20 May 2016 State and Local Tax Weekly for May 13 Ernst & Young's State and Local Tax Weekly newsletter for May 13 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. Ohio Supreme Court issues ruling in Corrigan, holds tax on nonresident's capital gain from sale of ownership interest in an in-state LLC violates due process The Ohio Supreme Court (Court) recently issued its unanimous decision in Corrigan v. Testa, holding that the application of R.C. 5747.212 to impose Ohio personal income tax on a nonresident's capital gain from his sale of ownership interests in a limited liability company that was doing business in Ohio violated the Due Process Clause. In reaching this conclusion, the Court reversed a decision by the Ohio Board of Tax Appeals (Board) upholding the application of the statute and remanded the matter to the Ohio Tax Commissioner to grant a refund to the taxpayer. The decision is significant in that it is one of very few state court decisions to address the state personal income tax treatment of gain on the sale of equity interests in a pass-through entity (e.g., partnership, LLC). The decision seems to uphold the view that pass-through entity equity interests should be treated as the sale of intangible property whose gain is generally sourced to and, in the case of a sale by an individual, is subject only to tax in the state of residence of the seller and not as gain from the sale of the underlying assets of the pass-through entity. The Court's decision seems to indicate that unitary principles should apply when determining whether to apportion income. Taxpayers who have applied R.C. 5747.212 in past years should consider filing amended returns and refund claims with Ohio. Ohio has a four-year statute of limitations, with extended 2011 returns still open until Oct. 15, 2016. This also marks the second opinion in the past year when the Court has struck down under the Due Process clause a taxing statute (the other being the City of Cleveland's apportionment ordinance as applied to NFL football players in Hillenmeyer). While the courts have frequently looked to the Commerce Clause to address state tax matters, the Court's willingness to address taxpayer Due Process claims is an interesting development to continue to follow. This decision also calls into question whether other states may tax a nonresident on gain from the sale of an interest in a flow-through entity that owns underlying assets in the putative taxing state. Finally, the decision could open the door for courts to address the taxability of interests in flow-through entities in which state partnership or LLC law applies the entity, as opposed to the aggregate, theory of partnerships. For additional information on this development, see Tax Alert 2016-859. Bill proposed to eliminate VAT in Puerto Rico while Puerto Rico's Treasury Department continues to issue VAT guidance On April 29, 2016, a bill was presented in the Puerto Rico legislative assembly to eliminate the value added tax (VAT) that is scheduled to be implemented on June 1, 2016 (Replacement Bill). Thereafter, on May 2nd and May 5th, the Puerto Rico House of Representatives and Senate voted in favor of the Replacement Bill. The vote in favor of eliminating the VAT was unanimous in both legislative chambers. This sort of bipartisan collaboration is not common and could indicate growing opposition to the VAT's implementation within the government. The next step following the approval of the Replacement Bill is the approval or veto by the Governor of the Commonwealth. According to public statements made by the Governor, he does not agree with repealing the VAT. Should the Governor proceed to veto the Replacement Bill, the Constitution of Puerto Rico provides for an override mechanism if two thirds of the members of both chambers vote in favor of a bill. Leadership in Puerto Rico's House and Senate have expressed that such an override is a possibility if the Governor vetoes the Replacement Bill. The unanimous vote by the legislative assembly to repeal the VAT in Puerto Rico reflects a high degree of uncertainty for the VAT in the weeks before its implementation. Nonetheless, the VAT is still part of the statutory mandate under the PR Code until the VAT legislation is modified or repealed. At about the same time the legislative assembly was approving the Replacement Bill, Puerto Rico's Treasury Department issued VAT returns, a second draft of the proposed VAT regulations and guidance on the small-merchant certificate and eligible-merchant certificate. For additional information on this development, including detailed information on the guidance issued by the PRTD, see Tax Alert 2016-829. Colorado: A multistate company is challenging the determination of the Colorado Department of Revenue (Department) that it was not allowed make an election to use the Multistate Tax Compact's equally weighted three-factor apportionment formula instead of the state mandated single sales factor apportionment formula, for the tax year ending Dec. 31, 2009. The Sherwin-Williams Co. v. Colorado Dept. of Rev., Case No. 2016CV31072 (Colo. Dist. Ct., Denver Cnty., filed March 25, 2016). Michigan: In reversing a ruling by the Michigan Court of Claims (COC), the Michigan Court of Appeals (COA) held that a group of three entities — two corporations and a limited partnership — were not a "unitary business group" as defined in MCL 208.1117(6) because no one member of the group owns, through an intermediary or otherwise, more than 50% of any other entity. In reaching this conclusion, the COA held that the Michigan Department of Treasury (Department) in using a federal income tax law definition of "constructive" ownership when defining Michigan's "indirectly" ownership requirement improperly broadened its interpretation of "unitary business group" beyond the scope intended by the Legislature. Subsequent to this decision, the Department issued a notice to taxpayers indicating that it is evaluating the decision and next steps impacted taxpayers should take. Further, the COA has issued a stay on the enforcement of its decision until the Department exhausts its appeal rights. For additional information on this development, see Tax Alert 2016-867. Texas: A convenience store chain (store) and a fuel distributor failed to establish that they were entitled to franchise tax deductions for cost of goods sold (COGS) for their allocations of direct labor costs and warehouse expenses, respectively, beyond what auditors already permitted. The Texas Comptroller of Public Accounts found the store's spreadsheet presentation of direct labor costs was irreconcilable with percentages claimed on the store's franchise tax returns. Without witness testimony regarding the methods used to calculate the percentage of time spent stocking or the source of calculations, the evidence was mere assertions on the store's pleadings and was insufficient to substantiate its claims. In addition, the fuel distributor offered only a spreadsheet for each report period listing the original revenue for each period and the requested deductions. Tex. Comp. of Pub. Accts., No. 201601764H (Jan. 21, 2016). Georgia: New law (HB 937) extends the sunset date of the sales and use tax exemption for sales of tangible personal property used for and in the construction of a competitive project of regional significance to June 30, 2019 (from June 30, 2016). Provisions of HB 937 also extend the sunset date for Georgia's excise tax on rental car charges to Dec. 31, 2047 (from Dec. 31, 2038). Ga. Laws 2016, Act 596 (HB 937), signed by the governor on May 3, 2016. Louisiana: In reversing a lower court ruling, the Louisiana Supreme Court (Court) held that the limestone purchases of a power plant operator (operator) are excluded from sales and use tax under the "further processing exclusion" because the use of limestone in power generation creates ash as a by-product that is sold at retail. In reaching this conclusion, the Court first determined that ash is the appropriate end product to analyze for purposes of the operator's limestone purchases (as opposed to electricity), finding that the lower courts erred in narrowing the analysis solely to the end product of electricity. In doing so, the lower courts interjected a "primary product" test or "business purpose" test not rooted in any statutory, regulatory or jurisprudential authority. Moreover, International Paper expressly rejected a "primary purpose" test, favoring instead a dual-purpose or multi-purpose test, so long as one of those purposes was "inclusion in the end product." The Court then applied International Paper's three-part test in determining the "further processing exclusion's" applicability to raw material, finding that under the third prong of the test (the first two prongs were stipulated to having been met) the limestone raw materials are materials for further processing and, therefore, are purchased with the purpose of inclusion in the end products. This is evidenced by the operator's choice of manufacturing process and technology, its contractual language utilized in its purchasing of the limestone, and its subsequent marketing and sale of the ash. Lastly, the Court noted that it will continue to adhere to the exclusive three-prong test set forth by the courts until the legislature chooses to narrow the "further processing exclusion" by way of requiring a profit or writing into law a new test that embodies a "primary product" or "primary purpose" factor. Bridges v. Nelson Industrial Steam Co., No. 2015-C-1439 (La. S. Ct. May 3, 2016). Missouri: A doughnut company is not entitled to apply the lower 1% sales tax rate "on all retail sales of food" to its sales of food items sold in its stores (e.g., donuts, non-hot beverages, juices, milk, coffee beans and ground coffee) because it failed to prove that not more than 80% of its gross receipts were derived from the sale of food products for immediate consumption on or off the establishment's premises. In reaching this conclusion, the Missouri Supreme Court (Court) explained that the lower, 1% sales tax rate generally applies to food purchased from grocery stores while food purchased from restaurants generally would be taxed at the higher, 4% rate. Thus, the pertinent question in determining whether an establishment's food should count toward the 80% threshold is whether the food is akin to the food primarily sold by restaurants, fast food restaurants, delicatessens, eating houses, and cafes. The Court determined that the company's doughnuts are regularly consumed immediately by its customers and, as such, are akin to food sold by restaurants and count toward the 80% statutory threshold. If a food qualifies as a "food prepared … for immediate consumption," all sales of that food count toward the 80% threshold regardless of whether a particular customer actually consumes the food immediately, and Krispy Kreme I's emphasis on actual consumption should not be read to authorize otherwise. Further, the Court noted that whether a food meets the criteria often would be readily apparent by the surrounding circumstances indicating the general nature of the food, with actual or survey evidence and customer consumption optional. Since the company operates more like a restaurant than a grocery store, its sales are intended to be taxed at the higher rate and, therefore, the company is not entitled to a refund of sales tax based on use of the lower sales tax rate. Krispy Kreme Doughnut Corp. v. Mo. Dept. of Rev., No. SC95181 (Mo. S. Ct. May 3, 2016). Virginia: A fast food restaurant chain's sales of food and meals from its general and catering menus are sales of tangible personal property, not sales of services and, therefore, are subject to sales tax unless the purchaser has a valid exemption certificate. Any services provided in connection with taxable sales of food or meals are taxable as services in connection with the sale of tangible personal property, but separately stated delivery or transportation charges are exempt. In addition, in this ruling, the Virginia Department of Taxation outlined the sales tax treatment of specific sales transactions with public school systems and nonprofit schools, and stated as a policy clarification that it will evaluate exemptions from sales and use tax based on whether the entity claiming the exemption meets the use or consumption requirement of its respective exemption statute. This requires that the government or non-profit entity claiming the exemption establishes that the furnishing to individuals of meals or food, including catered meals, is an official function, mission, service or purpose of the government or nonprofit entity. Va. Dept. of Taxn., Commissioner. Ruling PD No. 16-64 (April 22, 2016); see also Va. Dept. of Taxn., Tax Bulletin 16-3 (May 2, 2016)(Department guidance on its change in policy regarding meals and catering purchased by nonprofit organizations, churches and governmental entities - the change in policy took effect April 22, 2016). Federal: In Notice 2016-31 the IRS updated guidance relating to the renewable electricity production tax credit under Section 45 and the energy investment tax credit under Section 48 to reflect the extension and modification of these credits by the Consolidated Appropriations Act of 2016. For additional information on this development, see Tax Alert 2016-848. Georgia: New law (HB 922) amends Georgia's tax credit for creating quality jobs to add a definition of "taxpayer." For purposes of this credit, "taxpayer" means any person required by law to file a return or to pay taxes, except that any taxpayer may elect to consider the jobs within its disregarded entities, as defined by the IRC, for purposes of calculating the number of new quality jobs created by the taxpayer for purposes of the credit. The law took effect on May 3, 2016, and applies to all taxable years beginning on or after Jan. 1, 2016. Ga. Laws 2016, Act 619 (HB 922), signed by the governor on May 3, 2016. Georgia: New law (HB 936) clarifies the wages necessary to qualify for a jobs tax credit, requiring the wage of each new job created to be above the average wage of the county that has the lowest average wages of any county in the state, as reported in the most recently available annual issue of the Georgia Employment and Wages Averages Report of the Department of Labor. For tax credits for business enterprises in less developed areas, HB 936 clarifies that a "new full-time employee job" means a newly created position of employment that was not previously located in Georgia, requires a minimum of 35 hours per week, and pays at or above the average wage earned in the county with the lowest average wage earned in Georgia. Finally, HB 936 creates an income tax credit for employers that hire certain qualified parolees for full-time jobs, effective for taxable years beginning on or after Jan. 1, 2017 and before Jan. 1, 2020. An employer that employs a qualified parolee in a full-time job for at least 40 weeks during a 12-month period is eligible for an income tax credit of $2,500 for each qualified parolee so employed against income tax during that 12-month period. A qualified parolee first employed in a full-time job by the employer before Jan. 1, 2017 does not qualify for the credit. An employer is eligible for up to $50,000 per year in tax credits, and employers can only receive the credit once per individual. The credit provided cannot exceed the employer's income tax liability, and any unused portion of the credit can be carried forward for up to three years. The credit cannot be applied against the employer's prior years' tax liabilities. These changes take effect July 1, 2016, unless otherwise noted. Ga. Laws 2016, Act 480 (HB 936), signed by the governor on April 27, 2016. Georgia: New law (HB 935) adds certain fulfillment centers to properties eligible for a freeport exemption from ad valorem tax. Eligible property includes stock in trade of a fulfillment center which, on January 1, are stored in a fulfillment center and which are made available to remote purchasers that may make such purchases by electronic, internet, telephonic, or other remote means, and where such stock in trade of a fulfillment center will be shipped from the fulfillment center and delivered to the purchaser at another location. The exemption is good for a period not exceeding 12 months from the date the property is stored in Georgia. This period is determined based on application of a first-in, first-out method of accounting for the inventory. The official books and records of the fulfillment center where the property is being stored must contain a full, true, and accurate inventory of all such property, including the date of the receipt of the property and the date of the withdrawal of the property. Provisions of HB 935 also amend requirements for the application for the level one freeport exemption to include a schedule of the stock in trade of a fulfillment center which on January 1 are stored in the fulfillment center. These changes are effective July 1, 2016. Ga. Laws 2016, Act 539 (HB 935), signed by the governor on May 3, 2016. Michigan: New laws (HB 5525, HB 5526, HB 5527 and HB 5545) amend provisions related to administration of personal property tax exemptions for eligible manufacturing personal property, and provide for the imposition of an Essential Services Assessment. Amending the General Property Tax Act, HB 5526: extends (for 2016 only) the deadline to file the required form 5278 to May 31, 2016 (previously, Feb. 22, 2016); makes leasing companies ineligible for the exemption; requires new and previously existing property tax exemptions to be claimed via filing a combined document that includes the form to claim the exemption, a fair market value report with year of acquisition by the first owner, and (for any year before 2023) a statement from the owner of personal property of all their personal property, whether owned or held for the use of another; clarifies that utility personal property and personal property used in the generation, transmission, or distribution of electricity for sale are not eligible manufacturing personal property and cannot be used to determine whether personal property located on occupied real property is predominantly used in industrial processing or direct integrated support; and requires the State Tax Commission (STC) (previously, the Michigan Department of Treasury (Department) to perform certain administrative duties, among other changes. Amending Public Act 198 of 1973, HB 5527 requires a holder of an industrial facilities exemption certificate that has been extended to file a combined document for eligible manufacturing personal property purposes, instead of an affidavit, for purposes of showing the portion of a facility that is eligible manufacturing personal property. HB 5525 amends the State Essential Services Assessment Act, and makes leasing companies ineligible for an exemption and cannot use the combined document; makes changes to the combined document similar to HB 5526; requires the Michigan Tax Tribunal to hear appeals rather than the STC; and requires the STC (rather than the Department) to perform certain administrative duties. Finally, HB 5545 amends the Alternative State Essential Services Act to make changes similar to HB 5525. Mich. Laws 2016, PA 107 (HB 5525), PA 108 (HB 5526), PA 110 (HB 5527), and PA 109 (HB 5545), all signed by the governor on May 5, 2016. Oregon: The Oregon Tax Court (Court) could not determine whether a limited liability company (LLC) that is partially owned by a public benefit corporation is entitled to a property tax exemption because it is unclear whether the public benefit corporation is a "nonprofit corporation" under the applicable statute. For Oregon property tax purposes, an LLC that is wholly owned by one or more nonprofit corporations qualifies for an exemption or special assessment if and to the extent that all of the nonprofit corporation owners of the LLC would qualify for an exemption or special assessment. The Court agreed with the Oregon Department of Revenue (Department) that the phrase "nonprofit corporation" is a term of art rather than a term of general usage as it has a well-established legal meaning, and is defined by Black's Law Dictionary as "a corporation organized for some purpose other than making a profit, and usually afforded special tax treatment … " While the phrase "nonprofit corporation" does not clearly exclude a public corporation such as the public benefit corporation, the Court reasoned that the phrase must be read in concert with the applicable exemption and special assessment statutes. Thus, each of the LLC's nonprofit corporation owners must meet the organizational requirements of a statute allowing a property tax exemption. Here, the parties could not agree whether the public benefit corporation is organized and operated under IRC §501(c). Life Flight Network LLC v. Deschutes Cty. Assessor and Oregon Dept. of Rev.,No. TC-MD 150396N (Or. Tax Ct., Magistrate Div., May 6, 2016). Tennessee: A non-profit educational, research and healthcare institution's (institution) personal and real property that it owns and uses in its health care operation (e.g., office furniture and equipment, furnishing specific to the medial field, medical equipment, certain real estate it owns that houses clinics) qualifies for the non-profit educational and research institution property tax exemption because the properties are an integral part of the institution's educational and research missions. In reaching this conclusion, the Tennessee State Board of Equalization (SBE) rejected all of the arguments submitted by two county assessors, finding that the Tennessee General Assembly has not included any restriction on exempt status based on the size of an institution's operation, the value of the property at issue, or its geographical location. Moreover, the Legislature has not placed any limitation on exempt status due to competition with for-profit business. In addition, the SBE rejected the county assessors assertion that the institution's medical functions are operated for economic gain, finding the assertion is not supported by any evidentiary proof and is inconsistent with the institution's designation as a 501(c)(3) entity by the federal government. Finally, the SBE rejected the county assessor's argument that the operations are in excess of what is necessary to support the institution's academic programs and scientific research, finding this issue is not within the common knowledge of laypeople and expert proof would be required to carry the burden of proof. In re Vanderbilt University, Nos. 64888, 12809, 58201, 54496, 57447, 58610, 59013 and 56083 (Tenn. St. Bd. Equal. May 4, 2016). New Hampshire: New law (HB 1290) amends the due dates for corporate and partnership returns. Effective for taxable periods beginning after Dec. 31, 2015, entities subject to the business profits tax and/or the business enterprise tax are requires to file partnership tax returns on or before the 15th day of the third month, while all other business organizations/business enterprises are required to file their tax return on or before the 15th day of the fourth month. Under prior law, corporate tax returns were due by the 15th day of the third month. NH Laws 2016, Ch. 66 (HB 1290), enacted on May 5, 2016. Michigan: The Michigan Department of Treasury (Department) recently issued an internal policy directive (Directive) explaining a taxpayer's right to an extension of time to file an appeal when the taxpayer's representative was or is not provided a copy of a letter or notice pursuant to Mich. Comp. Laws Ann. §205.8. According to the Directive, if the Department failed to provide the taxpayer's representative with a copy of a letter regarding the specific dispute and the affected taxpayer filed a valid written request with the Department indicating that copies of all letters and notices related to a dispute be sent to the taxpayer's representative, that taxpayer may be entitled to an extension of time to appeal the related issue. To determine if a taxpayer is entitled to an extension of time to appeal, the Directive states that one of the following types of documentary evidence must be on file with the Department or, if not on file, the taxpayer must demonstrate that it filed the documentary evidence with the Department: (1) a current Form 151 (Rev. 11-15, or a later version) — Authorized Representative Declaration (Power of Attorney) with Parts 1, 3, and 5 properly completed; or (2) a clear, written request in another format (such as a letter) that copies of all letters and notices regarding a specific dispute be sent to the taxpayer's named representative at an address specified in the written request. The Directive also discusses the actions a taxpayer should take to obtain the extension of time to file an appeal, the actions the Department will take in response to the taxpayer's request, and when the extended appeal period will commence. It also states in a footnote that if the appeal rights were denied by the Michigan Court of Claims or the Tax Tribunal after addressing the merits of any notice issues, the taxpayer is not entitled to relief under the Directive. For additional information on this development, see Tax Alert 2016-868. Nevada: The Nevada Supreme Court (Court) ruled that a coalition challenging a referendum petition that would ask voters to approve or disapprove of the commerce tax provisions contained in SB 483 (Nev. Laws 2015), failed to demonstrate that the referendum petition is invalid. Although the Court found the referendum valid as written, it found its description of effect is not. When reviewing a "description of effect" the Court determines whether its description identifies the petition's purpose and how that purpose is to be achieved in a manner that is "straightforward, succinct, and nonargumentative," and not deceptive or misleading. The referendum's description of effect describes the tax, but fails to mention that disapproval of the commerce tax will result in a significant revenue loss and unbalance the budgets for fiscal years 2015/16 and 2016/17. The Court remanded the case to the district court with an order that it clarify the description of effect by taking into account the material consequences of the referendum, including that disapproval will unbalance the budget. Coalition for Nevada's Future v. RIP Commerce Tax, No. 69501 (Nev. S. Ct. May 11, 2016). Ohio: On May 3, 2016, the Ohio Supreme Court (Court) heard oral arguments in three consolidated tax cases challenging the constitutionality of the bright-line factor presence nexus standard under the Ohio Commercial Activity Tax (CAT) — Crutchfield, Newegg and Mason Companies. The companies are unrelated on-line retailers that conduct all of their operations outside of Ohio with no physical presence in Ohio during the tax periods at issue. Each out-of-state retailer, however, sold more than $500,000 of products to Ohio customers. As a result, the putative taxpayers were assessed CAT for periods going back to the CAT's inception on July 1, 2005, and received final determinations on those assessments that were appealed to the Ohio Board of Tax Appeals (BTA). In early 2015, the BTA affirmed the Tax Commissioner's determinations, holding that each of the out-of-state retailers was subject to the CAT based solely on their having exceeded the statutory $500,000 sales threshold. The out-of-state retailer challenged the assessment, arguing that the CAT's bright-line nexus provision, which imposes the tax based solely on whether a putative taxpayer meets a statutory threshold (in this case the $500,000 gross receipts threshold from sales to Ohio customers), irrespective of whether the putative taxpayer has an in-state presence, is facially unconstitutional in violation of the substantial nexus requirement of the Commerce Clause. Specifically, the issues before the Court are: (1) does Ohio's CAT violate the US Constitution's Commerce Clause by imposing the tax on businesses that have no physical presence in Ohio? (2) is the bright-line presence rule in the state's CAT sufficient to determine if a business has the requisite substantial nexus with the state to be subjected to a "privilege of doing business" type of tax? For more on the arguments, see Tax Alert 2016-847. Federal: On Wednesday, May 25, 2016 from 1:00-2:00 p.m. EDT New York; 10:00-11:00 a.m. PDT Los Angeles, EY will host a webcast to provide an update on WOTC and other federal and state credits. The enactment of the PATH Act resulted in the short-term and long-term extension of several expiring or expired federal income tax credits and incentives. EY's Credits & Incentives practice has introduced a four-part webcast series that will explore and discuss the extensions of these credits and incentives and the opportunities they may create. Our second seminar in this series will address the extension of the WOTC program; from Jan. 1, 2015 through Dec. 31, 2019, as well as the provision that modifies the credit beginning on Jan. 1, 2016, by adding a target group for employers who hire qualified long-term unemployed individuals. Due to this unprecedented extension, employers may want to take a fresh look at this opportunity. Additionally, we will cover legislative updates on other federal and state credits. Topics that will be covered in this webcast include: PATH Act and legislative updates, eligibility categories, tax credit screening process options, leading practices, additional federal and state credit opportunities, and tax implications. 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: 2016-0903 |
