December 13, 2021
State and Local Tax Weekly for December 3
Ernst & Young's State and Local Tax Weekly newsletter for December 3 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.
Delaware Supreme Court invalidates revenue division's policy limiting state separate company net operating loss (NOL) to a corporation's federal consolidated group's NOL
In Verisign Inc., the Delaware Supreme Court (DE S.Ct.) agreed with (but for different reasons) the superior court's finding that the policy of the Delaware Division of Revenue (DE DOR) which limits the Delaware separate company NOL a corporation may claim to the consolidated NOL deduction of the federal consolidated group of which it is a member is invalid. In so holding, the DE S.Ct. found the policy "operated to manipulate [the corporation's] federal taxable income by substituting a consolidated [NOL] figure for [the corporation's] own, single-entity [NOL]." This policy, according to the DE S.Ct., exceeded the DE DOR Director's authority under 30 Del. Code §§ 1901—1903. Del. Dir. of Rev. v. Verisign, Inc., No. 18,2021 (Del. S.Ct. Nov. 29, 2021).
For state corporate income tax purposes, Delaware is a separate return filing state and the filing of consolidated corporate income tax return is not allowed. Thus, each member of a federal consolidated group that is required to file a Delaware corporate income tax return must file its own IRS Form 1120 pro forma return, reporting income and deductions as if it had filed a separate federal corporate income tax return.
The DE DOR policy limited the Delaware NOL a corporation may claim to that corporation's share of the consolidated NOL deduction of the federal consolidated group of which it is a member. The Superior Court of Delaware (superior court) held1 that this policy, while consistent with Delaware statutory law and nondiscriminatory under the Commerce Clause, nevertheless violated the Uniformity Clause of Delaware's state constitution by creating two classes of Delaware corporate taxpayers — those that filed as separate corporations for US federal income tax purposes and those that filed as part of a federal consolidated group which would result in a different Delaware corporate income tax result based on identical facts but different facts for the member of the consolidated group. The superior court's ruling was appealed.
While the appeal was pending, Delaware enacted legislation (83 Del. Laws ch. 107 (2021 DE HB 171 (HB 171)) codifying in part, the DE DOR's policy. HB 171 limits the amount of NOL carryforward calculated under the federal income tax law that can be deducted for Delaware income tax purposes to the amount of the deduction claimed on the taxpayer's federal income tax return for the tax year in which the taxpayer was included as a party.2 HB 171 took effect July 30, 2021 — the day it was signed into law by the governor.
Unlike the superior court, the DE S.Ct. did not reach the constitutional challenge to the DE DOR's policy, finding instead that the policy did not comply with Delaware's tax code under 30 Del. C. §§ 1901—1903. The DE S.Ct. "interpret[ed] [Del. Code] Title 30 — as it read before the 2021 amendment — as requiring each corporate taxpayer to report income and deductions as a standalone entity, rather than on a consolidated basis." The Del. S.Ct. found the text of the statute "clear", explaining that "the operative provisions of [Del. Code, tit. 30,] Sections 1902 and 1903 obligated each eligible corporation to pay Delaware income tax as a singular entity. They did not authorize the use of a consolidated deduction … ." Moreover, the DE DOR's Corporate Income Tax return instructions for 2015 provide that the starting point for Delaware corporate income tax is the federal taxable income of the separate corporations as if each corporation filed federal corporate income tax returns on a separate company basis.
The DE S.Ct. explained that the DE DOR's had corporate filers report a separate-company figure on the first 28 lines of their pro forma IRS Form 1120, but on the line used to report NOLs — line 29 — the DE DOR applied its policy and limited the filer to the consolidated NOL claimed on the federal return. The federal consolidated NOL, is the aggregate of the NOL carryovers and carrybacks and includes NOLs of the members arising in separate return years. The DE S.Ct. determined that the use of an aggregate deduction reported by a group of multiple companies is inconsistent with Del. Code tit. 30, Section 1902's requirement that each eligible corporation pay tax on its taxable income. Explaining differently, the DE S.Ct. said that by not allowing a corporation to claim its actual standalone NOL deduction "the corporation [paid] taxes on an amount of income that was not its taxable income … "
The DE S.Ct. also rejected various arguments made by the DE DOR to support the validity of its policy.
Ultimately, the DE S.Ct. invalidated the DE DOR's policy and struck its assessment against the corporation for the 2015 and 2016 tax years.
Minnesota: The Minnesota Department of Revenue (MN DOR) updated its frequently asked questions (FAQs) on the state's new elective pass-through entity (PTE) tax. Recently added FAQs provide that entities that qualify for the new Minnesota PTE tax election include partnerships, S corporations and limited liability companies (LLCs and separately, an LLC) taxed as either, if no partner, member or shareholder is a partnership, LLC or corporation, other than a disregarded entity. A single member LLC is not eligible to make a Minnesota PTE tax election. The MN DOR also clarified that a grantor trust can be a qualifying owner for purposes of the Minnesota PTE tax election if it is both (1) a disregarded entity and (2) owned by an individual who is a US citizen. The MN DOR further said that if, at any time during an entity's year, one or more of its owners is not a qualified owner, the entity will not be eligible to make the PTE tax election. Fiscal year entity filers whose fiscal year began before Dec. 31, 2020, cannot claim the Minnesota PTE tax election; the election is available for qualifying entities whose tax years begin after Dec. 31, 2020. The MN DOR also determined that: (1) the state's research and development (R&D) credit cannot be used to offset the Minnesota PTE tax; (2) the federal excess loss limitations are not applied on the Minnesota Schedule PTE; (3) for purposes of the Minnesota PTE tax, the 50% ownership interest is determined by the owner's capital account percentage, unless the entity's agreement specifies how ownership is calculated; and (4) a partner, shareholder or owner (collectively "partner") of a PTE cannot transfer estimated payments made to the partner's individual tax account to the PTE's Minnesota business tax account. Minn. Dept. of Rev., Law Change FAQs for Tax Year 2021 (last visited Dec. 3, 2021).
Minnesota: The Minnesota Department of Revenue (MN DOR) updated its frequently asked questions (FAQs) on various IRC conformity issues following law changes enacted in 2021. The MN DOR said Minnesota tax laws do not conform to the following federal tax law provisions: (1) changes to the Shuttered Venue Operators Grants program made by the America Rescue Plan Act of 2021 (P.L. 117-2) (ARPA); (2) the Employee Retention Credit (ERC); and (3) the qualified improvement property (QIP) technical correction. The MN DOR noted that taxpayers must report nonconformity adjustments on their nonconformity schedule. The MN DOR also said Minnesota follows the federal income tax treatment of Paycheck Protection Program (PPP) loan forgiveness amounts and related business expenses; thus, taxpayers do not report on their Minnesota return PPP loan forgiveness and related business expenses that were not deductible for federal income tax purposes. Lastly, the MN DOR said Economic Injury Disaster Loans (EIDL) amounts are taxable in Minnesota for 2021 and should be reported as a nonconformity adjustment on the taxpayer's 2021 return (MN DOR stated that EIDL loans, however, are not taxable for taxable years beginning after December 31, 2019 and before January 1, 2021). Minn. Dept. of Rev., Law Change FAQs for Tax Year 2021 (last visited Dec. 3, 2021).
New York: The New York Department of Taxation and Finance (NY DoTF) announced that the rate of the N.Y. Tax Law Article 9-A Metropolitan Transportation Business Tax Surcharge (MTA surcharge) will remain at 30.0% for tax years beginning on or after Jan. 1, 2022 and before Jan. 1, 2023. The 30.0% rate will remain in effect for succeeding tax years unless the Commissioner of the NY DoTF determines a new rate. New York Dept. of Taxn. and Fin., TSB-M-21(2)C 2022 MTA Surcharge Rate (Nov. 19, 2021).
Texas: A multistate company that had agreements with retail stores to provide lease purchase options to individuals that wanted to make purchases at the retail stores was not primarily engaged in the retail or wholesale trades during the period at issue and, therefore, was not entitled to calculate franchise tax using the lower rate of 0.5% of taxable margin. An Administrative Law Judge (ALJ) for the Texas Comptroller of Public Accounts found the company's activities fall within Division H of the federal Standard Industrial Classification (SIC) Manual — primarily engaging in providing loans to individuals or financing retail sales made on installment plans. The company, the ALJ reasoned, is not primarily engaged in retail or wholesale trade as it does not operate a place of business engaged in activities to sell merchandise. The ALJ also found no evidence that the company ever purchased merchandise or kept inventory for sales; rather, it did not purchase any merchandise until it was offered for sale by a retail store. In addition, the ALJ rejected the company's request for additional cost of goods sold deductions based on the depreciation of merchandise it purchased, noting that the company did not produce contemporaneous records and supporting documentation to verify its claim. Tex. Comp. of Pub. Accts., STAR No. 202110018H (Oct. 5, 2021).
SALES & USE
California: Adopted amendments to Cal. Code of Regs. tit. 18, §1706 modify the sales and use tax drop shipper regulation to clarify that marketplace sales generally are not drop shipment transactions and to provide guidance on how a person can overcome a presumption that they are a drop shipper. The regulation provides that a marketplace facilitator is not a "true retailer" when it is the retailer for a retail sale of tangible personal property to a California consumer by a marketplace seller. Further, if the marketplace seller contracts to purchase the property from a supplier and instructs the supplier to deliver the property directly to the consumer, the supplier is not a drop shipper. For purposes of determining who the retailer is for purposes of a marketplace sales, taxpayers are directed to see Cal. Code of Regs. tit. 18, §1684.5, Marketplace Sales. Amendments to the regulation add definitions of "marketplace", "marketplace facilitator", "marketplace seller", "retailer engaged in business in this state" and "true retailer" and add new examples of marketplace sales. A person presumed to be a drop shipper can overcome this presumption by timely accepting a resale certificate in good faith from the person's customer. The resale certificate must contain all the essential elements as provided in Cal. Code of Regs. tit. 18, §1668, Sales for Resale. A person that does not timely obtain a resale certificate can overcome the presumption by establishing that the person's customer was a retailer engage in business in California at the time of the sale or the person's customer was a marketplace seller and purchased the property via its sale facilitated by a marketplace facilitator that was the retailer for the purpose of the sale. The amended regulation took effect Nov. 30, 2021. Cal. Dept. of Tax and Fee Admin., amended Cal. Code of Regs. tit. 18, §1706 (approved by the California Office of Administrative Law, and filed with the Secretary of State, on Nov. 30, 2021).
Ohio: In response to a ruling request, the Ohio Department of Taxation (OH DOT) determined that for sales and use tax purposes video board and message displays (collectively, "video display systems") manufactured and installed by the taxpayer meet the statutory definition of business fixtures. The OH DOT found the video display systems, which are composed of separate pieces of tangible personal property, are "akin to 'equipment', 'signs', or a 'broadcasting system,' all of which are specifically listed in [Ohio Rev. Code] 5701.03(B) as examples of business fixtures." Thus, the video display systems retain their status as tangible personal property when they are affixed to sports stadiums/arenas, as digital billboards, on building facades, as signs by entrances to businesses and on interiors of buildings. Ohio Dept. of Taxn., Op. No. 21-0001 "Business Fixture" (Nov. 9, 2021)
Texas: The Texas Comptroller of Public Accounts (TX CPA) issued guidance on the application of sales and use tax to sales of security services. Taxable security services include: investigative or detective services; guard services (except guard dog companies); alarm systems installation or monitoring; armored cars or armed couriers; security services contractors; private security officers (excluding private security consulting companies); locksmith services; computer forensic services; unclaimed property services. Nontaxable services include: medical alert services; certain services provided by full-time peace officers; certain telematics services; and temporary security services that meet certain requirements. Those providing taxable security services must collect state and applicable local sales tax on the total amount billed for services unless a resale or exemption certificate is received from the purchaser. The TX CPA explained that the taxable sales price includes items such as meals, lodging, car rentals and insurance billed to the customer, and that sales and use tax is due on materials, supplies and equipment used to provide taxable security services. The TX CPA noted that instead of paying tax, the security service provider can provide a resale certificate on goods that will be transferred to the customer as part of the services or on a service that is an integral part of the taxable security service. Those providing nontaxable security services owe tax on all goods and services purchased to perform the services. Lastly, the TX CPA said that security services provided to a government agency are not taxable. Tex. Comp. of Pub. Accts., STAR No. 202122001L (accession date Nov. 16, 2021).
Montana: The Montana Department of Revenue (MT DOR) issued guidance on the trades education and training tax credit which can be claimed against the Montana corporate or individual income tax, starting in 2021. The credit is available to employers with qualifying education and training expenses for a trade profession. The MT DOR explained that qualifying expenses (1) must be for employees who work (or are anticipated to work) in Montana for at least six months of the year, and (2) be paid by the employer to an unrelated third party for tuition, fees, books, supplies or equipment that will be used to assist an employee in developing additional techniques and skills in a trade profession. (The guidance includes a list of "trade professions" for purposes of the credit.) The credit is 50% of the cost of qualifying trades education or training expenses incurred by an employer during the tax year. It cannot exceed $2,000 per employee and is capped at $25,000 annually. The credit cannot be carried back or forward. Qualifying expenses cannot be paid for with a grant or similar program. Further, to claim the trades education and training tax credit, an employer must add back any qualifying expenses taken on a federal income tax return to the employer's Montana corporate income tax return. The MT DOR said that a form for the credit will be available in 2022; employers claiming the credit for the 2021 tax year will need to include a statement on their 2021 Montana corporate income tax return. An employer cannot claim the trades education and training tax credit if they claimed the apprenticeship tax credit or the jobs creation tax credit for the same employees. Mont. Dept. of Rev., "Trades Education and Training Tax Credit" (Nov. 15, 2021).
New Jersey: The New Jersey Economic Development Authority announced that applications are now open for the state's offshore wind tax credit program. The credit is available to businesses making a capital investment in a New Jersey qualified wind energy facility of $50 million and employing at least 150 new, full-time employees at the facility. A business will be able to claim 20% of the total credit amount per year over a five-year period against its New Jersey corporate business tax or insurance premiums tax. Alternatively, businesses can sell the credit for an amount not less than 75% of the credit's amount. Additional information on the wind tax credit program, including application and credit eligibility requirements, is available here. N.J. Economic Development Authority, Press Release "Applications Now Open for NJEDA Offshore Wind Tax Credit Program" (Dec. 3, 2021).
COMPLIANCE & REPORTING
Hawaii: The Hawaii Department of Taxation (HI DOT) provided Schedule C filers guidance on how to report amounts applicable to forgiven federal Paycheck Protection Program (PPP) loans and related expenses for Hawaii income tax purposes. Specifically, the guidance describes whether Schedule C filers are allowed to exclude forgiven PPP loans from income and deduct business expenses paid with such loans for Hawaii income tax purposes. The HI DOT said the treatment of these expenses — inclusion or exclusion — depends on "what reason and amount the PPP loan application was filed." The HI DOT explained that if a sole proprietor's PPP loan was based on net income, the forgiven PPP loan is excluded from income subject to Hawaii income tax and the sole proprietor can deduct all other expenses in determining their wages. If, however, the PPP loan application was submitted specifically to cover the amount of employees' wages and any qualified expenses, then the proceeds from the forgiven PPP loan are not reported as taxable income for Hawaii tax purposes and the sole proprietor is not allowed the deduction for PPP amounts received to specifically cover wages and qualified expenses. In this instance, the HI DOT said that TIR 2021-05 "Details and Timing of Paycheck Protection Program Loan Forgiveness" applies. Haw. Dept. of Taxn., Updates for Taxpayers webpage: Schedule C and PPP loans (page last updated Nov. 18, 2021).
PAYROLL & EMPLOYMENT TAX
Virgin Islands: The U.S. Department of Labor (USDOL) released the final federal unemployment tax (FUTA) credit reduction for calendar year 2021 (paid with the 2021 IRS Form 940) which shows that the Virgin Islands is again the only jurisdiction with a FUTA credit reduction because it continued to have an unpaid federal unemployment insurance loan balance on Nov. 10, 2021. For additional information on this development, see Tax Alert 2021-2156.
VALUE ADDED TAX
International — Cyprus: The Cyprus Administrative Court recently held that a Correction of Error request to the Value Added Tax (VAT) authorities cannot be approved for claiming allegedly overpaid VAT in Cyprus, later assessed and settled in another European Union (EU) Member State. It was held that the correction process needs to be completed within three years from the payment of VAT and the taxpayer could not subsequently invoke double taxation in Germany to request back VAT already paid in Cyprus. The fact that the taxpayer at the VAT registration timing considered the place of its transactions (business establishment) in Cyprus charging Cypriot VAT to its consumers and confirming such approach via a VAT Ruling was inadequate when the German VAT authorities assessed German VAT on the basis that the services were predominantly carried out from a German fixed establishment. For additional information on this development, see Tax Alert 2021-2154.
Monday, Dec. 13, 2021. Implications of the federal Superfund chemicals excise tax (2:00 - 3:00 pm EST). Please join our EY cross-functional panel of professionals for a webcast focusing on the recently enacted Infrastructure Investment and Jobs Act (P.L. 117-58) and specifically on the reinstatement and expansion of the federal Superfund chemicals excise tax. During the webcast, the panel will discuss the impact of the reinstatement and expansion of this excise tax to sectors that import or manufacture chemicals or chemical compounds subject to the tax and some of the nuances of the new law as enacted that will prove challenging in identifying them. The panelists will also share insights into what businesses will need to consider as they evaluate the readiness of their existing systems and processes to comply with the reinstated tax requirements. Topics will include affected chemicals, sector implications, tracking and compliance requirements and leading practices to evaluate the adequacy of existing systems and processes to the reinstated federal excise tax laws. 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 Verisign, Inc. v. Del. Dir. of Rev., C.A. No. N19C-08-093 JRJ (Del. Super. Ct. Dec. 17, 2020).
2 The amendment to the Delaware statute did not incorporate the DE DOR policy's carve-out for taxpayers filing a consolidated return exclusively with other Delaware taxpayers.