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February 28, 2022

State and Local Tax Weekly for February 18

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


California Franchise Tax Board TAM discusses application of P.L. 86-272 to activities conducted over the internet

In its Technical Advice Memorandum 2022-01 (FTB TAM 2022-01) (issued Feb. 14, 2022), the California Franchise Tax Board (CA FTB) advised on applying P.L. 86-2721 to "fact patterns that are common in the current economy due to technological advancements … " (i.e., activities conducted over the internet and telecommuting). P.L. 86-272 is a federal law that prohibits states from imposing state income tax on out-of-state sellers whose in-state activities do not exceed soliciting orders of tangible personal property for which both the acceptance of contracts for and the fulfillment of occur outside of the state.

The CA FTB's positions on protected and nonprotected internet activities largely follow those expressed in the recently revised Statement of Information concerning practices of the MTC and supporting states under P.L. 86-272 (Statement) issued by the Multistate Tax Commission (MTC), without specifically adopting or referencing the Statement. For a detailed discussion of the Statement, see Tax Alert 2021-1608.

CA FTB's position

CA FTB TAM 2022-01 addresses how out-of-state sellers should apply P.L. 86-272 to common fact patterns seen in the current business environment as a result of technological advancements. The business in the TAM's fact patterns (1) makes sales to California customers, (2) is commercially domiciled in another state and (3) only has California activities mentioned in the fact patterns.

Under CA FTB TAM 2022-01, the FTB views protected business activities for purposes of P.L. 86-272 to include:

  • Providing post-sale assistance to California customers by posting a static list of frequently asked questions on the business's website (Fact Pattern 10)
  • Placing on California customers' computers or other electronic devices "cookies" that gather customer information for uses "entirely ancillary" to soliciting orders for tangible personal property (e.g., remembering items added to a customer's shopping cart during a web session, storing personal information provided by the customer, reminding customers of items they considered on prior visits to the website) (Fact Pattern 11)
  • Offering only tangible personal property for sale on the business's website, with the website allowing customers to search for items, read product descriptions, purchase items and select delivery options (assumes that the business does not engage in any California business activities not described in the fact pattern) (Fact Pattern 12)

In contrast, the FTB views unprotected business activities to include:

  • Having an employee who telecommutes from California on a regular basis performing non-sales solicitation activities (e.g., business management and accounting tasks)2 (Fact Pattern 1)
  • Regularly providing post-sale assistance to California customers through an electronic chat or email that customers initiate by clicking on an icon on the business's website (Fact Pattern 2)
  • Soliciting and receiving online applications for its branded credit card through the business's website (Fact Pattern 3)
  • Placing on the business's website an invitation for California viewers to apply for non-sales positions within the business (e.g., the website enables viewers to fill out and submit an online application and submit a resume and cover letter) (Fact Pattern 4)
  • Placing on California customers' computers or other electronic devices "cookies" that gather customer search information for use in adjusting production schedules and inventory amounts, developing new products or identifying new items to offer for sale (Fact Pattern 5)
  • Remotely fixing or upgrading California customers' previously purchased products by transmitting code or other electronic instructions to those products over the internet (Fact Pattern 6)
  • Offering and selling extended warranty plans through the business's website to California customers who purchase the business's products (Fact Pattern 7)
  • Contracting with a marketplace facilitator to facilitate the sale of the business's products on the marketplace facilitator's online marketplace, where the marketplace facilitator maintains inventory, including that of the business, at fulfillment centers in a state in which the business's customers are located (Fact Pattern 8)
  • Contracting with California customers to stream videos and music to electronic devices for a charge (Fact Pattern 9)

CA FTB TAM 2022-01 includes the CA FTB's reasoning as to how it determined whether each fact pattern is a protected or an unprotected activity.

The CA FTB concluded the TAM by stating "an Internet seller is shielded from taxation in the customer's state if the only business activity it engages in within that state is the solicitation of orders for sales of tangible personal property, which orders are sent outside that state for approval or rejection, and if approved, are shipped from a point outside of that state."

For additional information on this development, see Tax Alert 2022-0281.


Pennsylvania: The Pennsylvania Department of Revenue (PA DOR) issued a bulletin to provide guidance on the application of split-factor apportionment when a taxpayer is subject to both the standard single sales factor apportionment under 72 P.S. §7401(3)2.(a)(15)-(17) and one or more special apportionment formulas under 72 P.S. §7401(3)2.(b)-(e). The PA DOR said that it has "consistently applied the split factor methodology" adopted by the Pennsylvania Commonwealth Court in Buckeye Pipeline Co.3 since the opinion was issued. The bulletin describes the 12-step process to follow in applying the split-factor apportionment methodology and includes examples of when the taxpayer: (1) is involved in one activity subject to special apportionment and one or more activities subject to standard apportionment, (2) is involved in two different activities subject to special apportionment and one or more activities subject to standard apportionment, and (3) is in a loss position for the year. Pa. Dept. of Rev., Corporation Tax Bulletin 2022-01 (Feb. 17, 2022).

Texas: The Texas Comptroller of Public Accounts (TX CPA) issued a list of frequently asked questions regarding the determination of the cost of goods sold (COGS) for purposes of the state's corporate franchise tax, including what is included in COGS, capitalizing or expensing allowable costs and the COGS deduction. As to the computation of COGS, the TX CPA said that (1) the calculation for COGS is specifically defined for Texas corporate franchise tax purposes; (2) flow-through funds excluded from total revenue cannot be included when calculating COGS; (3) a contractor's payments to a subcontractor may be included in the computation of COGS; (4) costs of labor provided by retail store and fulfillment center stockers are included in COGS, but costs incurred after the goods are initially displayed for sale or incurred to fulfill specific orders are excluded from COGS unless they qualify as an additional cost; (5) costs of labor provided by cooking staff are included in COGS, but labor costs of waitstaff are not included in COGS; (6) costs of labor to install tangible personal property outside of the manufacturing process, unless part of construction, improvement, remodeling, repair or industrial maintenance of real property, is not allowed as part of the COGS deduction; (7) a salesperson's compensation and benefits cannot be included in COGS; and (8) a motor vehicle sales finance company that offers loans to the public can subtract as COGS an amount equal to interest expense. The TX CPA explained that a taxable entity electing to capitalize allowable cost for COGS must capitalize all allowable costs for corporate franchise tax reporting purposes that it capitalized for federal income tax purposes; items not capitalized for federal income tax purposes must be expensed in computing COGS for Texas franchise tax purposes. In terms of an entity switching from capitalizing to expensing allowable costs for COGS (and vice versa), the TX CPA described limits on deducting costs incurred before the first day of the report period. Specific to pass-through entities, the TX CPA said that a limited partnership cannot elect to amortize intangible drilling costs over 60 months instead of expensing the costs because such an election is not available to a partnership. Further, partnerships and S corporations can include oil and gas depletion as COGS, but the owners of such entities may not include in COGS the depletion reported to them. Tex. Comp. of Pub. Accts., STAR No. 202202001L (Feb. 4, 2022).

Virginia: In calculating its apportionable Virginia taxable income, a multistate corporation should not include in its property factor the value of raw materials (in this case, leaf tobacco) that were not used, but merely aged, while being stored in Virginia before the materials were used in the manufacture of cigarettes in another state. In so holding, the Virginia Supreme Court (Va. S.Ct.) rejected the Virginia Department of Taxation's (VA DOT) argument that the corporation's storage of the leaf tobacco at its Virginia facility constituted a "use" because the tobacco aged during this time and that while being stored the tobacco was being processed for the next phase of production. Finding no ambiguity in the Virginia tax code's employment of the term "used", the Va. S.Ct. applied its plain meaning — i.e., "to put into action or service" or "to employ for the accomplishment of a purpose" — and stated that "[a]llowing raw materials to sit does not constitute processing because processing requires that these materials undergo treatment that will result in a product that is more marketable or useful." The corporation does nothing to the leaf tobacco to prompt or aid the aging process; rather, the aging of the leaf tobacco as it sits in the facility "is a natural consequence of the passage of time, not of any effort on [the corporation's] part." Accordingly, the value of the leaf tobacco should not be included in the corporation's property factor as the tobacco is not being used during the aging process. Virginia Dept. of Taxn. v. R.J. Reynolds Tobacco Co., No. 201263 (Va. S. Ct. Feb. 10, 2022).


Illinois: The Illinois Department of Revenue (IL DOR) has adopted amendments to various rules that implement the state's "level the playing field for Illinois Retail Act". The rules address the following topics and are codified at: 86 Ill. Adm. Code §§ 131.105 (definitions), 131.107 (description of different types of retailers on and after Jan. 1, 2021 — Scope of the regulations), 131.110 (remote retailers — general provisions), 131.115 (remote retailer — determination of status as a remote retailer), 131.120 (factors used by remote retailers in determining if the nexus threshold has been met), 131.125 (remote retailers hold harmless provisions), 131.130 (marketplace facilitators — general provisions), 131.135 marketplace facilitators — determination of obligation to remit tax), 131.140 (factors used by marketplace facilitators in determining if nexus thresholds are met), 131.145 (marketplace facilitators hold harmless provisions), 131.150 (marketplace sellers hold harmless provisions), 131.155 (tax sourcing provisions), 131.160 (certified service providers hold harmless provisions), 131.165 (certified automated systems hold harmless provisions), 131.170 (IL DOR responsibilities), 131.175 (local taxing jurisdiction and responsibilities), 131,180 (application of other rules) and 131.Illustration A (leveling the playing field retailer flowchart). Among the changes to the rules are the addition of a definition for "out-of-state seller" and the amendment to the definition of "remote retailers" to provide that a remote retailer's inventory at the location of a marketplace facilitator in Illinois does not create a physical presence nexus when the inventory is used exclusively to fulfill orders made over a marketplace that meets the economic nexus threshold. In its rule, the IL DOR stated in this instance the marketplace facilitator is considered the retailer with respect to such sales. Another change from the earlier rules provides that marketplace facilitators incurring state and local retailers' occupation tax (ROT) using origin sourcing for their own sales that are either fulfilled from inventory located in Illinois or for which selling activities otherwise occur in Illinois (the location at which the ROT is incurred is determined using the provisions in 86 Ill. Adm. Code 270.115(c) and (d)). For marketplace facilitators, Rule 131.140 is amended to provide that in calculating whether the sales threshold has been met, marketplace facilitators must include occasional sales and, starting Feb. 1, 2022, they must include certain sales of tangible personal property required to be titled or registered with agency of Illinois. The amended rules took effect Jan. 26, 2022. The rules and other IL DOR guidance are available on the IL DOR's "Leveling the Playing Field for Illinois Retail Act" resource page.

Texas: In response to a ruling request, the Texas Comptroller of Public Accounts (TX CPA) said that copy fees charged by a company for retrieval of medical records are subject to sales and use tax as taxable data processing services. The TX CPA noted that there is a statutorily provided 20% exemption for data processing services charges. Thus, the company is responsible for collecting and remitting sales and use tax on 80% of the copy fee. The TX CPA determined that the company's custodian and authorization fees are not taxable. The custodian fee, which reimburses the company for the amount charged by the medical services provider for the medical records provided pursuant to a pending lawsuit, subpoena or other court order, are part of the medical services provider's nontaxable medical services and, as such, the fee is not taxable. The authorization fee is a service charge for preparing record requests, reviewing records for accuracy and completeness and transferring records to customers. The fee is not subject to sales and use tax as these activities do not fall under the list of taxable services. Tex. Comp. of Pub. Accts., STAR No. 202201017L (Jan. 7, 2022).


Kansas: New law (SB 347) establishes new credits and incentives to attract large capital investments in Kansas by (1) businesses engaged in specified industries in new business facilities and operations in Kansas or (2) in a new national headquarters in Kansas by any business, and to encourage the development of a Kansas-based supply chain for large enterprises. A "qualified firm" that makes an investment of at least $1 billion in a qualified business facility may be eligible for the following credits and incentives as approved by the Kansas Secretary of Commerce (KS Secretary): (1) refundable income, privilege and premium tax credits are available for a portion of the investment; (2) reimbursement of a percentage of total payroll; (3) reimbursement of a percentage of eligible employee training and education expense; (4) reimbursement of a percentage of relocation expenses and incentive for relocation of employees to Kansas; and (5) sales tax exemption for construction costs of a qualified business facility. A "qualified firm" that enters into an agreement with the KS Secretary and commences construction of a qualified business facility may also qualify to have its Kansas income tax rate reduced. A "qualified supplier" that meets certain requirements may be eligible to receive the incentives mentioned in (1), (3) and (4) above or a partial retention of payroll withholding taxes for employees. The new law defines a "qualified firm" as a for-profit business engaged in one or more of the following industries: (1) advanced manufacturing; (2) aerospace; (3) distribution, logistics and transportation; (4) food and agriculture; or (5) professional and technical services. A "qualified firm" does not include a business engaged in mining, swine production, ranching or gaming. The new law specifies qualification requirements for the various credits, the amount of credits available, and the portion of credits the company can claim in a year. The new law also includes repayment provisions if the qualified firm or qualified supplier breaches the terms of the incentives agreement. The agreement can only be entered with one taxpayer in calendar year 2022. The KS Secretary cannot enter into an agreement with more than one qualified firm in calendar year 2023 and cannot enter into any agreement with a qualified firm after Dec. 31, 2023. Kan. Laws 2022, SB 347, signed by the governor on Feb. 10, 2022.


Iowa: Three above-ground fuel storage tanks on a propane distributor's commercial property and used in its propane distribution systems are not taxable real property as the tanks were not attached to the property under Iowa Code §427A.1(3). In so holding, the Court of Appeals of Iowa (IA App. Ct.) rejected the district court's finding that the tanks were taxable under Iowa Code §427A.1 as improvements or equipment. Instead, the IA App. Ct. determined that the while the tanks are pieces of equipment integral to the propane distribution process, they can be disassembled and removed from the distribution process without leaving any damage to the property around it. Moreover, once the tanks are removed they can be transported to another location for use and that the tanks are freely bought and sold within the fuel industry. Citing the exception to the attachment requirement under Iowa Code §427A.1(3), the IA App. Ct. further found that the tanks, although connected to pipes, are not "attached" to a building, structure or improvement to land because they are the kind of property that would ordinarily be removed when the property owner moves to another location. Accordingly, the tanks are excluded from the property tax assessment for the tax year at issue. McDermott Propane, LLC v Board of Review of Dubuque County, No. 20-1619 (Iowa Ct. App. Feb. 16, 2022).


Alabama: The Alabama Department of Revenue (AL DOR) adopted a new rule (Ala. Admin. Code 810-3-36-.01 (final rule)) to provide guidance on filing a pass-through entity (PTE) tax return and paying the tax due for PTEs4 electing to be taxed at the entity level (i.e., electing PTE). The final rule requires a PTE to electronically submit via My Alabama Taxes (MAT) Form PTE-E "Pass-Through Entity Election Form" on or before the 15th day of the third month following the close of the tax year for which the PTE elects to be taxed as an electing PTE. If the electronic election form is not timely filed through MAT, the election to become an electing PTE will be denied for that year. The election, once made, is binding for subsequent years until a request to revoke the election is made. If an entity no longer qualifies as a PTE, the election is automatically revoked. An electing PTE is required to file Alabama Form EPT "Electing Pass-Through Entity Payment Return" in addition to a complete Form 20S "S-Corporation Information Tax Return" or Form 65 "Alabama Partnership/Limited Liability Company Return of Income" for the tax year for which the election is made and thereafter until the election is terminated. In computing the PTE tax liability, the PTE: (1) must apply the maximum individual income tax rate; (2) may not use a net operating loss (carryforward) to offset income or gain; and (3) cannot eliminate or exempt any owner, member, partner, or shareholder's pro rata distributive share of Alabama taxable income. PTE tax returns are due on the 15th day of the third month following the close of the PTE's tax year; PTEs are granted an automatic six-month extension of time to file the electing PTE return. The filing extension does not extend the time to pay the PTE tax due. Owners, members, partners, or shareholders (collectively "owner") of an electing PTE must file an Alabama return to report its pro rata or distributive share of income from the PTE. A refundable credit is available to owners in an amount equal to the owner's pro rata or distributive share of Alabama income tax paid by the electing PTE. Tax credits generally pass through to the owner, however, the 2017 Alabama Historic Rehabilitation Tax Credit and the Railroad Modernization Act of 2019 Credit can only be claimed by the electing PTE. Lastly, the following rules apply to PTEs transitioning to an electing PTE: (1) estimated quarterly payments must be 25% of the required annual payment; and (2) once the election is made, the initial return's preceding tax year's computation is computed using the total of (income (loss) and deductions) column C (apportioned amount) reported on the Schedule K of either the PTE's Form 20S or Form 65, as the case may be, multiplied by 5%. If an electing S corporation reported a loss on Schedule K for the first tax year, these transition rules do not apply. The final rule took effect Feb. 13, 2022.


Delaware: The Delaware Division of Revenue announced in Technical Memorandum 2022-2 that the temporary COVID-19 income tax relief for teleworkers, which was effective June 1, 2020, applies through Dec. 31, 2021. For more on this development, see Tax Alert 2022-0289.


Alabama: The Alabama Department of Revenue (AL DOR) issued guidance on the rental tax collection and remittance or notice and reporting requirements for persons or entities that facilitated third-party rental transactions of Class II or IV property (rental facilitators). To comply with remittance or reporting requirements, rental facilitators must apply for a special rental tax account with the AL DOR. Rental facilitators that choose to comply with the notice and reporting requirements in lieu of collecting and remitting tax, must submit an annual informational report with the AL DOR and provide an annual transaction summary notice to each third-party owner/lessor who engaged in transactions facilitated by the rental facilitator for lease or rental of Class II or IV property. The informational report must be electronically filed by January 31 of the year succeeding the year for which the report is provided. The AL DOR also recommends facilitators include a statement on the lease contract, or another readily available form, to each third-party owner/lessor, indicating whether it is collecting Alabama rental tax for the transactions for which they are facilitating. Ala. Dept. of Rev., Notice: Alabama Rental Tax Guidance for Rental Facilitators (Feb. 11, 2022).


International — Ukraine: In January 2022, the Law of Ukraine No. 1525-IX of June 3, 2021 (Law No. 1525), took effect. The Law No. 1525 has introduced new value added tax (VAT) treatment for supplies of electronic services by nonresidents to Ukrainian private individuals. As of 2022, such nonresidents may need to register for VAT in Ukraine, charge 20% VAT on their services, submit simplified VAT tax returns and pay tax in Ukraine. Starting from January 2022, Ukrainian tax authorities started accepting VAT registration applications filed by nonresidents through the special web-portal. For additional information on this development, see Tax Alert 2022-0265.

International — Uruguay: In Decree No. 37/022, Uruguay extended from Dec. 31, 2021 to Dec. 31, 2022, the applicability of the reduced VAT rate on sales of goods and services to consumers who pay for the goods and services with debit cards or similar electronic instruments. In addition, the government extended from Dec. 31, 2021 to Dec. 31, 2022 the period during which certain financial entities are exempt from the requirement to withhold VAT on sales of goods and services to (1) taxpayers subject to the single tax regime known as "monotributo" and "monotributo social," and (2) taxpayers that generate income from business activities that does not exceed 305,000 indexed units (approximately USD 35,000). The new exemption period is from Jan. 1, 2016 to Dec. 31, 2022. For more on this development, see Tax Alert 2022-0286.


Wednesday, March 2, 2022. The indirect tax technology journey. (1:00-2:00 p.m. EST; 10:00-11:00 a.m. PST). Join our EY team of tax technology professionals for the fourth in a series of webcasts focused on the evolving technology landscape. During these 60-minute webcasts, we 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 fourth webcast in the series will focus on: leading practices for developing and implementing a tax technology road map, the role of Tax in large global transformations, leading practices for selecting the right technology, and successful implementation and maintenance of indirect tax technology. To register for this event, go to Indirect tax technology.

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 Currently codified at 15 U.S.C § 381.

2 P.L. 86-272 protection would still apply if the telecommuting employee's activities in California were limited to the solicitation of orders for sales of tangible personal property or are entirely ancillary to the solicitation.

3 Buckeye Pipeline Co. v. Commonwealth, 689 A.2d. 366 (1997).

4 For purposes of the final rule, a pass-through entity is defined as an S Corporation (defined in Ala. Code §40-18-160) or Subchapter K Entity (defined in Ala. Code §40-18-1). The definition of pass-through entity does not include single member limited liability companies, estates, trusts, business trusts and disregarded entities except in the capacity as an owner, member, partner or shareholder of the entity.