Ernst & Young's State and Local Tax Weekly newsletter for February 26 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.

—————————————————————————
Top Stories

Tenth Circuit Court of Appeals upholds Colorado's remote seller notification and reporting statute, finds no discrimination or undue burden on interstate commerce

The US Court of Appeals for the Tenth Circuit (the court) issued its much anticipated ruling in Direct Marketing Association, holding that a Colorado statute, which requires remote sellers lacking physical presence within the state to file an annual statement with the Colorado Department of Revenue (Department) showing the total amount paid for Colorado purchases during the preceding calendar year for each Colorado purchaser, does not violate the dormant Commerce Clause.

The court's decision is not surprising, given the US Supreme Court's 2015 ruling that the Colorado remote seller notification statute did not implicate the "assessment, levy or collection" of a state tax. Based on that decision, the court would have been required to expand the Quill physical presence requirement beyond the scope of sales and use tax collection; given Justice Anthony Kennedy's concurring opinion in the earlier Direct Marketing Association case, in which he called for a reexamination and potential reversal of Quill, such a result was unlikely. It also appears unlikely that the US Supreme Court will hear an appeal of this decision, or use such an appeal as a vehicle for overturning Quill. In our view, a more likely occasion for such a review would be the potential challenge to Alabama's regulation asserting an "economic presence" nexus standard, which became effective Jan. 1, 2016, and which directly contradicts the Quill nexus standard. As of Feb. 26, 2016, no such challenge has been filed by any remote seller against the Alabama regulation and at least two other states — Rhode Island and South Dakota — have introduced bills which would go just as far as Alabama in asserting an economic nexus standard for sales tax collection.

For now, the court's decision likely will serve as a signal for the states to adopt similar provisions requiring online and other remote sellers that maintain a narrow "nexus footprint" to comply with significant state sales and use tax reporting requirements. As recently as 2010, the Multistate Tax Commission (MTC) was working on draft legislation modelled after the Colorado notice statute. That project could now find new life in the wake of this decision and state revenue authorities and legislatures could adopt it as their own, even without any additional action by the MTC. Should this occur on a wide scale, remote sellers will need to consider whether to simply register, report, collect and remit sales tax, rather than burdening themselves with what could be onerous, costly and complex sales and use tax reporting requirements that would be imposed by these remote seller notification laws.

Finally, it is worth noting that, should a number of states begin to adopt similar notice requirements, Congress may be forced to act through one of the remote seller nexus bills currently pending in both houses. As noted by the court in its conclusion, paraphrasing the Quill Court, "Congress holds the 'ultimate power' and is 'better qualified to resolve' the issue of 'whether, when, and to what extent the States may burden interstate [retailers] with a duty to collect [sales and] use taxes.'" Given that the likely outcome will be of the states each enacting a complex variety of sales and use tax reporting requirements in response to this ruling, having Congress enact a national, uniform nexus standard for sales and use tax collection may prove to be a more viable alternative for remote sellers throughout the US. For additional information on this development, see Tax Alert 2016-365.

Permanent Internet Tax Freedom Act, including a 2020 sunset date for taxes imposed by grandfathered states, enacted into law

On Feb. 24, 2016, President Obama signed into law the Trade Facilitation and Trade Enforcement Act of 2015 (HR 644) (the Act), provisions of which make the Internet Tax Freedom Act (ITFA) permanent, and place a four-year sunset on the ITFA "grandfathering" provisions, which allowed a few states to continue to impose taxes on certain Internet services. Originally enacted in 1998, ITFA bars federal, state and local governments from taxing Internet access and from imposing "multiple and discriminatory taxes on electronic commerce," but provides an exception for those states that imposed a tax on Internet access prior to Oct. 1, 1998 (the so-called grandfathered states — Hawaii, New Mexico, North Dakota, Ohio, South Dakota, Texas and Wisconsin). The current provision contained in the Act will allow the grandfathered states to continue to tax Internet access for an additional four-and-a-half years (through June 30, 2020), at which point the prohibition on such taxes imposed by the Act will apply and these grandfather states will no longer be allowed to do so. For additional information on this development, see Tax Alert 2016-299.

—————————————————————————
Income/Franchise

California: The California Franchise Tax Board (FTB) issued a Chief Counsel Ruling regarding the application of market-based sourcing rules for non-marketing services under Cal. Rev. & Tax. Code §25136 and Cal. Code Regs. tit. 18, §25136-2. Under California law, sales from services are in California to the extent the purchaser of the service receives the benefit of the service in California. The FTB's Chief Counsel ruling advised that for purposes of assigning sales of non-marketing services under these provisions, the taxpayer must assign the sales of its services to California to the extent its customers (and not its customer's customers) receive the benefit of the service in California. In so holding, the FTB's Chief Counsel noted that because the provisions do not specify how to determine where the benefit of the service is received for a non-marketing service where both the taxpayer's customer and the taxpayer's customer's customers receive a benefit from use of the service in the taxpayer's customer's business operations, it applied comparable guidance for non-marketing intangibles. In addition, for purposes of assigning sales of non-marketing services under these provisions, a taxpayer may use Central Processing Unit data from its books and records kept in the regular course of business as a reasonable proxy for financial data in the taxpayer's books and records kept in the regular course of business that cannot be reasonably extrapolated to determine the location and extent of the benefit of the service received by the taxpayer's customers in California. Cal. FTB, Chief Counsel Ruling 2015-02 (Feb. 1, 2016).

California: The Franchise Tax Board (FTB) issued a notice advising taxpayers and their representatives of its intended course of action following the California Supreme Court's ruling in Gillette regarding the use of the Multistate Tax Compact apportionment election (Compact election). The FTB said that given the taxpayer's intent to appeal the ruling in Gillette to the U.S. Supreme Court (USSC), it will take no action on refund claims that have been made to avoid the bar of refunds by the statute of limitation. The FTB will take action on these claims once the case has been resolved either by a denial of certiorari by the USSC or final state court action after a decision by the USSC. The FTB also said that it will seek to defer administrative appeals pending before the State Board of Equalization until all litigation has concluded. In regard to audits where the Compact election is an issue, the FTB indicated that it will proceed with the audit in the normal course of business. If the statute of limitations barring additional proposed assessments will expire before the conclusion of the litigation, the FTB will request a waiver from the taxpayer to extend the statute of limitation. If the taxpayer agrees to execute a waiver, the case will be held until the litigation concludes, but if the taxpayer declines to execute the waiver, the FTB will issue the proposed assessment. Cal. FTB, Notice 2016-01 (Feb. 23, 2016).

Colorado: Proposed bill (HB 1275) would require an affiliated group filing a combined return to include income from an affiliated entity incorporated in a tax haven jurisdiction, provided that the tax haven bill is approved by voters during the November 2016 election. The bill would define a tax haven as a jurisdiction that, during the year at issue, has no or nominal effective tax on the relevant income and that: (1) has laws or practices that prevent effective exchange of information for tax purposes with other governments on taxpayers benefiting from the tax regime; (2) has a tax regime that lacks transparency so that the details of legislative, legal or administrative provisions are not open and apparent or are not consistently applied among similarly situated taxpayers; (3) facilitates the establishment of foreign-owned entities without the need for a local substantive presence or prohibits these entities from having any commercial impact on the local economy; (4) explicitly or implicitly excludes the jurisdiction's resident taxpayers from taking advantage of the tax regime's benefits or prohibits enterprises that benefit from the regime from operating in the jurisdiction's domestic market; and (5) has created a tax regime that is favorable for tax avoidance. A taxpayer will not be deemed to be incorporated in a tax haven jurisdiction if the taxpayer can prove that it is incorporated in the jurisdiction for a legitimate business purpose. If the bill is enacted and approved by voters, its provisions would take effect on the date of the official declaration of the vote by the governor. HB 1275 was introduced on Feb. 17, 2016.

Georgia: New law (HB 742) updates Georgia's date of conformity to the IRC as amended and in effect on or before Jan. 1, 2016 (from Jan. 1, 2015), effective for taxable years beginning on or after Jan. 1, 2015. The state continues to decouple from bonus depreciation, the IRC §199 production deduction, and various other provisions. Ga. Laws 2016, Act 313 (HB 742), signed by the governor on Feb. 23, 2016.

Minnesota: The Minnesota Revenue Commissioner (Commissioner) may aggregate all the days a taxpayer spent in Minnesota during the taxable year in determining whether the taxpayer was a "resident" under Minn. Stat. § 290.01, subd. 7(b), including the days spent in the state as a domiciliary. In reversing and remanding a state tax court ruling, the Minnesota Supreme Court (Court) concluded that the tax court's interpretation of the statute was erroneous, and agreed with the Commissioner's interpretation that the definition of "resident" applies to all individuals who fulfill three conditions during the tax year: (1) domicile outside Minnesota, (2) maintenance of an abode in Minnesota, and (3) physical presence in Minnesota for more than half the tax year. Although the Court found the statute to be ambiguous and susceptible to two reasonable interpretations, it found that the example in Minn. R. 8001.0300, subp. 10B clarified that if an individual maintains an abode in Minnesota that year, whether as a domiciliary or not, that time can be aggregated to determine whether an individual is a full-year resident. Marks v. Minn. Comr. of Rev., A15-1145 (Minn. Sup. Ct. Feb. 17, 2016).

Ohio: New law (SB 2) updates Ohio's conformity date to the IRC from March 22, 2013 to April 1, 2015. The bill took immediate effect. Ohio Laws 2016, SB 2, signed by the governor on Feb. 14, 2016.

Virginia: A multinational corporation, with a Virginia headquarters, was not entitled to use an alternative apportionment method to source its income to Virginia because it failed to prove that its proposed formula more accurately assigned its income to Virginia. The corporation's income is derived from an annual fee for internet access to bundled products and tools executives can use to analyze business functions and processes as well as for data, insights, classroom and web-based learning. For the years at issue (2008-2010), Virginia used a double weighted sales factor apportionment formula and the costs of performance method to source income from the sale of non-tangible property to customers in the state. The corporation filed a refund claim, arguing that the standard apportionment method cause it to pay significantly more tax to Virginia than what Virginia was "constitutionally entitled", effectively resulting in double taxation. The corporation filed amended returns applying a single sales factor apportionment formula and using a destination-based method to source its service revenues (the destination of the customer determined using its billing address - "zip code method"). Applying the proposed destination-based method instead of the statutory costs of performance method, the corporation's sales factor to Virginia went from 100% (for each of 2008-09), 93.519% (for 2010) to 2.221%, 3.238% and 2.870%, respectively. A circuit court (court) rejected the corporation's arguments, finding that it failed to meet its burden of proving that income attributed to Virginia through the use of the standard method was in fact out of all appropriate proportion to the corporation's business activity in the state or that the standard method led to a grossly distorted result. Rather, the court found that the corporation's interstate activities were related to its in-state activities at its headquarters, its activities that resulted in the income taxed under the standard method has some minimal connection to Virginia, the income produced was rationally related to the corporation's activities at its headquarters and to the values connected to Virginia, and the double-weighted sales factor formula is not in fact out of all appropriate proportion to the corporation's business activities in Virginia or that the statutory method lead to a grossly distorted result. Lastly, the court found that the tax commissioner did not act in an arbitrary, capricious or unreasonable manner in denying the corporation's request to use an alternative apportionment method, nor did the tax commissioner abuse his discretion in applying the standard method of apportionment to the corporation's income activities in Virginia. Corporate Executive Board v. Virginia Dept. of Taxn., No. CL13-3104 (Va. Cir. Ct., Arlington Cnty., Feb. 25, 2016).

West Virginia: New law (HB 4148) updates the state's conformity to the IRC and adopts the federal law in effect after Dec. 31, 2014 but before Jan. 1, 2016. Amendments made to the IRC on or after Jan. 1, 2016, will not be given any effect. W. Va. Laws 2016, HB 4148, signed by the governor on Feb. 25, 2016.

—————————————————————————
Sales & Use

Alabama: Proposed bill (SB 242) would expand the definition of taxable tangible personal property to include "digital goods". The term "digital good" would be defined as "sounds, images, data, facts, or information, or any combination thereof, transferred electronically, including, but not limited to, specified digital products and any other service transferred electronically that uses one or more software applications." If enacted, this provision would take effect immediately. SB 242 was introduced on Feb. 16, 2016.

Nebraska: Proposed bill (LB 1087) would expand the definition of "engaged in business in this state" to reach remote retailers by adopting economic and affiliate nexus provisions. LB 1087 was introduced on Jan. 20, 2016.

North Carolina: The North Carolina Department of Revenue (DOR) has issued Directives and Important Notices regarding the upcoming sales and use tax law changes that will take effect in that state beginning on March 1, 2016. Specifically, these directives and notices relate to the new law changes affecting repair, maintenance, and installation services; service contracts; and qualifying datacenters. For additional information on this development, see Tax Alert 2016-369.

Tennessee: A taxpayer's provision of customer access to its website at no extra charge is not subject to Tennessee sales or use tax because the true object of this grant of access is the provision of services, and any manipulation of the information online, which requires use of the website, is merely incidental to the taxpayer's provision of services. In addition, the taxpayer's purchase of a license of a system from a third party for resale to the taxpayer's customers is exempt from sales tax if the taxpayer provides the third party with a properly completed resale certificate. However, the taxpayer's charges to its customers for access to the system are subject to sales and use tax as remotely accessed software, since the system is housed on the third party's servers and accessed remotely by the taxpayer's customers from locations within Tennessee. The taxpayer may present the seller with a Remotely Accessed Software Direct Pay Permit at the time of purchase and remit sales tax directly to the Tennessee Department of Revenue on the portion of the sales price that corresponds to the percentage of its users located inside Tennessee. Alternatively, the taxpayer may present the seller with a fully completed Streamlined certificate of exemption at the time of purchase to exclude the portion of the sales price that corresponds to its percentage of users located outside Tennessee, and pay sales tax based on its percentage of users located inside Tennessee. Tenn. Dept. of Rev., Letter Ruling #16-01 (Jan. 26, 2016).

Texas: In affirming in part and reversing in part a lower court ruling, the Texas Court of Appeals (Court) held that Texas can impose sales tax on an insurance carrier's (carrier) purchase of claims-adjustment services from a third-party vendor (vendor), however, the vendor's services are exempt from sales tax as temporary employment services to the extent the vendor's employees worked out of the carrier's office. In reaching this conclusion, the Court explained that claims-adjustment services generally are taxable, but Texas excludes temporary employment services from sales tax when five conditions are met: (1) a vendor's employee performs a service for a contracting employer to supplement the contracting employer's existing work force on a temporary basis, (2) the vendor must be an employment service as defined by Texas Labor Code § 93.001, (3) the service is normally performed by the contracting employer's own employees, (4) the help is under the direct or general supervision of the contracting employer to whom the help is furnished, and (5) the contracting employer provides all supplies and equipment necessary. The Court found that the insurance carrier met the first four requirements for all of the claims-adjustment services for which it contracted with the vendor. However, the provision of laptops to the vendor's employees was essential or indispensable to the provision of adjusting services under the agreements between the parties, and with the exception of vendor employees who performed claims-adjustment services in the carrier's office (inside adjusters), the carrier failed to provide the laptops to vendor's employees. Accordingly, the carrier is entitled to a refund of sales tax paid on purchases of services performed by adjusters inside the carrier's office, but not on services performed by adjusters outside the carrier's office. Allstate Insurance Co. v. Hegar, No. 03-13-00341-CV (Tex. Ct. App., 3d Dist., Feb. 18, 2016).

—————————————————————————
Business Incentives

Alabama: Proposed bill (SB 208) would require state agencies that administer an economic tax incentive to submit to the Legislature at the start of the 2018 Regular Legislative Session a report regarding each tax incentive that it administers. The report would have to include an assessment of each economic tax incentive based on the following criteria: (1) whether or not each economic tax incentive has been successful in meeting the purpose for which it was enacted, (2) whether or not the state receives a positive return on investment, and (3) unintended or inadvertent effects, benefits or harm caused by each economic tax incentive. SB 208 was introduced on Feb. 11, 2016.

Louisiana: Individual members of a limited liability company (LLC) that both sold and leased inventory are entitled to an inventory tax credit for items reported to the tax assessors as inventory as well as property reported as leased equipment, because all of the items for which a tax credit was requested were goods awaiting sale. In reaching this conclusion, the Louisiana Court of Appeal (Court) found that the evidence supports the Louisiana Board of Tax Appeal's findings that nothing in Louisiana statutory law provides that an item held for resale cannot be rented while it is in inventory awaiting a buyer; all of the items for which a tax credit was requested were goods awaiting sale, thereby constituting the inventory of the LLC; and that the LLC is a retailer engaged in the sale of products to the ultimate consumer. The case was remanded to the trial court to determine the amount of refund due the individual members as a result of the inventory credit. Bridges v. Bullock, No. 50,297-CA (La. Ct. App., 2d Cir., Feb. 19, 2016).

—————————————————————————
Property tax

South Dakota: New law (HB 1150) increases the property tax exemption for property owned by a local industrial development corporation to $750,000 (from $100,000), effective July 1, 2016. The full and true value of the real property owned by the local industrial development corporation in excess of $750,000 will be taxed as other property in the same class is taxed. Property will not qualify for this exemption if it is located in a tax incremental district. S.D. Laws 2016, HB 1150, signed by the governor on Feb. 29, 2016.

—————————————————————————
Compliance & Reporting

Georgia: New law (HB 742) amends the tax return due date for corporations, Georgia S corporations and partnerships, effective for all taxable years beginning on and after Jan. 1, 2016. Under the revised law, corporate returns will be due on or before April 15 (previously March 15th) for calendar year taxpayers and for fiscal year taxpayers by the fifteenth day of the fourth month following the close of the fiscal year (previously the fifteenth day of the third month following the close of the fiscal year). For Georgia S corporations and partnerships, the return is due on or before March 15 for calendar year taxpayers and for fiscal year taxpayers on or before the fifteenth day of the third month following the close of the fiscal year. Ga. Laws 2016, Act 313 (HB 742), signed by the governor on Feb. 23, 2016.

West Virginia: New law (HB 4148) changes the due date of the corporate tax return. Effective for tax years beginning after Dec. 31, 2015, the corporate net income tax return must be filed on or before the fifteenth day of the fourth month following the close of the corporation's taxable year (previously the fifteenth day of the third month following the close of the taxable year). Returns filed by exempt corporations with unrelated business taxable income also must file the annual return by the fifteenth day of the fourth month following the close of the taxable year (previously the fifteenth day of the fifth month following the close of the taxable year). W. Va. Laws 2016, HB 4148, signed by the governor on Feb. 25, 2016.

—————————————————————————
Miscellaneous Tax

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.

Delaware: The Delaware Department of Finance, Office of Unclaimed Property, State Escheator proposed to revise and replace its regulations related to voluntary disclosure agreements (VDA) and escheat examinations, as required by Delaware Laws 2015, HB 11. The proposed regulations are intended to be a manual framework to ensure greater transparency and predictability so that holders of unclaimed property have a basic understanding of the processes available to them and the state's expectations. In entering into a VDA, holders must complete a review of books and records and file reports beginning with calendar year 1996, report year 2002, and for all subsequent years, and pay all abandoned property due to Delaware for those years within six months from the date the state accepted the holder's Form AP DE-1, Disclosure and Notice of Intent to Voluntarily Comply with Abandoned and Unclaimed Property Law. For holders entering the VDA program beginning on and after Jan. 1, 2017, there is a rolling 19 report year look back period from the year of enrollment, and holders should pay over all abandoned property due to Delaware for those years. Delaware can audit a VDA three years from the date that a holder has paid over property under a VDA. In addition to guidance on the VDA program, the proposed regulation also includes guidelines on unclaimed property examinations. Topics covered include: guiding principles, examination of holders, notice of examination, third party advocates, confidentiality and non-disclosure agreements, opening conference, scope of the examination, the examination, reportable property types and dormancy periods, projections and estimation, approved remediation outreach letter, entity sampling, bankruptcy, statement of findings and request for payment, and general information. This regulation would take effect upon approval and would apply to all VDAs/examinations commenced after that date and, to the extent possible, the regulation would apply to any ongoing VDAs/examinations. Comments are due by 4:30 p.m. April 1, 2016. Del. Dept. of Fin., Office of Unclaimed Property, State Escheator, 19 Prop. Regs. 723 (Feb. 1, 2016).

South Carolina: The state Attorney General (AG) recently opined that intangible property is presumed abandoned if it has been unclaimed for more than five years unless South Carolina's unclaimed property laws specifically provide otherwise. In reaching this conclusion, the AG found the relationship between certain unclaimed property statutes was that of a general rule that all intangible property is presumed abandoned after five years unless a different time period is otherwise specified (S.C. Code §27-18-30) and exceptions that deal with presumed abandonment for specific types of intangible property (S.C. Code §§27-18-60 through 27-18-170). This contrasts with a more restrictive statutory interpretation asserted by certain businesses, arguing that under S.C. Code §27-18-40, the conditions raising a presumption of abandonment under the requirements of general rule and the requirements of the exceptions must be met for intangible property to be subject to the custody of the state. The AG cited the interpretations of the Uniform Disposition of Unclaimed Property Act as additional support for the opinion, noting that Colorado, New Jersey, and Michigan all interpreted similar unclaimed property provisions in their states in a like manner. Finally, the AG noted that the intangible property that the state can collect is not limited to intangible property specifically described in the statutes. S.C. Attorney General Opinion (Feb. 10, 2016).

* 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.