October 20, 2021
State and Local Tax Weekly for October 8
Ernst & Young's State and Local Tax Weekly newsletter for October 8 is now available. Prepared by Ernst & Young's State and Local Taxation group, this weekly update summarizes important news, cases, and other developments in U.S. state and local taxation.
Washington high court upholds constitutionality of the additional business and occupation tax imposed on certain financial institutions
The Washington Supreme Court (Court) reversed the trial court ruling in Washington Bankers Association1 and upheld the constitutionality of the additional 1.2% Washington business and occupation (B&O) tax rate imposed on specified financial institutions under Wash. 2019 Laws, ch. 420 (2019 Wash. Sub. HB 2167), (Ch. 420). Washington Bankers Association et al v. Washington, No. 98760-2 (Wash. S.Ct. Sept. 30, 2021).
Effective Jan. 1, 2020, Ch. 420 (enacted in 2019) imposes an additional 1.2% B&O tax on the gross taxable service and other income of specified financial institutions. Ch. 420 defines a "specified financial institution" as a financial institution that is a member of a consolidated financial institution group that reported on its consolidated financial statement for the prior calendar year annual net income of at least $1 billion (income threshold), not including net income attributable to noncontrolling interests. If a specified financial institution is no longer required to file a consolidated financial statement, a specified financial institution means any person that was subject to the additional tax in at least two of the prior four calendar years.
Following enactment of this additional B&O tax, the Washington Bankers Association and the American Bankers Association (collectively, banking associations) filed a complaint for declaratory relief stating that the additional tax violates the Commerce Clause of the U.S. Constitution. The banking associations argued that the tax "discriminates against interstate commerce by imposing a separate B&O surtax that applies exclusively to large financial institutions with headquarters out-of-state." The trial court in a one paragraph ruling agreed with the banking associations and held the additional B&O tax on specified financial institutions is "illegal, invalid, and unenforceable because it discriminates in effect and in purpose against interstate commerce in violation of the dormant Commerce Clause of the United States Constitution." The state appealed the trial court decision.
On appeal, the Court reversed the trial court and ruled the additional tax is constitutional. The Court determined that the tax is facially neutral since it is imposed on "any financial institution meeting the $1 billion consolidated net income threshold" and the statute imposing the tax "does not distinguish between in-state and out-of-state taxpayers … "
The Court also found that the additional tax does not "discriminate in effect", explaining that "[c]ontrary to the [banking associations'] argument, disproportionate economic effect on taxpayers does not render a tax discriminatory." Finding the U.S. Supreme Court rulings in Commonwealth Edison2 and Exxon3 instructive, the Court determined that the additional tax applies equally to all financial institutions operating in Washington that meet the income threshold, the burden of the tax depends on net income and the additional tax does not prevent financial institutions from entering or operating in Washington. The Court further held that the increased tax would not offend the dormant Commerce Clause if no Washington-based financial institution met the income threshold and the increased tax was borne primarily by out-of-state financial institutions. In addition, the Court rejected the bank associations' argument that the additional tax increased the cost of conducting business in Washington for an out-of-state financial institution, reasoning that (1) raising the cost of doing business alone does not show a discriminatory effect and (2) evidence of increased cost is not evidence of a discriminatory effect on out-of-state institutions (the Court noted that in-state financial institutions meeting the income threshold "would also presumably suffer increased costs as a result of paying the increased tax"). Further, the Court found the additional tax satisfies the internal consistency test, concluding double taxation would not occur if every other state adopted the same tax scheme because tax is apportioned such that it is remitted only on income generated in the state.
Lastly, the Court found (1) the Legislature did not act with a discriminatory purpose in enacting the additional tax on financial institutions and (2) the Pike4 balancing test is unnecessary because the Commerce Clause is not implicated since the additional tax does not directly burden interstate commerce in effect or purpose.
Federal: In New York, et al. v. Yellen, the Second Circuit affirmed a federal district court's dismissal of a complaint filed by the states of Connecticut, Maryland, New Jersey and New York challenging the constitutionality of the $10,000 limitation on the federal income tax deduction for state and local tax (SALT) imposed by the Tax Cuts and Jobs Act. The states claimed that the SALT deduction is constitutionally mandated or, in the alternative, that the limitation violates the 10th Amendment (dealing with reserved sovereign rights of the states) because it "coerces them to abandon their preferred fiscal policies." The federal district court found the claim lacked merit and the appeals court agreed. New York, et al. v. Yellen, Dkt. No. 19-3962-cv (2nd Cir. Oct. 5, 2021).
New Jersey: The New Jersey Division of Taxation (NJ DOT) extended through Jan. 3, 2022, the combined reporting initiative for its Corporate Business Tax. Without the extension, the initiative would have ended on Oct. 15, 2021. For a limited period, the NJ DOT is offering a unique closing agreement to any corporation that (1) joined in a New Jersey combined return; (2) indicated it has New Jersey nexus; and (3) did not file separate company returns in prior years, even if it may have been obligated to do so. Under this initiative, NJ DOT offers the following terms to all corporations that apply for a closing agreement between June 15, 2021 and Jan. 3, 2022: (1) a limited look-back to the privilege periods (i.e., return periods) ending after June 30, 2016, or the date nexus was established with New Jersey, whichever is later (returns for prior periods will not be required) and (2) waiver of all penalties. As part of the closing agreement, applicants must do all of the following: (1) provide the New Jersey registration number of the Managerial Member of the New Jersey combined reporting group of which they are a member (which begins with "NU"), (2) remit payment of interest within 30 days of assessment, and (3) file all required returns and remit payment of the reported tax liability in full within 45 days of executing the closing agreement. Corporations requesting a closing agreement cannot have been (1) incorporated in New Jersey, (2) authorized to do business in New Jersey or (3) registered for Corporation Business Tax purposes before being included as part of a 2019 or 2020 combined return. In addition, all submitted returns will be subject to routine audits. Corporations that do not take advantage of this initiative will be subject to all applicable penalties and interest for the look-back period going back beyond the privilege periods ending after June 30, 2016.
Tennessee: In response to a ruling request, the Tennessee Department of Revenue (TN DOR) said the Employee Retirement Income Security Act of 1974 (ERISA) does not preempt the imposition of Tennessee franchise and excise tax on an S corporation that is wholly owned by an employee stock ownership plan (ESOP) that qualifies as an employee benefit plan. The TN DOR cited various federal ERISA cases upholding generally applicable taxes that merely increase a plan's cost, noting that "[t]he mere fact that a statute has some economic impact on an ERISA plan does not invalidate the statute." The TN DOR determined that the state's franchise and excise tax are generally applicable to all persons doing business in Tennessee and are not designed to affect employee benefit plans. The taxes, the TN DOR found, increase the cost of doing business for the S corporation; they do not directly apply to the ESOP itself or to its beneficiaries. Tenn. Dept. of Rev., Letter Ruling #21-09 (Sept. 22, 2021).
SALES & USE
Multistate: The EY Sales and Use Tax Quarterly Update provides a summary of the major legislative, administrative and judicial sales and use tax developments for the third quarter of 2021. Highlights of this edition include a review of the most recent developments involving nexus, tax base and exemptions, technology and compliance and controversy affecting state sales and use tax activities throughout the US. A copy of the Quarterly is available via Tax Alert 2021-1814.
California: A company that operated as a construction contractor when it installed satellite television systems for a related entity's customers owes sales and use tax in connection with its sales of low noise block feed-horns (LNBF) it furnished and installed (pursuant to a construction contract) for the entity's customers. In so holding, the California Office of Tax Appeals (OTA) found that the entity was the ultimate consumer of the LNBFs, which allow customers to use the satellite television services, and that the company's sales of LNBFs to the entity were not sales for resale. The OTA also found that the LNBFs fit within California's regulatory definition of fixtures. The LNBFs were accessories attached to buildings and other structures; they did not lose their identity when installed. The OTA noted that Cal. Code Regs., tit. 18, § 1521 does not require a fixture be attached directly or permanently to the realty. Lastly, the OTA found the company was not entitled to an offset of sales tax remitted by the entity in connection with the entity's sale of receivers to customers because the evidence failed to show that the entity collected sales tax in connection with the sales of the LNBFs to customers who purchased receivers. Matter of Appeal of DISH Network California Service Corp., OTA Case No. 20025821 (Cal. Off. of Tax App. Aug. 6, 2021) (Nonprecedential).
Hawaii: The Hawaii Department of Taxation (HI DOT) issued guidance in the form of a tax information release (TIR) clarifying the exemption for state taxes in a foreign trade zone (FTZ) in regard to tax imposed on certain services and contracting in an FTZ (i.e., a designated geographic area that for purposes of US federal customs and tariff laws are treated as if they were located outside the United States). The HI DOT explained that in Hawaii Attorney General (HI AG) Opinion No. 64-52 (Nov. 5, 1964) (HI AG Op. 64-52), and in subsequent and other legal advice, the HI AG "generally opined that the imposition of all state taxes were preempted in an FTZ." The HI DOT noted that it issued guidance consistent with HI AG Op. 64-52. The HI AG, however, on Sept. 22, 2021, issued HI AG Opinion No. 21-01 (HI AG Op. 21-01) advising that HI AG Op. No. 64-52 has been superseded to the extent it "assumed that Congress intended to occupy the entire field with respect to FTZs such that all state taxation would be preempted," and that Hawaii's general excise tax (HI GET) and use tax are not expressly preempted by the federal Foreign Tax Zones Act. The HI AG also determined "that Congress did not assume exclusive regulatory power over FTZs such that state taxation was preempted." Consequently, all prior HI DOT guidance inconsistent with HI AG Op. 21-01 is no longer valid. The HI DOT included a list of business activities that are not preempted from tax and, thus, subject to HI GET in an FTZ. Such transactions include sales of tangible personal property (TPP) delivered in an FTZ for consumption in an FTZ or outside the FTZ but in Hawaii; sale or import of machinery, vehicles and other equipment for use within an FTZ; services related to machinery, vehicles and other equipment used in an FTZ; engaging in business of contracting for real property located in an FTZ; services relating to real property located in an FTZ that are not considered "contracting" for HI GET purposes; other services used and consumed in an FTZ; and lease rents received for letting of real property in an FTZ. The HI DOT expressed that this list "is not intended, nor shall it be interpreted, to be an exclusive list of Hawaii tax impositions." The HI DOT is recommending that taxpayers who filed returns and paid taxes inconsistent with the guidance announced in HI DOT TIR No. 2021-07 apply to its voluntary disclosure program. Haw. Dept. of Taxn., Tax Information Release No. 2021-07 "Exemption from Taxes in Foreign Trade Zones" (Sept. 29, 2021).
Texas: A company that extracts and processes lignite coal for ultimate sale is entitled to the manufacturing exemption from Texas's sale and use taxes. In so holding, the Texas Court of Appeals (TX Ct. App) rejected the arguments of the Texas Comptroller of Public Accounts (TX CPA) that the exemption does not apply because the coal constituted real property, not personal property, when processing began and processing under the applicable statute does not encompass extracting minerals from the earth. The TX Ct. App. said that for the processing exemption to apply (1) tangible personal property (TPP) must be the ultimate product offered for sale by the taxpayer, (2) the item used or consumed in the production of the ultimate product must be TPP, and (3) the item directly used or consumed in production must directly make or cause a chemical or physical change to the product being produced for ultimate sale. In this case, the TX Ct. App. found that the company met each requirement. The product it sold was TPP, the excavators directly used to process the product were TPP and the excavators caused physical changes to the lignite coal during the production process. The TX Ct. App. also considered whether an input in the production process has to be TPP itself and found that the "exemption does not … either grammatically or conceptually contemplate that the inputs themselves are being manufactured, processed, or fabricated." Further, in construing statutory terms, the TX Ct. App. found "the fact that the noun 'processing' is listed with the noun 'manufacturing' — an activity expressly having to do with the production of a final end product (a tangible good) for sale — indicates that the focus of the activity is on the end product, not the inputs." Hegar v. Texas Westmoreland Coal Co., No. 03-20-00406-CV (Tex. Ct. App., 3rd Dist., Oct. 7, 2021).
California: New law (AB 176) contains changes to tax exemptions related to the state's COVID-19 relief grant program, homeless hiring tax credit and film tax credit, among other programs. The law: (1) excludes from gross income subject to corporate income tax grant allocations from the California Microbusiness COVID-19 Relief Grant Program (this is similar to the exclusion already provided for personal income tax purposes), effective for tax years beginning on or after Sept. 1, 2020 and before Jan. 1, 2023; and (2) excludes from gross income subject to corporate and personal income taxes grant allocations from the California Venues Grant Program, effective for tax years beginning on or after Sept. 1, 2020 and before Jan. 1, 2030. The law also extends the recapture provisions in the California Competes Grant program to the California Microbusiness COVID-19 Relief Grant Program and the California Venues Grant Program. The law amends the homeless hiring tax credit to clarify certification procedures for qualified taxpayers and employed individuals. In regard to film credits, the law: (1) directs the California Film Commission (instead of the state's Go-Biz agency) to adopt motion picture film credit implementing regulations; and (2) modifies the certified studio construction project credit's diversity work plan and reporting requirements to include diversity goals the motion picture seeks to achieve in terms of qualified wages paid by ethnicity (in addition to gender and race), and requires these diversity goals be broadly reflective of California's population. According to the legislative analysis for AB 176, technical and clarifying changes have been made to the California Small Business Development Technical Assistance Expansion Program, the California Small Business COVID-19 Relief Grant Program (including the definition of "qualified small business"), the California Microbusiness COVID-19 Relief Grant Program, the California Venues Grant Program, the California Competes Program, and the Golden State Stimulus II. AB 176 took effect immediately. Cal. Laws 2021, ch. 256 (AB 176), signed by the governor on Sept. 23, 2021.
PAYROLL & EMPLOYMENT TAX
Indiana: The Indiana Department of Revenue released Departmental Notice #1, How to Compute Withholding for State and County Income Tax, reflecting changes in local income tax rates that are effective Oct. 1, 2021. For additional information on this development, see Tax Alert 2021-1816.
Maryland: New law (SB 811) requires that Maryland Governor Larry Hogan deposit enough federal relief funds into the state's unemployment insurance (SUI) trust fund to ensure that Rate Schedule C - the midway point of SUI rate schedules under the state UI law - be in effect for calendar year 2022. SB 811 also requires that Rate Schedule C be used for calendar year 2023. SUI tax rates on Rate Schedule C range from 1.0% to 10.5%. For additional information on this development, see Tax Alert 2021-1799.
New York City: New York City (NYC) Mayor Bill de Blasio has signed into law Retirement Security for All Acts (NYC Law Nos. 2021/051 and 2021/052) which seek to encourage individuals to set aside money for retirement by establishing an NYC-operated Individual Retirement Account (IRA) plan and by requiring that covered private-sector employers enroll eligible NYC employees into their own qualified retirement savings plan or the NYC-managed IRA plan. The employer requirement is effective Aug. 9, 2021; however, the NYC retirement savings board, created under NYC Law No. 2021/052, has up to two years to implement the program. For additional information on this development, see Tax Alert 2021-1805.
Oregon: New law (HB 3389) reduces the impact of COVID-19 unemployment insurance (UI) benefits on employer state unemployment insurance (SUI) tax rates, codifies the program that allows employers to defer payment of their SUI contributions and offers forgiveness of SUI contribution deferrals to employers who experienced significant SUI tax rate increases in 2021. For additional information on this development, see Tax Alert 2021-1821.
New York: The U.S. Supreme Court declined a trade association's request that it determine whether "New York's Opioid Stewardship Act's surcharge is a 'tax' within the meaning of the federal Tax Injunction Act [28 U.S.C. § 1341], despite having features that other circuits repeatedly have held indicative of a punitive fee." Healthcare Distribution Alliance, et al. v. James, petition for cert. denied, Dkt. No. 20-1611 (U.S. S.Ct. Oct. 4, 2021).
Thursday, Oct. 21, 2021. Examining the Multistate Tax Commission's revised statement on P.L. 86-272: Updates, impact and considerations (1:00-2:15 pm ET). Join EY panelists for a discussion of how multistate taxpayers may be affected by the recently approved fourth revision to the Statement of Information concerning practices of the Multistate Tax Commission (MTC) and supporting states under P.L. 86-272 (statement). The revised statement added a new section on protected and unprotected activities conducted over the internet and clarified other items such as those performed by telecommuting employees and independent contractors, among other changes. Specifically, EY panelists will: (1) provide a history and overview of P.L. 86-272, the MTC and prior revisions to the statement; (2) examine the specific changes made to the statement by the latest revision; (3) review the authoritative power of the MTC generally; (4) consider whether states will adopt the revised statement and whether such adoption would spur Congress to amend P.L. 86-272; (5) consider the interplay between the U.S. Supreme Court's decision in South Dakota v. Wayfair, Inc. and the MTC's interpretation in the statement of protected and unprotected internet activities within the framework of P.L. 86-272; and (6) evaluate the impact of the statement on combined versus separate reporting states. Register.
Wednesday, Nov. 3, 2021. The indirect tax technology journey. Now. Next. Beyond (1:00-2:00 pm ET). Join our EY team of tax technology professionals for the third in a series of six webcasts focused on the evolving technology landscape. During these 60-minute webcasts, EY panelists will share insights into how market-leading organizations are using technology to adapt to new legislation and market trends, and to effectively transform tax operations. Because technology is a vital component for every business looking to build a resilient, future-ready tax function, these webcasts will be relevant across all sectors and to businesses of every size. This third webcast in the series will focus on the following: (1) how artificial intelligence (AI) is transforming the tax function through automation of key tax processes; (2) the use of AI to aggregate, analyze, prepare and review unprecedented volumes of information; and (3) blockchain technology's ability to provide secure, auditable records of transactions and assets. 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.
1 Washington Bankers Assn et ano. v. Washington et al., Cause No. 19-2-29262-8 SEA (Wash. Super. Ct., King Cnty., May 15, 2020). See Tax Alert 2020-1505.
2 Commonwealth Edison Co. v. Montana, 453 U.S. 609 (1981).
3 Exxon Corp. v. Governor of Maryland, 437 U.S. 117 (1978).
4 Pike v. Bruce Church, Inc., 397 U.S. 137 (1970).