In the last several weeks, the Ohio Department of Taxation (Department) has issued updated guidance in response to a recent Supreme Court of Ohio decision on individual income tax and two legislative changes affecting Ohio's sales and use tax. This guidance has been issued in the form of an Information Release, which communicates to taxpayers the Department's position on various tax issues. Information Releases do not carry the weight of law but rather describe the Department's position on various tax matters.

Information Release IT 2016-01 — Guidance on an equity investor's apportionment of gain from the sale of a closely-held business (O.R.C. Section 5747.212)¹

This individual income tax Information Release respond to the Ohio Supreme Court's unanimous decision in Corrigan v. Testa,² which held that the application of O.R.C. Section 5747.212³ to 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 of the US Constitution. The Corrigan decision, which is discussed in Tax Alert 2016-859, held that the statute was unconstitutional as applied to the taxpayer, not on its face. The Court concluded that an ownership interest in a business is an intangible asset and that the sale of that asset was allocable, as nonbusiness income, to the taxpayer's state of domicile.

In response to numerous inquiries about the decision, the Department's Information Release IT 2016-01 provides the following guidance:

— If a taxpayer has already filed a refund claim or has a protest outstanding⁴ on the applicability of O.R.C. Section 5747.212, its case will be reviewed in light of Corrigan. Those taxpayers with additional information after reviewing Corrigan should provide that information to their Department contacts as soon as possible.

— Taxpayers who believe they are entitled to a refund based on Corrigan should file amended Ohio individual income tax returns and refund claims, along with a citation to the case in the "Reasons and Explanations of Corrections" page, along with a detailed statement of facts and analysis as to why the decision applies to the taxpayer's situation.

O.R.C. Section 5747.11 provides a four-year statute of limitations on refund claims. Finally, the Department's Information Release IT 2016-01 states that any capital gain to which O.R.C. Section 5747.212 does not apply will be treated by the Department as allocable nonbusiness income, with that income being assigned to the taxpayer's state of domicile. Since the gain is nonbusiness income, it will not be eligible for Ohio's Small Business Deduction.

Information Release ST 1999-04 — On-line services and internet access⁵

The Department recently updated its sales and use tax guidance on online services in response to H.B. 466, in which Ohio added "digital advertising services" to the definition of nontaxable "personal and professional services," which is an exception to the definition of taxable "automatic data processing," "computer services" and "electronic information services." O.R.C. Section 5739.01(RRR) was added to the Ohio Revised Code, which defines "digital advertising services" 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."

H.B. 466's addition of this exclusion responds to the Department's December 2015 revisions to Information Release ST 1999-04, which set forth a list of services that the Department deemed to be taxable "electronic information services." The list of services falling into this interpretation includes online chat features, mass e-mails and credit reporting. The December 2015 revisions also provided an example in which charges for advertising would be taxable when a purchaser logs into an on-line account to perform various functions, such as maintaining contact information, including hours of operation and address, uploading pictures and videos, attaching descriptions of products, adding taglines or slogans, and manipulating inventory to provide real-time inventory reporting. H.B. 466 clarifies that digital advertising is not a taxable electronic information service. The H.B. 466 changes are discussed in more detail in Tax Alert 2016-1223.

While H.B. 466 has brought some clarity to the issue of the taxability of digital advertising, the other services discussed in the December 2015 revisions to Information Release ST 1999-04 will still be pursued in audit situations. It is unclear whether the December 2015 revisions were founded in long-standing Department policy or represent new thinking on the Department's part in applying these definitions, which are more than two decades old. Taxpayers under audit by the Department should carefully analyze assertions of taxability, particularly when those services would have been historically nontaxable if delivered via other (non-Internet) means.

Information Release ST 2001-01 — Use tax nexus standards (revised august 2016)

The Department revised Information Release ST 2001-01 to update its guidance on use tax collection nexus to take into account the changes adopted in H.B. 64, which adopted Ohio's version of "click-through nexus." H.B. 64 added O.R.C. Section 5747.01(I)(2)(g), which provides that an out-of-state seller is presumed to be subject to an Ohio use tax collection obligation if it enters into an agreement with a state resident in which the resident receives a commission for referring potential customers to the seller, provided that the cumulative gross receipts from such sales referred to the seller by the resident exceed $10,000 in the preceding 12 months. A seller may rebut this presumption by obtaining evidence that each resident engaged by the seller did not engage in any activity in Ohio during the preceding 12 months that was significantly associated with the seller's ability to establish or maintain a market. Such evidence may include written statements advising that the state residents did not engage in solicitation in Ohio on behalf of the seller.

Implications

Under Information Release IT 2016-01, taxpayers who believe they are entitled to a refund of Ohio individual income tax based on Corrigan should file amended individual income tax returns and refund claims in accordance with the Department's guidance.

Taxpayers under audit by the Department should carefully analyze assertions of sales and use taxability of on-line services and internet access under Information Release ST-1999-04, particularly when such services would have been historically nontaxable if delivered via other (non-Internet) means.

Finally, companies making remote sales into Ohio should evaluate the standard the Department will use to determine whether an out-of-state seller is subject to Ohio's use tax collection responsibility in connection with activities by Ohio residents on its behalf.

———————————————

———————————————
ENDNOTES

¹ Issued October 7, 2016.

² Corrigan v. Testa, Slip Opinion No. 2016-Ohio-2805 (2016).

³ O.R.C. Section 5747.212 would override the Ohio Revised Code's normal sourcing of a capital gain (i.e., to a nonresident's state of domicile) and requires apportionment of the gain based on a three-year average of the investee entity's apportionment factors if the investor has owned a 20% or greater interest in the investee entity during the current and two preceding tax years.

⁴ Any protests or refund claims that have been subject to a prior settlement agreement with the Department will not be eligible for a refund under this guidance.

⁵ ST 1999-04 - On-line Services and Internet Access - January, 1999; Updated December, 2015; Updated September, 2016.