26 February 2016 State and Local Tax Weekly for February 19 Ernst & Young's State and Local Tax Weekly newsletter for February 19 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. Pennsylvania Department of Revenue issues information notice on corporate net income tax related party add-back On Feb. 19, 2016, the Pennsylvania Department of Revenue (Department) issued Information Notice Corporation Taxes 2016-1 (Notice) describing its interpretation, explanation and illustration of Pennsylvania's add-back rule, which disallows corporate income tax deductions for certain related party transactions. Specifically, effective for taxable years beginning after Dec. 31, 2014, add-back is required for an intangible/interest expense or cost paid, accrued or incurred directly or indirectly in connection with one or more transactions with an affiliated entity, unless one of three exceptions is met. The Notice sets forth the Department's view of the scope of the add-back rule, the exceptions to the add-back rule and the manner in which the credit to the add-back is to be calculated. According to the Notice, "intangible assets" the payments for which are subject to the add-back rule include patents, patent applications, trade names, trademarks, service marks, copyrights, mask works and other similar expenses and costs (e.g., franchise rights, know-how, trade secrets, goodwill, contract rights). The Department notes that the list of "intangible assets" to which the add-back rule applies is not exhaustive and the classification or label of a transaction is not determinative. Rather, according to the Department, it is the substance of the transaction that is determinative. The Notice further provides guidance on when a direct or indirect intangible expense or cost arises from a transaction between a Pennsylvania corporate taxpayer and an affiliated entity, noting that through an indirect transaction, a corporation could be subject to add-back even where the corporation and the affiliated entity are not parties to the same agreement with respect to an intangible asset. Further, an indirect intangible expense or cost deduction also may arise through amortization of intangible property or through the use of embedded intangibles. The Notice also provides guidance on the disallowance of interest expenses directly related to intangible expenses or costs, and when interest paid to an affiliate is presumed to be "directly related." In general, related party intangible expenses and costs are required to be added back unless one of the exceptions is met. Exceptions include the principal purpose/arm's-length exception, the foreign treaty exception, or the conduit exception. Taxpayers must maintain documentation to support the exception. The Notice also states that "mere statements or assertions" that a taxpayer engaged in a transaction to generally enhance management or intangible asset efficiency "or similarly unsubstantiated claims" will not be sufficient to substantiate a claim of a principal non-tax business purpose. In addition, according to the Notice the Department will presume tax avoidance exists for transactions between or among affiliates that generate intangible expenses or deductions that did not change the overall economic position of the Pennsylvania corporate taxpayer and its affiliated entities in a meaningful way. In discussing the application of the credits, the Notice quotes the statute; however, it veers away from the statutory language by stating that the credit "does not apply to taxes based upon capital, gross receipts taxes, or business and occupation taxes." The Notice also includes detailed examples that illustrate the manner in which it views the credit to be calculated. New Jersey: Proposed bill (SB 982) would adopt mandatory "water's edge" combined reporting provisions and require that a member of a unitary group incorporated in a tax haven also be included in such a "water's edge" return. The provisions would take effect immediately and apply to privilege periods ending after the bill's date of enactment. SB 982 was introduced on Feb. 4, 2016. South Carolina: The state's Supreme Court (Court) recently ruled that a multistate energy corporation is not allowed to include the principal recovered from the sale of short-term securities in the determination of its sales factor for formulary apportionment purposes because such inclusion "leads to absurd results by distorting the sales factor within the formula, and by defeating the legislative intent of the apportionment statutes." In reaching this conclusion, the Court noted that whether principal recovered is includable in total sales under the apportionment statute is a novel issue in the state and found instructive extra-jurisdictional cases that addressed this issue. In addition, the Court found supportive of its finding, the General Assembly's 2007 amendment to the definition of "sales" in the apportionment formula to explicitly exclude from the sales factor: (1) repayment, maturity, or redemption of the principal of a loan, bond, or mutual fund or certificate of deposit or similar marketable instrument; and (2) the principal amount received under a repurchase agreement or other transaction properly characterized as a loan. The Court reasoned that the General Assembly's action "supports [the Court's] finding that the legislative intent has always been to exclude such distortive calculations from the apportionment formula." Accordingly, the Court rejected the corporation's claim for a refund of corporate income tax. Duke Energy Corporation v. South Carolina Department of Revenue, No. 27606 (S.C. S. Ct. Feb. 17, 2016). Arizona: A company's income from subscriptions to access and use its online research and analysis database located on a remote server is subject to transaction privilege tax because the company's Arizona customers use its software and servers and they have sufficient use and control when they access the customer's content for these transactions to qualify as rental transaction under the personal property rental classification of the state's transaction privilege tax. The Director of the Arizona Department of Revenue (Department) also found that the company is not entitled to any exemption or deduction from the tax. In reaching this conclusion, the Department reasoned that there is no evidence of an established "common understanding" of the company's trade or business as a provider of database access and content, but the dominant purpose of the company's transactions with its customers is to enable database browsing and searching through the use of its software. The Department rejected the company's argument that users never have exclusive use and control of its platform or information, finding that when customers browse, search, print and arrange the company's content, they independently control its software to manipulate the presentation of the content. Citing Ball Aerospace & Technologies Corp. v. City of Boulder, a 2012 Colorado appellate decision, the Department concluded that the company's customers use its software and servers and they have sufficient use and control when they access and manipulate the company's content for the company's transactions to qualify as rental transactions under the personal property rental classification. Lastly, the Department rejected the company's argument that the assessment constituted a new position in relation to an older private letter ruling, noting that it overlooks numerous newer rulings that are on-point. Ariz. Dept. of Rev., Dir. Rev, of the decision of the ALJ re: [REDACTED], Case No. 201400197-S (Oct. 27, 2015). South Carolina: The South Carolina Department of Revenue (Department) issued a draft revenue ruling on the taxability of streaming television programs, movies and music (streaming content). In the draft ruling, the Department concludes that charges paid by a customer for streaming content are subject to South Carolina's sales and use tax because the charges are for a taxable communication service. The Department noted that "streaming" is not defined in the state's sales and use tax laws, and instead looked to the dictionary definition for guidance. The Department cited to the American Heritage Dictionary, 5th edition (2011) which defines "stream", in this context, to mean "to transmit (audio or video content), especially over the Internet, in small, sequential packets that permit the content to be played continuously, as it is being received and without saving it to a hard drive." Based on this definition of streaming and the state's definition of communication services, the Department found that the transmission of streaming content is no different than cable and satellite transmission of similar content. Comments on the draft ruling are due by March 11, 2016. SC DOR, Revenue Ruling #16-xx (Draft Feb. 18, 2016). South Dakota: Proposed bill (SB 106), as approved by the Senate, would establish an economic nexus provision for sales and use tax. Specifically, a seller selling tangible personal property, products transferred electronically or services (collectively, goods) for delivery into South Dakota would be required to follow all applicable sales and use tax collection and remittance procedures as if the seller had a physical presence in the state, if: (1) the seller's gross revenue from delivery of such goods into South Dakota exceed $100,000; or (2) the seller sold such goods for delivery into South Dakota in 200 or more separate transactions. Provisions of the bill include appeal process and procedures (e.g., enjoin the state from enforcing the provisions) and lists the legislature's reasoning for enacting these provisions. According to the bill, such reasons include the state's inability to effectively collect sales or use tax from transactions involving remote retailers, the revenue losses to the state from this inability, the structural advantages of remote sellers over instate, bricks and mortar retailers, the benefit remote sellers receive from the state's market (e.g., economic and infrastructure), the decrease in the costs of sales tax collection and reporting due to modern computer software, Justice Kennedy's concurring opinion in DMA, and the urgent need for the U.S. Supreme Court to reconsider the physical presence requirement set down in Quill and National Bellas Hess. If enacted, these provisions would be in full force and effect on the first day of the month that is at least 15 calendar days from the date this bill is signed by the governor. SB 106 was approved by the Senate on Feb. 19, 2016, and is now being considered by the House. West Virginia: An out-of-state corporation (corporation) that provides exterior facilities maintenance management services has nexus with West Virginia because the in-state activities of independent contractors (e.g., snow removal, landscaping, window washing) on its behalf are more than just "associated" with the corporation's ability to establish and maintain a market in the state; these activities create and maintain in totality the corporation's West Virginia market. In reaching this conclusion, the Administrative Law Judge (ALJ) cited Tyler Pipe Industries, Inc., stating that the crucial factor governing nexus is whether the activities performed in a state on behalf of the taxpayer are significantly associated with the taxpayer's ability to establish and maintain a market in the state for sales. In this case, the corporation provides exterior facilities maintenance management through contracts with in-state service providers that the corporation characterizes as independent contractors, and without these services, the corporation would be out of business in the state. Comparing this case to Scripto, Inc., the ALJ found that the corporation failed to explain exactly how the Scripto sales force is different than the workers working for it in West Virginia. Finally, while both parties discuss the fact that what is being taxed is a service — as opposed to the sale of tangible personal property — neither party cited to cases that analyze substantial nexus to tax out-of-state service providers. W. Va. Office of Tax Appeals, Nos. 12-432 U, 12-433-CU, 12-434 C and 12-435-NFN (Jan. 30, 2015). Wisconsin: Markup amounts an online travel company (OTC) collected as part of its reservation facilitation services are not subject to Wisconsin sales/use tax because this service is not among the taxable service enumerated in Wis. Stat. § 77.52(2)(a)1. In reaching this conclusion, the Wisconsin Court of Appeals (Court) concluded that the Wisconsin Tax Appeals Commission (Commission) reasonably interpreted the statute as not imposing a sales tax on the OTC because it was unclear whether "furnishing" includes establishing or arranging for reservation arrangements, or means literally providing physical accommodations, and statutory ambiguity is resolved in the taxpayer's favor. In addition, the Commission's conclusion that the statute does not impose a sales tax on those selling the service of making reservations on behalf of members of the public with those who provide rooms or lodging is not contrary to the clear meaning of the statute. The Wisconsin Department of Revenue did not persuade the Court that the Commission's interpretation is contrary to the clear meaning of the statute or that a more reasonable interpretation exists. Wis. Dept. of Rev. v. Orbitz LLC, No. 2015AP200 (Wis. Ct. App., Dist. IV, Feb. 11, 2016). Mississippi: New Law (HB 1) provides economic development incentives in the form of income tax, franchise tax, property tax, and sales and use tax incentives for tire or other rubber or automotive manufacturing plants and their affiliates, as well as certain maritime fabrication and assembly facilities. To qualify for these incentives, the taxpayer's project must meet certain requirements that include minimum capital investments, meeting target plant construction completion dates, and creating and maintaining specified minimum numbers of full-time jobs earning annual salaries of at least $40,000 each. These projects are eligible for an income tax exemption on income arising only from these projects, with the exemption inapplicable to activities subject to Mississippi income tax before project certification. The income tax exemptions are capped at either 20 or 25 years, and for any year that this qualified business or industry files Mississippi income tax, it is eligible to use a single sales apportionment factor. Similarly, any fee-in-lieu of franchise tax agreement is capped at 25 years for certain tire or other rubber or automotive manufacturing plant projects; the agreement applies only to new franchise tax liability connected with the project; these taxpayers are eligible to use a single sales apportionment factor attributable to the project for any years a Mississippi franchise tax return is filed. In regards to property tax, if a municipality changes its boundaries to include the project site of certain tire or other rubber or automotive manufacturing plants, all real and personal property located on the project site within the boundaries of the municipality that is owned by a business enterprise operating the project is exempt from ad valorem taxation for a period up to 30 years. Finally, the new law exempts from sales tax certain sales or leases to enterprises operating these projects, and the affiliates of certain tire or other rubber or automotive manufacturing plant projects. Miss. Laws 2016 (First Extraordinary Session), HB 1, signed by the governor on Feb. 8, 2016. Ohio: The Ohio Supreme Court (Court) determined that the Board of Tax Appeals (Board) did not abuse its fact-finding discretion in identifying a local health organization as a qualified charitable institution, but its grant of a property tax exemption was premature as there is no indication that the local health organization exercises any authority over the provision of dialysis services by a property lessee. The property lessee is in that business and conducts that operation on the premises, and the record lacks evidence that could support a finding of direction and control by the local health organization. Therefore, the Court vacated the Board's decision and remanded for consideration whether the property qualifies under the remaining criteria of Ohio Rev. Code §5709.121(A)(1) — whether a lessee can qualify as a charitable institution, and whether the lessee's provision of services on the site qualifies as charitable. Rural Health Collaborative of Southern Ohio, Inc. v. Testa, 2016-Ohio-508 (Ohio Sup. Ct. Feb. 16, 2016). Puerto Rico: In Informative Bulletin (IB) 16-01, Puerto Rico's Treasury Department (PRTD) has issued guidance on the filing of income tax returns and other documents for large taxpayers. The term "large taxpayers," is defined as taxpayers that are engaged in a trade or business in Puerto Rico and are either: (1) a commercial bank or trust company; (2) a private bank; (3) a brokerage or securities house; (4) an insurance company; (5) a telecommunications company; or (6) an entity with a volume of business of $50 million or more in the previous tax year. For tax years beginning after Dec. 31, 2014, large taxpayers must file their income tax returns, attachments and extensions in person or by certified mail. The PRTD indicates that informative and other returns that taxpayers are required to file electronically should continue to be filed electronically. Income tax returns and extensions that are not filed in accordance with the provisions of IB 16-01 will not be considered filed and taxpayers will be subject to penalty for failure to file a return or statement. For additional information on this development, see Tax Alert 2016-324. Hawaii: The Hawaii Department of Taxation (DOTAX) recently launched the pilot phase of its new Administrative Appeals and Dispute Resolution (AADR) program (Announcement No. 2016-03), offering a streamlined method to resolve, without litigation, any kind of tax dispute involving audit assessments. Program benefits include a simple application process, fair and neutral evaluation of tax disputes, timely resolution (completion of process within six-12 months upon acceptance) and lower costs than litigation. The AADR program is an informal appeals process that uses the Administrative Appeals Office (AAO) as a neutral intermediary to resolve tax disputes between the DOTAX and a taxpayer or return preparer that involves a proposed or final tax assessment, or return preparer penalty assessment. Taxpayers can represent themselves or be represented by a CPA, attorney or other tax professional. Any settlement reached must resolve the entire case, and the AAO generally will not raise new issues or examine issues on which the parties agree. The AAO will only accept cases where the issues and facts are fully developed and documented; there are a limited number of issues in dispute; and the parties are willing to resolve all of the disputed issues and act in good faith to find a resolution. For more information on this development, see Tax Alert 2016-339. Louisiana: A corporation that produces commodity chemicals (corporation) timely filed a refund claim before the prescription period expired because the Louisiana Department of Revenue's (Department) action to collect taxes suspended the prescription period, and the corporation met its burden of proof to support its refund claim. In reversing the Louisiana Board of Tax Appeals' (Board) decision, the Louisiana Court of Appeal (Court) found that under either a preponderance-of-the-evidence or a clear-and-convincing-evidence standard, the Board manifestly erred in finding that the corporation did not prove that it overpaid its taxes as "the result of an error, omission, or a mistake of fact of consequence to the determination of the tax liability, whether on the part of the taxpayer or the secretary," under La. Rev. Stat. 47:1621(B)(3). Further, the Court determined that the Board's findings were not reasonable in light of the evidence presented, including the testimony of the corporation's then-tax department manager that the overstatement of capital gains resulted from applying depreciation as though the corporation's partnership's assets were the its own, rather than those of the partnership; Schedule K-1 partnership returns submitted to the IRS; and the Department's position in its audit of the producer. The Court also rejected the Department's argument that the corporation is barred from claiming a "deduction" on its state return because it is so barred on the federal return — finding that capital gains are income calculated by determining the difference between the asset's sale price and its basis, and this basis is not a deduction. Sasol North America, Inc. v. La. Dept. of Rev., No. 15-569 (La. App. Ct., 3rd Cir., Feb. 10, 2016). All States: On Wednesday, March 9, 2016, from 1:00 - 2:30 p.m. EST (noon - 1:30 p.m. CST; 11:00 a.m. - 12:30 p.m. MST; 10:00 - 11:30 a.m. PST) EY will host the domestic tax quarterly webcast. The following topics will be discussed on the upcoming webcast:(1) Mike Reissig, Deputy Comptroller and Chief Clerk, Karey Barton, Associate Deputy Comptroller for Tax, and Nancy Prosser, Special Counsel to the Deputy Comptroller of the office of the Texas Comptroller of Public Accounts, will join us to discuss recent tax developments in their state, most notably issues related to the application of the Texas Franchise Tax and implications for Texas of the recent enactment by Congress of the Permanent Internet Tax Freedom Act; (2) a review of recent unclaimed property developments and emerging issues to watch in 2016; (3) tax policy matters, including an overview of notable 2016 governors' budget proposals that affect state taxes, consideration of an assortment of 2016 statewide ballot initiatives targeting state business taxes and the status of federal legislation that could impact state taxation; and (4) major judicial, legislative and administrative developments affecting state and local taxation. Click here to register for this event. (Note: 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. Document ID: 2016-0397 |
