24 February 2017 State and Local Tax Weekly for February 24 Ernst & Young's State and Local Tax Weekly newsletter for February 24 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. Colorado court finds out-of-state intangible holding company has nexus with state, revenue department's proposed alternative apportionment formula is not reasonable The Colorado District Court (Court) in Target Brands Inc. held that an out-of-state intellectual property holding company (Brands), which was formed as an 80-20 company and had no physical presence in the state, is "doing business" under Colorado's nexus standard and, therefore, is subject to Colorado corporate income tax. Additionally, while the Colorado Department of Revenue (Department) met its burden to depart from using the standard apportionment formula, the Court concluded that its proposed alternative apportionment formula was not reasonable. Target Brands Inc. v. Colorado Dept. of Rev., No. 2015CV33831 (Colo Dist. Ct., City and Cnty. of Denver, Jan. 27, 2017). A big-box retailer (Parent) that operates retail stores nationwide, including Colorado, formed Brands as a wholly owned subsidiary. Brands was formed outside of Colorado and it had no employees or property in the state. Parent and Brands executed contribution and license agreements under which Parent contributed its intellectual property (IP) to Brands, and Brands granted Parent an exclusive right to use its current and future IP. In exchange for the right to use the IP, Parent made monthly royalty payments to Brand. The royalty payments made up most of Brands' income, however, Brands also received limited income from unrelated third parties. During the years at issue, Brands did not file a separate Colorado income tax return, and Colorado had a three-factor apportionment formula with an "all or nothing" cost of performance standard for sourcing income from non-tangible personal property. The Department and the Multistate Tax Commission (MTC) audited Brands and concluded that Brands had nexus in Colorado during the audit periods, and that an alternative apportionment should be used to eliminate Brands' property and payroll factors (which were zero) and instead determine Brands' sales factor based on market-based sourcing (e.g., licensee affiliate's sales of licensed products in Colorado). On appeal, the Court affirmed the audit findings that Brands was "doing business" in Colorado under the state's nexus statute. The Court found supportive of this conclusion the fact that Brands chose to license its IP for use by Parent in Colorado, it chose to base the royalties it received under the license based on Parent's sales in Colorado and nationwide, it relied on Parent to represent its IP "in the best light possible" in Colorado, and it received millions in income related to the use of its IP in Colorado. The Court also held that imposition of the tax on Brands does not violate the Commerce Clause and that physical presence is not required to establish Commerce Clause substantial nexus for income tax purposes finding that the physical presence standard applies only to sales and use tax. The Court noted the reason for the different standards related primarily to the increase in the sales tax compliance burdens compared to those for income tax purposes. The Court also agreed with the Department that application of the then standard three-factor apportionment formula did not fairly represent Brands' Colorado activities. (The Court pointed out that the state adopted a single sales factor apportionment formula in 2009.) Application of the standard formula would have resulted in none of Brands' income being sourced to Colorado. Brands' payroll and property factors were both zero since all of its employees and property were located outside the state, and under the cost of performance sourcing method all of Brands' sales would be sourced outside the state (resulting in a zero factor) because all the income producing activity related to Brands' income occurred outside Colorado. Thus, under application of standard apportionment formula, Brands had a zero factor which would have resulted in Brands owing no Colorado corporate income tax. Although the Court found the Department permissible applied an alternative apportionment formula, it found the Department's proposed alternative, which excluded all of Brands' factors (property, payroll and sales) and instead substituted a single new factor consisting of Parent's sales factor, is not a reasonable alternative apportionment method, due to material contributions of Brands' employees and property to creating the income the Department sought to tax. The Court concluded that the alternative formula must include Brands' payroll and property factors. Arkansas: New law (HB 1390) updates statutory references to certain IRC provisions to those in effect on Jan. 1, 2017 (formerly, Jan. 1, 2015, unless otherwise noted). Updated references include the definition of "gross income" under IRC Section 117 (to Jan. 2, 2017, from Jan. 2, 2013) (all references to "Section" hereafter are to the relevant section or sections of the IRC); exclusions from the definition of "gross income" under Sections 108 and 1017 (discharge of indebtedness), disability and health plan payments under Section 105 (formerly March 30, 2010), 132 (fringe benefits); adoption of IRC Subchapter S; gains or losses on sales of property for purposes of computing income tax under Section 267 (formerly Jan. 1, 2001); gains or losses on exchanges of property for purposes of computing income under Sections 351, 354-358, 361, 362, 367 and 368 (formerly Jan. 1, 2009); deferred compensation plans under Sections 72, 219, 402-404, 406-416 and 457; interest deduction under Section 163; charitable contribution deduction under Section 170; depreciation under Sections 167 and 168(a)-(j); IRC Subchapter M (dealing with special business organizations such as insurance companies, REITs and RICs), and computing capital gains and losses for income tax purposes under Section 1202, regarding the exclusion from gain of certain small business stock (formerly Jan. 1, 1995). These changes are retroactively effective for tax years beginning on or after Jan. 1, 2015. Ark. Laws 2017, Act 155 (HB 1390), signed by the governor on Feb. 10, 2017. Massachusetts: The Massachusetts Department of Revenue (Department) issued a technical information release explaining that in addition to "safe harbor" rules provided in TIR 98-6, the holding of shareholders meetings or boards of directors meetings by offshore investment companies in Massachusetts will not, by themselves, result in the offshore investment company being treated as doing business in Massachusetts for corporate tax purposes. That extends to the holding of boards of directors meetings by non-US companies that serve as management companies for certain offshore investment companies, provided such meetings are exclusively related to the management of such offshore investment companies. The following activities conducted in Massachusetts by an offshore investment company, however, may expose it to Massachusetts tax jurisdiction: (1) maintaining its principal corporate records and books of account, (2) maintaining a place of business, and (3) executing contracts. If an offshore investment company is doing business in Massachusetts and is subject to the Massachusetts corporation excise, it may apply for security corporation classification if it is engaged exclusively in buying, selling, dealing in, or holding securities on its own behalf and not as a broker. If such an offshore investment company has no effectively connected income (ECI) and has no US-source non-ECI, it would have no federal gross income, and it would be subject only to the minimum excise imposed. Mass. Dept. of Rev., TIR 17-2 (Feb. 16, 2017). New York: Proposed amended regulations (draft amendments to N.Y. Comp. Codes R. & Regs. tit. 20 § 1-3.2) revise provisions related to foreign corporations subject to tax. Corporate tax reform legislation enacted in 2014, and amended in 2015, expanded New York State's corporation franchise tax (Article 9-A) economic nexus provisions, effective for tax years beginning on and after Jan. 1, 2015. This draft further amends draft amendments to New York Comp. Codes R. & Regs. tit. 20, §§ 1-3.1 through 1-3.5, which are intended to provide guidance on new nexus creating activities for foreign corporations or members of a unitary group. N.Y. Comp. Codes R. & Regs. tit. 20, § 1-3.2(a)(4) is amended to state that a foreign corporation engaged in activities that subject it to tax remains subject to tax even after it surrenders its authority to do business. N.Y. Comp. Codes R. & Regs. tit. 20, § 1-3.2(a)(6) and (7) amendments include the exception that corporate partners are subject to tax under Article 9-A unless already subject to tax under Article 9 or 33, which is consistent with other provisions. Finally, N.Y. Comp. Codes R. & Regs. tit. 20, § 1-3.2(b)(4) is amended to provide for a cross-reference of the definition of "credit cards" to the apportionment regulations. The draft amendments are in addition to those dated June 3, 2016. Comments to the draft regulations are due by May 11, 2017. N.Y. Dept. of Taxn. and Fin., Prop. Amended N.Y. Regs. 1-3.2 (Feb. 10, 2017). Arkansas: New law (HB 1162) imposes Arkansas' full gross receipts and use taxes on specified digital products and digital codes. The gross receipts tax is imposed on sales of digital codes and specified digital products sold to a purchaser who is an end user and who has a right of permanent use or less than permanent use granted by the seller, regardless of whether the use is conditioned on continued payment by the purchaser. The term "specified digital products" includes digital audio works, digital audio-visual works, and digital books. "Digital code" is defined as "a code that: (A) provides a purchaser with a right to obtain one or more specified digital products; and (B) may be obtained by any means, including email or tangible means, regardless of its designation as a song code, video code, or book code … " The definitions of "ancillary service" and "telecommunications service" are amended to specify that they do not include specified digital products or a digital code, and various exemption provisions are updated to specifically exempt these sales when made to certain groups (e.g., charitable and nonprofit organizations). Excise taxes also may be imposed on the sale of specified digital products and digital code. Further, out-of-state vendors that sell specified digital products and digital code for storage, use, distribution or consumption in Arkansas must register with the Director of Finance and Administration and provide the Director with certain information. Guidance is provided for sourcing sales of specified digital products and digital code as well as filing returns and remitting tax due. These changes are effective for tax years beginning on and after Jan. 1, 2018. Ark. Laws. 2017, Act 141 (HB 1162), signed by the governor on Feb. 7, 2017. Florida: The US Supreme Court will not review the Florida Supreme Court's decision in American Business USA Corp., in which it held that an in-state florist that sold flowers, gift baskets and other goods via its online website is liable for sales tax on all its sales, including sales to out-of-state customers for out-of-state deliveries, as the imposition of tax does not violate the dormant Commerce Clause or the Due Process Clause of the US Constitution. Florida Department of Revenue v. American Business USA Corp., No. SC14-2404 (Fla. S. Ct. May 26, 2016), cert. denied, Dkt. No. 16-567 (U.S. S. Ct. Feb. 21, 2017). Tennessee: Two trade associations are seeking a declaratory order that Rule 1320-05-01-.129(2) promulgated by the Tennessee Department of Revenue (Department) and which implements an economic nexus standard for sales and use tax purposes, is unconstitutional and unenforceable. The trade associations argue that the rule is unconstitutional under the substantial nexus requirement as it "runs afoul of the Quill physical presence standard." The trade associations further argue that the Department, in adopting the rule, "relied not on current law, but on a hoped-for future change in the Quill physical presence standard by the [U.S.] Supreme Court. An anticipated change in law cannot be the basis for an administrative rule that contravenes existing [U.S.] Supreme Court precedent." American Catalog Mailers Association and NetChoice, petition for declaratory order before the Tenn. Dept. of Rev. (filed Jan. 27, 2017). For additional information on the rule and its requirements, see Tax Alert 2017-164. Virginia: New law (HB 2058) expands Virginia's sales and use tax nexus provisions to include storage of inventory in Virginia by a dealer. Specifically, the statute is amended to provide that nexus is created for a dealer that "owns tangible personal property that is for sale located in this Commonwealth or that is rented or leased to a consumer in this Commonwealth, or offers tangible personal property, on approval, to consumers in this Commonwealth." This change is effective July 1, 2017. Va. Laws 2017, Ch. 51 (HB 2058), signed by the governor Feb. 20, 2017. Georgia: A manufacturer cannot amend its 2013 and 2014 tax returns to elect the quality jobs tax credit (QJTC) in lieu of the previously elected jobs tax credit (JTC) because the QJTC statute prohibits a taxpayer from using the JTC and the QJTC for the same jobs, and the regulation enacted to implement and administer the QJCT (Ga. Comp. R. & Regs. 560-7-8-.51) clarifies that a taxpayer may not interchange or alternately claim (i.e., switch back and forth) between the credits with respect to the same underlying jobs. Citing Chevron, the Georgia Tax Tribunal (Tribunal) upheld the validity of the regulation's prohibition on interchanging the credits, finding such prohibition authorized by statute when the QJTC statute is silent as to whether a JTC election can be changed. Moreover, such interpretation of the QJTC statute is reasonable as the tax savings of the QJTC and the JTC may be applied in, and carried forward to, other tax years. Although the QJTC and the JTC regulations do not state that claiming the JTC on an original return creates an "irrevocable election," the Georgia Department of Revenue's policy is not an unwritten policy in violation of the Administrative Procedures Act. Lastly, the Tribunal rejected the manufacturer's fairness argument that it was left with no warning of the consequences of claiming the JTC, reasoning that the manufacturer should have been on notice since the QJTC was enacted after the JTC and the limiting language was in the initial legislation creating the QJTC, which was enacted before the manufacturer made its claim for the JTC. Sewon America, Inc. v. Riley, No. 1627180 (Ga. Tax Trib. Jan. 24, 2017). New York City: New law (Int. No. 1281-A) requires the evaluation of economic development tax expenditures (i.e., any exclusion, exemption, abatement, credit, or other benefit allowed against city tax liability that induces behavior related to producing business income or investment income). The expenditure evaluator must submit a report to the speaker of the New York City Council (Council) regarding each economic development tax expenditure reviewed and evaluated. The report must include: (1) a description of the economic development tax expenditure reviewed and evaluated, (2) the data considered and the methodology and assumptions used in conducting the review and evaluation, (3) an analysis of the economic development tax expenditure's effectiveness and whether it is achieving its goals, (4) whether and to what extent the economic development tax expenditure goals are still relevant, (5) recommendations for future evaluations of the economic development tax expenditure, and (6) other information as may be requested by the Council or that the evaluator deems relevant to the report. The report must be made publicly available upon its submission to the speaker of the Council. The law took immediate effect. NYC Laws 2017, Local Law 18 (Int. No. 1281-A), signed by the mayor on Feb. 15, 2017. Michigan: The Michigan State Tax Commission (Commission) issued revised guidance related to the filing of Form 2698 (Idle Equipment, Obsolete Equipment and Surplus Equipment Report). The Commission stated that the form should not be altered in any manner, including adding on page two a new section called Part B: Cellular Telephone Electronic and Optical Switching and Routing Equipment, because such equipment is not subject to the idle/obsolete/surplus treatment. Assessors should not accept these modified forms. In addition, for Eligible Manufacturing Personal Property (EMPP) filings on Form 5278 (Eligible Manufacturing Personal Property Tax Exemption Claim, Ad Valorem Personal Property Statement, and Report of Fair Market Value of Qualified New and Previously Existing Personal Property) that include Form 2698 for the years 2013, 2014, 2015, 2016, as well as 2006 and prior, are reported on Form 5278 in Part 3. The guidance reiterates the statutory definition of "acquisition cost" and notes that the Michigan Department of Treasury (Department) may provide guidelines for circumstances in which the actual acquisition price is not determinative of acquisition cost and the basis of determining acquisition cost in those circumstances. The Department has not, for 2017 filings, issued guidelines that would allow for the reduction of acquisition cost for property that is idle, obsolete, or surplus, so EMPP reported for years 2013, 2014, 2015, 2016 and 2007 and prior on Part 3 of Form 5278 should be reported at the acquisition cost defined by statute (the fair market value at the time of the acquisition by the first owner) and should not be subject to any additional reduction for idle, obsolete, or surplus treatment. Mich. State Tax Comn., Revised: Idle/Obsolete Property (Feb. 14, 2017). Virginia: New law (HB 2246) establishes a tax amnesty program that will run for a 60-75 day period sometime between July 1, 2017 and June 30, 2018. The amnesty program is open to taxpayers required to file a return or pay any tax administered by the Virginia tax department. In exchange for participating in and complying with the terms of the amnesty program, penalties and one-half interest assessed or assessable for nonpayment, underpayment, nonreporting or underreporting of tax liabilities will be waived. A taxpayer is not eligible to participate in the amnesty program: (1) if the taxpayer is under investigation or prosecution for filing a fraudulent return or failing to file a return with the intent to evade tax; (2) with respect to any outstanding assessment that was issued less than 90 days prior to the start of the amnesty program or any liability arising from the failure to file a return that was due less than 90 days prior to the start of the amnesty program; and (3) for any corporate, individual and estate/trust income tax liabilities attributable to taxable years beginning on and after Jan. 1, 2016. If the eligible taxpayer has an outstanding balance due after the close of the amnesty program, a 20% penalty will be imposed on the unpaid tax. The Tax Commissioner has been tasked with setting the dates of the amnesty program and establishing the program's rules and guidelines. Va. Laws 2017, Ch. 53 (HB 2246), signed by the governor on Feb. 20, 2017. Colorado: Emergency amended regulation (emergency Colo. Rule 39-29-102(3)(A)), adopted in response to the decision by the Colorado Supreme Court (Court) in BP America, provides the method for calculating the cost of capital deduction and clarifies deductions allowable for purposes of the severance tax imposed on oil and gas companies. In BP America an oil company was allowed to deduct the cost of capital related to its transportation and processing facilities from revenue generated by natural gas sales subject to severance tax because the plain language of the deduction for any transportation, manufacturing or processing costs includes the cost of capital resulting from investment in transportation and processing facilities. Under the emergency regulation, "gross income" is calculated by deducting from gross lease revenues costs for transporting, manufacturing, and processing identifiable, measurable oil or gas. For purposes of the regulation, the term "identifiable and measurable oil or gas" is defined as oil or gas that has been separated from a bulk production stream and then is separately measured. No deduction is allowed for the cost of transporting, manufacturing, or processing an unseparated bulk production stream in which oil and gas has not yet been separated and measured. Except as otherwise required, costs are deductible in a manner consistent with the calculation of "net taxable revenues" by statute for property tax purposes. The emergency rule is effective for a 120-day period, unless sooner terminated or replaced with a permanent rule. Colo. Dept. of Rev., emergency Colo. Rule 39-29-102(3)(A) (effective Jan. 23, 2017). 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: 2017-0458 |
