Ernst & Young's State and Local Tax Weekly newsletter for April 26 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

California modifies economic nexus threshold for remote sellers, adopts provisions for marketplace facilitators

On April 25, 2019, Governor Gavin Newsom signed into law AB 147 (Ch. 5) provisions of which modify the economic nexus threshold for remote sellers and adopt economic nexus provisions for marketplace providers.

In December 2018, the California Department of Tax and Fee Administration (CDTFA) announced the establishment of an economic nexus standard for remote sellers starting April 1, 2019. Under the CDTFA's standard, a remote seller would have been deemed to have nexus with California for state and local sales and use tax collection purposes if during the preceding or current calendar year it met either of the following tests: (1) had more than $100,000 in sales, or (2) entered into 200 or more separate transactions with California customers. Provisions of AB 147, which supersede the CDTFA's guidance, modify the threshold by setting a $500,000 sales threshold and eliminating the 200-transaction threshold. Thus, effective April 1, 2019, a remote seller will be deemed to have nexus for California sales and use tax purposes if, during the preceding or current calendar year, it has total combined sales of tangible personal property for delivery in California by the seller or all persons related to the seller that exceed $500,000. (A person is related to another person if both persons are related to each other under IRC §267(b) and the regulations thereunder.) According to guidance¹ issued by the CDTFA, a remote seller that registered and collected taxes under the former threshold but does not meet the new threshold, may either close their account or continue to collect and remit tax.

AB 147 also establishes economic nexus provisions for marketplace facilitators, effective October 1, 2019. A marketplace facilitator meeting the sales threshold is required to collect and remit sales and use tax on each sale facilitated through its marketplace. A marketplace facilitator is considered the seller and retailer for each sale facilitated through its marketplace, in addition to each sale for which it is the seller or retailer or both. Further, a marketplace facilitator registered with the CDTFA and that facilitates a retail sale of tangible personal property by a marketplace seller is the retailer selling or making such sale through its marketplace. For purposes of determining if the sales threshold has been met, a marketplace facilitator's total combined sales includes all sales of tangible personal property for delivery in California, including sales made on its own behalf and by all related persons and those made on behalf of marketplace sellers. A marketplace seller, in determining whether the threshold has been met, will include in its combined sales all sales of tangible personal property for delivery in California, including sales made on its own behalf and sales facilitated through any marketplace facilitator's marketplace. A marketplace seller meeting the threshold is required to register with the CDTFA and collect and remit tax due for retail sales made on its own behalf and not facilitated through a registered marketplace facilitator.

A marketplace facilitator will be relieved of liability for failure to remit the correct amount of tax if such failure was due to incorrect or incomplete information provided to it by an unrelated marketplace seller. This relief does not apply to sales the marketplace facilitator makes on its own behalf or on behalf of a related seller.

AB 147 makes clear that a delivery network company is not a marketplace facilitator and that "facilitation" does not include "newspapers, internet websites, and other entities that advertise tangible personal property for sale, that do not transmit or otherwise communicate the offer and acceptance for the sale of tangible personal property between the seller and purchaser, and do not process payments directly or indirectly through third parties for the tangible personal property sold."

In addition, the Legislative Counsel's Digest to AB 147 states that "the changes made to the Sales and Use Tax Law by this bill, by conformity, would be automatically incorporated into local use taxes ordinances adopted pursuant to the Bradley-Burns Uniform Local Sales and Use Tax Law." CDTFA guidance further explains that AB 147 requires "all retailers required to be registered with the CDTFA, whether located inside or outside of California, to collect and pay to the CDTFA district use tax on all sales made for delivery in any district that imposes a district tax" if the sales threshold is met.

Additional information on California's use tax collection requirements can be found on the CDTFA's Wayfair webpage.

INCOME/FRANCHISE

Illinois: An out-of-state automotive company and its affiliates (collectively, "company") are not entitled to a refund resulting from claimed nonbusiness interest income deductions based on interest income it earned as a partner in three investment accounts because the company did not provide competent evidence supported by its books and records that it was entitled to the amount claimed on its amended return. In reaching this conclusion, the Illinois Appellate Court rejected the company's argument that it could estimate its nonbusiness interest income amounts, particularly when evidence indicated that a determination of the actual amounts was possible using daily reports for the applicable periods showing daily balances for each account and information about the cash held in the accounts by partner. Ford Motor Co. & Affiliates v. Ill. Dept. of Rev., No. 1-17-2663 (Ill. App. Ct., 1st Jud. Dist., March 29, 2019) (not to be cited as precedent).

Kentucky: Amended regulation (103 KAR 16:250) addresses the treatment of net operating losses (NOLs) as modified by legislation enacted in April 2018, namely Kentucky's adoption of mandatory combined reporting starting in 2019. The new combined reporting regime significantly altered Kentucky's treatment of NOLs. Under the prior nexus consolidated regime, Kentucky NOLs were computed on a pre-apportionment basis. Under the new mandatory combined reporting provisions, NOLs are computed on a post-apportionment basis. The amended regulation provides guidance on how to convert pre-apportioned NOLs from a nexus consolidated return to post-apportioned NOLs to be used on either a mandatory combined, elective consolidated, or separate company return. The proposed regulation sets forth the steps for a nexus consolidated filer to determine the NOLs to be carried into either a combined, elective consolidated, or separate return and sets forth several numerical examples to guide taxpayers in making these computations. The amended regulation took effect April 5, 2019. Ky. Register (Vol. 45, No. 9, March 1, 2019).

Maryland: The Maryland Comptroller of the Treasury (Comptroller) issued guidance on the state's treatment of global intangible low-taxed income (GILTI) under IRC §951A. The Comptroller determined that since GILTI is not a dividend or deemed dividend it is not eligible for Maryland's dividend subtraction. Instead both the GILTI income under IRC §951A and the GILTI deduction under IRC §250 are included in a corporation's Maryland taxable income; a foreign tax credit against this income is not provided for under Maryland law. For federal income tax purposes, GILTI amounts are included in federal adjusted gross income (FAGI). The starting point for the Maryland corporate income tax return (Maryland Form 500) is FAGI (line 28 on Form 1120, or line 25a on Form 1120-C). The GILTI deduction is a special deduction for federal income tax purposes (reported on line 29b of Form 1120, or line 26b on Form 1120-C) and, as a special deduction, it is subtracted from federal taxable income on the Maryland Form 500 (line 1c). In computing the Maryland apportionment factor, the total amount of GILTI is included in the denominator, and it is included in the numerator based on the average of property and payroll factors. If this apportionment formula does not fairly reflect the corporation's activity in Maryland, the Comptroller may use an alternative apportionment factor. GILTI is not included in the apportionment formula of a manufacturing corporation using a single sales factor apportionment formula. A pass-through entity (PTE) will include the entire amount of GILTI in its Maryland taxable income since PTE's are not eligible for the GILTI deduction under IRC §250 and no foreign tax credit is available for Maryland personal income tax purposes. GILTI is passed through to individual partners, members, and shareholders at the federal level and it flows through to the Maryland return. If a PTE uses an apportionment formula, GILTI must be included in Maryland income using the same apportionment formula described above (including the Comptroller's authority to use an alternative apportionment formula). Individuals and fiduciaries will include the entire GILTI amount in their Maryland taxable income and, because no deductions or credits apply, the entire amount of GILTI is subject to Maryland tax. The guidance also addresses treatment of GILTI by nonresident beneficiaries of resident fiduciaries and nonresident individuals, and a taxpayer's request to use an alternative apportionment formula. Md. Comp. of Treas., Tax Alert 04-19 (April 17, 2019).

New Jersey: The New Jersey Division of Taxation (Division) issued guidance on how the state treats the 30% business interest expense limitation under IRC §163(j) for New Jersey Corporation Business Tax (CBT) purposes. Under the CBT, New Jersey's starting point for its tax base known as entire net income (ENI) is federal taxable income (FTI) before net operating losses (NOLs) and special deductions with additional subtraction and addition modifications. The Division, citing the tax court's ruling in MCI Communications Services Inc.,² advised that even though a New Jersey CBT taxpayer under prior law was required to file its return on a separate entity basis, the starting point for determining a taxpayer's ENI must match its FTI as reported on a federal consolidated return before New Jersey modifications. Further, legislation enacted in 2018 (P.L. 2018, c. 48) established a method for applying the IRC §163(j) limitation for New Jersey CBT purposes by applying the IRC §163(j) limitation on a "pro rata" basis, including intercompany interest already required to be added back to ENI. The law did not modify the overall calculation of the IRC §163(j) limitation nor did it "indicate that the taxpayer should apply the IRC §163(j) limitation without regard as to whether the taxpayer was included on a federal consolidated return." Thus, the IRC §163(j) amount reported for federal purposes will be the amount reported to New Jersey and, as a result of this reporting, taxpayers "will use the interest expense and interest income allocations methods adopted in the federal regulations as the pro-rata calculation for New Jersey purposes … and any related party addbacks must be applied after the IRC §163(j) limitation." The Division noted that taxpayers that file separate New Jersey CBT returns but file a single federal consolidated return are treated as one taxpayer for purposes of applying the IRC §163(j) limitation, with each taxpayer making the required adjustments. The Division also provided guidance on the IRC §163(j) limitation and New Jersey combined returns. The Division determined that "it is fair and equitable to apply the single federal consolidated return rule to New Jersey combined returns." Thus, the members of a New Jersey combined return (including those filing a world-wide combined return) will be treated as though they filed a single federal consolidated return and as one taxpayer for purposes of applying the IRC §163(j) limitation. This is true regardless of whether some of the members of the New Jersey combined group are not included on the same federal consolidated return, or if the taxpayers on the federal consolidated return are not the same members as set forth on the New Jersey combined return. The Division indicated that additional guidance will be provided. N.J. Div. of Taxn., TB-87 "Initial Guidance for Corporation Business Tax Filers and the IRC §163(j) limitations" (April 12, 2019).

SALES & USE

District of Columbia: The amount of the paint stewardship assessments added to the purchase price of paint sold in the District of Columbia to cover the cost of collecting, transporting, and processing used paint in the District, is included in the sales price of paint and, therefore, is included in a vendor's gross receipts subject to the District's sales tax. D.C. Ofc. of Tax and Rev., OTR Notice 2019-03 (April 17, 2019).

Rhode Island: New law (HB 5278 Sub A) adopts economic nexus provisions for marketplace facilitators and sellers and modifies various sales and use tax nexus provisions. Effective July 1, 2019, any remote seller, marketplace seller, marketplace provider, and/or referrer that is not collecting and remitting sales tax will be required to do so if in the immediately preceding calendar year either has gross revenue from the sale of tangible personal property, prewritten computer software delivered electronically or by load and leave, vendor-hosted prewritten computer software, and/or taxable services delivered into Rhode Island of at least $100,000, or sold such in 200 or more separate transactions.³ Marketplace facilitators meeting the threshold are required to collect and remit sales and use tax on all sales made through its marketplace and are required to certify to its marketplace sellers that it will collect and remit tax on taxable sales made through its marketplace. Marketplace sellers may exclude sales through the marketplace from its return, provided that the seller accepts the marketplace facilitator's collection certificate in good faith. A marketplace facilitator is subject to audit on sales made through its marketplace; marketplace sellers cannot be audited for the same sales unless the marketplace facilitator seeks relief from liability due to incorrect information provided by the marketplace seller. In addition, HB 5278 does the following: (1) reclassifies "non-collecting retailer" as a "remote seller" and a "retail sale facilitator" as a "marketplace facilitator"; (2) modifies the definitions of "in-state customer", "in-state software", and "referrer" to include vendor-hosted computer software; and (3) adds definitions for "marketplace", "marketplace facilitator", and "marketplace seller". R.I. Laws 2019, HB 5278 Sub. A, signed by the governor on March 29, 2019.

BUSINESS INCENTIVES

Arkansas: New law (HB 1800) creates the Arkansas major historic rehabilitation tax credit. The credit can be taken against income or insurance premium tax, and is equal to 25% of the total qualified rehabilitation expenses incurred by the owner to complete a certified rehabilitation. A property owner will be eligible for the credit if it: (1) completes a certified rehabilitation that is placed in service after Jan. 1, 2019; (2) has a minimum investment of $1.5 million in qualified rehabilitation expenses; and (3) does not receive a tax credit under any other state law for the same eligible property. The credit can be issued once in a two-year period for each eligible property. It is not refundable, but unused credits may be carried forward for five consecutive taxable years. Credit owners and subsequent holders can transfer, sell, or assign part, or all, of the credit amount identified in the certification of completion, and any consideration received for credit transfers is not included in or deducted from Arkansas taxable income. The Department of Arkansas Heritage is responsible for promulgating rules to implement the credit, and it will begin accepting applications during the period from July 1, 2020 through June 30, 2025. HB 1800 takes effect 90 days after the legislature adjourns sine die. Ark. Laws 2019, Act 855 (HB 1800), signed by the governor on April 10, 2019.

Arkansas: New law (HB 1985) permits the transfer of income tax credits under the Water Resource Conservation and Development Incentives Act, entitling the transferee to the credit to the extent it has not already been used. The transferee must attach to its income tax return for the years it claims the credit a certified statement from the transferor that includes: (1) the name and address of the original purchaser and all transferees, (2) tax identification numbers for all persons entitled to any portion of the original credit, (3) the credit's original approval date, (4) the amount of the credit associated with the transfer, (5) the original credit amount, and (6) the remaining credit amount available for the transferee's use. Transferees are subject to credit carry-over provisions based on the taxable year in which the credit originated, but are not liable to repay the credit if the transferor that originally received the credit did not complete or maintain the project. Rather, the transferor must refund the credit to the Arkansas Department of Finance and Administration (Department). Lastly, owners or holders that assign part, or all, of the credit must notify the Department in writing within 30 calendar days after the transfer effective date and provide any information the Department requires. HB 1985 is effective for tax years beginning on or after Jan. 1, 2020. Ark. Laws 2019, Act 1073 (HB 1985), signed by the governor on April 16, 2019.

CONTROVERSY

Arkansas: New law (HB 1908) clarifies that the statute of limitations for filing amended returns (i.e., the later of three years from the time the return was filed or two years from the time the tax was paid) applies regardless of whether the amended return would reduce a taxpayer's tax liability, entitle the taxpayer to a refund of an overpayment of state tax, amend the taxpayer's filing status, or amend the taxpayer's return for any other purpose. This statute of limitations does not apply if the taxpayer is required to file an amended return due to a change made by the Internal Revenue Commissioner, in which case the taxpayer has 90 days from the receipt of the notice and demand for payment by the IRS. These changes are effective for tax years beginning on or after Jan. 1, 2019. Ark. Laws 2019, Act 863 (HB 1908), signed by the governor on April 10, 2019.

MISCELLANEOUS TAX

Arkansas: New law (HB 1564) levies emergency telephone service charges that include a commercial mobile radio service public safety charge, a voice over internet protocol (VoIP) public safety charge, and a nontraditional telephone public safety charge, each in the amount of $1.30 (previously $0.65) per month, per connection that has a place of primary use in Arkansas. The public safety access charges must appear as a single line on a subscriber's bill, must not be assessed on more than 200 exchange access facilities/VoIP connections per person per location, and must not be subject to any state or local tax or franchise fee. Additionally, the prepaid wireless public safety charge is amended to require sellers of prepaid wireless services to collect from consumers for each Arkansas retail transaction a public safety charge equal to 10% of the prepaid wireless service's value. (Previously, the prepaid wireless E911 surcharge was $0.65 per retail transaction, and the seller was not required to collect the fee in a specific situation). None of these provisions, which take effect Oct. 1, 2019, may overlap with existing charges. Ark. Laws 2019, Act 660 (HB 1564), signed by the governor on April 2, 2019.

Washington: In reversing a lower court, a Washington Court of Appeals (Court) held that group health care providers are entitled to a refund of business and occupation (B&O) taxes paid on certain premiums they received from their members for providing Medicare Advantage (MA) plans, because although the premiums are subject to the B&O tax, federal law preempts the imposition of the B&O tax on the premiums. The Court found that MA premiums are not "subject to taxation" under the state premium tax statute and therefore are not exempt from B&O tax. The Court next considered whether the federal statute, which preempts Washington from imposing a premium tax or similar tax on MA premiums, also preempts the imposition of B&O tax on the premiums. The Court determined that the B&O tax is similar to the premium tax as the two taxes have characteristics in common, including that they are assessed on a gross basis against premium revenue. Citing Group Health Coop. v. City of Seattle,⁴ the Court found it dispositive that the state taxes premium revenue on a gross basis, and rejected the Washington Department of Revenue's effort to distinguish the B&O tax as "dissimilar" from premium tax based on the broad applicability of the B&O tax and the nature of how Washington administers it. Further, as a tax assessed on gross receipts, B&O tax is preempted under federal law and the Centers for Medicare and Medicaid Services regulations and does not qualify for "savings clause" protection for taxes on net income and profit. Group Health Cooperative, et al. v. Wash. Dept. of Rev., No. 79091-9-1 (Wash. Ct. App., Div. 1, April 1, 2019).

Washington: A pharmacy benefit management company's (company) payments from clients for the value of prescription drugs are subject to business and occupation (B&O) tax and are not "pass-through" funds because this compensation is an integral part of the company's business model through which it can earn a profit. In so holding in the published portion of its opinion, the Washington Court of Appeals (Court) rejected the company's argument that the holding in First American Title Ins.⁵ created an alternative way to establish pass-through funds for B&O tax purposes, and instead analyzed the company's pass-through argument under Rule 111, noting that the company acknowledged it had no agency relationship with its clients as required by Rule 111. Ultimately, the Court found that the company is not a pass-through agent for clients when it negotiates clients' payments for the prescription drugs' value and then separately negotiates what it will pay retail pharmacies for filling clients' prescriptions. The following conclusions of the Court are part of the opinion that will not be published: (1) the Washington Department of Revenue (Department) properly imposed B&O tax on the company as a service provider, rather than as a wholesaler or retailer on the gross receipts from prescription drug sales, when the company received compensation from its clients for its prescription benefits management services; (2) the superior court's failure to invalidate all of the 2006 version of Rule 194 (rather than just part of it) did not entitle the company to relief because applicable statutes imposed the B&O tax, not Rule 194; and (3) the Department's apportionment computation was not unreasonable, excessive, or arbitrarily and capriciously achieved, thus the company wasn't entitled to zero apportionment. Express Scripts, Inc. v. Wash. Dept. of Rev., No. 50348-4-II (Wash. Ct. App., Div. II, March 26, 2019).

VALUE ADDED TAX

International: The Egyptian Tax Authority (ETA) is using withholding tax information to check if taxpayers are reporting reverse charge value-added tax (VAT) on their imported services. Taxpayers who have not correctly reported reverse charge VAT should consider filing amended returns to reduce their potential exposure to penalties. For more information on this development, see Tax Alert 2019-0826.

WEBCASTS

Multistate: On Wednesday, May 29, 2019, from 1:00-2:30 p.m. EDT (New York), Ernst & Young LLP (EY) will host its quarterly webcast focusing on state tax matters. For our second webcast in 2019, we welcome John Ficara, the Director of the New Jersey Division of Taxation, and Alan Kline, Counsel to the Director of the New Jersey Division of Taxation, as our guests who will join EY panelists to discuss New Jersey's implementation of the significant changes to its tax law enacted during 2018. Topics that will be addressed include: New Jersey's move to mandatory combined reporting, its selective conformity to many of the provisions of the federal Tax Cuts and Jobs Act, with a special focus on conformity to the new global intangible low-taxed income (GILTI) regime and the business interest limitation under IRC §163(j), as well as the state's adoption of sales and use tax economic nexus provisions. EY panelists also will provide: (1) an overview of significant legislative developments enacted in 2019, (2) an update on state responses to the U.S. Supreme Court's ruling in South Dakota v. Wayfair, (3) a synopsis of the seeming flood of petitions on state and local tax matters to the U.S. Supreme Court, and (4) a discussion of some of the more significant state and local judicial and administrative developments that have occurred since our last webcast in February 2019. To register for 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.

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ENDNOTES

¹ Cal. Dept. of Tax and Fee Admin., Special Notice New Use Tax Collection Requirements for Remote Sellers and New District Use Tax Collection Requirements for All Retailers — Operative April 1, 2019 (posted April 2019) (available on the Internet here (last accessed May 10, 2019)).

² MCI Communication Services, Inc. v. Director Division of Taxation, Dkt. No. 013905–2010 (N.J. Tax Ct. 2015), aff'd 2018, N.J. Super. Ct. (Unpublished).

³ The Rhode Island Division of Taxation in the April/May/June 2019 issue of "Rhode Island Tax News" stated that entities which elected to comply with Rhode Island's notice and reporting requirements instead of collecting and remitting sales and use tax can continue to comply with these provisions through June 30, 2019. As of July 1, 2019, however, the statement further directed that such entities must collect and remit tax.

⁴ Group Health Coop. v. City of Seattle, 146 Wn. App. 80 (2008).

⁵ First American Title Ins. Co. v. Dept. of Rev., 144 Wn.2d 300, 27 P.3d 604 (2001).