Ernst & Young's State and Local Tax Weekly newsletter for December 23 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.

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Top stories

50 state study of state and local taxes paid by business in FY2015 now available

EY's Quantitative Economics and Statistics practice (QUEST), in conjunction with the Council On State Taxation (COST), has recently released its 14th annual state and local business tax study. The study presents detailed, state-by-state estimates of the state and local taxes paid by businesses for fiscal year 2015. Some key findings of this year's study: Businesses paid more than $707.5 billion in state and local taxes in FY2015, an increase of 1.9% from FY2014. State business taxes grew less quickly than local taxes, with state taxes growing 1.0% compared to local tax growth of 2.9%. In FY 2015, business tax revenue accounted for 44.1% of all state and local tax revenue.

Highlights from this year's report:

— Revenue from state and local business taxes increased from FY14 to FY15. Overall state and local business tax revenue increased 1.9%, with state business tax revenue growing by 1.0% and local business tax revenue growing 2.9%.

— Business property tax revenue increased 2.8% in FY15, a gain of $7.0 billion. Property taxes remain by far the largest state and local tax paid by businesses, accounting for 36.5% of the total.

— General sales taxes on business inputs and capital investment totaled $150.6 billion, or 21.3% of state and local business taxes. Overall sales taxes paid by business increased 4.9%.

— In FY15, state and local corporate income and business gross receipts tax revenue was $67.3 billion, or 9.5% of all state and local business taxes. FY15 marked the fifth consecutive year of corporate income and business gross receipts tax growth. Overall corporate income and business gross receipts tax revenues increased by 4.1%.

— Individual income taxes on pass-through business income accounted for 5.5% of total state and local business tax revenue. Individual income tax revenue on business income increased by 4.1% in FY15.

— Due to the dramatic reduction in energy prices, state severance taxes decreased from $18.0 billion in FY14 to $12.8 billion in FY15, a decline of almost 29%.

— On average, businesses continue to pay more in state and local taxes than they receive in benefits from governmental spending.

Click here for a copy of the report.

Philadelphia passes bill that would increase scope and amount of City Realty Transfer Tax

On Dec. 8, 2016 the City Council of the City of Philadelphia (Council) passed Bill No. 16081001 (Bill),amending Chapter 19-1400 of The Philadelphia Code regarding the City's Realty Transfer Tax, by closing certain loopholes. Notable changes amend the definition of "value" as it relates to acquired real estate companies as well as the definitions of "real estate company" and "acquired real estate company."

The most significant change effected by the Bill is the way value will be calculated. Under Pennsylvania law, the value of a controlling interest transfer is based on the value of the underlying real estate owned by a real estate company. Value is calculated by multiplying the assessed value of the real estate for Pennsylvania property tax purposes by a common level ratio. The tax rate is applied to this amount to calculate the tax due. Instead of using this computation, for Philadelphia purposes, the value may not be less than the readily ascertainable market value of the underlying property. The Bill further creates a rebuttable presumption that when ownership of a real estate company is transferred the consideration paid for the company is the value.

The Bill also changes the definition of a change of ownership of a real estate company. Under existing law, a change of ownership only occurred if 90% or more of the interests in the real estate company was transferred within a three year period, which includes any binding commitment to make a future transfer if the commitment was entered into within that period. The Bill lowers the threshold and, if enacted, provides that a change of ownership will occur if only 75% or more of a real estate company is transferred within a six year period.

If enacted, not only does the Bill affect the tax base of real estate company transfers but it will likely also result in the Philadelphia realty transfer tax being applied to more transfers. Complicating matters is that the commonwealth of Pennsylvania imposes a separate 1% tax and its thresholds have not changed. Thus, if enacted, a transfer of a "real estate company" with property located in Philadelphia could be subject to the City tax but not the state tax.

Finally, the bill will also increase the Philadelphia tax by 0.1%.

If the Bill is enacted, its changes will apply to transactions occurring on or after July 1, 2017. For additional information on this development, see Tax Alert 2016-2159.

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Income/Franchise

All States: The Q4 State Income and Franchise Tax Quarterly provides a summary of the legislative, administrative, and judicial updates that occurred during Oct. 1, 2016 through Dec. 16, 2016. Highlights include: (1) a summary of legislative developments in the District of Columbia; (2) a summary of judicial developments in California, Colorado, Michigan, Minnesota, Mississippi, New Jersey, Oregon, South Carolina and Utah; (3) a summary of administrative developments in federal, Alabama, California, the District of Columbia, Illinois, Indiana, Massachusetts, Montana, New Hampshire, New York, New York City, North Carolina and Texas; and (4) a discussion of state and local tax items to watch in federal, California, Louisiana, New York and Virginia. A supplement covering the period December 17, 2016 through December 31, 2016 will be released in early January 2016, if necessary.

Alabama: A multistate corporation should compute the IRC §199 domestic production activities deduction (DPAD) limitation using its separate entity federal taxable income (i.e., income reported on Line 30 of the corporation's pro forma federal corporate income tax return). In so holding, the Alabama Tax Tribunal rejected the corporation's argument that the DPAD limitation applies to Alabama taxable income before allocation and apportionment (i.e., for purposes of determining the limitation, a taxpayer calculates its Alabama taxable income in order to determine separate entity federal taxable income). The Sherwin-Williams Co. v. Ala. Dept. of Rev., Dkt. BIT. 13-359, BIT. 11-741 (Ala. Tax Trib. Nov. 30, 2016).

District of Columbia: The District of Columbia Office of Tax and Revenue recently announced that pursuant to the Tax Revision Commission Implementation Act, the tax rates of both the unincorporated and incorporated business franchise taxes will be reduced to 9.0% (from 9.2%), effective Jan. 1, 2017, for income tax returns to be filed in 2018. D.C. OTR, Notice 2016-05 (Dec. 16, 2016).

Indiana: A multistate company that provides direct mail services was allowed to amend its Indiana corporate tax return to source income received for delivering materials to Indiana customers on a cost of performance basis because most of its costs in performing these services were incurred outside Indiana. On its originally filed returns, the company allocated its income based upon the state in which it delivered mail on behalf of its customers. Ind. Dept. of Rev., LOF No. 02-20150523 (Dec. 2, 2016).

Louisiana: The Louisiana Department of Revenue (LDR) has proposed a regulation (LAC 61:I.1115) to implement add-back provisions for related party intangible, interest and management fee expenses and costs, which were enacted in 2016. The proposed regulation lists exceptions to the add-back rule, defines terms, provides operating rules, and includes examples. The LDR also proposed amendments to the Corporate Franchise Tax regulations LAC 61:I.301, 302 and 311, to implement changes to the tax law changes enacted during 2016, LAC 61:I.1135 regarding new income apportionment rules and sourcing sales of non-tangible personal property and services, and LAC: 61:I.1902 to implement changes to the Inventory Tax Credit.

Massachusetts: The U.S. Supreme Court (USSC) once again is being asked to review the Massachusetts Supreme Judicial Court (MSJC) ruling in First Marblehead in which the MSJC held that the Commissioner of Revenue properly treated the loans of an out-of-state "holding" company as being located wholly in Massachusetts and, therefore, included in the numerator of its property factor, because the company failed to rebut the presumption that the loans should be sourced to its commercial domicile, which was Massachusetts. In so holding, the MSJC found that Massachusetts' statutory provisions, as applied to the company, did not violate the internal consistency test (in light of the USSC's recent ruling in Wynne) or the dormant commerce clause. The First Marblehead Corp. v. Commissioner of Revenue, No. SCJ-11609 (Mass. Sup. Jud. Ct. Aug. 12, 2016), petition for cert. filed, Dkt. No. 16-777 (U.S. S. Ct. filed Dec. 15, 2016).

Minnesota: The U.S. Supreme Court will not review the Minnesota Supreme Court's (MSC) decision in Kimberly-Clark Corporation & Subsidiaries, in which the MSC 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 the application of the more heavily weighted statutory sales factor formula in this case. Kimberly-Clark Corporation & Subsidiaries vs. Commissioner of Revenue, A15-1322 (Minn. S. Ct. June 22, 2016), cert. denied, Dkt. No. 16-565 (U.S. S. Ct. Dec. 12, 2016.

New York: The New York Department of Taxation and Finance enacted an emergency regulation to change the MTA surcharge rate. Under the emergency regulation, the MTA surcharge is increased from 28% to 28.3% for taxable years beginning on or after Jan. 1, 2017 and before Jan. 1, 2018. The 28.3% rate will remain in effect for succeeding tax years unless the Commissioner determines a new rate. N.Y. Dept. of Taxn. & Fin., Emer. Reg. 20 NYCRR Part 9 (released Dec. 1, 2016).

New York City: An administrative law judge of the New York City Tax Appeals Tribunal ruled In the Matter of the Petitions of Gerson Lehrman Group, Inc., that a consulting firm's receipts from providing expert knowledge, analysis and views to clients through its consultants and research managers (collectively expert services) are allocated based on where the service is rendered for purposes of the General Corporation Tax (GCT) of New York City (City). In the Matter of the Petitions of Gerson Lehrman Group, Inc., Nos. TAT(H)08-79(GC), TAT(H)12-38(CG), and TAT(H)12-39(GC) (NYC Tax App. Trib. Oct. 4, 2016). For additional information on this development, see Tax Alert 2016-2182.

New York City: The New York City Department of Finance (the Department) released an Update on Audit Issues addressing the use of broker-dealer sourcing rules by an entity that is not itself a registered securities or commodities broker or dealer when computing New York City Unincorporated Business Tax, General Corporation Tax or Corporate Tax of 2015. For additional information on this development, see Tax Alert 2016-2165.

Oregon: A multistate corporation that generates a portion of its revenues from the provision of cable television, internet and voice over internet protocol services to Oregon customers is required to determine its sales factor using the subscriber apportionment factor under the broadcaster statutes (ORS §§314.680 - 314.684 and OAR 150-314-0465), and not under the cost of performance method under ORS §314.655. In so ruling, the Oregon Tax Court rejected the corporation's argument that it was not subject to the broadcaster statutes in regard to revenue that does not arise from the transmission of one-way electronic signals. Comcast Corp. and Subsidiaries v. Ore. Dept. of Rev., TC 5265 (Ore. Tax Ct. Oct. 11, 2016).

Texas: The Texas Comptroller of Public Accounts (Comptroller) adopted amendments to 34 Tex. Admin. Code Section 3.584, revising the definitions of "primarily engaged in retailer or wholesale trade," "retail trade" and "wholesale trade," and defining the term "unrelated party," which is used in the definition of "primarily engaged in retailer or wholesale trade." The revision to the definition of "primarily engaged in retailer or wholesale trade" is not as broad and far reaching as originally proposed. The Comptroller, however, indicated that additional amendments to this definition may be proposed. The amendments were adopted and took effect Dec. 8, 2016. Tex. Comp., Reg. 3.584 (Tex. Register Dec. 2, 2016).

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Sales & use

All States: Taxpayers must develop and manage effective internal sales and use tax compliance systems as a vital component of their overall multistate business risk management function. They can face strategic and operational challenges and risks when they evaluate business requirements and identify existing systems and process gaps, but there are ways to improve the effectiveness of the tax function and the implementation of tax processes and software. Panelists from Ernst & Young LLP (EY) addressed these issues in the final installment of a four-part sales and use tax seminar series, now available for replay on the EY Thought Center website. For additional information on this development, see Tax Alert 2016-2166.

Alabama: An out-of-state leasing company (lessor) is not subject to Alabama's lease tax as it is not engaged in the business of leasing tractors and trailers in Alabama and, therefore, it is not exempted from paying the state's sales and use tax on its purchases of tires, repair goods, and other materials. In reaching this conclusion and reversing the lower court, the Alabama Court of Civil Appeals (Court) determined that there was no evidence of a taxable event to which Alabama's leasing tax would apply, because the business of leasing that the lessor engaged in occurred in Tennessee, regardless of the locations where the lessee operated the tractors and trailers. The only taxable event that occurred in Alabama was the lessor's purchase of tires, repair parts, and other goods in Alabama. Those repairs are incident to the lessor's ownership of the tractors and the trailers that it leases, but the Court could not conclude that having repairs made on the tractors and trailers in Alabama constituted "engaging or continuing within this state in the business of leasing or renting tangible personal property" under the leasing statute. Additionally, Alabama administrative provisions require that where a lessor leases a truck, truck trailer, or semitrailer to a motor carrier outside Alabama, the receipts would not be subject to the lease tax although the truck, truck trailer, or semitrailer may occasionally travel in Alabama in interstate commerce. Ala. Dept. of Rev. v. U.S. Xpress Leasing, Inc., No. 2150547 (Ala. Civ. App. Ct. Dec. 2, 2016).

Colorado: The US Supreme Court will not review the 10th Circuit's ruling in Direct Marketing Association, in which it held a Colorado statute that requires remote sellers lacking physical presence within the state to file an annual statement with the Colorado Department of Revenue showing the total amount paid for Colorado purchases during the preceding calendar year for each Colorado purchaser, does not violate the dormant Commerce Clause of the US Constitution. Direct Marketing Ass'n. v. Brohl, No. 12-1175 (10th Cir. Feb. 22, 2016), cert. denied, Dkt. No. 16-267 (U.S. S. Ct. Dec. 12, 2016).

Indiana: An out-of-state company's "cloud computing service with open source instances," "cloud computing service with third party instances," and remote storage products are all services enumerated by statute and, therefore, are not subject to Indiana's sales and use tax. The cloud computing transactions that the company engages in, for both the cloud computing service with open source instances and with third party instances, do not involve transfers of any specified digital products, prewritten computer software, or other type of tangible personal property. In addition, the statutory serviceperson test applies and the services are nontaxable because: (1) the company is primarily in the business of providing data storage and computing capacity, and not selling tangible personal property; (2) the software is for the purpose of enabling the company's customers to test their own applications incident to the company's computing resource service; (3) the company does not charge for the software and as such it would be considered as inconsequential compared to the overall service fee; and (4) the software fee was for the company to use, and thus the company did not have to pay sales tax when it was downloaded. Finally, these services are excluded from the definition of "telecommunication service." The service is providing dynamically scalable and virtualized computing resources for its customers. Remote storage is a service because customers are not required to download any computer software in order to use the remote storage product, the company does not transfer any specified digital products or other type of tangible personal property as part of the remote storage product and does not retain any ownership of the items uploaded, and the company does not charge customers for software. Finally, the separately stated data transfer fee, charged in connection with a customer's use of the remove storage service, also is not subject to sales and use tax because it is not transferred in conjunction with tangible personal property. Ind. Dept. of Rev., Revenue Ruling No. 2012-05ST (Oct. 4, 2016).

Michigan: The Michigan Department of Treasury (Department) issued guidance to explain the use tax base for a manufacturer/contractor that affixes its product to the real estate of others, and discuss the exemption from use tax available for tangible personal property purchased or manufactured by a contractor that is affixed to (and made a structural part of) real estate located in another state. Where a manufacturer/contractor either maintains an inventory of its product that is available for sale to others or makes its product available for sale to others by publication or price list, and affixes that product to Michigan real estate, the use tax base is the finished goods inventory value of the product. Where a manufacturer contractor does not maintain an inventory of its product available for sale to others or make its product available for sale to others by publication or price list, and affixes that product to Michigan real estate, the use tax base is the sum of the materials cost of the product and certain direct labor costs. Providing guidance on the expansion of the industrial processing exemption, a manufacturer/contractor may claim such exemption for tangible personal property used or consumed by the manufacturer/contractor for industrial processing in connection with its product so long as the product is either: (1) ultimately sold at retail, or (2) affixed to (and becomes a structural part of) real estate located in another state. The industrial processing exemption is limited to the percentage of exempt use to total use determined by a reasonable formula or method approved by the Department. The guidance provides examples and answers to frequently asked questions, and applies to tax years beginning on or after Jan. 1, 2005. Mich. Dept. of Treas., Rev. Admin. Bulletin 2016-24 (Dec. 8, 2016) (replaces RAB 1993-5).

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Property tax

Michigan: New law (HB 4580) prohibits the governing body of an eligible local assessing district, after Dec. 31, 2016, from adopting a resolution exempting new personal property from the collection of taxes without a written agreement entered into with the eligible business subject to the exemption. The written agreement must contain a remedy provision with certain tax exemption revocation and repayment requirements. The bill also requires a written agreement entered into after Dec. 31, 2016, between a Next Michigan Development Corporation and an eligible Next Michigan business subject to an exemption, to include additional tax exemption revocation provisions. Mich. Laws 2016, 2016 PA 329 (HB 4580), signed by the governor on Dec. 8, 2016.

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Compliance & reporting

New York: The New York State Department of Taxation and Finance (Department) explained in two recent technical memoranda several changes in tax return due dates for partnerships, trusts, and most C corporations (in response to recent federal changes to the same due dates). The memoranda also addressed changes to the mandatory first installment (MFI) for certain corporations and changes to the procedures for remitting the MFI for payments due on or after March 15, 2017. In addition, the state increased the Metropolitan Transit Authority (MTA) surcharge tax rate beginning for the 2017 tax year. (The MTA surcharge is an additional tax assessed against businesses based on their intra-New York state apportionment to the MTA region (generally, the City of New York and certain of its surrounding counties.)) N.Y. Dept. of Taxn. and Fin., TSB-M-16(9)C, (7)I (Dec. 9, 2016). N.Y. Dept. of Taxn. and Fin., TSB-M-16(10)C (Dec. 9, 2016). For additional information on this development, see Tax Alert 2016-2192.

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Controversy

Washington: The Washington Department of Revenue (Department) issued an advisory publication clarifying when the 5% substantial underpayment penalty applies to tax assessed on purchases made under the following Washington retail sales and use tax deferral programs: (1) High Unemployment and Rural Counties; (2) High Technology; (3) Fruit and Vegetable Processors; (4) Biotech Manufacturing; and (5) Corporate Headquarters. "Substantially underpaid" means that less than 80% of the amount of tax determined to be due was paid, and the amount of underpayment is at least $1,000. The amount of tax determined to be due includes those tax types that are the subject of the audit examination and that are due for the entire period of time covered by the audit examination. Each deferral statute provides guidelines to identify qualifying purchases. Non-qualifying purchases generally are those that are not integral or necessary to the qualifying activity. The 5% substantial underpayment penalty will not apply to taxes that were properly deferred, but that must be repaid because the taxpayer ceased using the investment project for a qualifying purpose before the expiration of the deferral period. Wash. Dept. of Rev., Excise Tax Advisory 3166.2016 (Dec. 6, 2016).

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Miscellaneous tax

Washington: The Washington Department of Revenue recently set the B&O tax economic nexus minimum thresholds for calendar year 2017. The thresholds, which remain unchanged from 2016, are: $53,000 in property, $53,000 in payroll, and $267,000 in receipts. Wash. Dept. of Rev., ETA 3195.2016 (Dec. 19, 2016).

Federal: On Thursday, Jan. 5, 2017, from 1:00 - 2:15 p.m. EST New York (10:00 - 11:15 a.m. PST Los Angeles), EY will host a webcast on the border adjusted cash flow tax plan floated as a potential component of federal tax reform. As a result of the 2016 election, the Republican Party will soon control the House, Senate, and the White House, increasing the likelihood of US tax reform. President-elect Trump issued tax reform proposals during the campaign, and his 100-day action plan includes a commitment to individual and corporate tax changes, as well as a commitment to repeal and replace the Affordable Care Act (ACA). House Republicans have released a separate tax reform "Blueprint" outlining their proposals, which is expected to be a starting point for legislative development of federal tax reform. Understanding these proposals and the impact they may have on American business is critical to determining what steps to take now in order to be prepared. Join our panel of Ernst & Young LLP professionals for the third part of our three-part US tax reform series, which will focus on understanding the proposed shift to a consumption-based tax included in the House Republican Blueprint. Our panelists will discuss: (1) What is a border adjusted cash flow tax?; (2) The proposed tax legislation driving the change; and (3) Considerations to prepare for change. Click here to register for this event.

All States: On Thursday, Jan. 12, 2017, from 1:00-2:30 p.m. EST New York (10:00-11:30 a.m. PST Los Angeles), Ernst & Young LLP will host a webcast on tax issues in debt modifications/restructuring and bankruptcy. In the context of debt restructuring (including bankruptcy), understanding the details and nuances of tax technical and administrative demands — in all areas of tax — is key. How a tax executive navigates these issues can make the difference between positive and adverse tax results. To help address this challenge, a panel of EY professionals will continue our discussion of the tax implications of both in- and out-of-court distress situations. The following topics will be discussed: (1) federal income tax impacts to creditors with regard to in- and out-of-court restructurings; (2) restructurings and alternative minimum tax (AMT) — traps for the unwary; (3) Section 382 computation of net unrealized built-in gain (NUBIG) or loss (NUBIL), and treatment of deductions on the change date; (4) state income tax attribute reductions — disconnects from federal income tax treatment; and (5) tax administration and "above-the-line" strategies that may yield cash savings. Register for this event.

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.