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Ernst & Young's State and Local Tax Weekly newsletter for September 18 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 emergency

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

EY's state guide to COVID-19 payroll and employment tax provisions, updated through Sept. 15, 2020, is available here.

TOP STORIES

Various tax measures to be voted on during the upcoming November 3, 2020 election

On Nov. 3, 2020, voters across the United States will cast votes for federal, state and local officials; and, in some states, they will also be asked to vote on tax-related ballot measures that if approved, could make significant changes to state and local tax policy throughout the country.

Most notable is California's Proposition 15, which if approved, would amend Article XIIIA of the California constitution (Proposition 13) by requiring local assessors to value most commercial and industrial real property at fair market value on a regular cycle while preserving Proposition 13's protections for residential property owners. Proposition 13, which was approved by voters in 1978, established an event-based system of real property assessment under which all real property in California is assigned a "base year" value that reflects fair market value at the time of purchase or new construction. Increases on this "base year value" are limited to no more than two percent annually, absent a subsequent change in ownership or new construction. Proposition 15 would eliminate those protections for commercial and industrial real property and subject them to cyclical reassessments to market value while retaining Proposition 13 protections for other real property (primarily residential real property). Approval of Proposition 15 will likely result in increased property taxes for any commercial or industrial property that has not been subject to a Proposition 13 event in recent years. (See Tax Alert 2020-1757.)

Also of note is an Illinois ballot question which, if enacted, would allow the state to impose a progressive individual income tax rate structure. Legislation enacted in 2019 authorizing this ballot initiative proposed amending Illinois' state constitution to permit graduated individual income tax rates, ranging from 4.75% up to 7.99% beginning in 2021. In addition, a "yes" vote would also cause the corporate income tax flat rate to increase from 7% to 7.99%. Together with the existing 2.5% personal property tax replacement income tax, the overall Illinois corporate tax rate would be 10.49%.

At the local level, voters in the City and County of San Francisco, California (City) are being asked to consider several tax related measures. Key among these measures is Proposition F, a business tax reform package that would increase the city gross receipts tax while phasing out the city payroll tax in 2021. The measure includes temporary tax relief for restaurants, retail and manufacturing businesses, hotels, and arts organizations on their first $25 million in gross receipts and increases the threshold for a small business exemption from the gross receipts tax to $2 million. Three other tax related ballot measures in the City are (1) Proposition L, which would impose an additional gross receipts tax rate on large businesses, progressively increasing based on the ratio of the pay of the highest-paid executive to median employee pay; (2) Proposition I, which would increase the City's real property transfer tax based on value; and (3) Proposition J, which would impose a parcel tax on real property located in the City. (See Tax Alert 2020-2107 and Tax Alert 2020-2117.)

Voters in a number of other state and local jurisdictions also will be considering tax rate changes, both increases and decreases in rates, on the November 3rd ballot. Tax rate increases are on the table in Alaska (Measure 1 would increase taxes on certain oil production in the North Slope); Arizona (Proposition 208 would impose a 3.5% additional income tax rate on individuals with income exceeding $250,000 for single filers ($500,000 for joint filers)); Arkansas (Issue 1 would make permanent a 0.5% sales tax rate earmarked for transportation); Denver, Colorado (a measure is on the ballot to increase that city's local sales tax rate from 4.31% to 4.56%); Portland, Oregon (a measure before the voters in the city would impose a new payroll tax, at a rate of up to 0.75% of wages, on employers in the Portland metropolitan area with more than 25 employees); and Seattle, Washington (a measure is presented to the city's voters which would replace the current city car license fee and 0.1% local sales tax with an 0.15% sales tax the proceeds from which would be dedicated to provide local transportation funding). Meanwhile, Colorado voters will consider a ballot measure (Proposition 116) that would decrease the state's income tax rate on individuals, estates and trust from 4.63% to 4.55%.

The legalization and taxation of marijuana is also on the ballot in four states: Arizona (Proposition 207), Montana (I-190), New Jersey (Constitutional Amendment), and South Dakota (Constitutional Amendment A). Meanwhile, in Colorado (Proposition EE) and Oregon (Measure 108), voters are being asked to consider measures which would increase cigarette and tobacco taxes.

Other state and local tax questions that have qualified for the November election include a California measure to change employment classification rules for app-based transportation and delivery drivers (Proposition 22); a Florida measure that would gradually increase the minimum wage to $15 by September 2026 (Amendment 2); a Maryland measure to allow sports betting in the state (Question 2); and property tax measures in Colorado (Amendment B) and Louisiana (Amendments 2 and 5).

Due to the likely increased use of mail-in ballots this year, it may take days or weeks to know whether any or all of these measures are approved.

INCOME/FRANCHISE

California: The California Franchise Tax Board (FTB) issued nexus guidance for out-of-state corporations that previously had no connections with California but now have employees indefinitely teleworking in the state in response to Governor Gavin Newsom's "stay at home" Executive Order N-33-20 (hereafter, "stay-at-home order"). The FTB said that it will not treat out-of-state corporations whose only connection to California is an employee currently teleworking in the state due to the governor's stay at home order as "being actively engaged in a transaction for the purposes of financial or pecuniary gain or profit." The FTB also said it will not include such employee's compensation in computing the minimum payroll threshold under California's factor presence nexus standard, and that the presence of such employee will not cause a corporation to exceed the protections of P.L. 86-272. This guidance applies while the stay-at-home order is in effect. Cal. FTB, COVID-19 FAQs (updated Sept. 11, 2020). For more on this development, see Tax Alert 2020-2242.

Georgia: The Georgia Department of Revenue on its webpage "Income Tax Federal Tax Changes" explained that effective for tax years beginning on or after Jan. 1, 2019, the state adopts the modifications to the depreciation of qualified improvement property (QIP) under the CARES Act, which allows QIP placed in service after Dec. 31, 2017, to be classified as 15-year MACRS property for federal depreciation purposes. Because of this federal change, QIP is now eligible for 100% bonus depreciation. Georgia, however, has not adopted bonus depreciation. Ga. Dept. of Rev., "Income Tax Federal Tax Changes" (updated Sept. 10, 2020).

New Jersey: The New Jersey Superior Court, Appellate Division (Appellate Division) reversed a ruling by the New Jersey Tax Court (Tax Court) and held that an individual could reduce his taxable distributive share of a partnership's income in 2010 by partnership losses incurred in 2009 because the New Jersey Gross Income Tax (GIT) Act did not bar the individual from applying his losses as required by "at risk" limitation rules set forth in IRC §465. In so holding, the Appellate Division rejected the New Jersey Division of Taxation's argument that the GIT did not follow the IRC § 465 "at risk" limitation rules, finding instead that IRC § 465 is a federal method of accounting incorporated into the GIT law which defines when and how the subject losses could be realized (i.e., when the loss for any tax year exceeds the "at risk" amount and, therfore, is not allowed for the tax year, the surplus amount applies in a subsequent tax year when the "at risk" amount exceeded the loss). Additionally, the Appellate Division explained that the plain language of N.J.S.A. §54A:5-2 prohibits losses realized in one tax year from being applied to a later year's income, but found that the statute assumes that the loss a taxpayer may try to carry forward is one that could be applied under federal accounting methods to an earlier year. Thus, a "commonsense reading" of the statute's plain language "requires that there be a loss that, but for the statute, could be carried over if allowed under federal accounting methods." In this case, under federal accounting methods, the individual did not have a loss he could fully apply in 2009. The Appellate Division also determined that the Tax Court's interpretation of the provision would "have been an allowable tax shelter contrary to the [GIT a]ct's purposes." Lastly, it noted that even if it had affirmed the Tax Court, the individual should have been able to recoup his lost deduction under the "square corners" doctrine, but he was not entitled to equitable recoupment or relief under the federal doctrine of mitigation. Shechtel v. N.J. Dir., Div. of Taxn., No. A-0252-18T1 (N.J. Super. Ct., App. Div., Sept. 3, 2020) (unpublished).

Virginia: Fees earned by a software developer from licensing electronically delivered canned software and related updates for corporate income tax purposes are treated as sales of tangible personal property sourced to Virginia on a destination basis, while fees for technical support are considered sales of services sourced to Virginia based on costs of performance. Citing the Virginia Supreme Court's ruling in General Motors Corp.,¹ the Virginia Department of Taxation (Department) noted that the cost of performance for purposes of sales of intangibles may not be limited to direct costs and may not exclude any indirect expenses such as interest or activities produced by independent contractors. Additionally, determining whether a transaction or sale is a Virginia transaction is an all or nothing test. A taxpayer would first determine the direct cost associated with each transaction for a different taxable year. Then, the direct costs would be attributed to the states in which they occurred. Multistate transactions will be sourced to Virginia if a greater portion of the costs occurred in Virginia than in any other state. The Department did not issue an opinion concerning what portion, if any, of the developer's sales should be sourced to Virginia. Va. Dept. of Taxn., Ruling of the Tax Comr. No. 20-128 (July 21, 2020).

SALES & USE

Mississippi: The Mississippi Department of Revenue issued a notice to food delivery service providers, explaining that recently enacted law (HB 379 (Miss. Laws 2020), effective July 1, 2020), removed from the definition of "retail sale" the sale of food made through a third-party delivery service. Sales tax is not due on such sales where the delivery service allows customers to order food for delivery from the restaurant of the customer's choosing and pay for the food through the delivery service's app or website. The restaurant is responsible for charging the applicable sales and local tax on the selling price of the food; tax does not apply to tips paid to the delivery driver. However, food delivery service companies that maintain their own inventory for sale (i.e., direct sale) or perform both third-party deliveries and direct sales of items are required to register to collect and remit sales tax on direct sales to customers. Food delivery service companies making direct sales are required to collect and remit state sales tax and any applicable local city/county taxes on the entire charge for food and delivery. Sales tax also applies to any other charges added by the delivery service related to sales of items out of its inventory. Non-required tips added at the customer's discretion are not subject to sales tax. Miss. Dept. of Rev., Notice 72-20-09 Notice to Food Delivery Service Providers Pursuant to the Mississippi Facilitator Act of 2020 (Sept. 16, 2020).

Ohio: The Ohio Department of Taxation updated its guidance on the application of sales and use tax to equipment used primarily in providing internet services to address business model changes since the guidance was originally released in 2004. Such business model changes include an internet service provider operating concurrently as an internet service vendor and a telecommunications service vendor, mobile telecommunications service vendor, or satellite broadcasting service vendor. These vendors qualify for the sales tax exemption under Ohio Rev. Code §5739.02(B)(34) for sales of property and services "used directly and primarily in transmitting, receiving, switching, or recording any interactive, one- or two-way electromagnetic communications … " For purposes of the exemption, internet access is a qualified use of such property; however, the vendor's primary use of the equipment in conjunction with internet services determines its taxability. Lastly, the guidance addresses the taxability of customer premises equipment (e.g., modems and routers), which is tangible personal property given to the customer as part of the provision of various services. Whether a vendor is required to collect and remit tax or is eligible to claim a resale exception on its purchase of the equipment, depends on how the service provider bills its customers (i.e., separate/non-separate billing, separate/non-separate charges). Ohio Dept. of Taxn., ST 2004-03 - Equipment Used Primarily in Providing Internet Services (revised Sept. 2020).

Virginia: According to a recent ruling of the Virginia Department of Taxation (Department), an out-of-state financing company that enters lease-to-own agreements with dealers' customers for purchases of the dealers' tangible personal must collect sales tax from the customer (lessee) on the gross proceeds from these transactions because the company (lessor) takes ownership of the property. The Department's longstanding policy is that the underlying document governs the sales and use tax treatment of a transaction. Under the agreement at issue, the company pays sales tax to the dealer on the property at the time of sale and acquires ownership of the property, it leases the property to the customer (lessee), and then collects monthly payments for the sales price and any additional fees. The customer (lessee) can elect to acquire ownership of the property but can terminate the lease at any time. Based on a review of the company's agreement, the Department determined that it constitutes a conditional lease agreement. Under Virginia law, sales tax is imposed on persons who sells, leases or rents tangible personal property, with the term "sale" including the lease or rental, conditional or otherwise, of tangible personal property. Here, the company (lessor) takes ownership of the property under the agreement, and since there is no contract between the company and the dealer indicating otherwise, the company is required to collect sales tax from the customer on the gross proceeds from these transactions. Va. Dept. of Taxn., Ruling of the Tax Comr. No. 20-123 (July 14, 2020).

Washington: The Washington Department of Revenue issued guidance on the data center exemption from retail sales and use tax. The guidance provides and overview of the exemption and addresses: (1) how tenants are treated under the statutory 12 data center exemption² limitation; (2) how the exemption applies to a computer data center with multiple buildings; and (3) how long the exemption lasts for a data center that includes multiple buildings constructed over several years. The guidance includes illustrative examples. Wash. Dept. of Rev., ETA 3221.2020 (Sept. 2, 2020).

PROPERTY TAX

New York: In reversing a lower court ruling, the New York Supreme Court, Appellate Division (Court) held that a solar photovoltaic electrical system (system) located on a university's land through a licensing agreement with a nonparty for-profit company is taxable real property, and the company, rather than the university, owned the system. In so holding, the Court found the system met the common-law definition of fixture, reasoning that: (1) the characteristics of the system showed that it was annexed to real property or something appurtenant to; (2) the university used the land to generate solar energy for its sustainability efforts and to further its educational mission; and (3) the university and the company "intended the [system] to be permanent over the life of the … agreement" (based on the agreement's purpose and duration, both parties' options to extend, and the terms permitting the system's removal upon termination). The Court further found that the parties' licensing agreement conferred incidents of ownership upon the company to justify that the company, and not the university, owned the system. Moreover, even though the agreement provides some minor incidents of ownership to the university, the Court concluded that the agreement does not confer the university with "some dominion and control over the property that it must be deemed the beneficial owner for tax purposes." Thus, the system is not tax exempt. Matter of Cornell Univ. v. Bd. of Asmt. Rev., 2020 NY Slip Op 04636 (N.Y. S.Ct., App. Div., 4th Dept., Aug. 20, 2020).

Wisconsin: Cheese manufacturers' clean-in-place (CIP) equipment does not qualify for the manufacturing personal property exemption because although the CIP equipment makes it possible for the cheese to be produced in a clean environment, it is not used directly in the production of the cheese. In reaching this conclusion, the Wisconsin Tax Appeals Commission (Commission) applied the exemption's plain statutory language (Wis. Stat. § 70.11(27)) and found that the CIP equipment did not cause any physical or chemical change in the raw materials, or any movement of raw materials, work in process, or finished products. Instead, in performing necessary cleaning functions, any movement that the CIP equipment caused was related to waste and residue. The Commission distinguished between the manufacturing sales tax exemption and the personal property tax exemption, finding that such exemptions cannot be analyzed together as they are "drafted with vastly different levels of specificity" (although they could before a 1991 statutory change in the exemption provisions). Further, the Commission noted that cases addressing manufacturing exemptions before the 1991 statutory change do not apply to the manufacturing personal property exemption to the extent they conflict with the current statutory language. Saputo Cheese USA, Inc. v. Wis. Dept. of Rev., Nos. 15-M-110, -112, -114 through -116, and -148; 16-M-140 through -144; 17-M-082 through -087; 18-M-034, -090 through -094; and 19-M-052 through -057 (Wis. Tax App. Comn. Aug. 4, 2020).

CONTROVERSY

New Mexico: Amended rules (amended N.M. Admin. Code 22.600.3.1 through .30) repeal and replace the procedural rules and guidance about the tax protest hearing process before the Administrative Hearings Office (AHO) of the New Mexico Taxation and Revenue Department. The changes are intended to refine the AHO's tax protest procedures and to implement law changes made in the 2019 legislative session, according to the proposed rule notice. Among the provisions addressed under the amended rules are: (1) hearing procedures and locations (including video-conference hearings, telephonic hearings, and telephonic testimony); (2) appearances by authorized representatives; (3) closure of tax protest hearings to the public and confidential nature of records; (4) protest withdrawals; (5) summary dispositions of protests; (6) filing methods and motions, conferences at various protest stages, discovery, subpoenas, evidence, continuance requests, failure to comply with orders and statutory deadlines, and failure to appear; (7) proposed findings, conclusions and briefs; (8) reasonable administrative costs, litigation costs and attorney fees; and (9) reconsiderations and appeals. The amended rules took effect Aug. 25, 2020. N.M. Taxn. and Rev. Dept. Admin. Hearings Ofc., amended N.M. Admin. Code 22.600.3.1 through .30 (N.M. Register, Vol. XXXI, Issue 16, Aug. 25, 2020).

PAYROLL & EMPLOYMENT TAX

Federal: On Aug. 28, 2020, the IRS in Notice 2020-65 responded to a Presidential Memorandum (executive order) by giving employers the option to delay their withholding of the 6.2% employee share of Social Security taxes and the comparable Railroad Retirement tax for certain employees from Sept. 1, 2020 to Dec. 31, 2020. For additional information on this development, see Tax Alert 2020-2200.

Alabama: Under a recent regulatory change, Alabama employers are now required to provide employees with notification of the availability of unemployment insurance (UI) benefits at the time of separation from employment. The emergency regulation provides the information the notice should contain. To be eligible for federal grants under the Families First Coronavirus Response Act (P.L. 116-127), state workforce agencies must have a provision requiring that employers notify employees at the time of layoff or reduced work of the availability of UI benefits. For more on this development, see Tax Alert 2020-2229.

Arkansas: The Revenue Legal Counsel of the Arkansas Department of Finance and Administration (Department) issued an opinion to a taxpayer concerning the applicability of Arkansas state income tax on wages paid to an out-of- state teleworker. Under the facts of the case, a computer programmer changed her physical work location from a business within Arkansas to the state of Washington. The Department determined that despite the employee's physical location within the state of Washington, her work for an Arkansas business meets the definition of "carrying on an occupation within the state" thereby subjecting her wages to Arkansas state income tax. (This opinion is not specific to COVID-19 as it relates to a 2017 change in work location.) For more on this development, see Tax Alert 2020-2207.

Missouri: Governor Mike Parson issued an executive order establishing the Interagency Task Force on Worker Classification. The task force will examine and evaluate existing misclassification enforcement by various state agencies; facilitate the sharing of information among members of the task force related to suspected worker misclassification violations; make recommendations for pooling, focusing, and targeting investigative and enforcement resources; assess existing methods in Missouri and other jurisdictions on preventing, investigating, and taking appropriate enforcement actions against worker misclassification violations and develop best prevention and enforcement practices for participating agencies; and review state worker misclassification laws, among other things. The task force report is due to the governor by Dec. 31 of each year, starting in 2020, with the final report due in 2024. Mo. Gov., Executive Order 20-15 (Sept. 11, 2020).

MISCELLANEOUS TAX

Virginia: The Virginia Department of Taxation (Department) amended its Guidelines for the Motor Vehicle Rental and Peer-to-Peer Vehicle Sharing Tax to explain the new peer-to-peer (PTP) vehicle sharing tax, which takes effect on Oct. 1, 2020. PTP vehicle owners that list no more than 10 different vehicles on any combination of vehicle sharing platforms at any one time are subject to a 6.5% PTP tax (increasing to 7% on July 1, 2021). If the PTP vehicle owner lists more than 10 different shared vehicles on such platforms at any one time, such PTP vehicle owner will be subject to the PTP tax at the rate of the Motor Vehicle Rental Tax (MVRT, a combined rate of 10% on the gross proceeds) otherwise imposed on the rental of a motor vehicle and daily rental vehicle. The higher tax rate applies for as long as the PTP vehicle owner continues to list more than 10 different vehicles, regardless of whether its vehicles are shared or rented at any given time. The guidelines include definitions and address the following: tax on vehicle rentals, nontaxable transactions, gross proceeds for purposes of computing the rental tax on vehicle rental and PTP vehicle sharing, charge or credit card sales, sourcing rules, registration of renters, vehicles registration and licensing, monthly filing and payment requirements, rental tax collection, timing of registration, PTP tax renter liability protection, local motor vehicle license taxes and fees, bad debt, penalties and interest, sale of the business, compliance provisions, records, administrative rulings, and appeals. Examples are provided throughout. Va. Dept. of Taxn., "Guidelines for the Motor Vehicle Rental and Peer-to-Peer Vehicle Sharing Tax" (effective Aug. 26, 2020).

GLOBAL TRADE

Federal: On Sept. 15, 2020, the United States Trade Representative (USTR) announced that the US would remove previously imposed punitive tariffs on non-alloyed, unwrought aluminum articles of Canadian origin. The 10% ad valorem tariff, levied under Section 232 of the Trade Expansion Act of 1962, went into effect on Aug. 16, 2020. The duty-free treatment of the goods is retroactive to Sept. 1, 2020. For additional information on this development, see Tax Alert 2020-2251.

International — United Kingdom: The United Kingdom's (UK) Department for International Trade has reported that the UK has secured a free trade agreement with Japan; this is the UK's first major trade deal as an independent trading nation following the UK's departure from the European Union (EU). The agreement will reportedly increase UK trade with Japan by an estimated £15.2 billion. For additional information on this development, see Tax Alert 2020-2228.

VALUE ADDED TAX

International — Poland: On Oct. 1, 2020, Poland's new value-added tax (VAT) reporting requirements will take effect. The traditional VAT return will be replaced by the JPK_V7M file, the new SAF-T file that combines information from the VAT return and the SAF-T file now in use, requiring new information to be included in the revised template. The planned entry into force of the new law was postponed twice as a stimulus measure to alleviate the effect of the COVID-19 emergency. Currently, there is no discussion on any further postponement and all Polish taxpayers will be required to file their VAT reports for October 2020 by Nov. 25, 2020, using the new file. For additional information on this development, see Tax Alert 2020-2258.

UPCOMING WEBCASTS

Tuesday, October 20.State and local tax developments in the real estate industry (1:00 p.m. ET).Topics to be discussed include state responses to the COVID-19 pandemic; state income tax conformity to the CARES Act; remote workforce issues, including wage withholding, business tax and individual income tax; and recent state and local tax legislation and proposals. Register.

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 General Motors Corp. v. Commonwealth of Virginia, 268 Va. 289 (Va. S.Ct. 2004).

² There are eight exemptions available for projects in Washington where construction started after July 1, 2015 and before July 1, 2019; and four exemptions for projects where construction occurs between July 1, 2019 and July 1, 2025.