March 28, 2022
State and Local Tax Weekly for March 18
Ernst & Young's State and Local Tax Weekly newsletter for March 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.
Ohio Supreme Court clarifies 'true-object test' for bundled transactions and sales tax on automated services
In its opinion in Cincinnati Federal Savings & Loan Co.1 the Supreme Court of Ohio (OH S.Ct.) affirmed a decision by the Ohio Board of Tax Appeals (OH BTA) that sales and use tax applies to transactions involving data processing services, but vacated the OH BTA's ruling that charges relating to customized software are taxable. The OH S.Ct. remanded the case to the OH BTA for further analysis.
Facts and history: The taxpayer (a bank) entered into an agreement with a service provider for "account processing services." The service provider received transactional data from the taxpayer and its customers, processed that data and maintained the taxpayer's general ledger. The services were automated and performed electronically. The service provider also provided software customization services by creating an electronic general ledger that was specific to the taxpayer and not usable by any other business. The taxpayer requested a refund of the sales and use taxes paid on the service provider's account processing services, arguing that Ohio law considered those services to be nontaxable accounting services or, alternatively, nontaxable customized software. The Ohio Department of Taxation (OH DOT) denied the taxpayer's refund claim.
The OH BTA separated the charges for software customization from the account processing services. Regarding the taxpayer's argument on software customization, the OH BTA construed the tax exemption strictly against the taxpayer. The OH BTA noted "that 'software customization is a spectrum' that ranges from a vendor selling 'prewritten software with no modifications specific to a purchaser' to a vendor who 'creates an entirely new software system from scratch'." The OH BTA observed that the services provided were "in the middle" of that spectrum and concluded that the taxpayer's claim must be denied because it is doubtful that the services are exempt. Regarding the account processing services, the OH BTA affirmed the OH DOT's denial of the taxpayer's refund claim, concluding that they were taxable data processing services.
Statutes at issue: Ohio Rev. Code (ORC) 5739.01(B)(3)(e) imposes Ohio's sales and use taxes on "automatic data processing services" when "the true object of the transaction is the receipt by the consumer of automatic data processing … rather than the receipt of personal or professional services to which automatic data processing … [is] incidental" (the true-object test). ORC 5739.01(Y)(1)(a) defines "automatic data processing services" as the "processing of others' data … or providing access to computer equipment for the purpose of processing data." ORC 5739.01(Y)(2) identifies "personal and professional services" as not subject to tax and delineates a non-exhaustive list of services that fall under this nontaxable category of services. Included in this list are accounting and legal services, including situations where the service provider receives data or information and studies, alters, analyzes, interprets or adjusts that data. See ORC 5739.01(Y)(2)(a).
Ohio Supreme Court's analysis: The OH S.Ct. took issue with the OH BTA's analysis of software customization, specifically that the taxpayer based its refund claim on an exemption that should be strictly construed in favor of taxability. The OH S.Ct. disagreed with the OH BTA's conclusion that ORC 5739.01(Y)(2)(e) created an exemption for an existing taxable service (in this case, automatic data processing). Instead, the OH S.Ct. found that ORC 5739.01(Y)(2) defined specific services as taxable while specifying that personal and professional services are not taxable. The OH S.Ct. said that the statutes at issue were crafted in anticipation of situations "in which different services could be bundled in one transaction," and conditioned taxability of the whole transaction based upon its true object. Concluding that the OH BTA should have applied the true-object test, the OH S.Ct. vacated the OH BTA's ruling on the treatment of the services as software customization, remanding that issue back to the OH BTA to apply the true-object test to determine taxability.
Regarding the tax treatment of "account processing services," the OH S.Ct. affirmed the OH BTA's conclusion that the services were taxable. The Court rejected the taxpayer's argument that the services were nontaxable accounting services under ORC 5739.01(Y)(2)(a). The OH S.Ct. reasoned that the statutory provision cited by the taxpayer described specific services that are performed by individuals, may be bundled with automatic data processing services and may be nontaxable. The OH S.Ct. observed that the account processing services did not involve any accounting services that required a professional license or services performed by individuals. In so finding, the OH S.Ct. rejected the taxpayer's argument that the account processing services allowed the taxpayer to replace a portion of its accounting personnel with automated accounting services. Because there was no bundled transaction, the OH S.Ct. concluded that the true-object test did not apply.
For additional information on this development, see Tax Alert 2022-0471.
Arizona: On remand from the Arizona Supreme Court (AZ S.Ct.), an Arizona Superior Court (AZ superior court) determined that Proposition 208 (Prop. 208), approved by voters in 2020 and imposes a 3.5% income tax surcharge on high wage earners to provide direct funding for Arizona public schools, is unconstitutional because annual education spending limits under Ariz. Const., Art. 9, §21 prevents Arizona public schools from spending a "material" amount of Prop. 208 tax revenue in 2023. In so finding, the AZ superior court, as directed by the AZ S.Ct., permanently enjoined enforcement of Prop. 208 in its entirety. Fann v. Arizona, CV2020—015495 (Ariz. Super. Ct., Maricopa Cnty., March 11, 2022).
Idaho: New law (2022 ID HB 563) adopts a single sales factor apportionment formula and market-based sourcing for sales of non-tangible personal property (i.e., intangible property and services).2 If the state or states of assignment under the market-based sourcing provisions cannot be determined, the state or states of assignment will be reasonably approximated. Communications companies can elect to use the cost-of-performance method to source sales of non-tangible personal property. Electrical corporations, telephone corporations, communications companies or taxpayers subject to special industry regulation may elect to apportion income using a three factor (i.e., based on property, payroll and sales) factor formula. If a taxpayer make an election to use a special industry regulation, the definitions of property, payroll and sales in the special industry regulations under Idaho Code § 63-3027(18) control to the extent they conflict with the definitions in Idaho Code § 63-3027(12)-(16). In addition to the general alternative apportionment provision, If the application of the allocation and apportionment provisions to taxpayers engaged in a particular industry or a particular transaction or activity do not fairly represent its business activity in the state, the Idaho state tax commission can establish an alternative apportionment method for such taxpayers. Affected taxpayers, however, can petition for an adjustment under the general alternative apportionment rules. The law also modifies various definitions, renaming the terms "business income" and "non-business income" as "apportionable income" and "nonapportionable income", respectively, and giving the terms "sales" or "receipts" the same meaning; and adding definitions for "broadcast customer", "broadcaster", "communications company" and "film programming". These changes are retroactively effective to Jan. 1, 2022. Idaho Laws 2022, ch. 52 (HB 563), signed by the governor on March 16, 2022.
Indiana: New law (2022 IN HB 1002) provides for planned and contingent rate reductions for Indiana individual income tax purposes. The current 3.23% individual income tax rate, will be reduced to 3.15% for tax years beginning after Dec. 31, 2022 and before Jan. 1, 2025. The individual income tax rate will be further reduced to 3.1% for tax years beginning after Dec. 31, 2024 and before Jan. 1, 2027, to 3.0% for tax years beginning after Dec. 31, 2026 and before Jan. 1, 2029, and to 2.9% for tax years beginning after Dec. 31, 2028, if state general fund revenue collections for fiscal years ending June 30, 2024, June 30, 2026 and June 30, 2028 exceed by at least 2% state general fund revenue collections for the fiscal years ending June 30, 2023, June 30, 2025 and June 30, 2027, respectively. If the revenue threshold for an applicable year is not met, the current rate will remain in effect and the rate reduction that did not take effect will take effect at the next scheduled reduction date if the then applicable revenue threshold is met. Ind. Laws 2022, Pub. Law 138 (HB 1002), signed by the governor on March 15, 2022.
Massachusetts: The Massachusetts Department of Revenue issued Technical Information Release (TIR) 22-6 to explain the state's new elective excise tax on pass-through entities (PTEs). The TIR describes: (1) the PTE excise tax election, which must be made on an eligible PTEs timely filed original return (including original returns filed on extension); (2) eligible PTEs (i.e., S corporations, partnerships, limited liability companies (LLCs) treated as either and certain trusts) and non-eligible entities (i.e., sole proprietorships and single-member LLCs that are disregarded for federal income tax purposes); (3) how to compute the PTE excise, which is imposed on the total amount of an entity's income that passes through to qualified members and that is subject to the state's income tax, including guaranteed payments; (4) filing and payment requirements for the PTE excise; (5) the personal income tax credit for qualified members, which is 90% of the qualified members share of PTE excise paid; and (6) the interaction of PTE withholding and composite return requirements. Mass. Dept. of Rev., TIR 22-6: Pass-through Entity Excise (March 18, 2022).
Michigan: Vetoed bill (2022 MI SB 768) would have reduced Michigan's individual income tax rate from 4.25% to 3.9% in 2022, among other proposed individual and retirement income tax changes. 2022 MI SB 768 was vetoed by the governor on March 18, 2022.
SALES & USE
Colorado: New law (Colo. Laws 2022, HB 22-1099) requires high-volume third-party sellers using online marketplaces to disclose certain information and makes clear that failure to disclose such information is a deceptive trade practice, which may be subject to a per violation civil penalty. A high-volume third-party seller is a seller who in any continuous 12 month period in the prior 24 months, entered into 200 or more discrete sales or transactions of new or unused consumer products for which the seller earned $5,000 or more in aggregate total gross revenue on sales made through the online marketplace. Participating high-volume third-party sellers must provide the online marketplace with the following current information: bank account number(if no account, the name of the payee to whom payments from the marketplace are issued), contact information, a business or individual tax identification number and a current e-mail address and phone number. The online marketplace is required to verify the information provided to it by the high-volume third-party seller. In addition, a participating high-volume third-party seller with an aggregate total of $20,000 or more in annual gross revenues on the online marketplace, and that uses the marketplace's platform, are required to disclose the following information to consumers: seller's full name, physical address and contact information and whether the third-party seller used a different seller to supply the product to the consumer. High-volume third-party sellers that fail to disclose the above information (or certify that the information provided to the online marketplace is current or, if changes occurred, that updated information has been provided to the online marketplace), will have their sales activity on the online marketplace suspended until such information is provided or certified. These provisions take effect Jan. 1, 2023 except that if a referendum petition if filed within 90 days after final adjournment of the general assembly, the provisions will not take effect unless approved by voters during the Nov. 2022 general election. Colo. Laws 2022, HB 22-1099, signed by the governor on March 17, 2022.
Indiana: New law (2022 IN SB 166) exempts from the state gross retail tax (i.e., sales tax) transactions involving tangible personal property, if the person acquiring the property acquires it for incorporation into a transportation facility under a public-private agreement or a development agreement executed under Ind. Code §§ 5-23-8-1(a) or (b), respectively. The exemption does not apply to the extent the applicable agreements is entered into before Jan. 1, 2023. Ind. Laws 2022, Pub. Law 57 (2022 IN SB 166), signed by the governor on March 10, 2022.
Indiana: In response to a ruling request, the Indiana Department of Revenue (IN DOR) determined that the sales of glucose test strips and lancets (and lancing devices), at home COVID-19 test kits and other at home test kits (e.g., pregnancy test kits, cholesterol kits), that are sold over the counter or pursuant to a prescription are subject to Indiana's gross retail tax (or sales tax). The IN DOR explained that while glucose test strips, lancets and lancing devices would generally fall within the definition of "blood glucose monitoring supplies", to be exempt, such supplies must be "furnished without charge" (see Ind. Code § 6-2.5-5-19.5(a)). Because these items are sold, they do not meet the definition of "blood glucose monitoring supplies" and, therefore, are not exempt from tax. Further, the glucose test strips do not fall within the definitions of exempt "durable medical equipment"(the strips are intended for single use and not repeated use) or exempt "other medical supplies or devices" (the test strips are used as a diagnostic device). Likewise, the at home COVID-19 test and any other at home test described in the ruling is not exempt from sales tax since it is used as diagnostic device in order to determine whether treatment is necessary. Ind. Dept. of Rev., Revenue Ruling #2022-01ST (Feb. 25, 2022).
Indiana: New law (2022 IN SB 166) exempts from property taxation tangible property (including land, personal property, real property and improvements to land) that is used as part of, or incorporated into, a transportation facility under a public-private agreement or a development agreement executed under Ind. Code §§ 5-23-8-1(a) or (b), respectively. The exemption applies to qualifying tangible property irrespective of the owner or taxpayer of the property or when the property was placed in service. This exemption applies to assessment dates occurring after Dec. 31, 2022. Ind. Laws 2022, Pub. Law 57 (2022 IN SB 166), signed by the governor on March 10, 2022.
Indiana: New law (2022 IN SB 145) provides that the cost approach will be used for determining the true tax value of certain new commercial property with a retail structure that is at least 100,000 square feet in size and is occupied by a single retailer. This provision applies to such retail structures assessed for the first time after Dec. 31, 2022. This provision does not apply to such property if it was: (1) vacated by the original occupant for which the property was constructed, (2) constructed more than five years before the assessment date, or (3) substantially and adversely impacted by a change in a roadway or traffic pattern. The structure will still be considered to be occupied by a single retailer if the retailer leases or subleases small undivided portions of the structure. The law provides that for purposes of applying the cost approach to commercial property subject to this provision, estimates of depreciation and obsolescence will not be based on data derived from sales comparisons or income capitalization approaches and that the Indiana Department of Local Government Finance will establish a standard construction cost per square foot. The law also provides that the land component of the property may be determined using the sales comparison approach. Ind. Laws 2022, Pub. Law 54 (2022 IN SB 145), signed by the governor on March 10, 2022.
Oklahoma: New law (Okla. Laws 2022, HB 4451) waives the payroll requirement for tax year 2021, which is based in part on the 2020 calendar year payroll reported to the Oklahoma Employment Security Commission, for manufacturing facilities qualifying for the ad valorem tax exemption. Such manufacturing facilities may continue to receive the exemption for a five-year period if all other requirements for the exemption are met. The bill took effect upon approval by the governor. Okla. Laws 2022, HB 4451, signed by the governor on March 14, 2022.
COMPLIANCE & REPORTING
Montana: Reminder - Montana's corporate income tax law requires members of a unitary business to file returns on a worldwide combined basis, unless a water's-edge election is made to exclude foreign affiliates from the combined group. A Montana water's-edge group pays tax at an elevated tax rate of 7% instead of the regular rate of 6.75%. While many states require a water's-edge election to be made by the due date or extended due date of the return for the year for which it is intended to be effective, Montana is unique in that a water's-edge election must be made within 90 days of the beginning of the first year in which it is first intended to become effective. Accordingly, a corporation wishing to make a new water's-edge election, or renew an existing election, for the 2022 tax year must file a Form WE-ELECT with the Montana Department of Revenue by March 31, 2022. For additional information on this development, see Tax Alert 2022-0017.
PAYROLL & EMPLOYMENT TAX
Texas: The Texas Workforce Commission (TX WC) announced that the agency sent the wrong insert with the 2022 state unemployment insurance (SUI) tax rate notices, but the notices themselves are correct. Go here to see what information should have been inserted with the 2022 rate notices. Employers can confirm their 2022 SUI tax rate notice information and view UI benefit chargeback and voluntary contribution information online via the TX WC's Unemployment Tax Services system by going here. For additional information on this development, see Tax Alert 2022-0432.
Indiana: New law (2022 IN HB 1002) repeals the state's Utility Receipts Tax and Utility Services Use Tax, effective July 1, 2022. The law also requires any utility subject to the jurisdiction of the Indiana Utility Regulatory Commission to adjust its rates and charges to reflect the repeal of the Utility Receipts Tax. Ind. Laws 2022, Pub. Law 138 (2022 IN HB 1002), signed by the governor on March 15, 2022.
VALUE ADDED TAX
International — European Union: On March 15, 2022, the Council of the European Union held an Economic and Financial Affairs Council (ECOFIN) meeting where the finance ministers of the European Union member states publicly discussed the proposal for a Directive on ensuring a global minimum level of taxation for multinational groups in the European Union (the Pillar Two Directive). The meeting took place one day following the release by the Organisation for Economic Cooperation and Development (OECD) of the long-awaited Commentary on the Pillar Two Model Rules and the launching of a public consultation on the Implementation Framework of the global minimum tax with a deadline for input by April 11, 2022. For more on this development, see Tax Alert 2022-0430.
Wednesday, April 6, 2022. US corporate income tax compliance: Tax year 2021 readiness and preparing your tax function for what's next (3:30-4:45 p.m. EDT New York; 12:30-1:45 p.m. PDT Los Angeles). The corporate tax landscape is more dynamic than ever as we prepare for the 2021 tax filing season. Join our Ernst & Young LLP professionals for insights on preparing for 2021 US federal and state tax filings as well as key considerations for international filers. Topics will include: (1) key federal and state tax compliance updates and developments, including interdependencies among federal, state and international compliance and filings; (2) an IRS update and discussion of current activities, including notifications and plans for compliance enforcement; and (3) trends and insights from the recent EY Tax and Finance Operate and Chief Executive Officer surveys, including preparing your tax function for tax year 2022 and beyond. Register.
Wednesday, April 13, 2022. Indirect tax considerations of digital assets, Web3 and the metaverse (1:00-2:15 p.m. EDT New York; 10:00-11:15 a.m. PDT Los Angeles). Join our EY team of tax professionals for the first in a series of discussions focused on the evolving digital landscape of blockchain technology, digital assets, Web 3.0 applications and how those items may converge in a metaverse ecosystem. During this 75-minute webcast, we will discuss this evolving landscape through a state and local and indirect tax lens. The agenda will include a discussion defining the "what" and the "why" — what the digital revolution is and why it is important to understand how it could change the way your company engages with other businesses and consumers. Specifically, we will provide an overview of the new digital landscape to identify and analyze some of the pertinent considerations from the perspective of state sales tax, state income tax, and value-added tax, as well as certain potential information reporting requirements. 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 Cincinnati Federal Savings & Loan Co. v. McClain, Slip Opinion No. 2022-Ohio-725 (Ohio S.Ct. March 15, 2022).
2 Prior to enactment of this change of law, Idaho applied a three-factor apportionment formula as well as the cost-of-performance method to source sales of intangible property and services.