31 October 2017 State and Local Tax Weekly for October 20 Ernst & Young's State and Local Tax Weekly newsletter for October 20 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. Pennsylvania Supreme Court affirms in Nextel that NOL 'dollar cap' violates commonwealth constitutional uniformity clause but reverses remedy and leaves many important questions unanswered On Oct. 18, 2017, the Pennsylvania Supreme Court (Court) issued its decision in Nextel Communications of the Mid-Atlantic, Inc.1 The Commonwealth of Pennsylvania brought this appeal before the Court after losing at Commonwealth Court. The question presented was whether the statutory $3 million cap imposed on Pennsylvania's net loss carryover (NLC) deduction violates the Uniformity Clause of the Pennsylvania Constitution and, if so, what is the proper remedy?2 The Court affirmed the Commonwealth Court's holding that, as applied to Nextel, "the NLC is unconstitutional as written because of its inclusion of the $3 million flat deduction."3 The Court reversed the refund awarded to Nextel by the Commonwealth Court, and instead severed only the $3 million flat cap on NLCs from the NLC statute — not the entire cap including the percentage cap. The Court's decision handed Nextel a victory on the issue, but denied the company any corresponding tax relief. It also leaves several important questions unanswered — most importantly, whether the percentage cap is constitutional. While the Court was silent on the constitutionality of the percentage cap, it did not sever the percentage cap. Because the Court did not rule on the constitutionality of the percentage cap, it's possible that another round of litigation on this issue could erupt. On the other hand, larger taxpayers may find that challenging the constitutionality of the percentage cap in light of the Court's decision results only in a pyrrhic victory. Although the Court wrestled vigorously during oral argument with the question of whether it must grant retroactive or prospective relief, the opinion itself is silent on this matter. Because the Court reversed the refund here and issued an as applied decision that has no future impact on any taxpayer other than Nextel, the Court did not need to step into the quagmire of whether the recent Mount Airy decision could be read to allow only prospective relief.4 That said, the Court will have an opportunity to address the prospective vs. retroactive question in a similar case (RB Alden v. Comm'w, 60 MAP 2017), which is currently before the Court and challenges the constitutionality of the dollar cap for a year in which there was no percentage cap. On Oct. 26, 2017, the Pennsylvania legislature passed an amended version of HB 542, provisions of which would eliminate the dollar cap for tax years beginning after Dec. 31, 2017, and increases the percentage cap to 35% for 2018 and 40% for 2019. Illinois: The Illinois Department of Revenue recently adopted amendments to its sales factor regulation, 86 Ill. Admin. Code § 100.3370, Sales Factor. The amendments reflect the state's 2008 enactment of market-based sourcing for service providers and include an example of how asset managers should assign income from investment management and other related services to Illinois. Although the amendments attempt to provide much-needed guidance, they appear to complicate, rather than clarify, the income-sourcing process for asset managers. They also leave several issues unaddressed. For more on this development, see Tax Alert 2017-1756. Illinois: Related companies in the business of making loans to fund purchases of insurance can be considered "sales finance companies" and, therefore, are "financial organizations" whose operational income was properly reported on the related companies' unitary business group income tax returns for financial organizations. Accordingly, the Illinois Department of Revenue properly denied the companies' refund claim based on re-characterizing the companies' from financial organization to general corporate organizations. In so holding, the Illinois Independent Tax Tribunal (Tribunal) citing Fox5 and McCarter,6 said that Illinois courts have held that the sale of insurance is the sale of a service rather than the sale of an intangible. It further noted that federal law does not define the character of insurance to be the purchase of a contract, and Illinois warranty contract cases do not hold that insurance is not a service. Lastly, the Tribunal rejected the companies' argument that the Illinois legislature intended for the definition of services in 35 ILCS 5/1501(a)(8)(C) to be restrictive, finding the definition of "service" is not ambiguous. Premier Auto Finance, Inc. v. Ill. Dept. of Rev., No. 15 TT 175 (Ill. Indep. Tax Trib. Sept. 7, 2017). Indiana: Financial institutions' payments received under shared-loss agreements (SLAs) are not exempt from the nondiscriminatory Indiana Financial Institutions Tax because the financial institutions failed to demonstrate that the payments were "notes, debentures, bonds, or other such obligations" issued by the Federal Deposit Insurance Corporation (FDIC). The Indiana Department of Revenue (Department) found that "other such obligations" were limited to obligations similar to notes, debentures, or bonds — the "issuance of interest-bearing bonds or Treasury notes." Citing Smith v. Davis,7 the Department determined that under the SLAs, the financial institutions had open account claims with the FDIC and the SLAs were contractual obligations under which both parties were required to perform, rather than the shared-loss payments being interest-bearing obligations under federal law. The Department abated the underpayment penalty based on the financial institutions' reasonable reliance on the interpretation of a federal statute. Ind. Dept. of Rev., Letter of Findings 18-20160156P (Sept. 27, 2017). Minnesota: The Minnesota Department of Revenue (Department) issued guidance to corporate taxpayers affected by the Minnesota Supreme Court's ruling in Ashland Inc. and Affiliates,8 in which it held state law clearly provides for conformity with the status of an eligible foreign entity electing to check the box to be disregarded as a separate entity from its parent, and that Minnesota's water's edge provisions could not render the conformity provisions superfluous. As a result of this ruling, the Department "must now recognize the income, losses, and deductions of a foreign entity owned by a U.S. corporation when the entity elects to be treated as a disregarded entity for federal income tax purposes." Further, taxpayers filing or amending returns are required to include the income and apportionment factors of foreign disregarded entities in the calculation of net income and apportionment percentage. Affected taxpayers may be entitled to a tax refund, owe additional tax, or may have to adjust net operating loss carryforwards. The Department said it will not assess or collect late filing, late payment or substantial understatement penalties resulting from the Ashland ruling. Minn. Dept. of Rev., Foreign Disregarded Entities (Oct. 4, 2017). Texas: Proposed amended regulation (Tex. Admin. Code tit. 34, § 3.588) would modify the margin on cost of goods sold (COGS) for purposes of the Texas franchise tax, implementing previously enacted legislation (HB 500, Tex. Laws 2013) and defining terms and "interpret[ing] ambiguous statutory language." Effective for reports originally due on or after Sept. 1, 2013, the COGS for a movie theater taxable entity that elects to subtract COGS would be the costs related to the acquisition, production, exhibition, or use of a film or motion picture, including expenses for the right to use the film or motion picture. For COGS deductions available to owners of goods, the proposed amendments would establish a rebuttable presumption that the taxable entity holding legal title to goods is the owner of the goods, and would define terms such as labor, material, and project for purposes of determining whether a taxable entity is considered an owner of the labor or materials. Additionally, effective for reports originally due on or after Jan. 1, 2014, a pipeline entity providing services for others related to the product that the pipeline does not own would be able to subtract as a COGS allowable depreciation, operations, and maintenance costs related to the services provided (for purposes of this provision, the proposed amendment would define pipeline entity and processing). Lastly, the proposed amendment would permit certain rental or leasing companies to subtract as COGS the costs otherwise allowed in relation to motor vehicles, heavy construction equipment, or railcar rolling stock the company rents or leases in the ordinary course of its business. These proposed changes would apply to franchise tax reports originally due on or after Jan. 1, 2008, unless otherwise noted. Tex. Comp. of Pub. Accts., Proposed Tex. Admin. Code tit. 34, § 3.588 (Sept. 29, 2017). Multistate: The EY Sales and Use Tax Quarterly Update provides a summary of the major legislative, administrative and judicial sales and use tax developments. Highlights of this edition include: (1) a discussion of the latest challenge to Quill by South Dakota, which has been appealed to the US Supreme Court; (2) an overview of the latest state efforts to require marketplace sellers and providers to collect sales and use taxes; and (3) a discussion about whether "cookie nexus" constitutes physical presence. For a copy of the update, see Tax Alert 2017-1773. Alabama: The Alabama Department of Revenue (Department) issued a revenue ruling on the applicability of the state's sales and use tax and lease tax on transactions related to the purchase and lease of aircraft. The Department determined that the following transactions would be exempt from sales and use tax: (1) an aircraft purchaser's (Purchaser) provision of buyer-furnished equipment (BFEs) to another company (Company B); (2) a leasing company's (Lease Co.) purchase of BFEs from the Purchaser under a sale and leaseback transaction closed in Alabama; and (3) the sale of aircraft from Company B to the Purchaser or Lease Co. in Alabama. Additionally, if Company B sells aircraft to the Purchaser in Alabama, and the Purchaser later sells the aircraft to Lease Co. in Alabama as part of a sale and leaseback transaction, the simultaneous sale from the Purchaser to Lease Co. in Alabama is exempt from sales and use tax. The lease payments from the Purchaser to Lease Co. are not subject to the Alabama lease tax. The Department noted that the following actions would not make the aircraft or BFE acquisition subject to Alabama sales and use tax or the lease payments subject to Alabama lease tax: (1) bringing aircraft back to Alabama for periodic repairs and maintenance (although the retail cost of replacement parts, components, and systems installed could be subject to state and/or local sales and use tax); (2) making an emergency landing in Alabama; (3) a third-party's charter or special flight with a rare stop in Alabama; (4) the future expansion of the Purchaser's routes in Alabama without expanding sufficiently to be considered a hub operation; or (5) flying over Alabama between destinations out of state. Ala. Dept. of Rev., Rev. Ruling No. 2017-002 (July 14, 2017). Colorado: A food service company's sales of meal plan meals to a school are not subject to the City of Golden's sales and use tax because under the relevant contract and the plain language of applicable law, these sales are exempt wholesale transactions and not retail sales between the company and students with meal plans. In a departure from City of Golden v. Aramark Educational Services, LLC,9 the Colorado Court of Appeals found that no sales occur between the company and the school's students with meal plans because students pay the school rather than the company for their meals, and the school (a licensed retailer) periodically pays the company for students' meals, at prices lower than the students pay the school. The meals are the school's property, even if the school does not physically receive them. Lastly, citing A.B. Hirschfield Press's10 primary purpose test for determining whether a wholesale purchase occurs, the Court found that the company's sales to the school are wholesale sales because the school acquires the meals and resells them to students at a higher price, and the school does not alter or use the meals provided to students. Sodexo America, LLC v. City of Golden, Colo., No. 16CA1355 (Colo. App. Ct. Sept. 7, 2017). Illinois: In rejecting a False Claim Act filed against a remote retailer for damages and civil penalties for failure to collect and remit use tax on internet and telephone sales to Illinois customers, the Illinois Appellate Court (Court) found the remote retailer did not have substantial nexus with Illinois. The remote retailer lacked a physical presence in Illinois, and a separate brick-and-mortar retailer that sold similar products neither acted as its agent or on its behalf. Moreover, the remote retailer and the brick-and-mortar retailer were separate entities, maintained separate merchandise, employed separate marketing schemes, competed against each other for business, had different and separate financial statements, had separate balance sheets, and had separate income tax returns. In addressing whether the trial court failed to consider Illinois's mail marketing provisions under the Illinois Use Tax Act, the Court citing Quill11 noted that even if the catalogs and emails sent from the remote retailer to Illinois were substantial and recurring, solicitations into a state without the internet retailer's physical presence is insufficient to establish nexus. Additionally, the record amply supported the finding that the remote retailer sought, received, and evaluated tax advice about its Illinois use tax obligation. Finally, the Court found that trial court properly admitted exhibits relevant in revealing the remote retailer's national nexus position on its use tax collection and remittance obligations as indicative of whether it had the requisite intent to violate the False Claims Act and whether it investigated its tax liability. State of Ill. ex rel. Diamond v. Lush Internet, Inc., No. 1-16-1601 (Ill. App. Ct., 1st Jud. Dist., Sept. 25, 2017). Indiana: An out-of-state company's advanced Software as a Service (SaaS) search offering, add-on service for the advanced SaaS search offering, and search engine optimization solution are nontaxable services because the software used is incident to the services provided. In applying Indiana's serviceperson test, the Indiana Department of Revenue found that: (1) the company is primarily in the business of developing search engine and marketing strategies and providing business marketing, promotion, and consulting services, and not selling tangible personal property; (2) the company uses the software to perform those services; (3) customers are not charged for the software, but are charged for the company's services (i.e., fees based on the number of searches performed, websites used, or number of referrals); and (4) the company created the software and, thus, it did not have to pay sales tax when it was created or purchased. In addition, the company's products are not a sale, lease, license, or other transfer of software or other tangible personal property, nor are they a "telecommunication service," as the product does not include data processing and information services. Ind. Dept. of Rev., Rev. Ruling No. 2017-01ST (July 21, 2017)(released Sept. 27, 2017). Alabama: A transferee of an investment credit is entitled to carryforward any amount of the credit it cannot offset against its current year taxes for the same period of time the transferor is authorized to carry forward the credit. The Alabama Department of Revenue found that the carryforward is an attribute of the investment credit being sold and, as such, the transferee steps into the shoes of the transferor and obtains the same full use of, and the same rights to, the investment credit as the transferor. This includes the right to fully utilize the carryforward provision. Therefore, if a project agreement allows for the carryforward of an investment credit then any allowed later transfer of those credits to a transferee includes the carryforward provided for by the agreement. Ala. Dept. of Rev., Rev. Ruling No. 2017-001 (June 1, 2017). Missouri: An assessor improperly determined the true value in money of an energy company's (company) natural gas pipeline real property by applying the reproduction cost valuation methodology without considering depreciation. In so holding, the Missouri Court of Appeals (Court) held that by law depreciation must be considered regardless of the cost approach utilized. The assessors' valuations, which were affirmed by the Missouri State Tax Commission (Commission), were the result of an improper application of an otherwise proper valuation methodology. Additionally, the Commission's findings that the company did not meet its burden to prove true value in money of its real property are arbitrary and capricious, are not supported by competent and substantial evidence, and are legally erroneous, when the company established that the assessors did not properly apply the reproduction cost approach methodology in failing to consider depreciation. Union Electric Co. D/B/A Ameren Missouri v. Estes, No. WD80659 (Mo. App. Ct., Western Dist., Sept. 26, 2017). Utah: An out-of-state air taxi business's (business) tangible personal property located in Utah is subject to property tax because the business's multiple arrivals and departures, overnight layovers, and ground hours in nine Utah cities are sufficient to create a taxable nexus within Utah. In so holding, the Utah State Tax Commission (Commission) determined that the business's contacts are more numerous than those the U.S. Supreme Court have upheld as reasonable exercises of states' right to tax property and activities within their borders. Further, citing Complete Auto Transit,12 the Commission found that besides having substantial nexus with Utah: (1) the business's operating statistics of weighted ground hours and originating and terminating tonnage is a reasonable apportionment for fair apportionment purposes; (2) the reasonable and fair apportionment based on verifiable facts is nondiscriminatory; and (3) the tax is fairly related to services provided in Utah when Utah provides facilities for loading and unloading, refueling, and parking planes overnight; clear, maintained and secured runways; air traffic control services; airport ground control services; and police and fire protection. Taxpayer v. Property Tax Div. of the Utah State Tax Comn., No. 14-1288 (Utah State Tax Comn. March 1, 2016)(released September 2017). California: The California Franchise Tax Board (FTB) issued a legal ruling finding that California's conformity to federal information filing requirements relating to foreign financial assets imposed by IRC § 6038D applies to nonresident aliens when they are required to file income tax returns. State law conforms to IRC § 6038D without modifications; Cal. Rev. and Tax. Code (CRTC) § 17024.5(b)(11) provides that any IRC provision referring to nonresident aliens is not applicable for California purposes unless otherwise specifically provided. The FTB found that CRTC § 19141.5(e), which states that the information filed with the FTB is a copy of the information filed with the IRS, is a specific exception to CRTC § 17024.5(b)(11)'s general rule concerning nonresident alien provisions. The legal ruling goes through three scenarios. Cal. FTB, Legal Ruling No. 2017-02 (Oct. 16, 2017). Virginia: Reminder — Virginia's tax amnesty program will end Nov. 14, 2017. The amnesty program is open to individuals and businesses for tax assessments issued before June 15, 2017 that are related to an amnesty eligible period (returns must correspond to an amnesty eligible period). In exchange for participating in, and fully complying with the terms of, the amnesty program, the Department will waive all civil and criminal penalties assessed or assessable and one-half of the interest assessed or assessable. Eligible tax liabilities that remain unpaid at the end of the amnesty program will be subject to a 20% penalty. Va. Dept. of Taxn., Ruling of the Tax Comm'r P.D. 17-156 (Sept. 5, 2017). For additional information on Virginia's amnesty program, see Tax Alert 2017-1488. Illinois: The Illinois Department of Employment Security (IDES) announced that it has successfully transitioned employer state unemployment insurance (SUI) tax reporting from the now-defunct TaxNet reporting system to the Illinois Department of Revenue (DOR)'s MyTax Illinois reporting system. For additional information on this development, see Tax Alert 2017-1722. Delaware: New law (HB 86) corrects an unintended effect of a law change enacted in 2015 under HB 15 by preventing the double taxation of premium ceded to a series captive insurance company or protected cell. Additionally, it precludes premium tax on series limited liability companies (LLCs) when the premium is written only in the series of such LLCs. Specifically, a special purpose captive insurance company formed as a LLC or statutory trust is not subject to the premium tax only if, during the entire calendar year for the which the tax is imposed, the special purpose captive insurance company: (1) did not contract for nor collect any direct premium, (2) did not contract for nor assume any reinsurance premium, and (3) was not obligated as an insurance company of any type under any contract of insurance or reinsurance. The minimum tax imposed on the ceding captive insurance company or series captive insurance company assuming a reinsurance premium and tax liability is still due. HB 86 is retroactively effective as of June 24, 2015. Del. Laws 2017, Ch. 147 (HB 86), signed by the governor on Aug. 30, 2017. Delaware: New law (HB 87) defines "dormant captive insurance company" as a captive insurance company that, for an entire calendar year, did not contract for or collect any direct premium, and did not contract for or assume any reinsurance premium; it was not obligated as an insurance company of any type under any insurance or reinsurance contract issued or entered into during any year in which it is a dormant captive insurance company; and it provides written notice and certification to Delaware to be treated as a dormant captive insurance company. Additionally, HB 87 provides dormant captive insurance company requirements, including the following: (1) it must have and maintain $25,000 or another amount as directed by the state in unimpaired capital and surplus; (2) it is not subject to or liable for premium tax payments; (3) it is not required to file annual statements with the state, prepare audited financial statements, or obtain statements of actual opinion; (4) when it is subject to state examination or when it is declared dormant by the state; (5) when it can resume transacting business after dormancy; (6) when additional license fees may be due; and (7) an allowance to adjudicate and settle insurance claims issued during any year in which it was not a dormant captive insurance company. In this case, the effective date of an insurance contract or reinsurance must be before the dormant captive insurance became a dormant captive insurance company. HB 87 took immediate effect. Del. Laws 2017, Ch. 148 (HB 87), signed by the governor on Aug. 30, 2017. International: The German Federal Ministry of Finance published a decree on Oct. 10, 2017, concerning Value Added Tax (VAT) on call-off stocks in Germany. The term "Call-off stocks" describes goods owned by a nonresident supplier that have been sent to be held in stock in the customer's country, generally at the customer's premises; the customer withdraws goods from the stock when it needs them (e.g., for its manufacturing process) and legal ownership in the goods is transferred at that time. This decree will fundamentally change their VAT treatment. For additional information on this development, see Tax Alert 2017-1711. Illinois: On Nov. 2, 2017, from 4:00 p.m.-5:00 p.m. EDT, join Ernst & Young LLP as we discuss the ever-changing unclaimed property landscape, specifically in Illinois after that state's recent adoption of the Revised Uniform Unclaimed Property Act (IL-RUUPA). IL-RUUPA repeals the existing business-to-business (B2B) exemption and also adds a transitional provision to the law, requiring holders to look back over an eight-year transactional period. Following the IL-RUUPA, holders will be required to reverse the B2B exemption previously taken and report additional due property by the May or November 2018 deadlines to ensure penalties and interest are not applied. The impact of IL-RUUPA is substantial and potentially material to holders of unclaimed property operating in Illinois or transacting with businesses in Illinois, which likely represents nearly all US business organizations. Topics that will be covered during this webcast include: introduction to the shifting unclaimed property landscape, overview of B2B exemptions, due diligence requirements, a discussion of the notable changes brought about through enactment of the IL-RUUPA, and practical application of the Illinois law changes. To register for this event, go here. Multistate: On Nov. 13, 2017, from 2:00 p.m.-3:00 p.m. EST, join Ernst & Young LLP as we provide an update on the $2.9b in grant funding for heavy-duty diesel vehicle and/or equipment replacements and repowers that will be made available as a result of an emissions litigation settlement with the US Environmental Protection Agency (EPA). During the webcast, our subject matter professionals will provide a comprehensive overview of the program, the disbursement process, insights from similar funding opportunities and leading practices. Topics that will be covered during this webcast include: an update on timing and next steps to securing funding, state activity to deliver the $2.9b of funding, likely eligible expenditures, expected program requirements, and why you should act now. Please register by Thursday, Nov. 9, 2017 using this link. Multistate: On Nov. 15, 2017, from 2:00-3:00 p.m. EST, Ernst & Young LLP will host a webcast on new multistate sales and use tax compliance requirements and the practical considerations related to complying with these new regimes. As states continue to look for new ways to expand their jurisdiction over sales and use tax collection, businesses that sell goods and services across state lines are having to deal with a host of new compliance, reporting, and record-keeping requirements. Whether via notice and reporting statutes, departmental information requests, or evolved views on what constitutes "physical presence" and "establishing and maintaining a market," taxpayers face growing compliance burdens and costs, as well as threats of significant non-compliance penalties. Topics covered will include: an overview of the statutory requirements, record keeping, managing information requests, best practices, using technology to manage compliance, and financial accounting/ASC 450 considerations. To register for this event, go to Multistate sales and use tax compliance requirements. 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. 1 Nextel Communications of the Mid-Atlantic, Inc. v. Commonwealth, No. 6 EAP 2016 (Pa. S. Ct. Oct. 18, 2017). 2 Nextel Comm. of the Mid-Atlantic, Inc. v. Pennsylvania, No. 98 F.R. 2012 (Pa. Cmnwlth. Ct. Nov. 23, 2015). Document ID: 2017-1811 |
