24 January 2017 State and Local Tax Weekly for January 13 Ernst & Young's State and Local Tax Weekly newsletter for January 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. Texas appellate court again rules movie theater's costs associated with viewing films included in COGS subtraction In American Multi-Cinema, Inc., a Texas Court of Appeals (Court) withdrew its April 30, 2015, opinion and substituted a new one, upholding a trial court's ruling that a movie theater company may include its costs of exhibiting films and other content in its cost of goods sold (COGS) subtraction for purposes of calculating its Texas Franchise "Margin" Tax (Margin Tax) based on a different definition of tangible personal property than the originally issued opinion. The Court also reversed the trial court's determination regarding which facility-related costs associated with the square footage of company's movie theater should be included in the COGS subtraction, ultimately holding that the company established that its costs associated with the square footage of its auditoriums are direct costs of producing its product and, therefore, properly includable in its COGS subtraction. American Multi-Cinema Inc. v. Hegar, No. 03-14-00397-CV (Tex. Ct. App., 3rd Dist., Jan. 6, 2017). As a result of the Court's decision, items that have historically been considered "services" have grounds to be considered "goods" under the Court's interpretation of the term "tangible personal property." By doing so, related production costs could be deductible for purposes of the COGS subtraction. This could ultimately result in expanded COGS subtractions across the board, as well as added benefits for traditional service providers that previously considered themselves ineligible to claim the COGS deduction method of computing their Margin Tax. This decision could have significant and potentially negative fiscal effects on the Texas state budget. Taxpayers should analyze their Texas COGS eligibility and calculations for 2016 reports, as well as for open periods up to four years back. The Comptroller is reviewing the latest decision and considering next steps, such as an appeal to the Texas Supreme Court. It is not anticipated that the Comptroller's office will change its tax policy and/or audit approach until this case is finally settled through the appellate process. For more on this development, see Tax Alert 2017-187. Connecticut: Income from an individual's stock options that were granted while he was a resident of Connecticut but exercised after he moved out-of-state are taxable compensation because the options were granted as compensation for performing services within Connecticut. In so holding, the Connecticut Supreme Court (Court) rejected the individual's argument that in order to tax the options, state regulatory law requires a taxpayer to be performing services in Connecticut at the time of exercising the options, as well as at the time the options were awarded. The Court further held that it is constitutional under federal due process to impose a tax on income derived from the exercise of nonqualified stock options by a nonresident who was granted the options as compensation for performing services within the state. The Court reasoned that the second prong of the due process test requiring a rational relationship between the tax and the values connected with the taxing state is inapplicable here because the taxpayer was awarded the stock options for performing services only in Connecticut and this issue does not implicate a multistate business enterprise. Moreover, "the intervening passage of time between [the taxpayer's] cessation of employment in the state and the exercise of the stock options he earned performing services in the state does not deprive the state of jurisdiction to tax the income derived from the exercise of the stock options." Jefferson Allen et al. v. Conn. Comr. of Rev. Svcs., No. SC 19567 (Conn. S.Ct. Dec. 28, 2016). North Carolina: A corporation engaged primarily in the business of engineering and procurement services and manufacturing plant sales, which includes advisory and field services, cannot utilize the single-factor apportionment formula available for excluded corporations because it is not engaged in business as a building or construction contractor. North Carolina requires corporations, other than excluded corporations, to apportion net income based on a standard three-factor apportionment formula (e.g., payroll, property and sales). The apportionment formula for an excluded corporation, however, is based on a single-factor sales formula. Excluded corporations are defined by the North Carolina Department of Revenue (DOR) as "any corporation engaged in business as a building or construction contractor … " When determining whether a corporation falls under the definition of an "excluded corporation" the DOR uses the North American Industry Classification System (NAICS), which classifies corporations based on their primary business. On appeal, the North Carolina Supreme Court affirmed the lower court ruling that because the corporation's business activities did not fall within the NAICS construction sector (rather it was assigned an engineering-related NAICS code), the corporation did not fall within the meaning of "excluded corporations" for apportionment formula purposes. Further, even though the corporation's employees preform a very limited amount of hands-on construction, it cannot be treated as a "building or construction contractor" based on this limited activity. Midrex Technologies, Inc. v. N.C. Dept. of Rev., No. 5A16 (N.C. S. Ct. Dec. 21, 2016). Texas: The Texas Comptroller of Public Accounts denied an information technology consulting company (company) a cost of goods sold deduction from franchise tax for computer consulting and programming services because the company did not own the deliverables it was providing to customers. Alternatively, the company was not allowed to exclude payments it made to independent contractors because the company failed to prove that these payments were more than a mere contractual obligation. The payments were not related to the design, construction, or repair of real property; rather the independent contractors were consultants working on computer programs, which are tangible personal property. Tex. Comp. of Pub. Accts., Hearing No. 201609097H (Sept. 14, 2016). Georgia: A manufacturer's rental or purchase of certain items to ensure the safety of its employees and items to test the quality of its products in its manufacturing plant before shipment, is exempt from state and local sales and use tax to the extent they are used in the manufacturer's plant because they meet the definition of equipment and are integral to manufacturing. Under Georgia law, machinery or equipment that qualifies and "necessary and integral" to the manufacture of tangible personal property includes such items that are "used to provide safety for the employees working at a manufacturing plant … including … safety machinery and equipment required by federal or state law … " as well as "[e]quipment used for the [sic] testing the quality of finished goods." Here, the exempt equipment includes booms, lifts, ladders, scaffolding, flashlights, headlamps, light towers, batteries for the various lights, ear plugs, barricade tape, chains, tags, signs, labels, and placards, because they are all tangible personal property, are not machines, and are not industrial materials used for future processing. In addition, to the extent these products are tangible personal property, chemicals and gases used by the manufacturer for quality control testing have the character of equipment. Ga. Dept. of Rev., LR SUT-2016-18 (Aug. 18, 2016). Indiana: A company's charge for its cloud-based webcasting solution and associated usage fees is not subject to Indiana's sales and use tax because the webcasting solution is statutorily enumerated as a nontaxable service, and it does not constitute or include the sale of tangible personal property, specified digital products, prewritten computer software or telecommunication service. The Indiana Department of Revenue (Department) found that the company's clients do not acquire the software for their own independent use, they are granted a limited right to access the software, the software functionality is limited and primarily provides the ability to host events as part of the webcast hosting service, and the software is available incident to the service provided. In applying the serviceperson test, the Department further determined: (1) the company is primarily in the business of webcast hosting and virtual communications, and not selling tangible personal property; (2) the software is for the purpose of enabling the company's customers to upload files and run events incident to the company's webcast hosting and virtual communications service; (3) customers are not charged for the software, but for the minutes of meeting time they use; and (4) the software was created by the company and as such the company did not have to pay sales tax when it was created or purchased. Finally, the Department concluded that the company is not providing a taxable "telecommunication service" because even though the company is transmitting, conveying or routing information, the definition of "telecommunication services" does not include "data processing and information services that allow data to be generated, acquired, stored, processed or retrieved and delivered by an electronic transmission to a purchaser whose primary purpose for the underlying transaction is the processed data or information," which is the service the company performs. Ind. Dept. of Rev., Rev. Ruling No. 2015-11ST (Nov. 21, 2016). Missouri: A telecommunications company that will provide interconnected voice over internet protocol (VOIP) telecommunications service to Missouri residents is not required to collect state and local sales tax on the Missouri Relay Assessment it will collect from customers because it is statutorily exempted and excluded from gross receipts for telecommunication service. In addition, the Missouri E-911 surcharge the company bills and collects from its customers for providing VOIP telecommunications service is not subject to state and local sales tax because the E-911 telephone taxes are imposed on the end user customer and are not part of the basic rate for telecommunications service. The Missouri Universal Service Fund and the Missouri Public Service Commission assessments charged by the company to its customers as surcharges for telecommunications service, however, are subject to state and local sales tax and, as such, the company should include both as part of gross receipts for providing telecommunications service. Mo. Dept. of Rev., LR 7766 (Dec. 12, 2016). Alaska: The Alaska Department of Revenue (DOR) issued a bulletin advising when a transferee can use a transferred tax credit certificate (TTCC), and how the "80% rule" is applied under Alaska Stat. §43.55.023(e). A TTCC issued under section 43.55.023(d) or a production tax credit certificate (PTCC) issued under section 43.55.025 that has been transferred from the party to whom the tax credit certificate was issued to another party may be applied only against the tax liability due under section 43.55.011(e) for calendar years that begin on or after the year in which the effective date the transfer of the tax credit certificate occurs. Under Alaska regulations, the transfer of a tax credit certificate is effective on the date the DOR sends notice to the transferor that the certificate has been transferred, thus the transferee of a tax credit certificate may apply the tax credits against the tax, or any installment payments of the estimated tax for the calendar year in which the effective date of the transfer of the certificate occurs. In addition, under the 80% rule of section 43.55.023(e), the TTCC may not be applied to reduce a transferee's total tax liability under section 43.55.011(e) for oil and gas produced during a calendar year to less than 80% of the tax that would otherwise be due without applying that credit. The 80% rule as applied to "total tax liability" means the sum of the tax liability due on March 31 of the year following the calendar year of production, plus or minus any amended or required liability subsequently determined to be due or owed for that calendar year of production, less any other credits that have been applied, prior to application of the credit under section 43.55.023(e). PTCCs issued under section 43.55.025 do not have this limitation. Alaska Dept. of Rev., Advisory Bulletin 2016-01 (Dec. 21, 2016). Georgia: The Georgia Department of Revenue issued guidance regarding series interim production period expenditures incurred by production companies. These expenses incurred before Jan. 1, 2017, qualify for the film tax credit and can be claimed in the tax year they are incurred. Series interim production period expenditures incurred on or after Jan. 1, 2017, qualify for the film tax credit if the subsequent season is filmed in Georgia and can only be claimed in the taxable year in which the subsequent season begins, even if some of the expenditures were incurred in the prior taxable year. Ga. Dept. of Rev., Policy Bulletin IT 2016-01 (Dec. 22, 2016). Illinois: The part of Illinois' property tax code granting a property tax exemption to a hospital applicant does not violate the Illinois Constitution's requirement that the property be used exclusively for charitable purposes because the Illinois General Assembly did not intend for satisfaction of the statute (35 ILCS 200/15-86) to ipso facto grant an exemption. Rather the General Assembly intended for the statutory requirements to be considered on a case-by-case basis, along with the constitutional requirements. In reaching this conclusion, the Illinois Appellate Court of the First District (Court) cited the Illinois Supreme Court's holding in Eden Retirement Center, Inc. v. Department of Revenue, 213 Ill. 2d 273, 285 (2004) that the satisfaction of a statutory requirement is not sufficient and does not end the analysis because the hospital seeking an exemption must still establish that the subject property is used exclusively for charitable purposes as required by Illinois Constitution Art. IX, section 6. The relevant part of, the statute at issue states: "A hospital applicant satisfies the conditions for an exemption under this Section with respect to the subject property and shall be issued a charitable exemption for that property … " Use of "shall" in the statute is directory in nature rather than mandatory, because: (1) the statute does not contain any negative language prohibiting noncompliance, and (2) the statute directs the Illinois Department of Revenue on its consideration of a hospital applicant's property tax status. The Court acknowledged that it reached a different conclusion than the Illinois Appellate Court of the Fourth District reached in a similar case, Carle Foundation v. Cunningham Township. Oswald v. Hamer, No. 12 CH 42723 (Ill. App. Ct., 1st Dist., Dec. 22, 2016). New York City: The New York City Department of Finance (Department) provided guidance on several changes in tax return due dates for partnerships and most C corporations (in response to recent federal and state changes to the same due dates), as well as 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. Due dates for the following tax returns (based on calendar year filing) have changed for tax years beginning on or after Jan. 1, 2016: (1) Form NYC 204, Unincorporated Business Tax Return for Partnerships (and attachments) is due March 15 (previously April 15); (2) Form NYC 204EZ, Unincorporated Business Tax Return for Partnerships (and attachments) is due March 15 (previously April 15); and (3) All NYC Business corporation Tax Returns (and attachments) are due April 15, including NYC-2, Business Corporation Tax Return (previously due March 15), NYC-2S, Business Corporation Tax Return (previously due March 15), and NYC-2A, Combined Business Corporation Tax Return (no previous due date). For MFI payments due on or after March 15, 2017, corporations subject to the business corporation tax under Administrative Code section 11-653 must compute the MFI by multiplying the tax imposed for the second preceding tax year by 25% if the business corporation tax imposed for the second preceding tax year exceeded $1,000. The MFI of the business corporation tax is still required to be paid on or before the 15th day of the third month following the close of each tax year, and must be made on Form NYC-300, Mandatory First Installment (MFI) By Business C Corporations. The remaining installments of estimated tax will continue to be paid with Form NYC-400, Estimated Tax by Business Corporations and Subchapter S General Corporations. N.Y.C. Dept. of Fin., Memo. Nos. 16-6 and 16-7 (Dec. 30, 2016). Alaska: The Alaska Department of Revenue's (Department) aggregation of a number of smaller oil fields that were economically interdependent with larger operations on the adjacent Prudhoe Bay oil field, in reliance on a statute, was not a regulation because it was a common sense interpretation of the statute. Therefore, the Department was not required to comply with rulemaking requirements under the Alaska Administrative Procedure Act (APA). In so holding, the Alaska Supreme Court (Court) found that the statute gives the Department the discretion to "aggregate two or more leases or properties (or portions of them), for purposes of determining [their effective tax rate], when economically interdependent oil or gas production operations are not confined to a single lease or property." The legislature never defined "economically interdependent" in production tax statutes, and the Department never defined it in related regulations. The Court reasoned that: (1) the Department interpreted the aggregation statute according to its own terms and did not add any requirements of substance; (2) the Department's interpretation of "economically interdependent" was foreseeable as consistent with the legislature's intent to tax different oil fields at different rates to reflect each field's underlying economics and incentivize oil production in smaller, less profitable fields, but there is no justification for maintaining different effective tax rates when fields become so integrated such that there is no meaningful separation between production in the different fields; and (3) the Department's decision did not depart from a previous interpretation of the aggregation statute. Chevron USA, Inc. et al. v. Alaska Dept. of Rev., No. S-15891 (Alaska S. Ct. Dec. 16, 2016). Illinois: The assignment of a mortgage on Chicago real estate is not subject to real estate transfer tax as an assignment of a beneficial interest in real property under the transfer tax ordinance because a mortgage creates a lien on a property and does not convey a beneficial interest in real property. In reaching this conclusion, an Illinois Appellate Court (Court) found the following supportive of this conclusion: legal authorities do not identify a mortgage as a beneficial interest in real property, statutorily listed beneficial interests all indicate a degree of ownership control, and a mortgage does not grant control over property. In addition, the availability of remedies to a mortgagee (such as the assignment of rents provisions) does not make the mortgagee the owner or controller of the property, because a mortgage creates only a security interest in real estate and confers no right to possession of that real estate on the mortgagee. City of Chicago v. Elm State Property LLC, Nos. 14 L 50273 and 14 L 50274 (Ill. App. Ct., 1st Dist., Dec. 22, 2016). New York: On the heels of landmark litigation and revisions to the Uniform Unclaimed Act, New York's unclaimed property (UP) administration (NY Administration) recently shortened the state's Voluntary Compliance Agreement (VCA) look-back period by 10 years and began contracting with third-party contingent fee audit firms. The NY Administration offers a formal VCA program that allows a holder to self-calculate and disclose its liability without the imposition of penalty or interest. The VCA is always a preferred method for a holder to come into compliance (as compared to being subject to a state or contract firm audit). In order to participate in the VCA, a holder must not have been contacted by the NY Administration for a UP audit and be a first-time reporting organization (in some cases, the state's VCA program allows Holders who filed in the past to apply again if they failed to report a particular type of property and want to voluntarily correct the error.) The NY Administration offers two options for complying voluntarily: (1) a self-audit checklist filed with the NY Administration with an accompanying liability report. This option does not provide a substantive review or a full closure of these periods, or (2) a more formal program in which a VCA is entered with the NY Administration with detailed exposure calculations prepared and presented to the state. This option will require greater review by the NY Administration but will provide closure after acceptance. For more on this development, see Tax Alert 2017-126. 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: 2017-0197 |
