01 April 2016 State and Local Tax Weekly for March 25 Ernst & Young's State and Local Tax Weekly newsletter for March 25 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. Recently enacted legislation (SB 106) makes South Dakota the second state (after Alabama) to establish an economic nexus standard for sales and use tax collection purposes. As acknowledged by the legislature, the new law directly exceeds the current physical presence standard for use tax collection, as articulated by the US Supreme Court (Court) in the 1967 National Bellas Hess and the 1992 Quill decisions. Under the new law, and effective May 1, 2016, a seller that sells tangible personal property, products transferred electronically or taxable services (collectively, goods) for delivery into South Dakota must follow all applicable sales and use tax collection and remittance procedures as if the seller had a physical presence in the state, provided that the seller meets either of the following in the previous calendar year or the current calendar year: (1) the seller's gross revenue from delivery of such goods into South Dakota exceeded $100,000; or (2) the seller sold such goods for delivery into South Dakota in 200 or more separate transactions. Provisions of SB 106 include appeal process and procedures that direct the courts to act as expeditiously as possible in regard to taxpayer challenges to these new provisions, and provide that an appeal of a circuit court ruling will be made directly to the South Dakota Supreme Court. Further, a filing of a declaratory judgment action by the state operates as an injunction during the pendency of the action, prohibiting state entities from enforcing the collection and remittance requirements against any taxpayer that does not affirmatively consent to remit the tax on a voluntary basis. If an injunction is lifted or dissolved, the state will assess and apply the collection and remittance requirement on that date going forward (i.e., no obligation to remit the sales tax will be applied retroactively). Further, SB 106 lists the legislature's reasoning for enacting these provisions, which include the state's inability to effectively collect sales or use tax on transactions involving remote retailers, the revenue losses to the state from this inability, the structural advantages of remote sellers over instate, brick-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 Direct Marketing Association (DMA), and the urgent need for the US Supreme Court to reconsider the physical presence nexus requirement. South Dakota's new law is modeled after a similar model law offered up by the National Council of State Legislatures. Given that the jurisdictional standards set forth in the new law exceed current Commerce Clause standards for sales and use tax collection purposes as established by the US Supreme Court, it is likely that the law will face legal challenges. For more on this development, see Tax Alert 2016-545. All States: On Wednesday, April 20, 2016, from 1:00-2:00 p.m. EDT New York; noon-1:00 p.m. CDT Chicago; 11:00 a.m.-noon MDT Denver; 10:00-11:00 a.m. PDT Los Angeles, EY will host a webcast analyzing allocation and apportionment issues. Our sixth income tax seminar in this series will address allocation and apportionment issues related to quirks of apportionment. The panelists will discuss apportionment related to specific industries and provide an in-depth analysis on the unique provisions used in the financial services industry. They will also discuss the differences between flow-up apportionment factors versus apportioning income at the partnership level. Finally, the panelists will discuss the factors to be considered in determining whether income should be classified as business or nonbusiness income and when it is appropriate to allocate instead of apportion income. Click here to register for this event. California: The California Franchise Tax Board (FTB) advised a regulated investment company (RIC) organized as a Massachusetts Business Trust, and a RIC organized as a Delaware Business Trust that each are not a "corporation" for California franchise tax purposes and, therefore, are not subject to California's minimum franchise tax. Although a business trust is considered a "corporation" for California corporation income tax purposes, it is not a "corporation" for franchise tax purposes because the definition of "corporation" under the franchise tax law was not expanded to include business trusts as it was under the corporate franchise tax. Cal. FTB, Chief Counsel Rulings 2016-1 and 2016-2 (Feb. 17, 2016). New York: The New York Division of Taxation (Division) properly disallowed a convenience store chain's (parent) reduction of its entire net income (ENI) by amounts it paid to its captive insurer (captive). In reaching this conclusion, an administrative law judge (ALJ) of the New York Division of Tax Appeals reasoned that payments from a parent to a wholly owned captive do not qualify as deductible insurance premiums for federal income tax purposes because the arrangement lacks risk shifting and risk distribution. There are four criteria to determine the existence of insurance for federal tax purposes, and all must be met: (1) the arrangement must involve insurable risk; (2) the arrangement must meet commonly accepted notions of insurance; (3) the arrangement must shift the risk of loss to the insurer; and (4) the insurer must distribute the risks among its policyholders. The ALJ found that the arrangement at issue lacks risk shifting because as the parent's wholly owned captive, the captive's payment to the parent for a covered loss will directly affect the parent's balance sheet and net worth. The arrangement lacks risk distribution because the risk is not spread among various subsidiaries and any loss by the parent is not subject to the premiums of any other entity. Although insurance premiums may be deductible under the federal income tax code, amounts placed in reserve as self-insurance are not. The ALJ did not consider parent's equal protection argument and it rejected parent's estoppel and detrimental reliance arguments. Finally, parent is not subject to penalty because the parent acted reasonably and in good faith when it relied on the treatment of the payments as premiums for purposes of Article 33 of the Tax Law and the Insurance Law. In re Stewart's Shops Corp., No. 825745 (N.Y. Div. Tax App. March 10, 2016). Tennessee: The Tennessee Supreme Court (Court) recently issued its much anticipated ruling in Vodafone upholding the imposition by the Tennessee Commissioner of Revenue (Commissioner) of a variance requiring a multistate mobile telecommunications company to use an alternative apportionment method to source its sales receipts for services to Tennessee customers in order to more accurately reflect its business activity in the state. The Court further held the Commissioner's variance, which uses the primary-place-of-use (PPU), or market sourcing method, instead of the statutory costs of performance method (COP), is not an abuse of discretion as it is within the range of acceptable alternatives available to the Commissioner. Vodafone Americas Holdings, Inc. & Subsidiaries v. Roberts, No. M2013-00947-SC-R11-CV (Tenn. S. Ct. March 23, 2016). A tax alert on this development is forthcoming. Alabama: A music retailer's receipts from maintenance contracts associated with lease-to-own agreements, if taxable at all, would be subject to lease tax rather than the sales tax. Further, because the final assessment was entered for the wrong tax type, the Alabama Tax Tribunal held that it must be voided. Hallman Enterprises, LLC v. Ala. Dept. of Rev., No. S. 15-1210 (Ala. Tax Trib. March 16, 2016). Arkansas: Surgical mesh implants used for soft tissue repair qualify for Arkansas' sales and use tax exemption for durable medical equipment and prosthetics, because they are prosthetics intended to be purchased on behalf of patients pursuant to a prescription/chart order written before sale. The Arkansas Revenue Legal Counsel (Counsel) noted in its opinion that the products are regulated by the Federal Food and Drug Administration (FDA) as "human tissue for implantation," are used to repair or replace damaged or integumental tissue, and are intended for use in one patient on a single occasion. However, to demonstrate entitlement to the sales tax exemption, the Counsel requested that the taxpayer keep a spreadsheet with the following information: (1) invoice date; (2) hospital/medical provider name; (3) invoice number; (4) description of the item (matching the item description on the invoice); (5) item price, state and local taxes paid; (6) service date; (7) patient name; (8) doctor name; and (9) patient ID. Note: the Counsel's ruling is binding on the Arkansas Department of Revenue and Administration for three years from the date of issuance. Ark. Dept. of Fin. and Admin., Rev. Legal Counsel Opinion No. 20160109 (March 11, 2016). Louisiana: New law (HB 43) caps the amount of vendor's compensation at $1,500 per month for a dealer operating one or more business locations in Louisiana. Dealers with multiple locations in the state will still be limited to $1,500 in the aggregate. Additionally, the Act prohibits the "Clean Penny" from being considered in the calculation of vendor's compensation. This Act applies to all transactions occurring on or after April 1, 2016. La. Laws 2016 (1st Special Session), Act 15 (HB 43), signed by the governor on March 10, 2016. For more on this development, see Tax Alert 2016-562. Louisiana: New law (HB 30) expands Louisiana's definition of "dealer" to include remote sellers. Effective for all tax periods beginning on and after April 1, 2016, the following activities now qualify a seller as a dealer in Louisiana: (1) soliciting business in the state through agreements with residents paying commissions, referral fees or other consideration in return for referring customers to the business and when the gross receipts generated from such business exceed $50,000 during the preceding 12 months (note: this provision can be rebutted); (2) selling the same or a substantially similar line of products under the same or a substantially similar name, using the same trademarks, or trade names that are similar to those used by a Louisiana retailer; (3) soliciting business and developing and maintaining a market in Louisiana through an agent, salesman, independent contractor, solicitor, or other representative under an agreement with a Louisiana resident or business (referred to as an "Affiliated Agent"), under which the Affiliated Agent is paid a commission, referral fee, or other consideration and engages in activities in Louisiana for the benefit of the person's development and maintenance of the market, such as referring potential customers, either directly or indirectly, whether by link on an internet website or otherwise. The law also creates a presumption that these provisions apply to any person holding a substantial ownership (defined as an interest greater than 5%, whether held directly or indirectly) through a subsidiary, in a retailer that maintains sales locations in Louisiana. La. Laws 2016 (1st Special Session), Act 22 (HB 30), signed by the governor on March 14, 2016. For more on this development, see Tax Alert 2016-562. Louisiana: New law (HB 62), which is effective beginning April 1, 2016, levies an additional 1% sales tax (i.e., Clean Penny) on certain purchases of tangible personal property or services in Louisiana. For a transaction that is not covered by any exemptions, this is expected to raise the state sales/use tax rate from 4% to 5%, exclusive of any additional local sales tax. Act 26 enumerates 65 specific exemptions from this new 1% tax, leaving many purchases subject to the tax that were traditionally exempt from the existing 4% Louisiana state sales and use tax. Some notable exemptions include sale for resale, purchases of property for lease or rental, isolated or casual sales of tangible personal property, installation charges, and several agricultural exemptions. Sales of manufacturing machinery and equipment (MM&E) will be subject to the 1% tax from April 1, 2016 through June 30, 2016, but are exempt from this levy beginning on July 1, 2016. Some purchases that have historically been exempt from Louisiana sales tax but are subject to the additional 1% tax include receipts from business utilities, the sale of medical devices, custom software, pollution control equipment and automobiles and certain freight charges. Because this additional 1% tax is levied separately from the existing sales tax, and the allowable exemptions are specifically listed, the determination of taxability will vary widely based on the specific facts and circumstances of each transaction. Finally, the "Clean Penny" extra sales tax is set to expire on June 30, 2018. La. Laws 2016 (1st Special Session), Act 26 (HB 62), signed by the governor on March 14, 2016. See also, La. Dept. of Rev., RIB 16-013 (March 24, 2016) and Acts 25 and 26 - Taxable Rate of Transactions for Exemptions and Exclusions (last accessed on March 29, 2016). For more on this development, see Tax Alert 2016-562. Louisiana: New law (HB 61) eliminates many exemptions and exclusions from the entire 4% Louisiana state sales tax during the period from April 1, 2016 through July 1, 2016, then eliminates them from only 2% of that tax from July 2, 2016 through July 1, 2018, in effect restoring them in full after July 1, 2018. This is accomplished by specifically enumerating a set of exemptions that will be the only exemptions from the general Louisiana state sales tax allowed during these periods. In addition to the 1% of additional tax added under the "Clean Penny", it is important to understand that Louisiana imposes its existing 4% state sales tax in three separate statutes, and the new list of exemptions, although largely similar across these statutes, is not always the same or perfectly synchronized. As a result, some transactions may only be subject to particular tax levies at particular times, and thus, the resulting total state tax rate can vary widely depending upon a particular transaction and when it occurred. Some notable transactions that remain exempted from all state sales tax include sale for resale, further processing, and several agricultural exemptions. Purchase, use and lease of manufacturing machinery and equipment (MM&E) remains exempt from 3% of the existing sales and use tax, but will be subject to 1% of the tax from April 1, 2016 through June 30, 2018, in addition to the "Clean Penny" described above. This means that, in total, purchases of MM&E should be subject to a 2% state sales and use tax from April 1, 2016 to June 30, 2016 and a 1% state sales and use tax for the period from July 1, 2016 to June 30, 2018. Numerous traditionally exempt purchases will now be subject to the full 4% sales tax until July 1, 2016, and subsequently to 2% of the existing sales tax until July 1, 2018. Some examples include business utilities, medical devices, purchases of property other than automobiles for the purposes of leasing, isolated or occasional sales, sales for first use offshore, pollution control equipment, custom software, freight charges, and installation charges. In many cases, these same types of purchases also will be subject to the "Clean Penny." La. Laws 2016 (1st Special Session), Act 25 (HB 61), signed by the governor on March 14, 2016. See also, La. Dept. of Rev., RIB 16-012 (March 23, 2016), and Acts 25 and 26 - Taxable Rate of Transactions for Exemptions and Exclusions (last accessed on March 29, 2016). For more on this development, see Tax Alert 2016-562. New York: The New York Department of Taxation and Finance (Department) issued a bulletin explaining how sales tax applies to repairs, maintenance, and installation services to real property by contractors and subcontractors, how contractors' purchases are taxed, how to bill customers, and the appropriate use of exemption certificates. Contractors and subcontractors must pay sales tax on all building materials and other tangible personal property they purchase, but if the materials are later transferred to a customer when performing taxable repair, maintenance, or installation services, the contractor or subcontractor may be able to take a credit for the sales tax previously paid. All charges by a contractor or subcontractor for materials and labor that are billed to customers for any repair, maintenance, or installation project, including any expenses or other markups, are taxable. Contractors and subcontractors do not have to collect sales tax from customers who are eligible for a sales tax exemption, as long as the customer provides a properly completed exemption certificate or other appropriate documentation. Finally, purchases for resale can occur between general contractors and subcontractors, or between two subcontractors, and the party hiring the subcontractor to perform taxable work as work as part of a project can use Form ST-120.1 to purchase the subcontractor's services for resale, and the hiring party collects sales tax on its total charge to the customer. N.Y. Dept. of Taxn. and Fin., TB-ST-129 (March 17, 2016). New York: The sale of internet-based document transfer subscription plans is not subject to New York's sales and use tax because the taxpayer is providing a nontaxable bridging service when it gives its customers the means by which to transfer files to a recipient through its web portal, without providing the customers with the telecommunications connections to the internet site. The New York Department of Taxation and Finance also advised that the additional functionality allowing customers to specify levels of access for each recipient, providing access to a digital dropbox, and allowing customers' administrators to control certain aspects of authorized employees' use of the file-sharing service, are ancillary to the main function of the plans, which is providing a bridging service that allows a customer to transfer large files to recipients over the internet. Therefore, this additional functionality does not change the nontaxable nature of the paid plans. N.Y. Dept. of Taxn. and Fin., TSB-A-16(6)S (Feb. 25, 2016). North Carolina: The North Carolina Department of Revenue (Department) updated its taxability matrix, changing the taxability for optional computer software maintenance contracts with respect to prewritten computer software that only provide support services to the software to 100% taxable. The Department noted that optional computer software maintenance contracts with respect to prewritten computer software that only provide support services meet the definition of "repair, maintenance, and installation services" that is fully taxable, unless the seller can demonstrate, using a reasonable method at the time of sale, the portion of the contract that is for nontaxable or exempt products. The change is effective March 1, 2016. N.C. Dept. of Rev., Important Notice: Taxability Matrix Changes Regarding Software Support Services (March 16, 2016). Federal: In a significantly redacted Legal Advice Memorandum (GLAM 20161101F) from an Associate Area Counsel (LB&I) to IRS Examination, Counsel reviewed the facts and circumstances surrounding the investment provisions of a Section 45 refined coal tax credit partnership and determined that Taxpayer is not a bona fide partner in the partnership because the investment does not provide it with either a "significant downside risk" or a "significant upside potential." On that basis, Counsel concluded that Taxpayer is not entitled to an allocation of the partnership's Section 45 refined coal tax credits. For additional information on this development, see Tax Alert 2016-547. Kentucky: New law (HB 237) clarifies that certain qualified data centers constitute manufacturing establishments and, therefore, may qualify for the local property tax exemption for up to five years, as an inducement to locate within the city or urban-county government limits. For purpose of this exemption, a "data center" means a structure or portion of a structure that is predominantly used to house and continuously operate computer servers and associated telecommunications, electronic data processing or storage, or other similar components. To qualify for the exemption, the data center owner must establish that the data center has an overall tier rating of three or four in a given taxable year, according to the TIA-942 Telecommunications Infrastructure Standard for Data Centers. The amendments only apply to new manufacturing establishments that locate in an applicable city or urban-county on or after the Act's effective date, which is 90 days after the legislature adjourns. Ky. Laws 2016, Acts Ch. 3 (HB 237), signed by the governor on March 14, 2016. South Dakota: New law (SB 52) establishes procedures for reporting federal tax changes for purposes of the bank franchise tax. If a taxpayer has a change or correction to its net income due to an audit or adjustment by the federal government, that increases or decreases the taxpayer's taxable income in South Dakota, must report the change or correction to the state. The report is in the form of a supplementary return and must be filed within 120 days of the final adjustment by the federal government. A penalty may be imposed for failure to timely report the change resulting from the federal adjustment. These changes apply to returns related to tax years ending in 2015 or thereafter and filed after Dec. 31, 2015. S.D. Laws 2016, SB 52, signed by the governor on March 7, 2016. Washington: The retroactive application of the Washington legislature's amendment to a business and occupation (B&O) tax exemption to narrow its scope does not violate a taxpayer's rights under due process, collateral estoppel, or separation of powers principles. In reaching its conclusion, the Washington Supreme Court (Court) cited the U.S. Supreme Court's Carlton rational basis standard — i.e., the statute must be supported by a legitimate legislative purpose furthered by rational means. The Court found that the 2010 amendment served a legitimate legislative purpose because the legislature identified the prevention of "large and devastating revenue losses" as the primary purpose for narrowing the statute's scope, and found that the legislature concluded that the former statute provided preferential tax treatment for out-of-state businesses over their in-state competitors and created a strong incentive for in-state businesses to move their operations outside Washington. The Court also found no evidence that the legislature had an "improper motive" of targeting the taxpayer, but rather it was "only the normal interplay between the legislature and the judiciary." Further, the Court found the 2010 amendment is rationally related to the legitimate legislative purpose because the actual retroactive effect of the amendment as applied to the taxpayer is rationally related to the legislature's legitimate, stated purpose to prevent the loss of revenues resulting from the exemption's expanded interpretation. The Court further held that collateral estoppel does not apply here to subsequent taxing periods that were not previously adjudicated. The Court, citing Hambleton, noted that "this reflects the well-established principle that an 'intervening change in the applicable legal context' — such as the retroactive amendment in this case — prohibits the application of collateral estoppel." Finally, retroactive application of the amendment does not run afoul of the separation of powers doctrine because the taxpayer cannot point to any evidence that the legislature intended to affect or curtail the judgment in a related case. Dot Foods, Inc. v. Wash. Dept. of Rev., No. 92398-1 (Wash. S. Ct. March 17, 2016). New York: On Jan. 13, 2016, New York State (NYS) Governor, Andrew Cuomo, introduced revenue legislation as part of his FY 2016-17 budget (hereinafter, Budget Bill) proposing technical amendments to New York State and New York City corporate tax reform as previously enacted in 2014 and 2015 as well as other substantive changes to those tax laws. On March 12, 2016, the NYS Senate and Assembly introduced their own separate versions of revenue legislation (S.6409-B and A9009-B) proposing technical amendments to Tax Reform and other substantive changes to the Budget Bill. Tax Alert 2016-563 contains a chart comparing the proposed technical amendments to Tax Reform and other substantive changes among the Budget Bill, the Senate and the Assembly bills, and showing whether a similar amendment was proposed in the New York City Administrative Code. Ultimately, the final budget bill must be approved by the Senate, the Assembly and the Governor. It is expected that a final budget bill will be presented to the Governor for signature on or around March 31, 2016. We will be monitoring Budget Bill developments closely given the potential quarter-end timing for calendar-year taxpayers. * 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: 2016-0609 |
