-related criminal investigation or prosecution, have previously filed false or fraudulent returns or statements, or filed a fraudulent tax amnesty return. In addition, the amnesty program does not cover existing tax liabilities. Taxpayers that participated in the 2014 or 2015 tax amnesty programs are not eligible to participate in the 2016 program for the same tax types or tax periods. Eligible taxpayers that do not participate in the amnesty program could be subject to double the amount of tax due and other penalties, they will lose the limited lookback period, and will face "escalating enforcement efforts". Mass. Dept. of Rev., MA Tax Amnesty 2016 (Jan. 14, 2016).

Ohio: On Dec. 31, 2015, the Regional Income Tax Agency of Ohio (RITA) issued a news release indicating that an internal investigation determined that personal information supplied by individuals to RITA on or before June 2012 may be at risk due to a missing DVD. RITA is in the process of contacting potentially affected individuals by regular mail and is offering free credit monitoring and identity protection for a period of time. For additional information on this development, see Tax Alert 2016-36.

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Miscellaneous Tax

Michigan: New law (SB 538) retroactively amends the Uniform Unclaimed Property Act to include a streamlined audit process for certain Michigan-related corporations. The streamlined audit process applies to "eligible holders," defined as holders that are one or more of: (1) a business with a principal place of business in Michigan as evidenced by 20% or more of its payroll or 20% or more of its real and tangible personal property (except inventory) owned or rented in Michigan during the period subject to examination, or the majority of officers that direct, control, and coordinate the activities of the business are employed in Michigan; (2) a corporation that wholly owns a corporation incorporated in Michigan, and the Michigan corporation meets the criteria from (1); or (3) a corporation that is wholly owned by a corporation incorporated in Michigan, and the Michigan corporation meets the criteria from (1). An eligible holder can elect to participate in the streamlined audit process by executing a nondisclosure agreement acceptable to the administrator within 30 days from the receipt of the audit notice. For an eligible holder participating in the streamlined audit process, the treasurer cannot begin an action or proceeding more than four years after any duty of a holder under the law arose, and the streamlined examinations cannot include checks voided within 180 days of their issuance. Finally, property worth $25 or less is not subject to the custody of the state as unclaimed property, subject to certain exceptions (such as dividends and stocks). The new law applies to audits in progress as of Aug. 15, 2015, but does not apply retroactively to contested determinations in litigation before Dec. 22, 2015. Mich. Laws 2015, PA 242 (SB 538), signed by the governor on Dec. 22, 2015.

New Hampshire: The New Hampshire Department of Revenue Administration (Department) issued guidance on how an employee leasing company and client company can jointly elect to make the client company solely responsible for paying the Business Enterprise Tax (BET) on leased employee wages under provisions of SB 211 (Laws 2015). Upon making the election, the client company is responsible for including the wages of leased employees in the client company's compensation portion of its enterprise value tax base. To make an election, both companies must jointly complete and file Form DP-216, "Employee Leasing Company Business Enterprise Tax (BET) Election," with the Department before the end of the employee leasing company's tax year to which the election relates. The election is available beginning Jan. 1, 2016. N.H. Dept. of Rev. Admin., TIR 2015-008 (Dec. 9, 2015).

* Tax alerts are available in the EY Client Portal. If you are not a subscriber to EY Client Portal and would like to subscribe to EY Client Portal and receive our Tax Alerts via email, please contact your local state tax professional.

Because the matters covered herein are complicated, State and Local Tax Weekly should not be regarded as offering a complete explanation and should not be used for making decisions. Any decision concerning matters covered herein should be reviewed with a qualified tax advisor.