March 15, 2019
State and Local Tax Weekly for March 8
Ernst & Young's State and Local Tax Weekly newsletter for March 8 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.
New Jersey Tax Court allows full exception to royalty addback requirement, creating potential refund opportunity
In Lorillard Tobacco Company v. Director, Division of Taxation (Lorillard II),1 the New Jersey Tax Court (tax court) held that the New Jersey Division of Taxation (DOT) improperly applied N.J.S.A. 54:10A-4.4(b) by requiring a taxpayer (Taxpayer) to add back royalties paid to one or more of its related subsidiaries (a Related Subsidiary) in computing its entire net income (ENI). The tax court ruled that it was unreasonable to require the Taxpayer to add back its royalty payments to its Related Subsidiary when that subsidiary: (i) filed its own New Jersey Corporation Business Tax (CBT) returns, (ii) included the income from the royalty payments received from the Taxpayer on those returns, and (3) properly allocated its income to New Jersey. Having concluded that the DOT failed to properly apply the statute, the tax court declined to address the constitutionality of the DOT's regulation, N.J.A.C. 18:7-5.18(b)(3), which the DOT had argued allows only for a partial refund to a royalty payor to the extent the royalty recipient pays New Jersey CBT.
The Taxpayer, an operating company in New Jersey, filed its 2002–2005 New Jersey CBT returns on a separate-company basis, reporting its federal taxable income as its New Jersey ENI. Due to amendments to the CBT law brought about by enactment of the Business Tax Reform Act of 2002 (BTRA), the Taxpayer was required to add back the entire amount of intercompany royalty payments made to a Related Subsidiary, which the Taxpayer had deducted from its federal taxable income, under N.J.S.A. 54:10A-4.4(b).
In 2006, the DOT assessed the Related Subsidiary for amounts related to the BTRA's "throw-out" rule, resulting in an increased New Jersey apportionment for the Related Subsidiary. (New Jersey's since-repealed "throw-out" rule required a taxpayer to exclude from both the numerator and denominator of its sale factor any amounts attributable to a state in which that taxpayer was not subject to state income tax. The result would generally be to increase the overall New Jersey apportionment factor. Even after applying the "throw-out" rule, the Related Subsidiary's apportionment to New Jersey was still lower than the Taxpayer's New Jersey apportionment for the relevant period). For more information on this aspect of the Taxpayer's dispute with the DOT see the related opinion in Lorillard Licensing Co., LLC v. Director, Div. of Taxation, 28 N.J. Tax 590 (Tax 2014), aff'd, 29 N.J. Tax 275, 277-78 (App. Div. 2015), certif. denied, 226 N.J. 212 (2012). (Lorillard I).
In 2007, the Taxpayer filed refund claims for tax years 2002–2005 claiming that it would be "improper, unreasonable, and unconstitutional" to deny a deduction if the Related Subsidiary was subjected to New Jersey CBT on the same amounts, even if the subsidiary's apportionment was lower.
Subsequent to the refund claims and the tax court's ruling in favor of the Related Subsidiary in Lorillard I, the DOT granted partial refunds to the Taxpayer for the amounts related to the "throw-out" rule. The Taxpayer then initiated a motion for summary judgment on the issue of being excepted from the addback rule entirely since the Related Subsidiary, in fact, reported the royalty amount to New Jersey and paid tax on that amount. The DOT denied this additional refund claim and the Taxpayer brought the action in the current matter.
In its opinion, the tax court applied both the royalty addback statute and the DOT's regulation providing for the exception to the Taxpayer's facts and concluded that it was unreasonable for the Taxpayer to be required to add back the royalty payments made to its subsidiary to its ENI since such amounts, as required by the statute, were actually subject to CBT on the Related Subsidiary's CBT return. The DOT argued that the exception to the addback was effectuated by Schedule G-2, which was referenced in the regulatory history of N.J.A.C. 18:7-5.18. Schedule G-2 allows for the exception to the extent the royalty recipient pays at least 9% CBT on the entire royalty deduction amount. Anything less would be met with only a partial exception. The tax court noted that the DOT's position effectively prevented payors from receiving a full exception if the royalty payor's New Jersey allocation factor was greater than the royalty recipient's allocation factor. The tax court saw no support for this position when it examined the royalty addback statute, the corresponding statutory history, and the exception set forth in the DOT's own regulation. The tax court noted that the BTRA included the addback requirement in the CBT statute to prevent taxpayers from avoiding New Jersey's higher CBT rate by making payments to related parties that were not subject to New Jersey taxation. The tax court found that those scenarios did not apply here. It also found that a payment to a related New Jersey taxpayer that included the income on its New Jersey CBT return and then properly allocated its income to New Jersey did not correspond with the anti-tax avoidance purpose that the BTRA amendments were intended to address. Therefore, the tax court found that the DOT's position of providing the Taxpayer only with partial relief from the addback statute was unreasonable.
The tax court rejected, however, the Taxpayer's call to eliminate or limit DOT's discretion to review royalty addbacks. The tax court found that DOT is still entitled to discretion when exercising its duty to review royalty expenses.
Federal: On March 4, 2019, the Treasury released proposed regulations (REG–104464–18) under Section 250 (proposed Section 250 regulations) with guidance on determining the deduction allowable to a domestic corporation for foreign-derived intangible income (FDII) and global intangible low-taxed income (GILTI). For more on this development, see Tax Alert 2019-0500.
New Jersey: The New Jersey Division of Taxation explained that the state follows the federal Opportunity Zones income tax benefits under IRC Section 1400Z-2, which provides benefits to those investing in a designated Opportunity Zone, namely in regard to the taxation of capital gains, including a temporary deferral of taxation, a step-up in basis, and a permanent tax exclusion for certain qualified transactions. For Corporation Business Tax (CBT) purposes, New Jersey follows IRC Section 1400Z–2 since it adopts the same accounting method used for federal income tax purposes and the CBT's starting point is an entity's federal taxable income before net operating losses and other special deductions. For Gross Income Tax (GIT) purposes (New Jersey's personal income tax), New Jersey follows the deferral of taxing capital gains because state law requires that the accounting method and basis of property be the same as that used for federal income tax purposes. New Jersey also follows the special rule in IRC Section 1400Z–2(c) for investments held for at least 10 years; gains from such investments are subject to the GIT when the gain is recognized for federal income tax purposes (this treatment applies to both individuals and pass-through entities). Additional information on New Jersey's conformity to the new federal Opportunity Zone provisions is available on the New Jersey Department of Community Affairs website. N.J. Div. of Taxn., Notice: Federal Tax Cuts and Jobs Act (TCJA) — Opportunity Zones (Feb. 5, 2019).
New York: A unitary group in filing a combined report must disregard a subsidiary's income from lines of business the subsidiary previously conducted, created, or developed when calculating the subsidiary's tax factor for its tax-free New York area (TFA) tax elimination credit under the START-UP NY program even if the subsidiary generated and received the income out of state. The New York State Department of Taxation and Finance further explained that the subsidiary chose proportional recovery of tax benefits after it failed to realize the amount of net new jobs it previously estimated. If the subsidiary is suspended from the START-UP NY program and the state proportionally recovers the tax benefits, the subsidiary's employees who work in the TFA will continue to qualify for the employee income tax benefits (e.g., exemption from state and certain local individual income tax) if they work exclusively within the TFA in net new jobs created by the subsidiary in the TFA for at least half of the taxable year, and all of the START-UP requirements (aside from job creation and maintenance) are met. N.Y. Dept. of Taxn. and Fin., TSB-A-18(1)C and TSB-A-18(4)I (Dec. 11, 2018).
North Carolina: A corporation that manufactures railroad brake pads and linings is not a public utility as defined by statute and, therefore, is not entitled to use the single sales factor apportionment formula for the tax years at issue (2011–2013). The Wake County Superior Court (Court) found that the corporation failed to satisfy the two requirements under N.C. Stat. Gen. Section 105–130.4(a)(6)2 that must be met to qualify as a public utility: (1) it was not subject to the control of a regulating agency listed in the statute; and (2) it did not own or operate its products to transport goods or persons, or for public use. The Court rejected the corporation's argument that it was subject to the Federal Railroad Administration's (FRA) control, when the statute does not include the FRA as a regulating agency, and the FRA could not be substituted as a successor agency to the since abolished Interstate Commerce Commission, which was one of the listed regulating agencies. The Court noted that the General Assembly intended to provide the single sales factor apportionment method to corporations that provide public services, rather than to the equipment and parts suppliers for those corporations. Lastly, the corporation was not entitled to a franchise tax refund based on its recalculation of its affiliated indebtedness component of its Capital Stock Base, when it did not provide sufficient notice of its claim and could not add a new refund claim basis in a summary judgment brief at the contested case stage. Railroad Friction Products Corp. v. N.C. Dept. of Rev., No. 18 CVS 3868 (N.C. Super. Ct., Wake Cnty., Feb. 21, 2019).
West Virginia: New law (SB 269) updates for individual income tax purposes the state date of conformity to the Internal Revenue Code (IRC) to the IRC in effect on Dec. 31, 2018. This change is effective retroactive to the extent allowable under federal income tax law. W.V. Laws 2019, SB 269, signed by the governor on Feb. 27, 2019.
SALES & USE
Michigan: A company that provides credit card processing services is not entitled to a refund of use tax paid on credit and debit card processing terminals it purchased and stored in Michigan until they were either placed for free with customers or sold outright, including those deployed outside the state, because the terminals were not "purchased for resale." In so holding, the Michigan Court of Appeals (Court) found that the Michigan Tax Tribunal properly concluded that the company sold only a small number of terminals, none of the sales were independent of the services the company provided, and all of the sales were merely incidental to the services it provided. The Court noted that the company' failure to keep separate books or treat the sales of the terminals in a distinguishable manner undermined its argument that the sold terminals should be treated differently from the terminals placed with customers for free as part of a services agreement. Lastly, the company's argument that the majority of its terminals are deployed outside of Michigan and, therefore, are not subject to use tax failed, because the terminals were subject to use tax based on their storage in Michigan. North American Bancard, Inc. v. Mich. Dept. of Treas., No. 344241 (Mich. Ct. App. Feb. 28, 2019) (unpublished).
Nebraska: On March 5, 2019, as part of a special election voters in six cities approved a 1% local sales and services tax that will become effective July 1, 2019. Ballot measures effectuating the 1% tax were approved in the cities of Alleman, Altoona, Des Moines, Pleasant Hill, West Des Moines, and Windsor Heights.
New York: The New York Department of Taxation and Finance (Department) issued a technical services bulletin in which it determined that a company facilitating third-party sales through its online marketplace is a "vendor," as defined under New York Tax Law, and is jointly liable with its third-party sellers for the collection and remittance of applicable sales tax to the extent that it has nexus with the state. N.Y. Tax Law Section 1101(b)(8), which defines a "vendor" required to collect the sales tax as "a person making sales of tangible personal property or services, the receipts from which are taxed by this article," includes a provision allowing the Commissioner to treat any "salesman, representative, peddler or canvasser" as an agent of the vendor for whom it solicits business as the vendor jointly responsible for the collection and payment of tax. Citing Jericho Boats of Smithtown, Inc.,3 the Department noted that this provision allows it to treat intermediaries that perform key acts in facilitating taxable sales as vendors. The ruling does not specify which party has the primary responsibility for collecting sales tax, but notes that both the marketplace provider and the third-party sellers would be liable for any uncollected tax, assuming that both entities have nexus with the state, and that both entities would be relieved of any such obligation if a valid resale certificate is provided by the customer. Further, the ruling explains that the marketplace provider would be entitled to a refund or credit for any excess sales tax it has collected and remitted, provided that it has refunded the customer the excess tax and makes a timely claim for refund. N.Y. Dept. of Taxn. and Fin., TSB-A-19(1)S (March 7, 2019). For additional information on this development, see Tax Alert 2019-0518.
Illinois: A non-profit hospice care provider is not entitled to a charitable property tax exemption for the 2013 tax year for property that houses its inpatient hospice care pavilion because it failed to show that the pavilion was exclusively used for a charitable purpose. The Illinois Appellate Court, applying the Korzen4 factors, found that the hospice care pavilion mostly provided medical services for remuneration, earned almost none of its revenue from charitable contributions, and spent almost none of its revenue to provide charitable services. Further, the pavilion did not qualify for the exemption as an extension of a property tax-exempt palliative care center, which was run by the provider as a different division on the same property, because the pavilion was not "reasonably necessary" to carry out the palliative care center's mission. Midwest Palliative Hospice and Care Center v. Beard, No. 1-18-1321 (Ill. App. Ct., First. Div., Feb. 25, 2019).
PAYROLL & EMPLOYMENT TAX
Missouri: News sources are reporting that Missouri taxpayers may see a surprise tax bill during the 2019 tax filing season (for tax year 2018) due to a combination of the effect the federal Tax Cuts and Jobs Act (TCJA) is having on state taxes and the discovery of a long-standing state withholding formula error. The Missouri Department of Revenue discovered the error late last year and released revised 2018 withholding tables/formula in October 2018. However, the revisions may not have occurred soon enough to avoid under-withholding for the year, which could result in taxpayers owing state income tax rather than breaking even or receiving a tax refund. Missouri State Representative Crystal Quade introduced legislation (HB 378) that would extend the 2018 income tax payment due date to June 15, 2019 for individuals who timely file their tax return by April 15, 2019 and have an outstanding tax liability of less than $200. The bill would also establish an installment plan for taxpayers unable to meet the proposed June 15 deadline. For more on this development, see Tax Alert 2019-0479.
Kentucky: The Kentucky State Treasury's Unclaimed Property Division issued its 2019 Holder Reporting and Instructions, incorporating select changes Kentucky made to its unclaimed property laws in 2018 through Kentucky's adoption of certain provisions of the Revised Uniform Unclaimed Property Act. The guide specifies holders' notice requirements for apparent owners, as well as deadlines for holders to file unclaimed property reports with the state (generally Nov. 1 covering the 12 months before July 1 of that year; insurance company holders must file before May 1 for the previous calendar year). Additionally, the guide lists the new dormancy periods for reporting certain unclaimed property, including travelers checks (15 years), money orders (7 years), wages over $50 (1 year), deposits by utilities (1 year), and safe deposit boxes (5 years). The guide also includes instructions on how to handle interest bearing accounts and how to report securities and stocks, as well as the contents of a safe deposit box; provides a copy of a holder reporting extension request; and answers frequently asked questions. Ky. State Treas., 2019 Ky. Holder Reporting & Instructions (Jan. 2019).
VALUE ADDED TAX
International: The Greek Supreme Administrative Court has ruled (Decision 355/20.02.2019) in pilot trial proceedings, in which EY had a substantive role, that the provision of the Greek Value Added Tax (VAT) Code which excludes the reduction of the taxable amount in the case of total or partial non-payment of the price (bad debts) is not in line with the provisions of the European Union (EU) VAT Directive. It also is not in line with the principle of VAT neutrality and the principles of effectiveness and proportionality of the Treaty on the Functioning of the EU. For more on this development, see Tax Alert 2019-0467.
Multistate: Now available is a replay of the Feb. 27, 2019, Ernst & Young LLP's webcast on the latest developments in US state and local taxation. The webcast covers major tax law changes in the 50 states and the District of Columbia, highlights important state tax policy developments and addresses federal tax developments that could impact state and local taxes. On this webcast, David Sawyer of the Council on State Taxation (COST) joined EY panelists to discuss the following: (1) the current state of the economy both nationally and regionally as it affects developing state tax policy responses; (2) the most significant state budget proposals that influence state taxes; (3) state responses to federal tax reform as well as to the U.S. Supreme Court's historic ruling in South Dakota v. Wayfair which greatly expanded the permissible nexus for the imposition of sales tax on remote sellers; (4) emerging state and local tax policy trends we're seeing in 2019; and (5) significant state and local judicial and administrative developments that have occurred since our last webcast in December 2018. Click here to listen to a 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.
1 Lorillard Tobacco Company v. Director, Division of Taxation, Dkt. No. 008305-2007 (N.J. Tax Ct. 2019) (Approved for Publication).
2 N.C. Stat. Gen. § 105-130.4(a)(6) was repealed for taxable years beginning on or after Jan. 1, 2018.
3 Jericho Boats of Smithtown, Inc. v. State Tax Commission,144 A.D.2d 163 (3d Dep't 1988) (concluding that the Department properly treated a broker that facilitated the sale of boats by displaying the boats or pictures of the boats, arranging the sales, sometimes providing financing, and collecting the purchase price as the "vendor").
4 Methodist Old Peoples Home v. Korzen, 39 Ill. 2d 149 (1968).