25 March 2019 State and Local Tax Weekly for March 15 Ernst & Young's State and Local Tax Weekly newsletter for March 15 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. Ohio Court of Appeals finds taxpayer's receipts from the sale of customer contracts are properly sourced to Ohio under the Commercial Activity Tax sourcing rules On Feb. 28, 2019, the Ohio Court of Appeals for the 10th appellate district (appeals court) issued another decision1 addressing the sourcing rules for purposes of the Commercial Activity Tax (CAT), this time with respect to the sale of customer contracts. In its latest decision, the appeals court in Defender Security Company, dba Defender Direct v. Testa,2 upheld the denial by the Ohio Department of Taxation (Department) of the taxpayer's refund claim, finding that the taxpayer's receipts from the sale of customer contracts are properly sitused to Ohio based on the location where the asset originated (i.e., the location of the customer) and not to the location where the asset was received and utilized (i.e., the purchaser's out-of-state locations). The appeals court reasoned that "[t]he contracts would not exist without property in Ohio to be monitored and equipment located within such property in Ohio by which the monitoring is performed." The taxpayer has the right to appeal this decision to the Ohio Supreme Court, but the review is not as of right. Rather, it is discretionary. It is unknown whether the taxpayer will appeal this decision. This case is one of the first cases relating to the sourcing of receipts from the sale of other than tangible personal property to come through the Ohio courts. The Department's "look-through" approach — sourcing the receipts from the taxpayer's sale to a contract entered into by its customer — is consistent with observed audit practices of the Department in other areas, such as the sale of services. What remains unclear is whether, as a matter of statutory construction, the term "purchaser" should be limited to the direct buyer in any application of Ohio Rev. Code Section 5751.033 or whether differing constructions of the term is appropriate depending on the character of the receipts at issue. Another issue in applying the sourcing statutes is whether, similar to the reasoning employed in Corrigan,3 a distinction should be made between receipts derived from a service contract, the sale of an intangible, and the service to be provided pursuant to that contract. For additional information on this development, see Tax Alert 2019-0531. California: The California Franchise Tax Board (FTB) advised that when appreciated property is transferred to an insurance company under Cal. Rev. and Taxn. Code (CR&TC) Section 24465, the principles of the regulations under IRC Section 367 (which concerns the transfer of appreciated property to certain foreign corporations) apply. The FTB explained that in the absence of applicable state regulations, California will rely on the federal regulations to the extent they address similar substantive transactions addressed under CR&TC Section 24465. In this instance, CR&TC Section 24465 is based on IRC Section 367, both of which provide an end to the deferred gain treatment for transferring appreciated property to an entity that does not pay the otherwise applicable income tax. CR&TC Section 24465 requires gain to be recognized in transfers of appreciated property from a corporation subject to the Corporation Tax Law to an insurer in a commonly controlled group (normally subject to nonrecognition provisions). CR&TC Section 24465, however, differs from IRC Section 367 in its treatment of complete liquidations of insurance companies, which is governed by California's conformity to IRC Section 332. For such liquidations, California law overrides IRC Section 332 and instead treats the liquidating distribution for federal income tax purposes as a dividend for California corporate tax purposes under CR&TC Section 24410. The FTB indicated that it intends to draft regulations to address any outstanding issues regarding the use of the IRC Section 367 regulations in administering CR&TC Section 24465. Cal. FTB, Notice No. 2019-01 (Feb. 25, 2019). Indiana: An out-of-state pharmacy benefit management provider (provider) is required to include receipts from transactions involving buying, selling, and delivering pharmaceuticals to Indiana customers in its sales factor numerator and denominator, and pay state income tax on Indiana-source income for the tax years at issue (2011--2013). The Indiana Department of Revenue (Department) found that the provider had an apparent right, title, and interest in the pharmaceuticals and made the bulk of its revenue from prescription drug sales (rather than the provision of a service), when it bought the drugs and sold them at a markup to Indiana customers. The Department noted that the provider refused to present certain information during the audit and administrative protest, and found that the provider's argument in an unrelated protest that it operates an automated pharmaceutical processing facility in Indiana that performs "the last integral, essential step to transform [drugs] into a marketable product" appears to negate its argument that it is a service provider incurring expenses entirely outside of Indiana. Lastly, the Department acknowledged the provider's multiple constitutional challenges, but declined to address them in the administrative hearing. Ind. Dept. of Rev., Letter of Findings 02-20160351 (Dec. 28, 2018). Indiana: An Indiana company that derived income from sales to customers located in other states must throw back the sales to Indiana because the company's business activities in those states did not exceed mere solicitation of sales of tangible personal property, and were protected from taxation in those states by P.L. 86-272. The Indiana Department of Revenue found that since the company filed on a separate basis, the Finnigan concept (under which the sales of a unitary group member to an out-of-state destination in a jurisdiction which the member was not taxable should not be thrown back to Indiana unless no member of the unitary group was taxable in the other state) did not apply. Ind. Dept. of Rev., Letter of Findings 02-20181620 (Dec. 20, 2018). Oregon: An out-of-state company that manufactures cigarettes and distributes them in Oregon through unrelated wholesalers is subject to Oregon's corporation excise tax because the in-state activities of the wholesalers of accepting returns on the company's behalf exceeded the protections of P.L. 86-272. The Oregon Tax Court (Court) found that making sure returns to wholesalers were accepted in Oregon was not a de minimis Oregon connection when it was integral to the company's marketing strategy, was part of its long standing policy, and was included in incentives contracts with the wholesalers. The parties did not dispute that the Oregon wholesalers did not meet the definition of an independent contractor under P.L. 86-272, but the Court found that the wholesalers met the broader independent contractor definition under Oregon law when they were paid remuneration to accept returns of cigarette cartons on the company's behalf. The Court did not consider whether the company's forwarding of pre-book orders also caused a loss of P.L. 86-272 immunity, and it found no reasonable basis to reduce the substantial understatement penalty imposed on the company. Santa Fe Natural Tobacco Co. v. Ore. Dept. of Rev., No. TC-MD 170251G (Ore. Tax Ct., Mag. Div., Feb. 26, 2019) (Unpublished). Federal: The proposed Digital Goods and Services Tax Fairness Act of 2019 (S. 765 and HR 1725) would prohibit state and local governments from imposing multiple taxes on the sale or use of covered electronic goods or services (i.e., digital goods, digital services, audio or visual programming services or VoIP services) or discriminatory taxes on the sale or use of digital goods or services. Instead, a state or locality would only be able to impose tax on the sale of covered electronic goods or services when the customer's tax address is located within its territorial limits. The term "digital good" would be defined as "any software or other good that is delivered or transferred electronically, including sounds, images, data, facts, or combinations thereof, maintained in digital format, where such software or other good is the true object of the transaction, rather than the activity or service performed to create such software or other good, that results in the delivery to the customer of a complete copy of such software or other good, with the right to use permanently or for a specific period, and includes, as an incidental component, charges for the delivery or transfer of such software or other good." The term "digital service" would be defined to mean "any service that is provided electronically, including the provision of remote access to or use of a digital good" but would not include "a service that is predominantly attributable to the direct, contemporaneous expenditure of live human effort, skill, or expertise, a telecommunications service, an ancillary service, Internet access, audio or video programming service, or a hotel intermediary service." These changes would take effect 60 days after enactment. S. 765 and HR 1725 were introduced on March 13, 2019. Similar measures have been considered in prior Congressional sessions. Hawaii: Rental car transactions engaged in by online travel companies (OTCs) using the merchant model during calendar years 2000 to 2013 are tourism-related services that qualify for the reduced General Excise Tax (GET) rate based on the portion of the proceeds the OTCs retained when they split gross income from arranging these transactions with third-party service providers. In reaching this conclusion, the Hawaii Supreme Court (Court) found that vehicle rentals are "services rendered directly to the customer or tourist" under the statute's plain meaning and legislative history, and are conventionally understood to be tourism-related services. The Court previously determined in Travelocity4 that the first two statutory requirements (i.e., arrangement made by travel agency or tour packager, and gross income from the transaction is divided between the service provider and the travel agency or tour packager) are generally met in the OTCs' merchant model transactions. Further, in considering whether the majority of the assessments (2000 through 2011) were barred when the OTCs already litigated their GET liability in Travelocity, the Court cited Medical Underwriters5 and held that the OTCs could not invoke claim preclusion as a defense against the state's sovereign taxing power. In re Tax Appeal of Priceline.com, Inc. et al. v. Haw. Dir. of Taxn., No. SCAP-17-0000367 (Haw. S.Ct. March 4, 2019). Texas: A company's purchases of temporary employment staffing services to provide supplemental housekeeping and special events food and beverage staff is exempt from sales and use tax as nontaxable services rendered by employees. The Texas Comptroller of Public Accounts found that the company's purchase of staffing services qualifies for the statutory exemption because: (1) the company is the "host employer;" (2) the employees of the temporary employment service supplement the company's existing work force on a temporary basis; (3) the staffing service is one that is normally performed by the company's regular employees; (4) the company provides the temporary staff with the supplies and equipment they need (the temporary employment service only provides the temporary employees with uniforms), it does not rent or purchase the equipment from the temporary employment service, and has the sole right to supervise, direct and control the temporary employees' work. Tex. Comp. of Pub. Accts., No. 201901050L (Jan. 28, 2019). Arkansas: New law (HB 1490) amends various tax incentive provisions that promote economic development in Arkansas under the Consolidated Incentives Act of 2003. The job creation tax credit average hourly wage provision is modified to provide that in order to qualify for the credit, the average hourly wage paid to employees whose payroll is subject to the incentives must be at least equal to the greater of the lowest county average hourly wage, or $12.50. Further, qualified businesses can receive an additional job creation tax credit equal to 1% of the payroll of certain new full-time employees when their average hourly wage exceeds 125% of the lesser of the county or state average hourly wage for the county in which the qualified business locates or expands. (Similar modifications regarding average hourly pay and the additional 1% credit are made to the payroll rebate, discussed below). The investment tax incentive program's state and local sales and use tax refund provisions are amended to change the current $100,000 minimum investment threshold to a tiered structure under which the business must meet the minimum investment threshold for the tier county in which it locates or expands. As revised, the minimum investment thresholds are: (1) for tier 1 counties, at least $500,000; (2) for tier 2 counties, at least $400,000; (3) for tier 3 counties, at least $300,000; and (4) for tier 4 counties, at least $200,000. For technology-based enterprises, HB 1490 decreases the average hourly wage amount required to qualify for the income tax credit or sales and use tax credit for new investment to 150% (previously 175%) of the lesser of the state or county average hourly wage for the county in which the business locates or expands. In terms of the payroll rebate part of the Economic Development Incentive Fund, qualified businesses must meet minimum annual payroll thresholds for new full-time permanent employees for the county in which the project is located. The bill changes the annual payroll threshold of $2,000,000 to a tiered structure under which the business must meet the threshold for new full-time permanent employees for the county tier in which the projected is located. The new thresholds are: (1) at least $2,000,000 annual payroll for tier 1 counties; (2) a least $1,750,000 annual payroll for tier 2 counties; (3) at least $1,500,000 million annual payroll for tier 3 counties; and (4) at least $1,250,000 annual payroll for tier 4 counties. HB 1490 also provides conditions under which Arkansas can offer an enhanced incentive to prospective eligible businesses of up to 5% of the payroll of new full-time permanent employees. Additionally, certain businesses that have not previously been approved for research and development (R&D) tax credits and that conduct in-house research that has been approved for federal R&D tax credits may qualify, at the Arkansas Economic Development Commission's discretion, for an income tax credit of certain in-house research expenses. HB 1490 also amends the definitions of various terms, including "applied research," "basic research," "in-house research," "corporate headquarters," "regional corporate headquarter," "eligible business," "scientific and technical service business," among other terms. Lastly, HB 1490 addresses when targeted incentives can be combined with each other for the same project. HB 1490 takes effect 90 days after the legislature adjourns sine die. Ark. Laws 2019, Act 327 (HB 1490), signed by the governor on March 6, 2019. Connecticut: The Connecticut Department of Revenue Services (DRS) released guidance that allows a pass-through entity (PTE) to remit tax on behalf of its members relative to the Connecticut-source guaranteed payments of its nonresident individual members. Connecticut's pass-through entity tax base calculation does not include guaranteed payments, so nonresident individuals generally must file a 2018 Connecticut personal income tax return and remit tax on their Connecticut-source guaranteed payment. Given the administrative burden this places on the DRS, the PTE and the PTE's partners, members or shareholders, as the case may be (each a "member" and collectively, "members"), this supplemental filing allows a PTE to report and remit tax to the DRS on behalf of the PTE's nonresident members. If the PTE pays the tax and executes the associated agreement, a nonresident individual PTE member's tax filing responsibility generally is fulfilled, unless the PTE member has other Connecticut-source income. Conn. Dept. of Rev. Svcs., Pass-Through Entities (PEs) with nonresident members who receive guaranteed payments (last visited March 7, 2019). For more information on this development, see Tax Alert 2019-0543. Montana: Reminder: Montana water's edge election is due March 31, 2019 for calendar year taxpayers.Montana's corporate income tax requires members of a unitary business to file returns on a worldwide combined basis, unless a water's edge election is made to exclude foreign affiliates from the combined group. A Montana water's edge group pays tax at a rate of 7% instead of the regular rate of 6.75%. While many states require a water's edge election to be made by the due date or extended due date of the return for the year for which it is intended to be effective, Montana is unique in that a water's-edge election must be made within 90 days of the beginning of the first year in which it is first intended to become effective. Accordingly, a corporation wishing to make a new water's edge election, or renew an existing election, applicable to the 2019 tax year must file a Form WE-ELECT by March 31, 2019. For more on Montana's water's-edge election, see Tax Alert 2019-0050. Multistate: Arizona has filed a bill of complaint with the U.S. Supreme Court challenging California's extraterritorial assessment and collection of its $800 "doing business" tax imposed on LLCs, including out-of-state companies that have no connection to California except for a passive investment in a California company. Arizona asserts California's actions violate the Due Process and Commerce Clauses. Arizona v. California, Case No. 22O150 (U.S. S.Ct. Motion for leave to file a bill of complaint filed Feb. 28, 2019). New Jersey: As we previously reported, in November 2018 the Jersey City, New Jersey city council unanimously approved the establishment of a 1% payroll tax paid by employers. The mayor swiftly approved the ordinance. According to information posted by the Jersey City Office of Tax Collector to its website, employers must register for the new payroll tax here. This tax is paid by employers and is not withheld from wages paid to employees. All private for-profit employers located within Jersey City with a quarterly gross payroll of $2,500 or more are subject to the tax on the wages of non-Jersey City residents. For additional information on this development, see Tax Alert 2019-0521. New Jersey: The State of New Jersey has issued guidance regarding employer reporting requirements in light of the State's adoption of the Health Insurance Mandate effective for calendar year 2019. New Jersey is the first state to indicate it will leverage the Federal Forms 1094-C and 1095-C to administer a state's own individual mandate. The guidance goes on to say that if the federal government stops requiring the use of these forms, the state will develop its own, similar forms. For more on this development, see Tax Alert 2019-0544. New Hampshire: Online travel companies (OTCs) are not required to remit meals and rooms tax on transactions with hotel consumers because they are not hotel "operators" under the plain statutory meaning when they did not manage, control, own, staff, or maintain the hotels, and were not involved in the day-to-day management or running of the hotels. In so holding, the New Hampshire Supreme Court (Court) found that an "operator" as it relates to hotels is "any person operating a hotel, … whether as owner or proprietor or lessee, sublessee, mortgagee, licensee, or otherwise." In addition, the Court rejected the State's argument that OTCs fall within the dictionary definition of "operator" since they provide "hotel-related services," finding that performing only one set of hotel functions (e.g., making room reservations, processing financial transactions) "does not transform them into operators of hotels." The Court also rejected the State's arguments that (1) the collection by OTCs of payments from consumers for their rights to occupy hotel rooms made them "operators", finding instead that the legislature limited the definition of "operator" to those "who actually 'operate' hotels"; and (2) OTCs are "operators" under Rule 701.15, agreeing with the trial court that the OTCs do not offer sleeping accommodations for rent to the general public or act as agents for hotels. Having determined the OTCs are not operators, the Court said it did not need to decide the issue of whether the meals and rooms tax should be imposed upon the retail amount paid by the consumer and whether the state has a remedy against the hotels to recover amounts owed. Lastly, the Court concluded that the OTCs did not violate the Consumer Protection Act by bundling taxes and fees without itemizing them for consumers since they disclosed the bundling and were not required to disclose markups. New Hampshire v. Priceline.com, Inc. n/k/a The Priceline Group, Inc., No. 2017 – 0674 (N.H. S.Ct. March 8, 2019). Federal: Two economic studies released by academics at the University of California, Los Angeles and the Centre for Economic Policy Research this month conclude that the imposition of US tariffs on imports and foreign retaliatory tariffs on US exports has harmed the US economy. One study estimates that the annual ongoing impact of these 2018 tariffs is a $7.8 billion loss for the US economy. The other study concludes that losses from import protection totaled nearly $6.9 billion during the first 11 months of 2018. This is the net of a $12.3 billion gain from tariff revenue and $19.2 billion cost to US consumers and importers. The study also estimated that US and foreign retaliatory tariffs have significantly impacted global supply chains; by the end of 2018, the study estimates, $11.4 billion of US imports and $2.4 billion of US exports were being redirected each month to avoid the tariffs. For more on this development, see Tax Alert 2019-0554. 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 The prior decision was reported in our earlier tax alert of the appeals court's ruling in Greenscapes Home and Garden Products, Inc. v. Testa, No. 17-AP-593 (Ohio Ct. App., 10th App. Dist., Feb. 7, 2019), see Tax Alert 2019-0430. 2 Defender Security Company, dba Defender Direct v. Testa, No. 18-AP-238 (Ohio Ct. App., 10th App. Dist., Feb. 28, 2019). Document ID: 2019-0614 |
