22 June 2018 State and Local Tax Weekly for June 22 Ernst & Young's State and Local Tax Weekly newsletter for June 22is 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. US Supreme Court overturns Quill and National Bellas Hess, eliminates physical presence nexus standard for sales and use tax collection On June 21, 2018, the U.S. Supreme Court (Court) issued its much anticipated ruling in South Dakota v. Wayfair. 1 In a 5-4 ruling, a majority of the Court voted to overturn both Quill 2 and National Bellas Hess, 3 finding that the physical presence nexus standard articulated in the two earlier opinions "is unsound and incorrect" Interpretation of the Court's dormant Commerce Clause jurisprudence. As a result of the Court's decision, states may now begin to require all remote sellers to register, and collect and remit sales and use taxes on transactions with in-state customers regardless of the seller's physical presence, provided that they do so in a manner that does not otherwise violate the Commerce Clause by discriminating against or imposing undue burdens on interstate commerce. Justice Anthony Kennedy, writing for the majority which included Justices Thomas, Ginsburg, Alito and Gorsuch, explained that through the Court's precedent, the Commerce Clause prohibits states from regulating interstate commerce in a manner that is discriminatory or imposes an undue burden. As applied to state taxes, the Court cited favorably the four-factor Complete Auto Transit 4 test, which held that a state tax will be sustained under the Commerce Clause if the tax: 1) applies to an activity with substantial nexus with the taxing state, 2) is fairly apportioned, 3) does not discriminate against interstate commerce, and 4) is fairly related to the services provided by the state. Through its prior rulings in National Bellas Hess and Quill, the Court had held that, at least with respect to sales tax, a seller that lacked any direct or attributed physical presence in a state could not be considered to have a substantial nexus with that state under the Commerce Clause. However, in 2015 in a concurring opinion,5 Justice Kennedy, who authored the opinion in Wayfair but also voted with the majority in Quill, noted that the physical presence standard constituted a "serious, continuing injustice faced by" the states. In Wayfair, with the physical presence nexus standard squarely at issue, Justice Kennedy explained that the doctrine had become "further removed from economic reality," resulting in significant state revenue losses, and that, "both as first formulated and as applied today, is an incorrect interpretation of the Commerce Clause." The majority also noted that, while not identical, the nexus standards under the Due Process and Commerce Clauses have significant parallels. This observation is noteworthy, given that the Quill majority drew a sharp distinction between the respective standards, with the Commerce Clause imposing a higher burden on the states. Given the ruling in Wayfair, that distinction becomes less clear, if not, completely non-existent, raising the possibility that for sales and use tax collection purposes the standard may now merely be "purposeful availment" or "minimum contacts" as asserted in previous cases, including in the original 1992 Quill opinion itself. Continuing its analysis, the majority explained that: 1) the physical presence standard "is not a necessary interpretation of the requirement that a state tax must be 'applied to an activity with a substantial nexus with the taxing State;'" 2) Quill does not resolve market distortion but creates it; and 3) Quill "imposes the sort of arbitrary, formalistic distinction that the Court's modern Commerce Clause precedents disavow." The Court illustrated these largely economic-based concerns by noting that the administrative costs of compliance were largely unrelated to a taxpayer's physical presence. The Court also expressed that Quill had effectively become a "judicially created tax shelter for businesses that decide to limit their physical presence and still sell their goods and services to a State's consumers — something that has become easier and more prevalent as technology has advanced." Instead, the Court advocated for a more "sensitive, case-by-case analysis of purposes and effects" over the physical presence standard that is "artificial in its entirety." The Court then noted the various state legislative attempts to expand physical presence and compliance burdens — such as "cookie" nexus, expanded affiliated and click-through nexus provisions, and state sales tax notice and reporting requirements — had eliminated physical presence as a clear or easily applicable standard, thereby undercutting any arguments based on principles of stare decisis (a legal term from the Latin for "to stand by things decided", that is to stand by legal precedent). As such, the majority noted, it was incumbent on the Court to address the "false constitutional premise" of its own creation, and that it would not be appropriate to ask Congress to change what had become "the constitutional default rule." Ultimately, the Court chose to focus primarily on the practical economic effect and the continued viability of the physical presence standard given the Internet's "prevalence and power," which has "changed the dynamics of the national economy." The Court also dismissed concerns that compliance costs would harm the market, noting that, eventually, software would be available at a reasonable cost to lessen the burden on small sellers. To this end, the Court noted that the protections in South Dakota's law — including sales threshold limitations, limits on retroactivity, and Streamlined Sales Tax (SST) membership — were sufficient to limit the burdens on interstate commerce. Nevertheless, the Court did not opine directly on the constitutionality of the law, choosing instead to vacate and remand the case back to South Dakota, where any other Commerce Clause questions might be raised. The dissent was noteworthy in likewise recognizing that the physical presence standard may have been wrongly decided but Chief Justice Roberts, writing for himself and Justices Breyer, Sotomayor and Kagen objected that the Court should have abided by stare decisis leaving to Congress the authority to establish nation standards no matter how wrong the physical presence standard was. Finally, although signing onto the majority opinions, both Justices Thomas and Gorsuch filed separate concurring opinions in which they both questioned the continued viability of the Court's dormant Commerce Clause jurisdiction in its entirety, perhaps presaging future rulings in this complicated area of state taxation. For more on the decision, including implications, see Tax Alert 2018-1269. For a discussion of tax accounting considerations see Tax Alert 2018-1318. Connecticut: The Connecticut Department of Revenue Services issued guidance on calculating the new pass-through entity (PTE) tax. The guidance addresses the following: (1) who is subject to the PTE tax; (2) how the PTE tax is calculated; (3) how the standard base is calculated (i.e., the default method used by a PTE unless the alternative base method is elected); (4) how the alternative base is calculated (including modified Connecticut source income and resident portion of unsourced income); (5) whether guaranteed payments included in a PTE's income are subject to tax under the standard or alternative base methods; (6) whether a PTE when calculating income under the standard or alternative bases can deduct the PTE tax and whether a PTE owner is required to addback any PTE tax paid by the PTE; (7) whether PTEs can file a combined return to offset gain and loss between PTEs; and (8) estimated tax payment requirements for the PTE tax. The guidance contains various examples. Conn. Dept. of Rev. Serv., OCG-6 (June 19, 2018). Hawaii: New law (SB 2821) updates Hawaii's date of conformity to the Internal Revenue Code (IRC) to the IRC as amended on Feb. 9, 2018, thus including changes made by the federal Tax Cuts and Jobs Act (P.L. 115-97) (TCJA) and the Bipartisan Budget Act of 2018 (P.L. 115-123). Hawaii law already decouples from IRC §§241-247 (with respect to special deductions for corporations (which includes the dividends received deductions, among others) and Subchapter N — IRC §§861-999 (the international tax provisions set forth in the IRC). Thus, Hawaii tax law decouples from IRC §§ 245A (new foreign dividend received deduction), 951A (global intangible low-taxed income (GILTI) inclusion and 965 (so called "transition tax" on post-1986 earnings and profits of certain foreign corporations), which were added by the TCJA. IRC provisions that have been added to the list of non-operative IRC provisions include: (1) IRC §91 (with respect to certain foreign branch losses); (2) IRC §199A (pass-through entity deduction for qualified business income); (3) IRC §250 (foreign-derived intangible income (FDII) and GILTI deduction); (4) IRC §267A (related party amounts — hybrid transactions); and (5) Subchapter Z (IRC §1400Z-1 to 1400Z-2) (opportunity zones). SB 2821 also decouples from various changes to the individual income tax made by the TCJA. These changes apply to taxable years beginning after Dec. 31, 2017. Haw. Laws 2018, SB 2821, signed by the governor on June 7, 2018. Massachusetts: On June 18, 2018, the Massachusetts Supreme Judicial Court (SJC) decided Anderson v. Attorney General, invalidating Initiative Petition 15-17 (IP 15-17), which was scheduled for the November 2018 ballot and, if approved by voters, would have amended the state constitution to allow an additional 4% tax on income over $1 million. According to IP 15-17, this additional revenue would be designated for transportation and education, "subject to appropriation" by the Massachusetts Legislature. The SJC held that IP 15-17 should not have been certified by the Attorney General "in proper form for submission to the people," because the petition violated the requirements of Article 48 of the Amendments of the Massachusetts Constitution concerning the subject matter and scope of initiative petitions and essentially requiring only single issues be brought before the electorate in initiative ballots. Anderson v. Attorney General, Slip. Op. SJC-12422 (Mass. SJC June 18, 2018). For additional information on this development, see Tax Alert 2018-1268. New Jersey: In MCI Communication Services, Inc. v. Director, Division of Taxation (MCI II), the New Jersey Superior Court, Appellate Division (appellate division) affirmed the decision of the New Jersey Tax Court (tax court) in MCI Communication Services, Inc. v. Director (MCI I). The tax court in MCI I upheld, for Corporation Business Tax (CBT) purposes, the Director's basis adjustments relating to attribute reduction for excluded cancellation of indebtedness income (CODI) under Internal Revenue Code (IRC) §108(b) through references to the federal consolidated return regulations (which many practitioners have suggested should not apply in New Jersey because, for the tax years at issue, it is a separate return reporting state). The appellate division in a short, three page opinion, did not provide a separate analysis for its decision. Instead the appellate division "affirm[ed] substantially for the reasons expressed by [the tax court]." For more on this development, see Tax Alert 2018-1276. Ohio: New law (HB 292) modifies procedures under which an individual can establish that he or she was a nonresident for income tax purposes. Ohio Rev. Code § 5747.24(B)(1) provides that an individual who has no more than 212 contact periods with Ohio is presumed to be a nonresident. Under this provision an individual may file an affidavit of nonresidency (Ohio Form IT DA) with the Ohio Department of Taxation (Department). The affidavit requires the individual to represent, under penalties of perjury that he or she was not domiciled in Ohio during the preceding tax year, had a place of abode outside Ohio, and had no more than 212 contact periods with Ohio. If timely filed, and truthful, the affidavit creates an irrebuttable presumption of residency. These changes were enacted in response to the Ohio Supreme Court's ruling in Cunningham v. Testa, in which it upheld the Department's position that the affidavit contained a false statement regarding the taxpayer's domicile because, among other facts, the taxpayer claimed a real estate tax homestead exemption, which can generally only be claimed by residents of Ohio. The Court's holding created uncertainty as to the efficacy of filing the nonresident affidavit. For tax years beginning on or after Jan. 1, 2018, HB 292 modifies Ohio Rev. Code § 5747.24(B) to add requirements that must be met and represented on the nonresident affidavit. If the individual timely files the Ohio Form IT DA and the representations made thereon are truthful, the presumption of nonresidency is irrebuttable. Ohio Laws 2018, HB 292, signed by the governor on June 14, 2018. For more on this development, see Tax Alert 2018-1245. Oregon: New law (HB 4301) expands the availability of the elective reduced personal income tax rate for certain pass-through income to taxpayers doing business as sole proprietors. This provision is effective for tax years beginning on or after Jan. 1, 2018. Ore. Laws 2018 (1st Special Session), Ch. 1 (HB 4301), signed by the governor on May 22, 2018. Pennsylvania: On June 11, 2018, the U.S. Supreme Court (Court) denied certiorari in Nextel Communications v. PA Dept. of Revenue. In its certiorari petition, Nextel had asked the Court to find that the Pennsylvania Supreme Court's holding - that a statutory cap on the net loss carryover (NLC) deduction under state law, as applied to Nextel - violated the Uniformity Clause of the Pennsylvania Constitution but denying Nextel a refund of the unconstitutionally paid tax- violated the Due Process Clause of the U.S. Constitution. Nextel Communications of the Mid-Atlantic, Inc. v. Commonwealth, No. 6 EAP 2016 (Pa. S. Ct. Oct. 18, 2017), petition for cert. denied, Dkt. No. 17-1506 (U.S. S. Ct. June 11, 2018). For additional information on this development, see Tax Alert 2018-1238. Ohio: New law (HB 430) clarifies Ohio's sales and use tax exemption relating to the production of oil and gas by listing certain items of tangible personal property and services deemed to be directly used in production. Ohio Rev. Code § 5739.02(B)(42)(a) provided an exemption from Ohio sales and use tax for purchases of tangible personal property directly used in the production of oil and gas. HB 430 creates a new provision, Ohio Rev. Code § 5739.02(B)(42)(q), that retains the direct use requirement and specifies that persons engaged in rendering production services for others are deemed engaged in the production of oil and gas. HB 430 defines the term "production" to mean operations to expose and evaluate an underground reservoir that may contain hydrocarbon resources, prepare the wellbore for production, and lift and control all substances yielded by the reservoir to the surface of the earth. HB 430 also provides a list of the tangible personal property that qualifies and does not qualify for the exemption. HB 430 was likely adopted in response to audit activity in this area by the Ohio Department of Taxation (Department) and is intended to be a remedial measure to clarify existing law. The provisions apply to all cases pending on a petition for reassessment, further appeal, or transactions subject to an audit by the Department on or after May 18, 2018. Ohio Laws 2018, HB 430, signed by the governor on June 14, 2018. For more on this development, see Tax Alert 2018-1245. Ohio: The Ohio Supreme Court (Court) in LaFarge N. Am., Inc. addressed the application of Ohio's sales and use tax exemption for manufacturing, specifically with respect to when the manufacturing process begins. The taxpayer manufactured pelletized slag at a facility in Ohio. At issue was the application of tax to fuel and repair parts for equipment used to break up and transport solidified slag from a "slag mountain." The Court focused on two questions: When is the slag changed, converted or transformed into a different state or form from which it previously existed? And when is the slag committed to the manufacturing process? The Court concluded that the bulldozers were not simply facilitating the movement of the slag from initial storage to the screening plant, but were crushing the slag during the separation process. The Court indicated that this resulted in the requisite change in form to conclude that the manufacturing process began at that point. The manufacturing process then continued with the front-end loader loading the slag into dump trucks for transport to the screening plant. Thus, the Court held that the property at issue was used in manufacturing and, as such, the purchases of fuel and repairs for those items were exempt from Ohio sales tax. LaFarge N. Am., Inc. v. Testa, Slip Opinion No. 2018-Ohio-2047 (Ohio S.Ct. May 31, 2018). For more on this development, see Tax Alert 2018-1245. Federal: The IRS has released the final round of designations of Opportunity Zones, approving submissions in the last four states, which will remain in effect for 10 years. New investments of capital gain properly made in these Opportunity Zones will now qualify for preferential tax treatment. The program has now designated Opportunity Zones in all 50 states, the District of Columbia and five US possessions. For additional information on this development, see Tax Alert 2018-1261. Hawaii: New law (SB 2821) adopts Internal Revenue Code (IRC) §§ 6223, 6225 and 6226 with respect to federal partnership audits and provides that a small partnership which makes an election under IRC § 6221(b) (i.e., elect out of the new audit rules) will make the same election for Hawaii income tax purposes. In addition, Hawaii will follow the definitions and special rules regarding partnerships set forth in IRC § 6241, with some exceptions. These changes apply to taxable years beginning after Dec. 31, 2017. Haw. Laws 2018, SB 2821, signed by the governor on June 7, 2018. Ohio: New law (HB 292) restores the right of direct appeal of Ohio Board of Tax Appeals' (BTA) decisions to the Supreme Court of Ohio (Court) for tax matters administered by the Ohio Department of Taxation (Department) and local income tax review boards. In 2017, as part of Ohio's last biennial budget bill, Am. Sub. H.B. 49 eliminated the right of taxpayers and tax authorities to appeal decisions of the BTA to the Court. This right had existed since the late 1930s. HB 292 restores the right of direct appeal for appeals from final determinations, assessments, findings, valuations, determinations or orders issued by the Ohio Tax Commissioner and final determinations from local income tax boards of review. Appeals of BTA decisions related to real property tax valuations will continue to be ineligible for the right of direct appeal to the Court and instead can be directly appealed only to the applicable county court of appeals as prescribed in amended Ohio Rev. Code § 5717.04. Ohio Laws 2018, HB 292, signed by the governor on June 14, 2018. For more on this development, see Tax Alert 2018-1245. Connecticut: The Connecticut Department of Revenue Services (DRS) issued guidance on calculating the new pass-through entity (PTE) tax, which is effective for taxable years beginning on or after Jan. 1, 2018. PTEs can recharacterize all or a portion of any of the 2018 estimated income tax payments made by any of their individual partners so that the payments are applied against the PTE's 2018 estimated tax payment requirement. PTEs have until Dec. 31, 2018 to recharacterize the 2018 estimated payments of their individual partners. The DRS indicated that it will issue guidance on how to recharacterize these payments by Sept. 30, 2018. The DRS guidance addresses the impact on estimated payments made by resident, nonresident and corporate partners. A PTE that underpaid estimated tax due to the enactment of the new tax may contact the DRS with a written explanation describing why it failed to comply. Conn. Dept. of Rev. Serv., SN 2018(4). Idaho: The Idaho State Tax Commission released to its website a further revision to the publication, A Guide to Idaho Income Tax Withholding (rev. 6-20-2018), containing several changes. Of significant note, the Commission has created a Form W-4 worksheet that Idaho employees can use to determine how to complete the form for Idaho income tax withholding purposes. Employees should use the worksheet to estimate their Idaho allowances and any extra state withholding that may be required. The Commission recommends that all employees update their Idaho Forms W-4 using the worksheet. Louisiana: The Louisiana Workforce Commission (LWC) and the Department of Revenue (DOR) recently announced that they are ramping up their efforts to fight worker misclassification in 2018. A worker misclassification task force known as GAME ON (Government Against Misclassified Employees Operational Network) is based in Louisiana, and is comprised of the Louisiana Workforce Commission's unemployment and workers' compensation divisions and the DOR, in cooperation with the IRS and US Department of Labor. For more on this development, see Tax Alert 2018-1079. New York: The New York Department of Taxation and Finance has issued guidance regarding the income tax changes provided for under the recently enacted New York State 2018-19 Fiscal Year budget bill. Guidance includes clarification of the definition of resident individual for New York State income tax purposes, confirms the change in employer wage reporting as of the first quarter 2019 and explains the expansion in the youth employment tax credit. For additional information on this development, see Tax Alert 2018-1247. Oregon: As previously reported, legislation enacted in 2017 created a new payroll tax on Oregon residents and nonresidents working in Oregon to fund state highway upgrades. The new tax, which must be withheld by Oregon employers, goes into effect July 1, 2018. In addition to the forms previously released to its website, the Oregon Department of Revenue has released revised Form OR-WR, Oregon Annual Withholding Tax Reconciliation Report, to be used by employers to report the statewide transit payroll tax in addition to income tax withholding. For additional information on this development, see Tax Alert 2018-1257. New Jersey: New law (AB 4111) legalizes sports gambling in certain locations throughout New Jersey. The law follows the landmark U.S. Supreme Court (Court) decision in Murphy v. NCAA, 6 in which the Court invoked the "anti-commandeering" doctrine to strike down a 1992 federal law intended to prevent states from repealing prohibitions on sports gambling.This new law permits sports gambling for most sports events, such as professional, Olympic and college sports, but does not include games of New Jersey college teams, college games taking place in New Jersey, high school sports, electronic sports, fantasy sports or competitive "video gaming." Participants may place wagers in-person in Atlantic City casinos and at both current and former racetrack locations in New Jersey. The law imposes an 8.5% tax on in-person wagers at these locations and a 13% tax on wagers made through the internet. Casinos and racetrack operators will be licensed by the state to accept these wagers. The tax base is the gross amount of revenue minus payouts to participants. The law takes effect immediately for in-person wagers and in 30 days for internet wagers. N.J. Laws 2018, A.B. 4111, signed by the governor on June 11, 2018. For additional information on this development, see Tax Alert 2018-1232. International: A recently released publication, the first in a series to be published by EY's Quantitative Economics and Statistics (QUEST) group, discusses the economic implications of key trade issues and trends. This edition focuses on the importance of US trade with China and possible adverse effects of a trade war between the two countries. For a copy of the publication, see Tax Alert 2018-1082. International: The President of the United States (US) announced on June 15, 2018 that the US will move forward and implement a 25% tariff on US$34 billion of goods from China that contain industrially significant technologies. The actions follow a determination by the United States Trade Representative on March 22, 2018 that the acts, policies, and practices of China to forcefully acquire US intellectual property are unreasonable, discriminatory, and burden US commerce, costing the US approximately $50 billion per year. For additional information on this development, see Tax Alert 2018-1237. International: At the end of 2017, the Angolan Government approved, through Presidential Decree nr. 258/17, an Interim Plan to implement a package of measures to achieve macroeconomic stability, boost the overall economy, and address the most pressing social issues of the country. Among these measures was the inclusion of the Value Added Tax (VAT) in the general state budget for 2019, which will come into force as of Jan. 1, 2019 and it will be gradually applied. VAT will be mandatory for large taxpayers during the first two years, and optional to the remaining taxpayers that intend to apply the VAT regime. For additional information on this development, see Tax Alert 2018-1248. International: The Central Bank of the United Arab Emirates (UAE Central Bank) on May 17, 2018, began publishing daily foreign currency exchange rates that UAE VAT-registered businesses should use when converting the Value Added Tax (VAT) due on a tax invoice from a price denominated in a foreign currency. This is a requirement provided by Article (69) of the Federal Decree-Law No. (8) of 2017 on Value Added Tax (the VAT Law). The UAE Central Bank has confirmed that these exchange rates are published solely for VAT reporting and compliance purposes. Consequently, this is likely to result in reconciliation differences with amounts converted to Dirhams in accordance with accounting rules. For more on this development, see Tax Alert 2018-1108. International: The Bahamian Government in its 2018-19 Budget Communication proposed an increase in the rate of Value Added Tax (VAT) from the current 7.5% to 12%, effective July 1, 2018. The rate increase and other changes to the VAT regime were announced on May 30, 2018. For additional information on this development, see Tax Alert 2018-1286. International: VAT Grouping was introduced in Malta with effect from June 1, 2018 via Legal Notice 162 of 2018. The main provisions of Legal Notice 162 of 2018 relate to three main topics: (1) eligibility, (2) practical considerations, and (3) VAT implications. For additional information on this development, see Tax Alert 2018-1284. Multistate: On Wednesday, July 18, 2018, Ernst & Young LLP will host its third webcast in its state income tax nexus and filing options webcast series. This webcast will focus on the limitations on tax liability provided by P.L. 86-272 and a discussion of the income tax implications of the recent U.S. Supreme Court decision in South Dakota v. Wayfair. Specifically, the webcast will cover: (1) an in-depth analysis of the specific requirements of P.L. 86-272 and the activities that may exceed its protections; (2) important judicial developments interpreting P.L. 86-272, including Wrigley; and (3)a discussion of the recent U.S. Supreme Court decision in South Dakota v. Wayfair and how it may impact state income tax nexus determinations. Click here to register for this webcast. Multistate: A replay of the Ernst & Young LLP and Bloomberg Tax webcast discussing employment tax compliance across the states in 2018 is now available. Topics covered during the webcast include: (1) multistate payroll tax compliance — what we learned from our 2017 employer survey; (2) federal actions to simplify multistate income tax compliance; (3) how states are adapting to the TCJA, including the new voluntary New York payroll expense tax; (4) healthcare changes with employer implications; (5) disability and paid family and medical leave; (6) mandatory participation in state retirement plans; (7) unemployment insurance trends; (8) state information reporting and withholding for nonwage income; and (9) employee communications and supplementary statements and why they are important in 2018. Click here to access the replay. 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. 6 Murphy v. NCAA, 200 L. Ed. 2d 854 (2018). The anti-commandeering doctrine is grounded in the dual sovereignty of the state and federal governments and mandates the overturning of federal laws which compel state legislatures to pass laws or state officers to administer federal regulatory systems. See, e.g., Printz v. United States, 521 U.S. 898 (1997). Document ID: 2018-1351 |
