28 October 2016 State and Local Tax Weekly for October 21 Ernst & Young's State and Local Tax Weekly newsletter for October 21 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. Final and temporary Section 385 regulations significantly narrow scope of earlier proposed regulations On Oct. 13, 2016, the Treasury Department (the Treasury) and the IRS released final and temporary regulations under Section 385 (TD 9790, the Final Regulations). Although the Final Regulations retain much of the general approach of the Proposed Regulations, they also contain numerous and significant modifications. Like the Proposed Regulations, the Final Regulations target instruments issued to a member of the issuer's "expanded group" that would otherwise constitute indebtedness for US federal income tax purposes under common law principles (a debt instrument). Like the Proposed Regulations, the Final Regulations: — Establish extensive documentation requirements that must be satisfied for a debt instrument to constitute indebtedness for US federal income tax purposes (the Documentation Rule). — Establish rules that allow the IRS to recharacterize a debt instrument issued after April 4, 2016, as stock if the instrument is: (i) issued in one of a number of specified transactions (herein referenced as tainted transactions), or (ii) funds a tainted transaction (the Recharacterization Rule). — Limited to US borrowers. In what is likely the most significant change, the Final Regulations apply only to instruments issued by domestic corporations (and certain partnerships and disregarded entities with domestic corporate owners) (a covered member). — Removal of the general bifurcation rule. The Final Regulations eliminate the "bifurcation" rule contained in the Proposed Regulations that allowed the IRS to treat an instrument as partially debt and partially equity. Treasury indicated, however, that it will continue to study this issue. — Changes to expanded group definition. Although the Final Regulations continue to apply to debt issued by a covered member within an "expanded group" or "EG," several significant changes were made to what constitutes an EG. — Delayed documentation requirement. Perhaps the most subtle but significant change was the relaxation of the effective date of the Documentation Rule. Delayed by a year, it now applies only to debt instruments issued on or after Jan. 1, 2018 and, perhaps even more significantly, a taxpayer is not required to complete the documentation until the due date of the issuer's return, including extensions, for the tax year that includes the "relevant date" (in many cases, the date of the instrument's issuance). With extensions, for a calendar year taxpayers, this would mean that first documentation is not required to be completed until September 2019 (for transactions entered into during the taxable year beginning Jan. 1, 2018.) — Other significant Documentation Rule changes. The Final Regulations provide additional clarity to the Documentation Rule, and important exceptions. — Exclusion of short-term debt from the Recharacterization Rule. Several categories of short-term debt instruments are excluded from the scope of the Recharacterization Rules: short-term funding arrangements, ordinary course loans, interest-free loans and deposits with qualified cash pool header. — Earnings and profits and other significant exceptions. The application of the Recharacterization Rule is reduced or eliminated under newly expanded exceptions, including: (i) exceptions based upon earnings and profits of the issuer accumulated in tax years ending on or after April 5, 2016, and (ii) certain capital contributions to the issuer. In addition, the Recharacterization Rule no longer applies in a wide variety of settings. US state and local income tax effects. The Treasury acknowledged the US state and local income tax implications posed by the Proposed Regulations and accepted a recommendation from a commenter that modified the consolidated group exception for purposes of both the Documentation Rule and the Recharacterization Rule. Although Treasury appears to be responsive to the state and local concerns, we believe these changes have not alleviated the potential that the new rules may apply much more broadly for US state and local income tax purposes, most notably to transactions between members of a federal consolidated group that may not be covered for state tax purposes. For an in-depth discussion of the final regulations under IRC Section 385, see Tax Alert 2016-1776. For a discussion on the impact these new regulations will have on insurance companies, see Tax Alert 2016-1765. For a discussion on the impact the 385 regulations will have on S corporations, see Tax Alert 2016-1763. For a discussion on the impact the final Section 385 regulations on the financial service industry, see Tax Alert 2016-1790. District of Columbia: New law (A21-448) makes various changes to the District of Columbia corporate and unincorporated business tax laws. Provisions of the bill delay when a combined group whose net deferred tax liability was increased as a result of the enactment of the combined reporting provisions can deduct a portion of the net increase (commonly referred to as the FAS 109 adjustment). Under the amended provisions, the deduction may be claimed by an eligible taxpayer for a seven-year period, beginning with the tenth year (formerly fifth year) of the combined filing. For taxpayers that took the deduction into account when making estimated 2015 payments and an underpayment results, the estimated tax interest resulting from such underpayment, upon application, will be waived. These provisions took effect upon enactment. A21-448 also includes provisions that have been previously enacted as emergency or temporary law, including the repeal of the tax haven country blacklist and reinstatement of the tax haven factor/criteria language, and adds 9.2% to the list of possible corporate and unincorporated business tax rates (this rate was part of the tax relief package enacted in 2015, but not included in the list of possible corporate and unincorporated tax rates). D.C. Laws 2016, L21-0160 (A21-0488, B21-669), became law on Oct. 8, 2016. Indiana: The Indiana Legislative Services Agency Office of Fiscal and Management Analysis issued two fiscal reports studying the potential impacts combined reporting would have on the state and a review of issues related to transfer pricing. The combined reporting fiscal report addresses the following topics: (1) combined reporting and related issues (business income and taxation in the US and corporate tax planning strategies); (2) corporate income tax reporting methods (formulary apportionment, separate reporting, consolidated reporting, combined reporting); (3) history and issues of combined reporting (determination of a unitary group, income of a unitary group, foreign income - water's edge v. worldwide reporting, apportionment of income, throwback, Joyce v. Finnigan, transition of certain tax attributes); (4) Indiana corporate AGI tax reporting (Indiana's responses to tax planning in the last decade); (5) administrative transition issues; (6) fiscal and economic impact (hypothetical taxpayer simulations, survey and interview, analysis by other states, anecdotal data analysis, review of research literature relating to combined reporting and economic analysis). The transfer pricing study reviews intercompany transfers, state enforcement of intercompany transfers, illustrative cases on transfer pricing issues, and experts' presentation to the Multistate Tax Commission. Maryland: The Maryland Tax Court (Court) issued a revised order in Branch Banking and Trust Company v. Comptroller of the Treasury, holding the denial of refunds associated with a carryforward subtraction of federal bond interest was unconstitutional. The Court determined that the Maryland Comptroller of the Treasury's (Comptroller) policy of not allowing a carryforward of unsubtracted exempt federal obligation interest discriminates against holders of federal obligations in favor of similarly situated holders of Maryland obligations. After its initial ruling was issued in August 2016, the Court granted the Comptroller's motion to withdraw its ruling. In its motion to withdraw, the Comptroller argued that the decision only addressed the legal issue in the case and not the factual issue of whether the bank met its burden of substantiating the amount of refund claimed. In the revised order, the Court found the amount of refunds claimed by the bank (approximately $4.67 million in total), were supported by the evidence presented by the bank (e.g., the bank's general ledger, which contained data used to financially account for federal obligations). Branch Banking & Trust Co. v. Md. Comptroller of the Treas., No. 13-IN-OO-0076 (Md. Tax Ct. Sept. 30, 2016). Minnesota: The US Supreme Court has been asked to review the Minnesota Supreme Court's decision in Kimberly-Clark Corporation & Subsidiaries, in which it upheld the tax court's ruling that the Legislature's repeal of the Multistate Tax Compact's (Compact) apportionment election provision and apportionment formula (Articles III and IV of the Compact, respectively) is constitutional. As a result of this holding, the taxpayer was not entitled to a refund of corporate income tax based on the use of the Compact's equally weighted three-factor apportionment formula, rather than the state's standard formula, which resulted in a more heavily weighted sales factor formula in this case. Kimberly-Clark Corporation & Subsidiaries vs. Commissioner of Revenue, A15-1322 (Minn. S. Ct. June 22, 2016), petition for cert. filed, Dkt. No. 16-565 (US S. Ct. filed Oct. 20, 2016). For more on the Minnesota Supreme Court's ruling, see Tax Alert 2016-1150. New Jersey: New law (AB 12/SB 2411) phases out New Jersey's estate tax and makes changes to various individual exemptions. The estate tax will be phased out by the 2018 tax year. For resident decedents dying on or after Jan. 1, 2017 but before Jan. 1, 2018, the tax on the transfer of the estate is subject to an exclusion of $2 million. There is no tax on the transfer of the estate for resident decedents dying on or after Jan. 1, 2018. Other tax-related changes contained in the law include the following: (1) veterans are granted a $3,000 personal exemption from taxation, (2) the exemption of income received as an annuity or other retirement income is increased, and (3) the earned income tax credit increases from 30% to 35% of the federal earned income tax credit for tax years beginning on or after Jan. 1, 2016. N.J. Laws 2016, c. 57 (AB 12/SB 2411), signed by the governor on Oct. 14, 2016. For additional information on this development, see Tax Alert 2016-1788. New York: The New York State Department of Taxation and Finance (Department) recently posted for comment draft proposed amendments to its general apportionment regulations to incorporate statutory changes made by tax reform legislation enacted in 2014 and 2015. These draft proposed regulations address the receipts factor sourcing rules contained within N.Y. Tax Law § 210-A, and provide examples as to the application of certain sourcing rules in that statutory section. The draft proposed regulations do not include the proposed rules for sourcing receipts from digital products and other business receipts or the proposed rules for discretionary adjustments, all of which were previously posted by the Department. References are made to these other draft regulations, however, as well as to the draft proposed Metropolitan Transit Authority (MTA) surcharge regulation. In addition, placeholders are provided for apportionment rules for corporate partners, investment capital regulations and other exempt income regulations, all of which have yet to be posted by the Department. The Department requested that comments on the draft proposed regulations be submitted by Dec. 28, 2016. For more on this development, see Tax Alert 2016-1780. All States: The EY Sales and Use Tax Quarterly Update provides a summary of the major legislative, administrative and judicial sales and use tax developments. Highlights of this edition include: (1) a discussion of the sales and use tax challenges posed by the threat of legal actions under state false claims act and qui tam suits; (2) an update on recent state legislative and regulatory changes with respect to sales and use tax nexus; and (3) a recap of recent sales and use tax developments related to technology, transactions, tax base, exemptions and refunds, and controversy and compliance. For a copy of the newsletter see, Tax Alert 2016-1764. Arizona: The Arizona Department of Revenue (Department) issued revised guidance on factors used to determine whether an out-of-state business has a substantial nexus with Arizona for transaction privilege (Arizona's sales tax) or use tax and municipal privilege tax purposes. In determining whether a the activities performed in Arizona for or on behalf of a business are significantly related to the business's ability to establish and maintain a market in Arizona, the Department will consider the type of activity performed in the state for or on behalf of the business and the degree of the activity (e.g., frequency of the activity, length of the activity, impact the activity has on the ability of the business to maintain a market). The Department listed various activities that may be themselves or in conjunction with others create substantial nexus. Such activities of a business which create substantial nexus include the following: having employees in the state for two days or more, maintaining an office or other place of business in the state, owning or leasing real or personal property in the state, maintaining an inventory of products in the state, delivering merchandise or goods into the state in vehicles owned or leased by the business, having independent contractors or other representatives in the state acting on the business's behalf, having activities performed on behalf of the business that enable it to establish and maintain a market in the state (e.g., soliciting sales, delivering property, training, collecting delinquent accounts; having affiliate cross-promotion and advertising, marketing to promote the operations of the business, accepting returns or exchanging merchandise, fulfilling orders made through an affiliated business, maintaining a kiosk in the state which a customer can use to purchase merchandise of the business). The Department also provided guidance as to when an out-of-state business that sells merchandise to Arizona customers will not be subject to tax, whether transaction privilege tax or use tax is due, and the appropriate tax rate that applies (e.g., sourcing rules). Lastly, the Department included various examples of nexus and non-nexus creating activities. Ariz. Dept. of Rev., TPR 16-1 (Sept. 20, 2016) (this ruling rescinds and supersedes TPR 08-1). Arizona: The Arizona Department of Revenue (Department) provided guidance on when a business that operates an online marketplace and makes online sales on behalf of third-party merchants will be deemed a retailer subject to Arizona's transaction privilege tax (TPT). An online marketplace business that has nexus with Arizona and that derives gross receipts from acting as an agent of third-party merchants by providing customer service, processing payments and refunds, and has control over the fulfillment process is deemed a retailer subject to the TPT. If the online marketplace business does not fulfill the orders or have control over the order fulfillment process or have the ability to direct when the orders will be delivered, the online marketplace is not making sales on behalf of the third-party merchant and is not responsible for collecting and remitting the TPT. Rather, the third-party merchant is the retailer if it has nexus with Arizona. If the business operating an online marketplace is deemed to be the retailer, all of its Arizona gross receipts are presumed to be subject to tax to the extent it can show that it offers other services that constitute separate lines of business from its retail operations. The guidance includes various examples. Ariz. Dept. of Rev., TPR 16-3 (Sept. 20, 2016). New Jersey: New law (AB 12/SB 2411) increases the state's gas tax rate and decreases its sales and use tax rate. The new law increases the tax on petroleum products from 2.75% to 7% of gross receipts. It also increases the tax on highway fuel to 12.85%. The rate is set to change quarterly on July 1, October 1, January 1, and April 1 of each year. The new law decreases the sales and use tax rate first, from 7% to 6.875% effective Jan. 1, 2017, and then to 6.625% effective Jan. 1, 2018. In addition, the hotel and motel occupancy fee is decreased first, to not exceed 13.875%, effective Jan. 1, 2017, and then, to not exceed 13.625%, effective Jan. 1, 2018. N.J. Laws 2016, c. 57 (AB 12/SB 2411), signed by the governor on Oct. 14, 2016. For additional information on this development, see Tax Alert 2016-1788. Pennsylvania: New law (Bill No. 160015-A) requires covered businesses that receive tax or other subsidies from the City of Philadelphia (City) to provide specific data to the City. A covered business includes business located within the City that have annual gross revenues of more than $2 million in the relevant calendar year; a business that receives financial assistance, when specific City Council approval was required in connection with the assistance (e.g., land transfer, certain leases, City capital expenditures) (note, the requirements of this provisions will be deemed imposed on such business regardless of whether the requirement was specifically identified in the Council approval); or a business that receives financial assistance but does not meet the prior two definitions. Subsidies include reduction of any tax obligations to the City or state, a TIF, governmental loan, leasing property from the government for less than fair market value, etc. By May 1 of each year, covered businesses must file a report with the City that includes the following information: (1) name and address of the business, location of the subsidized activity within the City, contact information; (2) type, date and amount of subsidy received; (3) amount and source of any subsidy received by a business in connection with business operations or real estate located within the City not identified under (2); (4) the number of full-time, part-time and temporary employees (excluding independent contractors) employed by the business at the start and end of the year and the locations at which these jobs were based; (5) number of individuals regularly employed as independent contractors at the locations where the business operates in the City at the start and end of the year; (6) identification and description of any jobs created in the City during the calendar year (e.g., type of job, compensation, full time or other); and (7) determinations of federal, state or local law violations relating to various issues including environmental protection, taxation, labor standards or employment discrimination. Businesses that fail to file the report will be subject to penalties — $1000 for failure to comply with the first 30 days of the report due date and following the first 30 days the penalty is $100 per day as long as the failure persists. A willful violation may result in the suspension or revocation of the business's Commercial Activity License. Philadelphia City Council, Bill No. 160015-A, signed by the mayor on Sept. 27, 2016. District of Columbia: New law (A21-448) changes the filing due date of franchise tax returns for corporations and financial institutions. Effective for tax years beginning after Dec. 31, 2015, returns for calendar year taxpayers are due on or before April 15 (formerly March 15), while returns for fiscal year filers are due on or before the fifteenth day of the fourth month following the close of the fiscal year (formerly the fifteenth day of the third month). D.C. Laws 2016, L21-0160 (A21-0488, B21-669), became law on Oct. 8, 2016. New York City: New law (AB 10266) updates return due dates for partnerships required to file the New York City Unincorporated Business Tax (UBT). Effective for tax years beginning on or after Jan. 1, 2016, a partnership must file its UBT return and pay tax due by the fifteenth day of the third month following the close of a taxable year. In addition, any prepaid tax will be deemed paid on the fifteenth day of the third month following the close of the taxable year for which the prepaid amount constitutes a credit or payment. N.Y. Laws 2016, Ch. 391 (AB 10266), signed by the governor on Sept. 30, 2016. Arizona: Reminder: The Arizona tax recovery program will end Oct. 31, 2016 (tax recovery program period). In exchange for paying the tax due, the Arizona Department of Revenue (Department) will abate or waive all penalties and interest due and not seek criminal prosecution. Eligible taxpayers must submit tax recovery program returns, the tax recovery program application and pay the full amount of tax due during the tax recovery program period. For taxes due on an annual basis, the tax recovery program applies to any taxable period ending before Jan. 1, 2014. For taxable periods due on a monthly or quarterly basis, the tax recovery program applies to those periods ending before Feb. 1, 2015. According to the tax recovery application and information about the program on the Department's website, tax recovery is available for the following taxes: income (corporate, individual, and fiduciary); use tax; and transaction privilege (sales) tax. Note, however, that transaction privilege tax for non-program cities (i.e., cities that collect their own transaction privilege tax) are not included in the amnesty program. In addition, tax recovery cannot be requested for the following taxes: bingo, luxury tax, withholding tax, property tax and estate tax. All States: On Thursday, Nov. 10, 2016 from 1:00-2:30 p.m. EST New York (10:00-11:30 a.m. PST Los Angeles), EY will host a post-election webcast. Following the November 8th US federal elections, policymakers will turn their attention to other pressing matters, including funding the federal government beyond December 9th, dealing with the more than three dozen tax "extenders" set to expire at year-end and addressing the federal debt limit. Lawmakers are also signaling their intent to move forward with federal tax reform in 2017. On the state side, tax departments will need to address the results of ballot initiatives impacting businesses and individuals, and some legislatures may have to address budget shortfalls. Join our panel as we discuss the election results and what they mean for tax and non-tax business executives. Topics will include: (1) Congressional makeup and political landscape — state and federal focus; (2) Outlook for federal tax policy and tax reform; (3) Outcome of key state ballot initiatives affecting tax — significant changes may be on the horizon. Click here to register for this event. All States: On Wednesday, Nov. 2, 2016 from 1:00-2:15 p.m. EDT New York (10:00-11:15 a.m. PDT Los Angeles), EY will host a webcast on tax issues in debt modifications and restructurings and bankruptcy. During this webcast, the following topics will be discussed: (1) federal and state income tax implications of an out-of-court debt modification or restructuring; (2) federal and state income tax implications of a bankruptcy filing; (3) tax administration and non-income tax issues and opportunities in bankruptcy; and (4) tax strategies that may yield cash savings. To register for this event, go to Debt modifications/restructurings and bankruptcy. (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: 2016-1836 |
