10 January 2019 State and Local Tax Weekly for January 4 Ernst & Young's State and Local Tax Weekly newsletter for January 4 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. On Dec. 10, 2018, Puerto Rico enacted Act 257-2018, which includes numerous amendments to the Puerto Rico Internal Revenue Code of 2011 (PR Code). Although Act 257-2018 maintains some basic elements of its precursor, House Bill 1544, which was filed in April 2018 (see Tax Alert 2018-1028), Act 257-2018 introduces substantial changes. The most noteworthy features of Act 257-2018 are amendments to income tax provisions applicable to individuals and corporations and changes to Puerto Rico's sales and use tax laws. In the case of individuals and corporations, Act 257-2018 places greater reliance on the use of the alternative basic tax and alternative minimum tax and the need to obtain external validation by Puerto Rico licensed Certified Public Accountants. Act 257-2018 also introduces an optional computation that will allow certain individuals and corporations, whose main business activity is rendering services, to meet their tax compliance obligations by making an election to have their taxes withheld at source by the payor. In the sales and use tax (SUT) area, the number of Puerto Rico merchants that will be required to collect the 4% intermediate rate applicable to certain services will be substantially reduced with the increase in the existing threshold for collection from gross sales of $50,000 per year increasing to $200,000 per year. Act 257-2018 also reduces the sales and use tax rate applicable to prepared foods sold by restaurants from 11.5% to 7%, effective Oct. 1, 2019. Other amendments will affect deductions, the filing of returns and source of income rules, among other tax revenue and enforcement measures. A guiding tax policy principle embedded in Act 257-2018 is revenue neutrality. That is to say, Act 257-2018 should have no effect on the tax revenues deposited in the government's coffers. The legislative evolution of Act 257-2018 resulted in tax rate reductions that are less ambitious than originally planned and increased focus on the use of technology and third-party validation to assist the Puerto Rico Treasury Department in its tax enforcement efforts. The statutory mandate of Act 257-2018 creates greater interdependencies among taxpayers and the information they are obligated to report, which is expected to enable greater oversight and verification of the information being reported to the government. For more on this development, see Tax Alert 2018-2560. Multistate: The latest state income tax quarterly newsletter provides a summary of the significant legislative, administrative and judicial actions that affected state and local income/franchise taxes during the fourth quarter of 2018. These developments are compiled from the EY Indirect/State Tax Weekly and Indirect/State Tax Alerts. See Tax Alert 2019-0054 for a copy of the newsletter. California: The California Franchise Tax Board (FTB) announced the bright-line "doing business in California" brackets, which were adjusted to reflect changes in the California Consumer Price Index as required by the applicable statute. The adjusted threshold values for taxable years beginning on and after Jan. 1, 2018 are as follows: (1) taxpayer's in-state sales that exceed the lesser of $583,867 (from $561,951) or 25% of the taxpayer's total sales; (2) taxpayer's real and tangible personal property in California exceeds the lesser of $58,387 (from $56,195) or 25% of the taxpayer's total real and tangible personal property; and (3) taxpayer's in-state compensation exceeds the lesser of $58,387 (from $56,195) or 25% of the total compensation paid by the taxpayer. Cal. FTB, taxnews (Oct. 2018). Louisiana: A 2015 law change1 that limited the availability of the credit for income taxes paid to another state available under La.R.S. 47:33 is unconstitutional in violation of the dormant Commerce Clause because failure to provide a credit results in double taxation of income that is earned outside the state but not intrastate. At issue in this case is Louisiana resident individual taxpayers' payment of Texas franchise tax based on Texas-sourced income of pass-through entities in which the taxpayers' own an interest and the denial of a Louisiana tax credit for their share of Texas taxes paid under the 2015 legislative amendment. The Louisiana Supreme Court (Court) first considered whether the Texas franchise tax is an income tax. This issue was initially considered in a 1999 case — Perez — where the Court found the Texas franchise tax was an income tax. The Louisiana Department of Revenue (Department) argued that this conclusion should be reconsidered in light of the 2006 amendments to the Texas franchise tax (in which the old income-based/capital-based tax was substituted by a tax on margin). The Court rejected the Department's argument, finding again that the revised franchise tax is still an income tax for purposes of the credit for income taxes paid to another state. The Court next considered whether the limit on the credit for taxes paid to another state is unconstitutional in violation of the dormant Commerce Clause. The Court agreed with the taxpayer's that the limit is unconstitutional as it fails the external consistency test because it not fairly apportioned and it results in double taxation of interstate commerce as compared with the taxation of intrastate income. Smith v. Robinson, No. 2018-CA-0728 (La. S.Ct. Dec. 5, 2018). Louisiana: Adopted regulations (LAC 61:I.1135 and 1136) implement provisions related to the state's new market-based sales factor sourcing rules for sales of services and non-tangible property that were established by Act 8 of the 2016 Second Extraordinary Session. The regulations include guidance on how to determine the extent to which the market for a sale of services or non-tangible property is in Louisiana, how to reasonably approximate the state(s) of assignment where the state(s) cannot be determined, and which sales to exclude from the numerator and denominator of the sales factor. Further, under the regulations, sales (including sales of tangible personal property) are excluded from the sales factor numerator and denominator if: (1) the taxpayer is not taxable in a state to which a sale is assigned, or (2) the state of assignment cannot be determined or reasonably approximated. Lastly, the regulations provide guidance on how to determine whether a taxpayer is taxable within another state and how to reasonably approximate the state of assignment using a taxpayer's known sales, related-party transactions, or based on place of sale. The regulations take effect Dec. 20, 2018. La. Dept. of Rev., Adopted LAC 61:I.1135 and 1136 (adopted Dec. 20, 2018). Michigan: Vetoed bill (SB 1097) would have decoupled the Michigan income tax from IRC §163(j), which, as modified by the "Tax Cuts and Jobs Act" (P.L. 115-97), imposes limitations on the deductibility of business interest expense. SB 1097 was vetoed by former Governor Rick Synder on Dec. 28, 2018. In his veto message Synder cited the estimated reduced revenue that would have been brought about by the bill — $115 million in FY 2018-19 and $100 million per year thereafter. New legislative language will have to be introduced in the 2019–2020 legislative session. Michigan: Vetoed bill (SB 1170) would have imposed a flow-through entity tax equal to the individual income tax rate on flow-through entities electing to be taxed and allowing individuals with flow through income to claim a credit to offset the tax paid at the flow-through entity level. This provision was intended as a work around to the new federal limitation imposed upon the deductibility of state and local taxes paid by individuals. SB 1170 was vetoed by former Governor Rick Synder on Dec. 28, 2018. In his veto message Synder said the bill was passed in little over a month and such a limited amount of time was inappropriate given that this was a new tax. New legislative language will have to be introduced in the 2019–2020 legislative session. New Jersey: The New Jersey Division of Taxation (Division) issued a technical bulletin to address the application of IRC §§ 250 (providing for deductions relating to global intangible low-taxed income (GILTI) and foreign derived intangible income (FDII)) and 951A (GILTI inclusion) to the New Jersey Corporate Business Tax (CBT). The Division explained that since the starting point for calculating entire net income (ENI) for CBT purposes is the amount reported for federal income tax purposes before net operating loss and special deductions, GILTI and FDII are included in ENI. For CBT purposes, the Division also concluded that neither GILTI nor FDII are treated as dividends or deemed dividend income. Rather, these are new separate categories of income and not treated as distributions from earnings and profits. New Jersey's statutory provisions (N.J.S.A. 54:10A-4(k)(5)) for dealing with the treatment of certain dividends does not apply. Recently enacted legislation (c. 131, N.J. Laws 2018) allows the GILTI and FDII deductions under IRC § 250(a) for CBT purposes, but "only to the specific taxpayer that included the respective GILTI and FDII income on its federal and New Jersey CBT returns, and that actually took the deductions for federal income tax purposes." If the IRC §250(a) deduction was not allowed for federal income tax purposes, it is not allowed for CBT purposes. In addition, the Division explained that GILTI and FDII are sourced under the category of "all other business receipts" as described in N.J.S.A. 54:10A-6(B)(6).2> Further, in order to prevent distortion, the Division is requiring all CBT taxpayers filing a CBT-100 or BFC-1 to calculate the portion of GILTI and FDII subject to New Jersey tax based on a separate special accounting method. For purposes of computing the tax on net GILTI and net FDII amount, the relevant allocation factor is equal to the ratio of New Jersey's gross domestic product (GDP) over the total GDP of every state (and the District of Columbia) in which the taxpayer has economic nexus. The Division has created new Schedule A-6 for reporting GILTI and FDII. The Division indicated that it will promulgate regulations addressing the sourcing of GILTI, FDII and the IRC §250(a) deductions consistent with this bulletin. N.J. Div. of Taxn., TB-85 - Tax Conformity to IRC §951A (GILTI) and IRC §250 (FDII) (revised Dec. 24, 2018). New Jersey: The New Jersey Director of the Division of Taxation (Director) has the authority to impose an alternative apportionment formula on a commercial financial services corporation when application of the statutory formula did not produce a fair approximation of the net income attributable to its activities, however, in this case the Director's imposition of a five-factor apportionment formula is invalid as "the features of rule-making predominated the Director's determination." The New Jersey Tax Court (Court) also found the Director unreasonably denied the corporation's related party interest deduction for pre-2010 tax years. With respect to the Director's application of an alternative apportionment formula, the Court rejected the corporation's assertion that it was entitled to apply the standard three-factor allocation formula even though it did not maintain a regular place of business outside the state (which was required), and found that the Director's five-factor formula did "not unfairly result in a degree of unfairness or inequity." The Court then applied the six Metromedia3 factors, in considering whether the Director's construction and application of the five-factor formula constitutes de facto rule-making in violation of the Administrative Procedures Act (APA). In finding the Director's imposition of the five-factor formula constituted de facto rule-making, the Court reasoned that the five-factor formula was not permitted or inferable from the statutory language of the alterative apportionment statute (N.J.S.A. 54:10A-8), since bifurcating the property fraction into two categories is not included in the statute explicitly or by inference. Further, bifurcating the property factor departs from existing policy and procedure. The Court also found that the Director's determination is an interpretation of the enabling law and a decision on administrative policy comporting with the general definition of a rule under the APA. The Court noted that Director's discretion to impose an alternative apportionment formula is not boundless. Additionally, the Court found it unreasonable for the Director to deny the corporation's deduction for related party interest paid for tax years before 2010, since the Director permitted the deduction in 2010 under similar loan agreements (arm's length transactions) with identical interest rates. Lastly, the Court found that underpayment and amnesty penalties did not apply to the extent they resulted from the application of the five-factor formula or the denial of the related party interest deduction. Canon Fin. Svcs., Inc. v. NJ Dir., Div. of Taxn., No. 000404–2014 (N.J. Tax Ct. Dec. 5, 2018)(unpublished). Iowa: In partially affirming the lower court, the Iowa Supreme Court (Court) held the Iowa Department of Revenue (Department) properly assessed sales tax on labor to install items sold by a home improvement retailer to homeowners through installment contracts, except when the labor was for carpentry installation services that were not repairs. The Court found that the definitions of "electrical and electronic repair and installation" and "pipe fitting and plumbing" (Iowa Admin. Code r. 701-26.12 and .16, respectively) include taxable installation services. Further, strictly construing the tax exemption, the Court found that electrical and plumbing installation services are not exempt as "new construction, reconstruction, alteration, expansion, remodeling, or the services of a general building contractor" because the small-scale installations of fixtures and other building components (such as windows, doors, dishwashers, garbage disposals, toilets, sinks, vanities, and ceiling fans) do not make structural changes to a customer's home. If, however, the retailer's installations included both carpentry services and electrical or plumbing services, such as the installation of ceiling fans, on remand the Department must adjust the sales tax according to the predominant service rule (i.e., if the predominant service was carpentry installation, the sales tax would not be assessed on that labor). Lowe's Home Centers, LLC v. Iowa Dept. of Rev., No. 18-0097 (Iowa S.Ct. Dec. 14, 2018). New Mexico: Services provided by a hazardous waste removal company under contract with the federal Drug Enforcement Administration (DEA) were performed in New Mexico and as such the company is liable for New Mexico's gross receipts tax on receipts derived from providing these services since the company does not qualify for a deduction for certain services sold to out-of-state buyers. An administrative law judge (ALJ) with the New Mexico Administrative Hearings Office determined that the company derives all of its benefits from engaging in business without leaving New Mexico (i.e., the company responds to sites within the state, collects and removes hazardous materials from those sites, and temporarily stores the materials in-state until they are shipped out-of-state for disposal). Moreover, the underlying purpose of the company's contract with the DEA indicates that the company's "primary objective" is to remove hazardous materials from sites within New Mexico. After determining that the services the company provides are taxable, the ALJ additionally found that the company did not qualify for a deduction for certain services to an out-of-state buyer under N.M. Stat. Ann. § 7-9-57 when the product of the company's services was initially delivered and used in New Mexico. The ALJ found that the initial use of the product (i.e., the removal of hazardous materials from specific sites in New Mexico) was practically simultaneous with delivery, since local law enforcement personnel could safely proceed with their activities at sites where the company performed its services and the DEA could minimize both potential harm to the public related to potential hazardous materials exposure and potential environmental harm. In re Protest of Advance Envir. Solutions Inc. v. N.M. Taxn. and Rev. Dept., D&O No. 18-42 (N.M. Admin. Hrngs. Ofc. Dec. 3, 2018). Ohio: The American Catalog Mailers Association voluntarily dismissed its complaint challenging the validity, enforceability, and constitutionality of Ohio's cookie and network nexus provisions enacted in 2017. Starting in 2018 these new provisions require certain remote retailers to collect and remit state sales tax. American Catalog Mailers Assn. v. Testa, No. 17 CV 011440 (Franklin Cnty. Common Pleas Ct. voluntarily dismissed Dec. 18, 2018). For more on Ohio's cookie nexus provisions, see the Ohio Department of Taxation's Information Release ST 2017-02 (Oct. 2017). New York: The New York Court of Appeals (Court) affirmed that a telecommunications company's cellular data transmission equipment (e.g., base transceiver stations, antennas, coaxial and fiber optic cables) mounted to the exterior of buildings is taxable real property under New York Real Property Tax Law (RPTL) 102(12)(i) (hereafter, paragraph i) based on the statute's plain meaning as well as legislative history. In so holding, the Court found that the plain language of paragraph i encompasses each component of the company's data transmission equipment. The Court rejected the company's arguments that its equipment was not subject to tax under 1987 tax phase outs, when those phase outs applied to property located in a telephone company's central office (as opposed to large equipment installations or "outside plant" in this case). Lastly, the company's equipment does not qualify for the statute's "station connections" exception, since this refers to wiring that physically connects customer telephones to telephone poles rather than the large outdoor equipment. Matter of T-Mobile Northeast, LLC v. DeBellis, No. 140 (N.Y. App. Ct. Dec. 13, 2018). Illinois: The Illinois Department of Revenue announced that it will honor any extensions or grace periods granted by the IRS as a result of the federal government shutdown. Ill. Dept. of Rev., 2018 Federal Government Shutdown (Dec. 24, 2018). New York: The New York Department of Taxation and Finance (Department) in a recent update to the instructions for its 2018 Article 9-A Corporation Franchise Tax returns included a discussion on Global Intangible Low-Taxed Income (GILTI). Based on the guidance included in the instructions to Form CT-3 "General Business Corporation Franchise Tax Return" and the instructions for Form CT-3-A "General Business Corporation Combined Franchise Tax Return," it appears that the Department is requiring that taxpayers include 0% of the IRC §951A GILTI inclusion in the numerator of the apportionment fraction and 50% or the net IRC § 951A amount (IRC § 951A minus the IRC § 250 GILTI deduction) in the denominator of the apportionment fraction. Specifically, the instructions state: "Line 53 — Section 210-A.11 — Discretionary adjustments GILTI — Global intangible low-taxed income (GILTI) under IRC section 951A must be included on line 53; include 100% of such income, less the IRC section 250(a)(1)(B)(i) amount (if applicable), on line 53 in the Everywhere row. Such income is not included in the New York row. You must attach to your return a statement that indicates the amount of GILTI included in the Everywhere row." Mississippi: Individual taxpayers were not entitled to claim a credit on their Mississippi return for taxes paid to another state because Mississippi's statute of limitation barred individual taxpayers from amending their Mississippi tax returns. The taxpayers had originally reported gain only to Mississippi. Upon audit, however, New York concluded that the taxpayers owed New York taxes which the taxpayers ultimately paid. The taxpayers then sought to claim a credit for the taxes paid to New York but the Mississippi tax authority denied the refund claim since the applicable statute of limitations for filing a refund had expired. The taxpayers then sought recourse in the courts claiming that the denial of the refund claim was unconstitutional under the Commerce Clause. The Mississippi Supreme Court (Court) concluded that the state's action did not unconstitutionally discriminate against interstate commerce because it does not distinguish between in-state or out-of-state taxpayers or between interstate and intrastate commerce. In doing so, the Court applied the discrimination/Pike4 balancing test used by the U.S. Supreme Court in Bendix Autolite Corp,5 and further found that the statute of limitation's incidental effect on interstate commerce is justified by the practical difficulties of tax administration and the state's interest in finality — i.e., it was not "clearly excessive in relation to the putative local benefits." The Court rejected the taxpayers' argument that the internal consistency test should be applied to an issue such as statute of limitations, and noted that the Complete Auto6 test is intended to evaluate the constitutionality of taxes rather than state regulations in general. Additionally, the statute of limitations did not violate the taxpayers' due process rights as the taxpayers voluntarily paid their taxes to Mississippi and the statute of limitations did not categorically deny the taxpayer's tax credit eligibility since they could have requested the credit in their original return. Kansler v. Miss. Dept. of Rev., No. 2017-CA-01295-SCT (Miss. S.Ct. Nov. 29, 2018). New Jersey: Reminder: The New Jersey tax amnesty program will end on Jan. 15, 2019. Amnesty applies to taxes administered and collected by the New Jersey Division of Taxation (NJ DOT). Importantly, local property taxes and payroll taxes are excluded from the amnesty program. The terms of the amnesty require taxpayers with delinquent taxes attributable to returns due from Feb. 1, 2009 through Sept. 1, 2017 to pay the delinquent tax, plus one-half of interest calculated through Nov. 1, 2018. Amnesty relieves participants of penalties, penalty collection costs, recovery fees and one-half of interest upon full payment, but taxpayers will still be required to pay any civil fraud or criminal penalties, if assessed. Taxpayers that do not remit eligible taxes under the amnesty program are subject to a non-waivable 5% penalty, in addition to any other applicable penalties, costs and interest. Iowa: The Iowa Department of Workforce Development (Department) reports that revised 2019 state unemployment insurance (SUI) tax rate notices were issued to approximately 60% of the state's employers due to a "data format issue" that occurred at the Department's vendor. However, the original 2019 notice posted to employers' electronic accounts in My Iowa UI were correct. The revised paper notices were mailed on Dec. 10, 2018. For additional information on this development, see Tax Alert 2019-0013. Kentucky: The Kentucky Department of Revenue (Department) has released the 2019 income tax withholding computer formula and wage-bracket tables. The Department has not yet updated its withholding tax guide for 2019, which was last revised in November 2018 to include legislative changes. For additional information on this development, see Tax Alert 2019-0005. Missouri: The Missouri Department of Revenue released its 2019 withholding computer formula and wage-bracket tables and its 2019 Form MO W-4. The Missouri Employer's Tax Guide has not yet been updated for 2019. Once updated, it will be available through this link. For additional information on this development, see Tax Alert 2019-0019. New Mexico: The New Mexico Taxation and Revenue Department (Department) released the 2019 wage-bracket and percentage method tables for state income tax withholding. The annual percentage method tables remain unchanged from June 2018. For more on this development, see Tax Alert 2019-0020. South Carolina: The South Carolina Department of Revenue has released the 2019 income tax withholding computer formula and wage-bracket tables to its website. The 2019 employer withholding guide, last updated in 2017, is not yet updated for 2019. For more on this development, see Tax Alert 2019-0011. California: In mid-December 2018, the California Department of Tax and Fee Administration (Department) announced that effective immediately, sellers of prepaid mobile telephony services (MTS) registered with the Department must stop charging and collecting the statewide portion of the prepaid MTS surcharge because a federal court declared it unenforceable.7 Sellers are only required to collect the prepaid MTS local charges on sales of prepaid MTS from customers. In the absence of the prepaid MTS surcharge, telecommunications service suppliers must report any applicable 911 surcharge and California Public Utilities Commission reimbursement fee and telecommunications universal fees on prepaid interstate telephone communication service in California. Prepaid MTS sellers must continue to file their prepaid MTS report and pay all surcharge amounts collected from customers, including any prepaid MTS surcharge amounts collected at the statewide 6.3% rate as sellers come into compliance with this guidance. The Department instructed MTS sellers to not refund any prepaid MTS surcharge to customers at this time, noting that it will provide further guidance on this as it is available. Cal. Dept. of Tax and Fee Admin., Prepaid Mobile Telephony Services Surcharge, L-592 (Dec. 2018). Multistate: On Thursday, Jan. 24, 2019 from 1:00-2:15 p.m. EST New York (10:00-11:15 a.m. PST Los Angeles) Ernst & Young LLP (EY) will host a webcast during which the panelists will discuss current developments in state and local tax controversy. Transfer pricing audits, assessments and court decisions have become more and more frequent over the last few months. Leaders from EY's tax practice will provide an overview of federal transfer pricing principles and recent decisions as well as dive into the details of how specific states and the Multistate Tax Commission (MTC) view transfer pricing. The webcast will conclude with updates on controversy trends in Illinois and California. On this webcast, Helen Hecht, general counsel for the MTC, will sit down with EY's Mike Semes and Scott Susko to discuss the MTC's point of view on transfer pricing and related issues. In addition, panelists will discuss the most recent judicial, legislative and administrative developments in Illinois and California. Click here to register for this event. Multistate: A replay of the Dec. 13, 2018, state tax quarterly webcast is now available. On this webcast, our special guest speaker Josh Pens, Director, Office of Tax Policy & Analysis, Colorado Department of Revenue met with Rachel Quintana of Ernst & Young LLP (EY) to provide his first-hand perspective on current issues in Colorado including recent guidance from the state on the application of the U.S. Supreme Court's decision in Wayfair on sales tax collection issues in state and local taxing jurisdictions. In addition, the following topics were discussed: (1) the results from the new 16th annual 50-state business tax study conducted by EY's Quantitative Economics and Statistics (QUEST) Practice with the Council on State Taxation (COST) and the State Tax Research Institute (STRI); (2) our annual wrap-up (and rating) of 2018's Top 10 state and local tax developments; and (3) an update of the major judicial and administrative developments affecting state and local taxes over the last quarter. To listen to a replay of 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. 1 La. Laws 2015, Act 109. Specifically, Act 109 limits the credit for income taxes paid to another state on income earned in that state only if that other state's laws provide a reciprocal credit for residents of that state who earn income in Louisiana. 2 The Division noted that sourcing GILTI and FDII using N.J.A.C. 18:7-8.12(e) as "Other Business Receipts" "may not reflect a fair and equitable allocation." 7 MetroPCS California, LLC v. Michael Picker et al., No. 17-CV-05959-SI (N.D. Cal. Nov. 15, 2018). A notice of appeal has been filed, but the state cannot enforce the surcharge while the case is being appealed. Document ID: 2019-0078 |
