04 March 2019

State and Local Tax Weekly for February 22

Ernst & Young's State and Local Tax Weekly newsletter for February 22 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.

TOP STORIES

Ohio Court of Appeals holds out-of-state corporation met the CAT's bright-line factor presence nexus standard based on application of the state's receipts sourcing rule

An Ohio Court of Appeals (appeals court) affirmed the Ohio Board of Tax Appeals’ (BTA) ruling in Greenscapes Home and Garden Products, Inc.,1 that an out-of-state corporation with no physical presence in Ohio is subject the Ohio Commercial Activity Tax (CAT) because application of the state’s sourcing provisions resulted in one of the CAT’s bright-line presence factors (in this case, the receipts factor) being satisfied.

Greenscapes Home and Garden Products, Inc., (“Greenscapes”) is a Georgia-based corporation and had no locations or other physical presence in Ohio. It sold lawn and garden products to big box retailers that have distribution centers and retail outlets in Ohio. The Ohio Department of Taxation (Department) made nexus inquiries of Greenscapes, and issued an assessment for the audit period that went back to 2007.

The assessment was based on an application of Ohio Rev. Code §5751.033(E), which sources receipts from sales of tangible personal property to Ohio to the place where property is ultimately received after all transportation is completed. In applying the sourcing statute, the Department also relied on two Ohio Supreme Court decisions: Dupps Co.2 and House of Seagram, Inc.,3 applying a similar sourcing statute relating to the former Corporation Franchise Tax. In Greenscapes, the Department concluded that once the taxpayer’s receipts were sourced to Ohio, one of the CAT’s bright-line presence factors (i.e., the $500,000 Ohio receipts factor), was satisfied, triggering nexus for CAT purposes.

The Department’s assessment was upheld by the BTA. Greenscapes appealed, arguing that the assessment violated both the Commerce Clause and the Due Process Clause of the U.S. Constitution. In rejecting Greenscapes’ Commerce Clause objections, the appeals court relied on the Ohio Supreme Court’s decision in Crutchfield Corp.,4 and the U.S. Supreme Court’s decision in Wayfair,5 and noted that physical presence is not required to have nexus for CAT purposes. The appeals court then noted that the Ohio Supreme Court found in Dupps and House of Seagram that there was “ample nexus to support the tax in question.” However, those cases held that the sourcing statutes were constitutionally applied for purposes of the measurement of the tax liability, not nexus. In both cases, the appeals court noted, the taxpayers had nexus and were already filing returns. Nonetheless, the appeals court held that Greenscapes had nexus for CAT purposes based on the application of the sourcing statute as informed by those Corporation Franchise Tax decisions with the resultant triggering of bright-line presence nexus under the CAT statute.

The appeals court also found that the application of the CAT to the corporation’s sales does not violate the Due Process clause because the corporation by purposefully distributing its products through national retailers, knew that its products would be shipped to Ohio.

For more on this development, see Tax Alert 2019-0430.

INCOME/FRANCHISE

Iowa: Revenue an Iowa-based transportation brokerage service provider receives from connecting clients that need transportation services with transportation services providers should be apportioned to Iowa using the default rule for income derived from business other than the manufacture or sales of tangible personal property (Iowa Admin. Code r. 701-54.6(1)), and not the subrule that applies to transportation companies. The Iowa Department of Revenue (Department) found that the subrule for transportation companies is inapplicable because the brokerage service provider does not qualify as a transportation company since it does not transport its clients’ goods itself. Further, based on the application of the default rule, the brokerage service provider’s Iowa receipts (apportionment factor numerator) should include the part of its gross receipts for which “the recipient of the service receives the benefit of the service in this state.” The brokerage service provider asserted that it was unclear from the default rule where the benefit of the service it provided is received. While the Department agreed that there is no rule directly on point, it found the rules dealing with direct mailing services were most analogous to the brokerage services at issue. Under the direct mailing services rule, the benefit of the service is considered received at the location to which the materials are mailed. Here, the end result of the services being provided is the delivery of goods to the location specified by the client. Thus, the benefits of the brokerage services are received at the clients’ delivery locations and as such, receipts are sourced to Iowa when the clients’ goods are delivered in Iowa. In re BLX, Inc., No. 2018-240-2-0390 (Iowa Dept. of Rev. declaratory order Dec. 31, 2018).

New Mexico: An out-of-state credit card bank is entitled to a refund of corporate income tax where it filed in compliance with the special regulation governing apportionment of financial institutions, but the New Mexico Department of Taxation and Revenue (Department) improperly made an equitable adjustment to the apportionment by eliminating the payroll factor. The administrative law judge (ALJ) for the New Mexico Administrative Hearings Office found that while the bank’s payroll factor was de minimis under the Department’s 3% de minimis threshold, the Department failed to provide enough evidence or explanation on how the special regulatory apportionment method distorted the bank’s New Mexico business activities. The ALJ noted that the 3% de minimis threshold was not established through statute or regulation, but rather came from the Department’s 2012 CIT-1 instructions. The ALJ also held that the bank was not entitled to costs and fees when the Department reasonably applied the law to the facts, using the de minimis payroll factor and the Department’s expert witness’ testimony. In re Protest of Discover Bank v. N.M. Taxn. and Rev. Dept., No. 18-44 (N.M. Admin. Hearings Ofc. Dec. 21, 2018).

Philadelphia: The Philadelphia Department of Revenue (Department) issued guidance on how the city treats the global intangible low-taxed income (GILTI) inclusion under IRC §951A and the GILTI and foreign-derived intangible income (FDII) deduction under IRC §250 for purposes of the city’s Business Income and Receipts Tax (BIRT). For Method II BIRT taxpayers, GILTI income is treated as dividend income that is included in the BIRT income tax base; the city does not conform to the GILTI deduction (which is considered a special deduction). Most BIRT Method II taxpayers’ GILTI income is eligible for the following deductions: (1) dividends received from another corporation that is part of the same affiliated group; or (2) dividends received from a corporation of which the receiving corporation or partnership owns at least 20% of the voting power of all classes of stock and at least 20% of each class of nonvoting stock. In calculating the BIRT Gross Receipts Tax, GILTI income is excluded as items (1) or (2) described above. Only dividends received from a less than 20% owned subsidiary is included in the BIRT gross receipts and net income tax bases and in the sales factor apportionment of taxable income. In regard to the FDII, for BIRT Method II taxpayers’ FDII is included in the BIRT income tax base. Like the GILTI deduction, the city also does not conform to the FDII deduction. Neither the GILTI adjustments nor the FDII deduction apply to BIRT Method I taxpayers because these items are not reflected on a taxpayer’s books and records. Philadelphia Dept. of Rev., Advisory Notice – GILTI and FDII Tax Policy Update (Feb. 15, 2019).

Texas: A retail drugstore is not entitled to cost of goods sold (COGS) deductions from franchise tax for labor costs associated with the time a pharmacist spends counseling customers and the costs associated with the purchase of customer lists from pharmacies it acquired, because these costs were not direct costs of acquiring or producing goods. The Texas Comptroller of Public Accounts (Comptroller) found that the labor costs related to customer counseling by pharmacists are selling costs excluded from COGS by statute, as the counseling occurs after the goods have been displayed for sale. Further, such counseling did not involve any kind of inspection allocable to the production of goods, and did not otherwise accomplish a quality control function related to the production of goods.  The Comptroller also determined that the purchase of customer lists in the acquisition of a pharmacy are not deductible as a COGS because the drugstore did not provide evidence that the costs were associated with and necessary to the production of goods, and instead were selling costs excluded from COGS. Tex. Comp. of Pub. Accts., No. 201901038H (Jan. 14, 2019).

SALES & USE

Iowa: The Iowa Department of Revenue (Department) issued guidance on the applicability of state sales and local option sales taxes (collectively sales tax) to the storage of tangible or electronic files, documents or other records following a 2018 law change. Beginning Jan. 1, 2019, these transactions are generally subject to sales tax, but statutory exemptions could apply. The sale of storage services for tangible files (i.e., physical archives, title or abstract storage, among others) or electronic files (any digital product such as cloud storage, storage on computers, hard drives, serves, etc.) are taxable regardless of how long they are stored. Additionally, tangible storage is taxable regardless of the purpose of the storage and whether the purchaser has access to an individual storage unit. Electronic storage is taxable regardless of the size or quantity of the service, which often include providing remote access for customers to servers that store content, data, applications, software, and other electronic files for safekeeping and later retrieval. A statutory sales tax exemption which applies to qualifying commercial enterprises for commercial purposes could apply; this exemption does not apply to storage of household goods, mini-storage, and warehousing of raw agricultural products. The Department noted that its recent declaratory order for Amazon Web Services, Inc.6 addressed whether certain services constitute electronic storage of files, documents, and other records. Iowa Dept. of Rev., Storage of Tangible or Electronic Files, Documents or Other Records (Feb. 14, 2019).

New Mexico: An oil field services company could not deduct from gross receipts tax the chemicals it used when carrying out hydraulic fracturing because the use and consumption of the chemicals were incidental to the performance of its hydraulic fracturing services, rather than a sale of goods. In making this determination, an administrative law judge (ALJ) from the New Mexico Administrative Hearings Office considered the plain meaning of the chemical and reagents deduction under NMSA § 7-9-65 and found that the deduction applies only to the sale of the chemicals or reagents themselves rather than the use of those chemicals and reagents in the related services. Further, the ALJ rejected the company’s argument that the predominant ingredient test (which compares relative inputs of services and tangible personal property to determine whether the sale involved a service or property) applied, finding that application of the test would render the statute meaningless. Moreover, citing various out-of-state cases, the ALJ found that hydraulic fracturing is primarily the performance of a service the essence of which is the company’s specialized skill and knowledge, laboratory data and tests and information regarding specific wells. Although the determination of the first issue was dispositive, the ALJ nevertheless addressed additional issues based on the likelihood of appeal. The ALJ determined that multiple types of chemicals could constitute an 18-ton “lot” under the statute, and a “lot” means a discrete and identifiable set of goods rather than a continuous flow. The ALJ noted that another case currently being litigated, Tucson Electric,7 could be dispositive in this case, as it addresses what constitutes a “lot” by statute. Therefore, if on appeal the statute is found to permit a continuous flow of delivery, the ALJ determined that the most logical measuring time period is a calendar’s day worth of deliveries. Lastly, the curable resin-coated proppant the company used in sample wells is not a chemical since it is not used to produce a chemical reaction. In re Protest of Halliburton Energy Services, Inc. v. N.M. Taxn. and Rev. Dept., No. 19-05 (N.M. Admin. Hearings Ofc. Feb. 4, 2019).

Wyoming: New law (HB 69) requires marketplace facilitators to collect tax on sales they make on their own behalf and those made by third-party sellers through the facilitators’ marketplace if, in the current or preceding calendar year, the marketplace facilitator's Wyoming sales (both direct and those made by third-party sellers) exceed $100,000 or occur in 200 or more transactions. The Wyoming Department of Revenue will audit the marketplace facilitator for sales made by marketplace sellers but facilitated by the marketplace facilitator. In addition, a marketplace facilitator will be relieved of liability for failure to collect or remit if the marketplace facilitator fails to collect or remit tax because of incorrect or insufficient information provided by the marketplace seller. These provisions take effect July 1, 2019. Wyo. Laws 2019, Ch. 41 (HB 69), signed by the governor on Feb. 15, 2019.

BUSINESS INCENTIVES

Virginia: New law (HB 2065) moves forward the sunset date for the Telework Expenses Tax Credit and the date before which an employer must enter into a telework agreement with a participating employee to taxable years beginning before Jan. 1, 2019 (formerly Jan. 1, 2022). Va. Laws 2019, Ch. 21 (HB 2065), signed by the governor on Feb. 15, 2019.

PROPERTY TAX

Minnesota: The Minnesota Supreme Court (Court) held that the Minnesota Tax Court (Tax Court) erred in concluding that it was not bound to apply Minnesota Rule 8100 regarding how utilities, including an energy company’s petroleum pipeline system, should be valued for ad valorem tax purposes. In reversing the Tax Court’s decision, the Court, citing its ruling in Minn. Energy Resources Corp. (MERC),8 found that the Tax Court could not disregard the rule after finding that it was likely to lead to an incorrect valuation. Rather, it could only ignore the rule if it had held that the rule violated a statute—which it didn’t. Further, the Court reiterated its finding in MERC that the rule not only applies to the Revenue Commissioner but also by extension to the Tax Court. Therefore, the Tax Court was required to apply the rule upon finding that the Revenue Commissioner had failed to properly apply it, and then fully explain its reasoning. Minn. Comr. of Rev. v. Enbridge Energy, LP, No. A18-0864 (Minn. S.Ct. Feb. 13, 2019).

PAYROLL & EMPLOYMENT TAX

Multistate: The final report of 2019 state unemployment insurance taxable wage bases (as compared to 2018) and employee SUI withholding rates, if applicable, is now available. For a copy of the report, see Tax Alert 2019-0389.

Illinois: Recently enacted SB 0001 (Public Act 101-0001) will increase the state minimum wage incrementally to $15 per hour by 2025, starting with a jump from the current $8.25 to $9.25 effective Jan. 1, 2020 and to $10 per hour effective July 1, 2020. After the increase to $9.25 per hour effective Jan. 1, 2020 and $10 per hour effective July 1, 2020, the state minimum wage will rise to $11 per hour on Jan. 1, 2021, and then increase by $1 per hour every January 1st until it reaches $15 per hour on Jan. 1, 2025. For more on this development, see Tax Alert 2019-0399.

Massachusetts: The Massachusetts Department of Family and Medical Leave released draft regulations aimed at clarifying the state paid family and medical leave insurance program that, effective Jan. 1, 2021, will allow eligible individuals to take paid leave to care for a family member or bond with a new child and deal with a personal medical issue or an emergency related to deployment of a family member for military service. A payroll tax shared by employers and employees is set to begin July 1, 2019. For more on this development, see Tax Alert 2019-0393.

VALUE ADDED TAX

International: The Greek Tax Administration, through Decision A. 1035/2019 of the Governor of the Independent Authority of Public Revenues (IAPR) published on Feb. 5, 2019 in the Government Gazette, explicitly acknowledged the reduction of the taxable amount for Value Added Tax (VAT) purposes for rebates granted by pharmaceutical companies to social security organizations and hospitals pursuant to article 35 par. 3 of Law 3918/2011, as in force. For more information on this development, see Tax Alert 2019-0376.

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.

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ENDNOTES

1 Greenscapes Home and Garden Products, Inc. v. Testa, No. 17-AP-593 (Ohio Ct. App., 10th App. Dist., Feb. 7, 2019).

2 Dupps Co. v. Lindley, 62 Ohio St.2d 305 (1980).

3 House of Seagram, Inc. v. Porterfield, 27 Ohio St.2d 97 (1971).

4 Crutchfield Corp. v. Testa, 151 Ohio St.3d 278 (2016).

5 South Dakota v. Wayfair, 138 Sup. St. 2080 (2018).

6 In re Amazon Web Services, Inc., No. 2018-300-2-0508 (Iowa Dept. of Rev. declaratory order Dec. 18, 2018).

7 In re Protest of Tucson Electric, Admin. Hearings Ofc. Dec. and Order No. 16-29 (non-precedential, currently under appeal, Court of Appeals No. A-1-CA-35781).

8 Minn. Energy Resources Corp. v. Comr. of Rev., 886 N.W.2d 786 (Minn. S.Ct. 2016) (MERC).

Document ID: 2019-0464