Ernst & Young's State and Local Tax Weekly newsletter for April 24 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.

COVID-19

State tax agency responses to the COVID-19 pandemic

The Indirect Tax COVID-19 state response matrix provides updates on the latest state tax agency responses related to the COVID-19 emergency. EY's site is accessible directly through this link, or on ey.com where other important tax-related information pertaining to the COVID-19 emergency is available.

TOP STORIES

Texas Supreme Court issues three opinions analyzing the cost-of-goods-sold deduction under franchise tax

In three opinions addressing the state's franchise tax, the Supreme Court of Texas (Court) analyzed the cost-of-goods-sold (COGS) deduction, ruling largely in favor of the Texas Comptroller of Public Accounts (Comptroller). The Court, however, did find in favor of one taxpayer with regard to certain flow-through funds that could be excluded from total revenue.

In Sunstate Equipment Co. v. Hegar,¹ the Court held that a heavy construction rental company could not deduct equipment delivery and pick up costs as part of its COGS deduction, affirming the judgment of the Texas Court of Appeals. Sunstate Equipment Co. (Sunstate) was in the business of renting heavy construction and industrial equipment to customers throughout Texas. In filing its Texas franchise tax report, Sunstate sought to include as COGS the costs related to dropping off and picking up the equipment, asserting that such costs were deductible under Texas Tax Code §§ 171.1012(k-1) and 171.1012(i).

The Court held that Sunstate, as a heavy equipment leasing company, could claim a COGS deduction under Texas Tax Code § 171.1012(k-1) but could only include the costs that were otherwise allowable under the general COGS statute in Texas. The Court found the taxpayer's delivery and retrieval of equipment was akin to outbound distribution and rehandling (both of which are expressly excluded by the statute from COGS in Texas). As such, the costs did not qualify as includable COGS expenses.

The Court also held that Sunstate could not subtract the equipment delivery and pick up costs under the real property construction provisions in Texas Tax Code § 171.1012(i) because the labor was not furnished to a project for the construction or improvement of real property.

In Hegar v. Gulf Copper & Manufacturing Corporation,² the Court held that Gulf Copper & Manufacturing Corporation (Gulf Copper) could exclude payments made to subcontractors from its total revenue for Texas franchise tax purposes, but the Court was more restrictive than the trial or appellate courts in allowing a COGS deduction. Gulf Copper surveys, repairs and upgrades offshore oil and gas rigs for rig owners and drilling contractors that in turn use the rigs to drill offshore wells for exploration and production companies. In providing these services, Gulf Copper utilized various subcontractors. Gulf Copper sought to exclude these payments to subcontractors from total revenue for Texas franchise tax purposes under Texas Tax Code § 171.1011(g)(3). Gulf Copper also sought to deduct repair-related costs as a part of its COGS deduction under Texas Tax Code § 171.1012(i).

The Court concluded that Gulf Copper could exclude its subcontractor payments from total revenue as flow-through funds under Texas Tax Code § 171.1011(g)(3), as its payments to a subcontractor were mandated by contract, and the underlying payments were made in connection to real property construction or repair services. The Court determined, however, that certain costs related to Gulf Copper's repair work were not eligible for a COGS deduction under Texas Tax Code § 171.1012(i), as those costs did not qualify as construction or repair of real property as defined in Texas Tax Code § 171.1012(i).

The Court expressly stated that a taxpayer could not build its COGS deduction from what was reported on its federal return. For Texas COGS purposes, costs need to independently meet the requirements of Texas Tax Code § 171.1012 regardless of whether they qualify for COGS for federal income tax purposes.

In Hegar v. American Multi-Cinema, Inc.,³ the Court reversed the decision of the appeals court, which had affirmed the trial court's opinion. Instead, the Court held that film exhibitions are not tangible personal property that is sold, so the taxpayer could not include exhibition-related costs in COGS for Texas franchise tax purposes for 2008 and 2009.

Effective Sept. 1, 2013, Texas Tax Code § 171.1012 was revised to add new subsection (t), which expressly allows movie theaters to subtract exhibition costs as COGS in future years. American Multi-Cinema, Inc. (AMC) sought to include costs incurred in exhibiting films, including film acquisition costs and costs associated with theater auditoriums in COGS for 2008 and 2009. To qualify as COGS in Texas, the cost must relate to tangible personal property that is sold in the ordinary course of the taxable entity's business or for which an industry-specific provision has been adopted.

The Court determined that film exhibitions do not qualify as tangible personal property under Texas Tax Code § 171.1012(A)(3A), as film exhibitions are not personal property subject to ownership. Further, film exhibition is not a sale, which requires some transfer of property or title in exchange for value. The Court also concluded that AMC's business activity did not constitute film production or distribution for which COGS is expressly permitted under Texas Tax Code § 171.1012(o) and dismissed any argument that the change in statute allowing a movie theater to take such costs under Texas Tax Code § 171.1012(t) was a clarification of law and should be applied.

For more on these developments, see Tax Alert 2020-1006.

INCOME/FRANCHISE

Federal: In Revenue Procedure 2020-22, the IRS granted relief for real estate and farming businesses that want to withdraw or make late IRC § 163(j) elections based on amendments to the provision enacted as part of the Coronavirus Aid, Relief, and Economic Security Act (P.L. 116-136) (CARES Act). The CARES Act added new IRC § 163(j)(10), which increases the business interest expense limitation amount from 30% to 50% of "adjusted taxable income" that may be deducted for the 2019 and 2020 tax years. Revenue Procedure 2020-22 allows real estate and farming businesses to change their elections if doing so would be advantageous following the changes made by the CARES Act. (The CARES Act amendments to IRC §163(j) also allows taxpayers to use 2019 ATI for purposes of determining any limitation in 2020.) For additional information on this development, see Tax Alert 2020-0979.

Indiana: The Indiana Department of Revenue (IN DOR) announced that under certain circumstances due to the COVID-19 emergency, it will not assert nexus or that the protections of P.L. 86-272 have been exceeded due to a temporary remote work assignment by an employee of a taxpayer within the state. This temporary relief applies only for the period that: (1) there is an official work-from-home order issued by an applicable federal, state or local government unit; or (2) there is an order of a physician in connection with the COVID-19 outbreak or an actual diagnosis of COVID-19, plus 14 days to allow for return to normal work locations. In its announcement, the IN DOR cautions that if the employee remains in Indiana after the temporary remote work requirement has ended, nexus may be established for that employer. Ind. Dept. of Rev., COVID-19 FAQs (April 2020).

Massachusetts: The Massachusetts Department of Revenue (MA DOR) adopted amendments to its NOL deductions and carryforwards regulation 830 CMR 63.30.2. The MA DOR explained that changes to the regulation reflect statutory and other changes since the regulation's adoption in 1993, and "include the extension of the carryforward period from five years to twenty years; the elimination of the separate rules for utility corporations; and revisions that take into account corporate combined reporting rules." The amended regulation was promulgated on March 20, 2020.

Minnesota: The Minnesota Department of Revenue announced that it will not seek to establish nexus for any business income tax or sales and use tax solely because an employee is temporarily working from home due to the COVID-19 pandemic. The guidance also suggests, however, that "an employer that transacts business or derives income from sources in Minnesota must withhold for employees" (implying that if an employee is engaged in business activities on behalf of its employer while physically present in Minnesota, it must withhold Minnesota personal income tax on compensation paid to that employee.) Minn. Dept. of Rev., COVID-19 FAQs for businesses (last updated April 14, 2020).

New York: On April 3, 2020, Governor Cuomo signed into law several Fiscal Year 2020/2021 budget bills, including S. 7508B / A. 9508B (the Budget Bill). The Budget Bill changes how both New York State (NYS) and New York City (NYC) treat the IRC § 163(j) limitation on business interest expense (BIE) deductions as modified by the Coronavirus Aid, Relief, and Economic Security Act (P.L. 116-136) (CARES Act) for both corporate and personal income tax purposes (as well as for unincorporated business tax (UBT) purposes in NYC). For corporate income tax purposes, the Budget Bill provides that both NYS and NYC will conform to the new federal rule that allows corporate taxpayers to elect to use 2019 "adjusted taxable income" (ATI) in 2020 but will not conform to the increase in the ATI percentage business interest expense limitation from 30% to 50%. For individual taxpayers, things are a bit more complicated and will require careful consideration of the ability to elect to use NYS or NYC itemized deductions in lieu of the taxpayer's federal itemized deductions in computing NYS or NYC taxable income. Lastly, the Budget Bill also effectively transforms NYS and NYC into "fixed date" conformity jurisdictions but only for NYS and NYC personal income tax purposes (not NYS or NYC corporate tax purposes) with respect to any federal tax legislation enacted after March 1, 2020, for tax years beginning before Jan. 1, 2022. Consequently, neither the amendments to the IRC brought about the CARES Act or any subsequent changes to the federal income tax law affecting individuals will automatically be incorporated into NYS or NYC personal income tax law in the future without express legislative action. For additional information on this development, see Tax Alert 2020-1092.

New York: In BTG Pactual NY Corporation, the New York Tax Appeals Tribunal (Tribunal) determined that the corporate owner of two disregarded single-member limited liability companies (each an SMLLC) cannot use the broker-dealer customer-based sourcing rules that applied to the SMLLC registered as a broker-dealer to also source the sales of the other SMLLC, which was registered as an investment advisor. The Tribunal also held that the Brazilian Income Withholding Tax is required to be added back to federal taxable income in determining the corporate owner's entire net income because the corporation failed to prove that the Brazilian Income Withholding Tax is a deductible gross receipts tax rather than a non-deductible tax on or measured by profits or income. Matter of BTG Pactual NY Corporation, DTA No. 827577 (N.Y. Tax App. Trib. March 24, 2020).

North Dakota: In frequently asked questions (FAQs) on business taxes, the North Dakota Office of the State Tax Commissioner announced that if employees are working temporarily in a telecommuting capacity due to COVID-19 restrictions and recommendations, it will not assert income tax nexus on that basis alone. For additional information on this development, see Tax Alert 2020-1062.

Utah: New law (HB 200) requires a corporation in computing adjusted income to add to unadjusted income any royalty or other expense deduction it paid to a related entity for the use of an intangible asset, where the intangible asset is owned by the entity related by common ownership, unless the corporation can demonstrate that for the same tax year the related entity is subject to income tax on the royalty or other expense under the laws of Utah, another state, or a foreign government that has in force an income tax treaty with the US. If this exception does not apply, the corporation paying the royalty or other expense is treated as having never owned the intangible asset. This provision applies retroactively to tax years beginning on or after Jan. 1, 2020. Utah Laws 2020, HB 200, signed by the governor on March 28, 2020.

SALES & USE

Colorado: New law (HB 1023) establishes hold harmless provisions for vendors that remit sales/use tax based on the Colorado Department of Revenue's (Department) geographic information system database (GIS database). The GIS database can be used by vendors to determine the jurisdiction tax is owed and to calculate the appropriate sales/use tax rate for individual addresses. A vendor that directly uses the GIS database (or uses it through a third-party database that is verified to use the most recent information provided by the GIS database), to determine the jurisdiction to which tax is owed will be held harmless for any tax, charge, or fee liability to a taxing jurisdiction that is due as a result in an error or omission of the GIS database. The Department will notify vendors when the tested and verified GIS database is online and available for use. Colo. Laws 2020, HB 1023, signed by the governor on March 11, 2020.

Minnesota: The Minnesota Department of Revenue announced that it will not seek to establish nexus for any business income tax or sales or use tax solely because an employee is temporarily working from home due to the COVID-19 pandemic. Minn. Dept. of Rev., COVID-19 FAQs for businesses (last updated April 14, 2020).

West Virginia: New law (HB 4474) establishes new statutory provisions to regulate peer-to-peer car sharing programs, including state and local tax provisions. Peer-to-peer car sharing programs⁴ operating in West Virginia are required to collect and remit all state and municipal consumer sales and services and use taxes on all sales of taxable services to purchasers in the state. Peer-to-peer car sharing programs operating in the state are not required to collect and remit the daily rental car passenger tax but may collect the vehicle license cost recovery fee. The law makes clear that these provisions may not be "interpreted to void, abrogate, restrict, or affect imposition of" certain other taxes on peer-to-peer car sharing program or shared vehicle owner, such as ad valorem property tax on tangible personal property, corporate net income tax, personal income tax, motor fuel excise tax, among other licenses or fees. These provisions take effect June 5, 2020 (i.e., 90 days from the bill's passage on March 7, 2020). W.Va. Laws 2020, ch. 222 (HB 4474), signed by the governor on March 25, 2020.

BUSINESS INCENTIVES

Federal: In response to the COVID-19 pandemic, the IRS has extended certain deadlines that are relevant for qualified opportunity zone (OZ) investors and businesses. First, in Notice 2020-23, the IRS extended, for certain investors, the 180-day deadline for investing in a qualified opportunity fund (QOF), as well as the deadline for certain OZ filings. Second, as of April 11, 2020, President Trump approved major disaster declarations for all 50 states, the District of Columbia and US territories (except for American Samoa), thereby granting QOFs additional time to reinvest certain proceeds in investments located in OZs and granted qualified opportunity zones businesses (QOZBs) additional time to spend working capital in OZs. For additional information on these developments, see Tax Alert 2020-1041.

PROPERTY TAX

Florida: New law (HB 7097) adds certain community benefit reporting requirements for hospitals that apply for property tax exemption (applicants). The law effectively limits a tax-exempt hospital's property tax exemption to the amount of community benefit that the hospital provides to its residing location(s). These new requirements take effect on Jan. 1, 2022. Fla. Laws 2020, Ch. 2020-10, 2, at 3-5 (HB 7097), signed by the governor April 8, 2020. For additional information on this development, see Tax Alert 2020-0995.

Georgia: Self-checkout component parts that a big-box retailer agreed to purchase from another business that held the parts in its Fayette County facility for up to 90 days before shipping the parts to the retailer's out-of-state stores for installation is exempt from ad valorem tax under the freeport exemption. In so holding, the Georgia Court of Appeals (court) concluded that the parts at issue met the definition of "inventory of finished goods", which is required in order to qualify for the freeport exemption. The court rejected the argument of the Fayette County Board of Tax Assessors (Board) that the property consists of "stock in trade of a retailer," finding instead that since the retailer does not resell the parts either from the warehouse in which they are stored or once they are shipped to out-of-state stores the parts constitute "finished goods." In addition, the court rejected the Board's argument that the parts are equipment not inventory, noting that it has previously rejected a narrow definition of "inventory" in favor of the broad definitions of inventory in Georgia's Uniform Commercial Code, its model code commentary and various dictionaries. Using the Webster Dictionary definition of "inventory" (i.e., "a list of goods on hand" or "a quantity of goods or materials on hand") as an example, the court found that "[u]nder the plain meaning of this broad definition, we agree with [the retailer] that the self-checkout component parts constitute inventory." Fayette Cnty. Bd. of Tax Assessors v. Walmart Stores, Inc., No. A19A2238 (Ga. Ct. App. March 13, 2020).

VALUE ADDED TAX

International: Following an appeal by Shreeji Enterprises (K) Limited due to the decision by the Commissioner of the Kenya Revenue Authority to disallow input tax claimed by the appellant, the Kenya Tax Appeals Tribunal, on March 25, 2020, determined that the appellant had properly discharged its duty of paying output Value-Added Tax (VAT) and supplying corresponding information to the effect that it had purchased from registered persons prior to claiming input tax. Accordingly, the taxpayer was legally entitled to claim input VAT. For additional information on this development, see Tax Alert 2020-0962.

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 Sunstate Equip. Co., LLC v. Hegar, No. 17-0444 (Tex. S.Ct. April 3, 2020).

² Hegar v. Gulf Copper and Mfg. Corp., No. 17-0894 (Tex. S.Ct. April 3, 2020).

³ Hegar v. Am. Multi-Cinema, Inc., No. 17-0464 (Tex. S.Ct. April 3, 2020).

⁴ "Peer-to-peer car sharing" is defined as "the authorized use of a vehicle by an individual other than the vehicle's owner through a peer-to-peer car sharing program". W.Va. Code §17A-6F-2. "Peer-to-peer car sharing program" is defined as a "business platform that connects vehicle owners with drivers to enable the sharing of vehicles for financial consideration". Id. These terms expressly exclude a "daily passenger rental car business" from their scope. Id.