12 September 2017 State and Local Tax Weekly for August 31 Ernst & Young's State and Local Tax Weekly newsletter for August 31 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. The Wisconsin Tax Appeals Commission (TAC) recently issued its decision in Microsoft Corp. v. Wisconsin Dep't. of Rev., in which it determined that a multistate tech company's sales factor does not include receipts from royalties received from original equipment manufacturers (OEMs) to the extent no income-producing activity occurred in Wisconsin. In so doing, the TAC rejected the Wisconsin Department of Revenue's (Department) arguments asserting a "look-through" approach in situsing the royalties based on where end-users utilized the software that was the subject of the royalties. Microsoft Corp. v. Wisconsin Dep't. of Rev., Wisconsin Tax Appeals Comm'n. Dkt. No. 13-I-042 (Wis. Tax Appeals Comm'n Aug. 10, 2017). The Department argued that Wis. Stat. §71.25(9)(df) (which provides that receipts from the use of computer software are sitused to Wisconsin if the purchaser or licensee uses the software in Wisconsin), applied to the royalties the tech company received from the OEMs for the use of its software and, therefore, they should be sitused to Wisconsin as receipts from the use of software. Although most of the OEMs did not have a presence in Wisconsin, the Department argued any royalty that a manufacturer pays the tech company for software used by a Wisconsin customer should be apportioned to the state regardless of where the manufacturer is located, reasoning that the right the OEMs purchased under the licensing agreement in order to "install" the software is worthless without the accompanying right to "use" the software. Accordingly, the Department argued that a "look-through" approach to the end-user was warranted. In contrast to the presence of the OEMs in Wisconsin, a significant percentage of their end-users were located in Wisconsin. The tech company's argument was two-fold: (1) Wis. Stat. §71.25(9)(df) did not apply as the receipts were not from the use of software in Wisconsin; and (2) instead, Wis. Stat. §71.25(9)(d), which addresses the situsing of royalties from intangibles, applied to the payments received from the OEMs. The TAC first stated this case was a matter of statutory interpretation and that both parties agreed that the receipts at issue were not from the sale of tangible personal property. The TAC then turned to the issue of whether Wis. Stat. §71.25(9)(df) applied. Since the OEMs did not "use" the software (the TAC finding that "[t]he OEMs are not creating documents or running spreadsheets") as contemplated by the statute, the TAC concluded the tech company sold licenses that allowed the OEMs to replicate the tech company's software onto some, but not necessarily all, of the computers they built for potential sale to end-users or retail customers. The OEMs, and not the end-users or retail customers down the line, were the tech company's customers. Therefore, since: (1) the royalties received by the tech company were not a function of use by actual end-users, and (2) the royalties were due without regard to whether the software was ever used by any end-users, the TAC rejected the Department's look-through approach. Instead, the TAC found that Wis. Stat. §71.25(9)(d) applied and found that because none of the income-producing activities performed by the tech company occurred in Wisconsin, the royalties could not be sourced there. For additional information on this development see Tax Alert 2017-1367. Arkansas: A company's sale of tax credits are an integral part of its business under the functional test; thus, the proceeds generated from the sales are apportionable business income. The Administrative Law Judge (ALJ) for the Arkansas Department of Finance and Administration (Department) citing Kroger,1 reasoned that under the functional test, the credits were used in the company's business operations. The company received the credits based on the business in which it is engaged, it has managed the credits since 2011, and it sold credits in 2013, 2014, and 2015, with credit sales contributing to its federal taxable income for 2015. Citing Getty Oil Exploration Co.,2 the ALJ did not address whether the credits constitute business or nonbusiness income under the transactional test, stating such analysis was not necessary because satisfaction of either the transactional test or functional test is determinative. Further, the ALJ rejected the company's questioning of the validity of a separate functional test after a 2015 law change requiring a narrow construction of the statute, finding this change "did not operate to repeal or reverse" the Arkansas Supreme Court's interpretation of business income in Getty Oil. Ark. Dept. of Fin. and Admin., Admin. Dec. No. 17-396 (Aug. 7, 2017). Colorado: The Colorado Department of Revenue (Department) adopted amendments to Rule 1 CCR 201-2, 39-22-303(11)(c), clarifying that an affiliated group of corporations should use the post-apportionment method for combined reporting and consolidated return purposes when group members do not use the same apportionment methodology. Under the amended rule, members of an affiliated group filing a combined report must derive a single apportionment factor for the combined group by summing the numerator of each affiliated corporation doing business in Colorado. Intercompany transactions are eliminated before calculating income, gross sales, apportionment, or de minimis determinations under this rule. When members of an affiliated group are subject to multiple apportionment methodologies and the gross sales of one commercial activity are less than 1% of the taxpayer's total gross sales, the activity is conclusively de minimis. Taxpayers must apportion income from de minimis activity in the same ratio they apportion their gross sales, using the sales factor they use for the remainder of the commercial activity. If that amount is less than 5% of the taxpayer's total gross sales, the commercial activity may be de minimis depending on the facts. If it is de minimis, the taxpayer will apportion that income as described. If the multiple activities give rise to gross sales that are not de minimis, then the taxpayers must use the apportionment methodology most applicable to each commercial activity and separately allocate and apportion Colorado income for all commercial activity. Colorado taxable income for each commercial activity is computed on a separate apportionment schedule and then combined. NOL carryforwards are applied, and tax and credits are computed, on a combined basis. The rule includes examples of the application of these provisions. The amended rule takes effect Sept. 14, 2017. For more on this development see, Tax Alert 2017-1394. New York: In corporate income tax guidance the New York State Department of Taxation and Finance (Department) determined that direct and indirect owners of a registered broker-dealer cannot use the broker-dealer rules to assign their own service receipts to New York, as neither were registered broker-dealers eligible for the market-sourcing treatment under the pre-2014 rules. This ruling is merely the Department's interpretation of the law, and may not be used as precedent. NYT-G-17(2)C, Corporation Tax, Receipts Factor Methodology For The Owners Of Single Member Limited Liability Companies That Are Registered Broker-Dealers (Aug. 2, 2017). For additional information on this development, see Tax Alert 2017-1366. New York: InIn the Matter of Stewart's Shops Corporation, the New York's Tax Appeals Tribunal upheld an Administrative Law Judge (ALJ) decision that a parent company cannot deduct premiums paid to a subsidiary captive insurance company from its New York entire net income (NY ENI) because the arrangement for which the premiums were paid did not constitute insurance for federal income tax purposes. For additional information on this development, see Tax Alert 2017-1381. North Carolina: New law (SB 628) reinstates a franchise tax deduction (previously eliminated in 2015) that permits taxpayers to reduce the tangible property base by the amount of any debt owed on the property. The debt must be specifically incurred and exist solely for and as a result of the purchase of any real estate and any permanent improvements made on the real estate. This becomes effective for taxable years beginning on or after Jan. 1, 2020, and is applicable to the calculation of franchise tax reported on the 2019 and later corporate income tax returns. Provisions of SB 628 also modify the base of the franchise tax to be the greatest of: (1) the proportion of its net worth, (2) 55% of the corporation's appraised value as determined for ad valorem taxation of all the real and tangible personal property in North Carolina, or (3) the corporation's total actual investment in tangible property in North Carolina. For C corporations, the tax rate is $1.50 per $1,000 of the tax base, with a minimum tax of $200. For S corporations, the tax rate is $200 for the first $1 million of the corporation's tax base, and $1.50 per $1,000 of its tax base that exceeds $1 million, with a minimum tax of $200. These tax base provisions took effect Aug. 11, 2017. N.C. Laws 2017, S.L. 2017-204 (SB 628), signed by the governor on Aug. 11, 2017. North Carolina: New law (SB 628) amends various definitions under North Carolina's corporate income allocation and apportionment provisions. For example, the term "apportionable income" is amended to mean all income that is apportionable under the U.S. Constitution, including income that arises from either transactions and activities in the regular course of the taxpayer's trade or business, or tangible and intangible property if the acquisition, management, employment, development, or disposition of the property is or was related to the operation of the taxpayer's trade or business. (Emphasis added to reflect new text). Additionally, the "qualified interest expense" paid or accrued to a related member in a taxable year limitation is modified so that it is limited to the taxpayer's proportionate share of interest paid or accrued to a person who is not a related member during the same taxable year (previously, the qualified interest expense was limited to either this proportionate share or 15% of the taxpayer's adjusted taxable income). Finally, in determining whether a nominal debt instrument creates deductible interest, the revenue secretary will not apply the covered debt instrument rules contained in the IRC § 385 debt-equity regulations. These changes are effective for taxable years beginning on or after Jan. 1, 2017. N.C. Laws 2017, S.L. 2017-204 (SB 628), signed by the governor on Aug. 11, 2017. Virginia: Proposed amended regulations (23 Va. Admin. Code §§ 10-330-20 and -30) would modify bank franchise tax regulations relating to the computation of net capital and deductions from gross capital to reflect current Virginia Department of Taxation (Department) policy. Under the proposal, the computation of a bank's net capital would be amended to include in the gross capital computation one half of any reserve for loan losses net of applicable deferred tax, and include in the deduction from gross capital the value of goodwill determined using generally accepted accounting principles and delete from inclusion amounts of reserve for loan losses. In addition, gross capital (currently the total of capital stock, surplus, and undivided profits) would be expanded to include one half of any reserve for loan losses net of applicable deferred tax. Under the proposal, an addition to gross capital would have to be made "equal to one half of the reserve for loan losses net of applicable deferred tax." "Reserve for loan losses" would be the amount of the reserve for loan losses as shown on the bank's official report of condition, and "applicable deferred tax" would equal the "reserve for loan losses" divided by two and then multiplied by the bank's effective federal and state income tax rates that were used to calculate any deferred tax amounts included in the bank's official report of condition, but not less than zero. Finally, the proposal would provide that any portion of an amount added to federal taxable income by a corporation for interest expenses and costs paid to the bank for a loan or other obligation made by the bank to the corporation would have to be deducted from the bank's gross capital if certain requirements are met. The Department's proposed changes are being implemented on a fast-track basis as they are expected to be noncontroversial because they reflect current law and will not change the Department's current policy. Public comments are due Oct. 6, 2017. If approved, the changes would take effect Oct. 23, 2017. Va. Dept. of Taxn., Proposed Amended 23 Va. Admin. Code §§ 10-330-20 and -30 (issued Aug. 7, 2017). Alabama: The US Supreme Court (USSC) has been asked to review the Alabama Supreme Court's decision in Jefferson County in which it held that a constitutional amendment can be retroactively applied to cure a constitutional deficiency affecting a piece of enacted legislation that imposed a local sales and use tax in Jefferson County. The Justices of the USSC will consider whether to grant or deny certiorari during their Sept. 25, 2017 conference. Jefferson Cnty. and Jefferson Cnty. Comn. v. Taxpayers and Citizens of Jefferson Cnty., Nos. 1150326 and 1150327 (Ala. S. Ct. March 17, 2017), petition for cert. filed, .Dkt. 17-281 (U.S. S. St.). Michigan: A convenience store's (store) sales of electronic personal identification numbers (EPIN), but not its sales of PINless top-up transactions, for wireless calling arrangements for prepaid cellphones are subject to Michigan's sales tax because only the EPINs fall within the definition of a taxable prepaid authorization number for telephone use. In interpreting for the first time the statute (Mich. Comp. Laws Sec. 205.52(2)(b)) imposing sales tax on the sale of prepaid telephone calling cards or prepaid authorization numbers for telephone use, the Michigan Court of Appeals (Court) found the Legislature's intent was "to tax the sale of both prepaid tangible (calling cards) and intangible authorization number for telephone services, as well as reauthorization of those numbers." Based on the plain meaning of the statute, the Court held the Michigan Tax Tribunal erred in finding both the EPIN and the PINless top-up calling arrangement to be new types of taxable telephone calling cards. EPINs nevertheless are taxable as they represent prepaid authorization numbers. In so holding, the Court reasoned the EPIN purchaser receives a PIN on a receipt that must be entered on his/her cellphone in order to access the telephone services associated with the PIN. Sales of "PINless top-up minutes," however, are not subject to sales tax, because no authorization number or PIN is needed to access the phone service as the additional minutes are downloaded instantly to the purchaser's cellphone. Garfield Mart, Inc. v. Mich. Dept. of Treas., No. 333094 (Mich. App. Ct. Aug. 8, 2017). New York: The New York Department of Taxation and Finance issued guidance on the recent statutory change that eliminated the resale exemption from sales tax for sales of tangible personal property between certain related entities and the narrowing of the use tax exclusion for purchases made out of state by nonresident businesses. Both changes were enacted earlier this year as part of the FY 2018 Executive Budget and apply to sales made and uses occurring on or after April 10, 2017. N.Y. Dept. of Taxn. and Fin., TSB-M-17(4)S (Aug. 14, 2017). For more on this development, see Tax Alert 2017-1401. North Carolina: New law (SB 628) amends various sales and use tax law provisions. Changes in the bill do the following: (1) apply the general principle that a service is sourced to where the purchaser can potentially make first use of the service; (2) define/amend various terms, including capital improvement, service contracts, mixed transaction contracts, new construction, remodeling and reconstruction; (3) modify provisions related to real property contracts and provide that a service to real property is subject to tax as retail sales of or the gross receipts derived from repair, maintenance, and installation services, unless the taxpayer substantiates that the transaction is a real property contract, is subject to tax as a mixed transaction, or it is not subject to tax; (4) modify sales and use tax exemption provisions for motor vehicles, installation charges, and repair, maintenance or installation services, among others; (5) establish a no assessment grace period (March 1, 2016 through Dec. 31, 2017) for specific sales tax base expansion changes that took effect in 2016 (certain assessments are not prohibited); (6) permit the North Carolina Department of Revenue to reduce by 90% a sales and use tax assessment against a taxpayer when it is based on the incorrect application of certain linen charges furnished by a facilitator, rental agent, or other person; and (7) exempt from sales and use tax human blood and human tissue, and the sales price of or the gross receipts derived from the repair, maintenance, and installation services and service contracts of an aircraft with a gross take-off weight of more than 2,000 pounds (applicable to sales made on or after July 1, 2019). These changes have various effective dates. N.C. Laws 2017, S.L. 2017-204 (SB 628), signed by the governor on Aug. 11, 2017. Illinois: On Aug. 13, 2017, the Illinois General Assembly approved HB 162 (the bill), to restore the Economic Development for a Growing Economy (EDGE) tax credit. If enacted, the bill would allow the Illinois Department of Commerce and Economic Opportunity (DCEO) to enter into EDGE agreements through June 30, 2022 (from the prior expiration date of April 30, 2017). The bill also would modify the manner in which the maximum amount of credit allowed is determined, change the requirements that must be met in order to qualify for the credit, prohibit EDGE credits from being credited against the taxpayer's withholding tax liability, and establish clawback provisions. The bill will next go to Governor Rauner (sent to him on Sept. 11, 2017), who will have 60 days to act on it. The Governor is expected to sign the bill. For additional information on this development, see Tax Alert 2017-1363. New Jersey: New law (AB 4432) amends the Grow New Jersey Assistance Program to increase tax credits available for certain businesses that have collaborative research relationships with colleges or universities. A business can qualify for the highest base tax credit amount ($5,000 per job, per year) if the business locates a qualified business facility at or within three miles of a New Jersey doctoral university, and the facility is used by the business in a targeted industry to conduct a collaborative research relationship with that university. An additional $1,000 tax credit per job, per year, also is available if the business is in a targeted industry, locates a qualified business facility on, or within three miles of, the campus of a college or university other than a doctoral university, and the facility is used by the business to conduct a collaborative research relationship with the college or university. These changes took immediate effect. NJ Laws 2017, Ch. 221 (AB 4432), signed by the governor on Aug. 7, 2017. All States: In response to the significant destruction caused by Hurricane Harvey in Southeastern Texas and Southwestern Louisiana, government entities throughout the US are providing various tax relief to affected individuals and businesses. Such relief includes extending tax filing deadlines, providing exemptions or suspensions from tax, and waiving certain regulatory requirements. To date, the IRS, Texas, Alabama, California, Florida, Georgia, Kansas, Maryland, Mississippi, New Mexico and Pennsylvania are among the jurisdictions providing some form of relief to those affected by Hurricane Harvey. Additional states are expected to provide filing relief to taxpayers impacted by Hurricane Harvey as well. Taxpayers should note that in some situations, they must specifically request the relief available. For additional information, see Tax Alert 2017-1420. California: New law (AB 1719) modifies various penalty provisions. AB 1719 repeals a provision imposing a penalty on a person who has a duty to file an information return as a material advisor on certain reportable transactions and fails to keep the records, absent reasonable cause. In addition, for voluntary disclosure agreements entered into on or after Jan. 1, 2017, AB 1719 expands the types of partnership penalties waived to include a penalty related to a limited liability company classified as a partnership that fails to make specified returns. It also waives a penalty for S corporations that fail to make specified returns. Finally, AB 1719 retroactively decouples from the $50,000 federal penalty imposed on a real estate investment trust (REIT) to maintain its status when it fails to satisfy requirements under IRC §§ 856 through 859 retroactively to taxable years beginning on or after Jan. 1, 2005 (with the Legislature recognizing the duplicative nature of the inadvertent duplication of the federal penalty). Cal. Laws 2017, Ch. 176 (AB 1719), signed by the governor on Aug. 7, 2017. North Carolina: New law (SB 628) adds a new administrative statutory provision to clarify that the term "inaction" (i.e., a taxpayer not responding to the North Carolina Department of Revenue's (Department) initial request for additional information or to the reissuance of the request by the requested response date) by a taxpayer after timely filing a request for review will result in the proposed refund denial or the proposed assessment becoming final. Partial responses, requests for additional time, or any other contact by the taxpayer with the Department does not constitute inaction. The Department is required to send the taxpayer a notice of inaction stating that the proposed refund denial or assessment becomes final 10 days from the notice date unless the taxpayer responds to the Department. No further administrative or judicial review will be provided once the proposed refund denial or assessment becomes final, and a taxpayer cannot file another amended return or refund claim to obtain the denied refund. Once the taxpayer pays the tax, the taxpayer can request a refund. The bill makes other amendments to refund review procedures. This change took effect upon becoming law. N.C. Laws 2017, S.L. 2017-204 (SB 628), signed by the governor on Aug. 11, 2017. Massachusetts: New law (HB 3822), starting in 2018, increases the Employer Medical Assistance Contribution and adds a new second tier tax to partially fund the $600 million MassHealth shortfall. These added taxes will be offset by a decrease in future employer state unemployment insurance rates. For more information on this development, see Tax Alert 2017-1357. North Carolina: New law (SB 628) clarifies that the additional tax imposed on property coverage contracts is a special purpose assessment based on gross premiums and is not a gross premiums tax. In addition, for taxable years beginning before Jan. 1, 2017, a taxpayer that elected to take a business energy and tax credit against the gross premiums tax for a taxable year beginning before 2017, may take an installment or carryforward of the credit against the additional tax. A refund request related to this change must be made before Jan. 1, 2018. The option of taking an installment sale or carryforward of the credit against the additional tax is not allowed for taxable years beginning before or after Jan. 1, 2017. The North Carolina legislature indicated a reason for the law change was to expressly codify the North Carolina Department of Revenue's long-standing interpretation of the law. N.C. Laws 2017, S.L. 2017-204 (SB 628), signed by the governor on Aug. 11, 2017. International: The United Arab Emirates (UAE) Federal Government has approved the Value-Added Tax (VAT) Law (the Law) and published the statute on Aug. 27, 2017. Article 85 provides that the Law shall be effective from Jan. 1, 2018. For additional information on this development, see Tax Alert 2017-1390. International: Saudi Arabia's General Authority of Zakat and Tax (GAZT) will commence the value-added tax (VAT) registration of companies and businesses or entities during the first week of September 2017. The GAZT has launched an official website exclusively for VAT. The GAZT has announced on its website that businesses with a threshold of annual taxable supplies of goods and services in excess of SAR375,000 (US$100,000) are required to register for VAT before Dec. 20, 2017. For additional information on this development, see Tax Alert 2017-1356. All States: On Sept. 20, 2017, from 1:00-2:30 p.m. EDT (10:00-11:30 a.m. PDT), EY will host the domestic tax quarterly webcast focused on state tax matters. On this webcast, Ernst & Young LLP panelists will discuss the following topics: (1) the importance of understanding and being engaged in state tax policy matters throughout the tax policy lifecycle; (2) hot issues in property tax, including those related to dark stores and nonprofits; (3) the latest with respect to sales and use tax nexus; and (4) an update covering major judicial and administrative developments at the state level. To register for this event, go to State tax matters. 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: 2017-1465 |
