04 October 2016 State and Local Tax Weekly for September 30 Ernst & Young's State and Local Tax Weekly newsletter for September 30 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. California Franchise Tax Board issues guidance on treatment of water's-edge election when a foreign affiliate becomes a taxpayer under bright-line nexus standard The California Franchise Tax Board (FTB) will not seek to terminate the water's-edge election of a water's-edge combined reporting group that is unitary with a foreign affiliate that becomes a taxpayer under the state's doing business statute's bright-line nexus standard (Cal. Rev. and Taxn. Code §23101(b)), which took effect in 2011. Taxpayers required to file a combined report can make an election to file a water's-edge election. To be effective, the water's-edge election must be made by every member of the combined reporting group that is subject to taxation. For tax years beginning before 2011, a unitary foreign affiliate of a water's-edge group was not a taxpayer under the doing business provision and, therefore, could not make the water's edge election. Beginning Jan. 1, 2011, however, a foreign affiliate may become a taxpayer as a result of California's establishment of the bright-line nexus standard. Consequently, if the foreign affiliate's income and apportionment factors would have been properly considered in computing income of the taxpayers making the water's-edge election, the foreign affiliate would have been required to make the election in order for it to be effective. In its notice, the FTB said that it will treat a unitary foreign affiliate in a water's-edge combined reporting group that is affected by the new bright-line nexus rules as follows: — If a unitary foreign affiliate has income derived from or attributable to sources within the US both before and after the beginning of a taxable year in which the affiliate becomes a taxpayer solely due to the bright-line nexus law change, the deemed election provisions will apply. — If a unitary foreign affiliate does not have US income either before or after the beginning of a taxable year in which the unitary foreign affiliate becomes a taxpayer solely due to the bright-line nexus law change, the affiliate would never have been includable in the water's-edge combined report, but the unitary foreign affiliate will be deemed to have made an election as of the taxable year in which it became a taxpayer under the new law. — Finally, if a unitary foreign affiliate does not have US income before, but has US income after, the beginning of a taxable year in which the affiliate becomes a taxpayer solely as a result of the law change, the unitary foreign affiliate will be deemed to have made an election as of the taxable year in which it becomes a taxpayer. The treatment of the foreign affiliate, as described above, is limited to situations in which all of the following conditions apply: — At the time the water's-edge election, a foreign affiliate that was unitary with the electing water's-edge combined reporting group members could not make a water's-edge election because it was not subject to tax in California; — The unitary relationship between the members of the water's-edge combined reporting group and the foreign affiliate remained continuously in effect between the time the valid water's-edge election was made and the time the unitary foreign affiliate became a taxpayer because of the new law; and — The unitary foreign affiliate of the water's-edge combined reporting group became a taxpayer in a taxable year ending on or before Dec. 31, 2016 due solely to the addition of the bright-line nexus provisions, such that, had the foreign affiliate been a taxpayer member of a self-assessed combined reporting group at the time of the water's-edge election of the group, the foreign affiliate would have been required by statute or regulation to make a water's-edge election in order for the water's-edge election to have been valid. If all of these conditions are met, the FTB will not seek to terminate the water's-edge election. Cal. FTB, FTB Notice 2016-02 (Sept. 9, 2016). Federal: The Section 385 final regulations were listed as being under White House Office of Information and Regulatory Affairs (OIRA) review. Accordingly, this means: (1) final regulations are ready for review as far as Treasury/IRS are concerned but still could change; (2) OIRA has up to 90 days to review the regulations but could move more quickly; and (3) OIRA could ask Treasury to reconsider its approach and make changes to the regulations. For more on this development, see Tax Alert 2016-1674. Michigan: The Michigan Court of Appeals (Court) has held that the Michigan Department of Treasury's (Department) interpretation of the renaissance zone business activity factor requiring the taxpayer, an LLC, to remove an undefined number from the formula when the taxpayer did not have payroll in a renaissance zone or in Michigan, was reasonable even though the interpretation differed from its interpretation of an analogous provision under prior law. In reaching this conclusion, the Court found that the Department's interpretation of how to compute the credit does not conflict with the statute's language, and that the Michigan Tax Tribunal lacked cogent reasons to overturn the Department's interpretation. The Court reasoned that the legislature was aware of a method to alter a tax formula's denominator in response to missing factors in the formula's numerator, but it did not do so in this instance. In addition, the statutory language indicates that the legislature wanted to provide a tax benefit to businesses that both own property in a renaissance zone and invest in payroll in the renaissance zone, and it is sensible that if a taxpayer only does half of those things, it would receive half a credit. Andersons Albion Ethanol, LLC v. Mich. Dept. of Treas., No. 327855 (Mich. Ct. App. Sept. 13, 2016). North Carolina: The North Carolina Department of Revenue (Department) published proposed market-based sourcing rules for income from non-tangible property and intangibles, and examples of how the rules apply. The Department will hold a hearing on the proposed rules on October 31, 2016. Florida: A company's sale of subscriptions to customized software that is delivered to clients electronically and is not part of the sale of tangible personal property is not subject to sales and use tax because the sale of customized software is a nontaxable service transaction. Similarly, the company's sale of cloud computing services is not taxable because it is not a service specifically enumerated as subject to sales and use tax. Fla. Dept. of Rev., Technical Assistance Advisement No. 16A-014 (Aug. 8, 2016). Florida: In technical advice, the Florida Department of Revenue (Department) set forth the conditions under which a taxpayer could accept electronic exemption certificates (EECs) (other than for resale certificates and other state issued exemption certificates), provided that the exemption certificate documentation requirements are met. The EEC must contain the purchaser's name, address, the reason for which the use of the property or service qualifies for exemption based on its use, the reason for which the use of the property or service qualifies for exemption based on its use, and the signature of the purchase or an authorized representative of the purchaser — essentially all requirements for "paper" exemption certificates. The selling dealer seeking to accept an EEC must make certain that any electronic sound, symbol, or process that is used to create an electronic signature is made by the purchaser with the intent to sign the certificate, and the selling dealer must establish a procedure to authenticate or prove the identity of the purchaser and/or the authorized purchaser's representative. The selling dealer must make reasonably certain that the individual accessing and electronically signing the EEC is the individual identified on the certificate. The Department must be able to verify, upon request or audit, a dealer's procedures used to ensure the accuracy or integrity of the authentication process, and all procedures must be readily available for inspection and access by the Department. The Department stated, however, that the guidance in this advisement "should not be interpreted to include resale certificates and State-issued exemption certificates." Fla. Dept. of Rev., Technical Assistance Advisement 16A-012 (July 26, 2016). Illinois: Amended regulation (86 Ill. Admin. Code § 150.201) provides that a retailer can rebut the presumption of nexus under Illinois's click-through nexus provisions by maintaining documentation showing that persons with whom it has agreements have not engaged in solicitation activities on its behalf in Illinois that are sufficient to meet Constitutional nexus standards during the preceding four quarterly periods. The retailer must maintain documentation of retailer agreements that prohibit such solicitation activity, and must document the retailer's annual certification by January 1 of each year, under penalty of perjury, that it has not engaged in any prohibited solicitation activities in Illinois at any time during the previous year. The term "solicitation" means a direct or indirect communication to a specific person or persons, including emails or text messages, done in a similar manner that is intended and calculated to incite a person or persons to purchase tangible personal property from a specific retailer or retailers; it does not mean or include advertising. The term "advertisement" is defined by the amended regulation as a written, verbal, pictorial, or graphic announcement of goods or services for sale, employing leased or purchased space or time in print or electronic media, which is intended to communicate that information to the general public. Ill. Dept. of Rev., amended 86 Ill. Admin. Code § 150.201 (effective Sept. 12, 2016). Michigan: Financing companies were ineligible to claim a bad debt deduction for sales tax purposes because they failed to meet the requirements of the bad debt statute. In reaching this conclusion, the Michigan Court of Appeals (Court) found that one of the financing companies failed to make clear elections regarding whether the lender or the retailer would be entitled to claim the refund. In addition, all three financing companies included repossessed property in their claims when repossessed property is specifically excluded under the statute. Finally, they failed to submit proper documentation that the sales tax had been paid in RD-108 forms. Ally Financial, Inc. et al. v. Mich. Dept. of Treas., Nos. 327815, 327832, and 327833 (Mich. App. Ct. Sept. 20, 2016). New Mexico: A company that sells licenses to use software in New Mexico is responsible for collecting and remitting gross receipts tax on all of its sales to customers, including those financed through financing institutions. In reaching this conclusion, the New Mexico Hearing Officer determined that the company failed to prove that the taxes were paid by the financial institutions on its behalf and failed to prove equitable recoupment. Equitable recoupment, which allows a party to use a claim or defense that would otherwise be barred by a statute of limitations when the claim arises from the same transaction, was not established because there was not one single taxable event as required — the first taxable event was the company's sale of the license to the customer, and the second taxable event was the financing institutions' loans to customers. The company and the financing institutions were each responsible for their own gross receipts taxes on those events. In re the Protest of Market Scan Information Systems, Inc., No. 16-44 (NM Admin. Hearings Office Sept. 12, 2016). Ohio: The Ohio Department of Taxation (Department) updated Information Release ST 1999-04 addressing on-line services and internet access to reflect legislative changes enacted in 2016 that added "digital advertising services" to the definition of "personal and professional services" for purposes of the definitions of "automatic data processing," "computer services" and "electronic information services," effective Dec. 1, 2016. The term "digital advertising services" is defined as "providing access, by means of telecommunications equipment, to computer equipment that is used to enter, upload, download, review, manipulate, store, add, or delete data for the purpose of electronically displaying, delivering, placing, or transferring promotional advertisements to potential customers about products or services or about industry or business brands." The Department stated that advertising (digital or otherwise) is not, and has not been, treated as a taxable service; however, transactions may combine digital advertising services with electronic information services, where the electronic information service is a significant component. In these instances, the Department will tax the components of these transactions that represent electronic information services and deem mixed transactions (as described in the information release) to be taxable. Ohio Dept. of Taxn., ST 1999-04 (updated Sept. 2016). Puerto Rico: In early September at the Puerto Rico CPA State Society's Annual Convention, a panel of representatives from the Puerto Rico Treasury Department (PRTD) discussed their plan to launch Puerto Rico's new electronic internal revenue unified system, SURI by its Spanish short name, on Nov. 1, 2016, for sales and use tax (SUT) purposes. The PRTD has announced in previous official guidance that SURI will be the new system that the PRTD will use to administer the tax system and that it will implement SURI in phases. The PRTD commented during the panel that merchants should be expecting official administrative guidance on these plans to be issued soon. For additional information on this development, see Tax Alert 2016-1656. Tennessee: The Tennessee Department of Revenue issued a letter ruling clarifying that fees paid for assembling products, including shipping fees and materials fees, are subject to sales and use tax as part of the sales price when a taxpayer drop ships a product that it fabricates to a customer located inside Tennessee, because taxable sales include charges for fabrication of tangible personal property for consumers who furnish materials used in fabrication work. Tax is not due if the seller provides the taxpayer with a valid resale and/or exemption certificate. In addition, technical support fees are not subject to tax because they are not specifically enumerated as a taxable service in Tennessee. Finally, warranty support fees charged to end-users are subject to sales and use tax as the sale of a warranty or service contract if the fees meet certain statutory criteria, while any associated shipping fees are part of the sale price of the contract, but no tax is due if the seller provides a properly completed resale certificate. Tenn. Dept. of Rev., Letter Ruling No. 16-06 (Aug. 30, 2016). Washington: The Washington Department of Revenue (Department) issued a special notice to explain a retail sales and use tax exemption on new building construction used for airplane repairs and maintenance that is available July 1, 2016 through Jan. 1, 2027. The exemption applies to charges for labor and services used in construction of new buildings, materials used as an ingredient or part during the course of construction, and labor and services used to install building fixtures not otherwise eligible for the manufacturer's machinery and equipment sales and use tax exemption. Qualified parties include an eligible maintenance repair operator that is engaged in the maintenance of airplanes, or a port district, political subdivision, or municipal corporation that enters into an agreement with an eligible maintenance repair operator to build the facility and lease to the operator. The exemption is claimed as a refund (state and local sales tax must be paid when purchasing qualified construction labor and materials), and it can be claimed in two parts — the local portion is available beginning after July 1, 2016, and the state portion may be requested after the aircraft maintenance and repair station has been operationally complete for at least four years but not before Dec. 1, 2021. To qualify for the state portion, the party seeking the refund must have reported more than 100 average employment positions to the Employment Security Department with an average annualized wage of $80,000 for Sept. 1, 2020 through Sept. 1, 2021. Wash. Dept. of Rev., Special Notice: Sales and use tax exemption available for new FAR Part 145 repair stations construction (Sept. 8, 2016). California: New law (AB 1920) permits the California Tax Credit Allocation Committee, in relation to low-income housing credits, to establish a specified schedule of fines for violations of the credit terms and conditions, the regulatory agreement, other agreements, or program regulations. The fines can be established up to $500 per violation or double the amount of the financial gain because of the violation, whichever is greater. Serious violations will be defined by the committee. However, first-time property owner violators will have at least 30 days to correct the violation before a fine is imposed. The committee can record a lien against the property if a fine assessed against a property owner is not paid within six months from the date when the fine was initially assessed by the committee and after reasonable notice has been provided to the property owner. Cal. Laws 2016, Ch. 611 (AB 1920), signed by the governor on Sept. 25, 2016. California: New law (AB 2900) amends the California Competes tax credit oversight provisions. It requires the Governor's Office of Business and Economic Development to post on its website the primary location where a taxpayer has committed to increasing the net number of jobs or make investments, information that identifies each tax credit award that was given priority for being located in an area of high unemployment or poverty, and information that identifies each tax credit award that is being counted toward the amount of the credit required to be allocated to small business. The law is repealed on Dec. 1, 2025. Cal. Laws 2016, Ch. 582 (AB 2900), signed by the governor on Sept. 24, 2016. New Jersey: A city was acting as a regulator, not a market participant, when it enforced an ordinance for tax exemption and abatement requirements for private developers of projects in designated areas and conditioned the tax benefits on the developers' entry into agreements with labor unions that bind the developers to specified labor practices. In reaching this conclusion, the US Court of Appeals for the Third Circuit (Appeals Court) found error in the decision by the US District Court for the District of New Jersey (District Court) when the city's activities failed to meet the two-part Sage's test determining whether a government is a market participant, because under Camps Newfound/Owatonna, a tax exemption is not the sort of direct state involvement in the market that falls within the market participation doctrine. In analyzing Sage's first test, the city does not purchase or otherwise fund the services of private developers or contractors who are constructing tax-abated projects or the goods used in those projects, nor does it sell those services or goods or invest, own, or finance the projects. Instead the city reduces the developers' tax burden for a period of time, which is assessment and computation of taxes — a "primeval government activity" — rather than direct state involvement. Because exemptions do not give a city the proprietary interest in tax-abated projects, the Appeals Court did not consider the second part of the Sage test. In reversing and remanding to the District Court, the Appeals Court did not decide whether the ordinance is in fact preempted by the National Labor Relations Act or the Employee Retirement Income Security Act, or whether it runs afoul of the dormant Commerce Clause, and did not decide whether the City is acting as a market participant for public construction projects — only tax-abated projects. Associate Builders and Contractors, Inc., New Jersey Chapter, et al. v. Jersey City, New Jersey, No. 15-3166 (3d Cir. Sept. 12, 2016). New Jersey: New law (SB 2361) authorizes certain counties to establish a county hospital authority and for a county hospital authority to enter into a contract with a private entity — a public-private partnership agreement — that allows the private entity to assume full financial and administrative responsibility for a project. A project predominantly used in furtherance of the purposes of a county hospital authority, provided that it is owned by or leased to a public entity, non-profit business entity, or a business wholly owned by a non-profit business entity is exempt from property tax and special assessments of the state, municipality, or other political subdivisions and will not be required to make payments in lieu of taxes. The land upon which the project is located also is exempt from property tax. Further, it is not subject to New Jersey laws regarding the tax liabilities of private parties conducting for profit activities on tax exempt land, or New Jersey laws regarding the taxation of leasehold interests in exempt property that are held by nonexempt parties. These changes took immediate effect. NJ Laws 2016, P.L. 2016, ch. 55 (SB 2361), signed by the governor Sept. 21, 2016. Oregon: Neither the properties nor owner of a communication services corporation (corporation) for which primary use of the properties was in the cable television business were subject to central assessment for property tax purposes. In reaching this conclusion, the Oregon Tax Court (Court) found that the legislature's intent under the assessment statute was that central assessment only apply to those who render communication services to others for a fee (as opposed to companies that delivered their own data to customers as part of conducting their own business). In providing cable television, the corporation does not transmit data or content created by the customer or as to which the customer has the right to make a transmission. Even if the corporation receives communications from its customers in the interactive processes that are part of the service, these communications are secondary or auxiliary to the primary relationship in which the corporation delivers its content to the customer. Although the corporation's Voice over Internet Protocol (VoIP) and internet access business fit within the definition of "data transmission service," and it individually qualifies for central assessment, the corporation's record fully supports that in the year at issue, the primary use of the corporation's property was in connection with the cable television business. Comcast Corp. v. Or. Dept. of Rev., TC 4909 (Or. Tax Ct. Sept. 15, 2016). Oregon: A vacant lot owned by a home-building charity was exempt from property tax because the home-building charity directly performs its charitable works when it acquires and develops property. In reversing and remanding the Oregon Tax Court's decision, the Oregon Supreme Court (Court) found that determination of eligibility for a charitable property tax exemption turns on how the vacant property fits within the organization's charitable works. The Court found that the home-building charity in this case makes present use of its vacant lots not only when it sells homes to low-income families, but also when it acquires and maintains those lots, even if it cannot immediately begin construction of each of them. Habitat for Humanity of the Mid-Willamette Valley v. Or. Dept. of Rev., No. S063542 (Or. S. Ct. Sept. 15, 2016). Illinois: Amended regulation (86 Ill. Admin. Code § 100.5020) provides that without any application required, the Illinois Department of Revenue (Department) will grant an automatic extension of six months to taxpayers whose returns are due on the 15th day of the fourth month after the end of the taxable year and seven months for all other taxpayers to file any Illinois income tax return. The deadline to pay taxes is not extended, thus, tentative tax due should be paid. The Department will approve an additional extension if the IRS grants an extension beyond the automatic extension date. For corporations, the additional Illinois extension will be one month beyond any approved federal extension, and for other taxpayers, the additional extension will be for the length of time approved by the IRS. All taxpayers must attach a copy of the approved federal extension to their return when it is filed. Ill. Dept. of Rev., Amended 86 Ill. Admin. Code § 100.5020 (effective Sept. 7, 2016). Rhode Island: The Rhode Island Department of Revenue issued guidance on extended due dates (i.e., time to file, not time to pay) for certain entities that will apply for 2016 and thereafter. For corporations, the extended due date depends on the entity's year end. Corporations with a calendar year end have a five month extension, corporations with a June 30 year-end have a seven month extension, and corporations with a year-end other than December 31 or June 30 have a six month extension. Partnerships and LLCs that are treated as pass-through entities for federal income tax purposes have a six month extension. The extended due date for a single member LLC that is treated as a disregarded entity for federal income tax purposes is the same extended due date as its owner. The guidance includes examples and extension due date tables for various entities. R.I. Dept. of Rev., Extended due dates set for certain entities" AVD 2016-16 (Sept. 29, 2016). California: New law (AB 2258) requires that beginning Jan. 1, 2018, for purposes of determining whether property held or owing by a business association escheats to the state, a holder must regard specified transactions that are initiated electronically and are reflected in the books and records of a banking or financial organization as evidence of an increase or decrease in the amount of the funds or deposit in an account held by the banking or financial organization, and therefore not consider the property to be abandoned. These transactions are: (1) a single or recurring debit transaction authorized by the owner; (2) a single or recurring credit transaction authorized by the owner; (3) recurring transactions authorized by the owner that represent payroll deposits or deductions; (4) recurring credits authorized by the owner or a responsible party that represent the deposit of any federal benefits, including social security benefits, veterans' benefits, and pension payments. Generally, any demand, savings, or matured time deposit, or account subject to a negotiable order of withdrawal, made with a banking organization escheats to the state if the owner, for more than three years, has not increased or decreased the amount of the deposit. Cal. Laws 2016, Ch. 463 (AB 2258), signed by the governor on Sept. 22, 2016. Connecticut: The Connecticut Departments of Revenue Services and Social Services (collectively, Departments) jointly upheld the constitutionality of the Connecticut Hospital User Fee, which is a tax on the net patient revenue of a hospital. In reaching this conclusion, the Departments found: (1) the general assembly did not delegate authority to set a tax rate of the Hospital User Fee in violation of the Connecticut Constitution, nor was its delegation of authority to the Department of Social Services an unconstitutional delegation of authority; (2) the Departments did not enact an illegal regulation; (3) the Hospital User fee does not violate the Equal Protection Clause of the US Constitution; (4) the Departments have not implemented the Hospital User Fee in a manner inconsistent with Connecticut law that governs the Medicaid programs; and (5) the Departments have not administered the Hospital User Fee in an arbitrary and capricious manner, nor have they abused their discretion under the Hospital User Fee. Conn. Dept. of Rev. Serv., DRS Declaratory Ruling No. 2016-1 (Sept. 22, 2016). 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: 2016-1686 |
