December 5, 2022
State and Local Tax Weekly for November 18 and 25
Ernst & Young's State and Local Tax Weekly newsletter for November 18 and 25 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.
Texas appeals court allows taxpayer's use of cost-of-performance data to apportion its subscription receipts for services to Texas
In the latest holding in the Sirius XM Radio1 (Sirius XM or the Taxpayer) Texas franchise tax saga, the Texas Court of Appeals, Third Circuit (appeals court), on remand from the Texas Supreme Court, held that the Taxpayer provided sufficient evidence to support its cost-based analysis of the "fair value" of services performed in the state for purposes of sourcing gross receipts from the sale of services. Accordingly, the Taxpayer can use cost-of-performance data to apportion its subscription receipts for services performed in Texas.
The Texas franchise tax applies to a taxpayer's taxable margin apportioned to the state. In apportioning its margin, a taxpayer uses an apportionment factor, the numerator of which includes gross receipts from business conducted in the state and the denominator of which includes its gross receipts from business conducted everywhere. Specifically, the statute2 sources the gross receipts from "each service performed in this state [i.e., Texas]" to Texas.
Sirius XM receives subscription fees from broadcasting satellite radio channels. The majority of the content and programming Taxpayer produces is delivered to its subscribers through satellite transmission to customers' radios. The Taxpayer's production and transmission activities are primarily performed outside of Texas. On its original 2010 and 2011 Texas franchise tax reports, the Taxpayer sourced its subscription receipts to the locations where its primary production and broadcasting facilities were located, which were primarily outside of Texas. Under audit, the Texas Comptroller revised the apportionment based on where the Taxpayer's subscribers received the satellite transmissions, resulting in an assessment. The Taxpayer paid the additional tax and interest under protest and sued the Texas Comptroller to recover the disputed Texas franchise tax and interest paid. The Texas district court applied an origin-based sourcing standard looking to where the Taxpayer's production and transmission activities were performed and held in the Taxpayer's favor on the issue of sourcing gross receipts. On appeal, the appeals court reversed and found in favor of the Texas Comptroller, agreeing with the Comptroller's position that the "receipt-producing, end-product act" performed by the Taxpayer in Texas was unscrambling the radio signal at its customers' location.
In March 2022, the Texas Supreme Court held3 that gross receipts from the sale of services should be sourced based on an "origin-based" system. Thus, in determining whether services are performed in Texas for purposes of apportioning receipts, taxpayers should look to where their employees or equipment performed services. (See Tax Alert 2022-0539.) Although the Texas Supreme Court reversed the appeals court's technical ruling, it remanded the case back to that court to review whether the Taxpayer had sufficiently established the "fair value" of services performed in the state by applying the cost-of-performance analysis.
On remand, the appeals court affirmed the trial court's finding that the method used by the Taxpayer to apportion the fair value of its services performed in the state for tax years 2010 and 2011 was supported by the comparative cost-of-performance evidence presented by the Taxpayer.4 In affirming the trial court's finding, the appeals court rejected the Comptroller's argument that the Taxpayer's evidence to establish "fair value" was legally insufficient because a taxable entity, as a matter of law, cannot use cost-of-performance data to apportion the fair value of its services.
As neither the Comptroller's rules nor the applicable Tax Code provisions define "fair value" under former Rule 3.591(e)(26), the appeals court looked to the dictionary, which defined "fair value" as "the monetary worth of the services at issue, based on an objectively reasonable assessment." The Comptroller, without offering an alternative interpretation of the term "fair value," contended that "nothing in the plain language of Rule 3.591(e)(26) suggests that 'fair value' means 'cost of performance.'" The Comptroller also argued that it was aware of the term "cost of performance" at the time of the Rule's adoption, but did not include it in the Rule; therefore, the rule's "use of the term 'fair value' … indicates that something other than 'cost of performance' was intended." The appeals court disagreed, finding instead that, even though the terms have different meanings, nothing in the Rule mandates the use of a specific method to calculate "fair value" or exclude the use of cost of performance as a reasonable method of assessing "fair value" for apportionment purposes.
The appeals court further noted the Comptroller's previous allowance, in certain circumstances, of cost of performance as "an appropriate method" for calculating "fair value" of services. The appeals court specifically mentioned Letter No. 200807139L (July 24, 2008), in which the Comptroller, citing former Rule 3.591(e)(26), said that the "best means" for determining the "fair value" of services in Texas, when services are performed both inside and outside the state, is the costs attributed to services performed in Texas versus the costs attributed to out-of-state processing. The appeals court concluded that the Comptroller's interpretation of the Rule — allowing "fair value" to be determined using cost of performance — "is not plainly erroneous or inconsistent" with the Rule or the Tax Code.
The appeals court also rejected the Comptroller's alternative argument that the taxpayer failed to prove the costs represent the "fair value" of services performed in Texas because the Comptroller failed to preserve this challenge for appeal by not objecting to the admission of the expert witness testimony at trial.
For more on this development, see Tax Alert 2022-1755.
Federal: The Treasury Department released proposed regulations (REG-112096-22; Proposed Regulations) on foreign tax credits. The Proposed Regulations would amend the final foreign tax credit regulations published on Jan. 4, 2022 (TD 9959; Final Regulations, as amended by technical corrections to those regulations published on July 27, 2022). For more on this development, see Tax Alert 2022-9008.
Multistate: On Nov. 17, 2022, the Multistate Tax Commission (MTC) Executive Committee voted unanimously to dissolve its State Intercompany Transaction Advisory Service (SITAS) Committee (i.e., transfer pricing committee). The Committee noted that the MTC's litigation and audit committee can provide similar services to those provided by the SITAS.
Arkansas: The Arkansas Department of Finance and Administration (AR DFA) adopted a rule that implements the state's elective pass-through entity (PTE) tax. The rule defines key terms, including "affected business entity", "applicable basis adjustments", "member", "substantially similar tax" (the AR DFA said it will annually publish a non-exhaustive list of states before Feb. 1 of each year); and "taxable year". In addition, the rule addresses the following topics: (1) making the PTE tax election — the election is made annually and it is binding on all members of the electing entity, an entity can revoke election; (2) filing a PTE tax return with the AR DFA and paying the tax due; (3) calculating the amount of PTE tax due; (4) information that must be reported by an entity to members, payments made by an entity, and members' calculation of gross income reportable on the member's income tax return; (5) income tax withholding on nonresidents members; and (6) annual payments of tax due for the tax year. The new rule is effective for tax years beginning on or after Jan. 1, 2022. The rule was adopted on Nov. 18, 2022.
Colorado: The Colorado Department of Revenue (CO DOR) issued for public comment draft rules for (1) Colorado net operating losses (NOL) for corporate taxpayers (Rule 39-22-504-2); (2) NOLs for individuals, estates and trusts (Rule 39-22-504-1); (3) corporation subtractions for Section 78 dividends (Rule 39-22-304(3)(j)); and (4) the foreign source income exclusion (Rule39-22-303(10)). The CO DOR is holding a public meeting on these proposed rules on Dec. 15, 2022; oral comments will be accepted during the hearing and written comments will be accepted until 5:00 pm on that day. Additional information on the hearing and proposed rules is available here.
North Carolina: The North Carolina Department of Revenue updated its frequently asked questions (FAQs) on the state's elective pass-through entity (PTE) tax. New FAQs address whether a PTE tax election can be made by (1) a partnership or limited liability company that is classified as a partnership for federal income tax purpose and does business in North Carolina as a rental real estate company, or (2) an investment partnership. Eligible PTEs doing business in North Carolina as a rental real estate company can make the PTE tax election if it is required to file a North Carolina information return for partnerships under N.C. Gen. Stat. § 105-154(c). An investment partnership, however, cannot make the PTE tax election because it is not considered to be doing business in the state and, as such, it not required to file a North Carolina tax return. N.C. Dept. of Rev., "Important Notice Regarding North Carolina's Recently Enacted Pass-Through Entity Tax" (updated Nov. 15, 2022).
Philadelphia, PA: New law (Bill 220660) amends Bill No. 210284, which was enacted in June 2022, to "fix a mistake in identifying the tax year to which a tax reduction applies. As originally enacted, the reduction of the business income and receipts tax rate to 5.99% (from 6.20%), applied to tax years 2023 and thereafter. As revised, the reduced rate applies to tax years 2022 and thereafter. Philadelphia Laws 2022, Bill No. 220660, signed by the mayor on Nov. 9, 2022.
Philadelphia, PA: New law (Bill 220659-A) amends Bill No. 220402, which was enacted in June 2022, to fix effective date of the reduction of the net profits tax rate. Effective July 1, 2022, the tax on salaries, wages, commissions, and other compensation is reduced to 2.29% (from 2.3398%) for residents and 3.44% (from 3.4481%) for nonresidents. Effective Jan. 1, 2022, and thereafter, the tax on net profits earned in businesses, professions or other activities is 2.29% (from 2.3398%) for residents and 3.44% (from 3.4481%) for nonresidents. Philadelphia Laws 2022, Bill No. 220659-A, signed by the mayor on Nov. 9, 2022.
SALES & USE
Federal: The U.S. Government Accountability Office (GAO) issued a report on states' remote sales tax provisions. The GAO estimated that remote sales tax collections were around $30 billion in 2021. According to the report, businesses, as a result of having to comply with remote sales tax legislation, reported increased costs related to software to expand multistate tax collection capabilities, audits and assessments, and staying current with legal requirements in multiple jurisdictions. Businesses also reported increased tax exposure. Further, the GAO found the overall remote sales system raised the following concerns as compared to a good tax system: (1) remote sellers having to devote significant time to understand various state requirements in states they have economic nexus; (2) remote sellers diverting resources away from business operations and investments toward tax compliance; and (3) understanding the various state requirements and remote sales tax obligations increased administrative costs for businesses selling remotely. The GAO recommended "that Congress consider working with states to establish nationwide parameters for state taxation of remote sales," and suggested that the parameters (1) balance state interest while addressing multistate complexities, (2) improve the overall system's alignment with a good tax system and address existing uncertainties related to taxing remote sales. GAO-23-105359 "Remote Sales Tax: Federal Legislation Could Resolve Some Uncertainties and Improve Overall System" (Nov. 14, 2022).
Colorado: The Colorado Department of Revenue (CO DOR) adopted Rule 40-10.1-607.5, which provides guidance on collecting, administering and enforcing prearranged ride fees imposed on transportation network companies (TNCs). TNCs required to collect and remit the fee must register with the CO DOR and create a prearranged ride fee account. TNCs that fail to register with the CO DOR are still liable and responsible for the full amount of the fees due plus any applicable interest. The return must be filed by, and the fee remitted on or before, the last day of the month following the close of each reporting period. The amount remitted to the CO DOR equals the product of the fee in effect for the reporting period and the number of prearranged rides requested and accepted through the company's digital network in the reporting period. Refunds for overpayment of the fee must be filed not later than three years after the date of payment. TNCs must keep and preserve for a period of at least three years it books, accounts, and records necessary to determine the amount of the fee. If a TNC does not timely file a return or remit the correct amount of fee due, the CO DOR can estimate the amount of fees due; the estimate becomes a notice of deficiency which a TNC can protest. The rule takes effect Dec. 30, 2022. The rule was adopted on Nov. 16, 2022.
Kentucky: The Kentucky Department of Revenue (KY DOR) has added new frequently asked questions (FAQs) on some of the 34 services that will become taxable on Jan. 1, 2023, under legislation (HB 8) enacted in 2022. The FAQs address: photography and photo finishing services, residential utility exemption changes, cosmetic surgery procedures, motor vehicle rental/ride share excise tax, parking services, rental space, transient room tax. The KY DOR said the website will be updated regularly.
South Carolina: In response to a ruling request, the South Carolina Department of Revenue said that separately stated "inflation fees", "convenience fees", "non-cash adjustment fees" or similar types of fees charged by a retailer as part of a retail sale of tangible personal property are included in "gross proceeds of sales" or "sales price" subject to the state's sales and use tax. Such fees, however, are not taxable if the retail sale of tangible personal property is otherwise exempt from sales and use tax or the transaction is not subject to tax (e.g., sale of a nontaxable service). S.C. Dept. of Rev., SC Rev. Ruling #22-10 (Oct. 20, 2022).
South Carolina: In response to a ruling requestion, the South Carolina Department of Revenue (SC DOR) said that retail sales of injectable medicine or injectable biologic for use in hospitals or in independent surgery centers are not exempt from South Carolina's sales and use tax under S.C. Code § 2-36-2120(80). The SC DOR noted, however, that such sales may be exempt from tax under another provision of S.C. Code § 2-36-2120, explaining that certain injectable medicines or injectable biologics that are prescription medicine and therapeutic radiopharmaceutical used to treat (1) cancer, leukemia, lymphoma, rheumatoid arthritis or related disease, or (2) the side effects of such treatment, may qualify for a sales and use tax exemption under S.C. Code § 2-36-2120(28)(a). S.C. Dept. of Rev., SC Rev. Ruling #22-9 (Oct. 20, 2022).
Federal: In a Notice of Allocation Availability (NOAA), the Treasury's Community Development Financial Institutions Fund (CDFI Fund) announced on Nov. 18, 2022, an allocation of $5 billion for the calendar-year 2022 round of the New Market Tax Credit (NMTC) program. There are some minor changes to the NMTC program for 2022, including: (1) requiring taxpayers that received allocations in prior rounds to comply with revised qualified equity investments requirements by May 4, 2023; and (2) complying with the updated application requirements in the revised CY 2022 NMTC Program Application FAQs. For more on this development, including applicable deadlines, see Tax Alert 2022-1752.
Massachusetts: New law (HB 5374) modifies the tax credit for employers employing members of the Massachusetts national guard and the offshore wind tax credit, both of which were enacted earlier this year. The law revises the language of the tax credit for employing members of the Massachusetts national guard enacted under ch. 154, MA Laws 2022, regarding an eligible employer, providing that the credit is available to an employer engaged in business in Massachusetts that is not a business corporation subject to excise under ch. 63 (changed from a partnership, limited liability corporation or other legal entity engaged in business in Massachusetts that is not a business corporation subject to the excise under ch. 63), and that employs not more than 100 employees. The new also provides that the Massachusetts Office of Business Development will authorize, administer and determine eligibility for the credit and will promulgate regulations establishing the application process for the credit. The offshore wind tax credit, enacted under ch. 179, Mass. Laws 2022, is amended to provide that the credit is attributable on a pro rata basis to the owners, partners or members of the entity entitled to the credit and is allowed as a credit against tax due under ch. 62 from such owners, partners or members in a manner determined by the revenue commissioner. Mass. Laws 2022, ch. 268 (HB 5374), signed in part by the governor on Nov. 10, 2022.
COMPLIANCE & REPORTING
Illinois: Adopted amendments to 86 Ill. Admin. Code 100.5020 permanently restore the extended due date for filing the Illinois corporate income tax return to one month after the federal automatic extended due date. The automatic seven-month extension to file the Illinois corporate income tax return retroactively applies to tax years ending on or after Dec. 31, 2021. (The automatic extension is eight months for fiscal year June 30th filers eligible for the federal automatic seven-month extension.) (Ill. Reg., Vol. 46, Issue 46, Nov. 16, 2022).
Maine: The Maine Revenue Services (MRS) is giving taxpayers in a federally declared disaster area related to Hurricane Ian additional time to file tax returns and pay tax due. Returns and payments due on or after Sept. 23, 2022 (Florida), Sept. 25, 2022 (South Carolina) and Sept. 28, 2022 (North Carolina) must be filed and paid on or before Feb. 15, 2023. The MRS will abate interest and penalties that otherwise would apply. Payment relief does not apply to payments originally due before the disaster date. This relief applies to all taxes administered by MRS, including corporate and individual income, sales and use, motor fuels and financial institution franchise tax. To qualify for the relief affected taxpayers must write "HURRICANE IAN" on the top of their return. Maine Rev. Servs., Maine Tax Alert - Nov. 2022 #2 (Vol. 32, Issue 23 Nov. 2022).
PAYROLL & EMPLOYMENT TAX
Multistate: Employers will be subject to a federal unemployment insurance (FUTA) tax rate of 0.9% for tax year 2022 for the jurisdictions listed in Tax Alert 2022-1728 because they had outstanding federal unemployment insurance (UI) loan balances on Nov. 10, 2022. Note that the U.S. Virgin Islands has a higher net FUTA rate because it has had a federal loan balance since 2009.
Colorado: On Nov. 8, 2022, Colorado voters approved Proposition 121, which lowers the state's personal income tax rate from 4.55% to 4.40% retroactive to Jan. 1, 2022. The Colorado Department of Revenue confirmed the 2022 personal income tax rate in its frequently asked questions; however, the Colorado Withholding Worksheet for Employers continues to show a withholding rate of 4.55% for 2022. For more on this development, see Tax Alert 2022-1743.
New Hampshire: The New Hampshire Department of Employment Security announced that for second-quarter 2022, state unemployment insurance (SUI) tax rates for positive-balanced employers continue to exclude 0.5% emergency power surcharge, the same that applies for the first-quarter 2021 through first-quarter 2022. Unfortunately, the second-quarter 2022 tax rates also continue to exclude a fund balance reduction, causing positive-balanced employers to continue to pay at the base rates. For additional information on this development, see Tax Alert 2022-1725.
District of Columbia: The District of Columbia Office of Tax and Revenue (OTR) issued guidance on the applicability of the purchase money exemption from recordation tax for security interest instruments. The recordation tax exemption under DC Code § 42-1102(5) applies to purchase money mortgages or purchase money deed of trusts (collectively, instrument) recorded simultaneously with the deed conveying the real property for which the instrument was obtained. The instrument may qualify for this exemption to the extent the amount of the instrument does not exceed the real property's purchase price. The OTR said that the Recorder of Deeds has given notice that in order for an instrument to qualify for the purchase money exemption, and to be consistent with statutory requirements, the instrument must (1) encumber only the real property purchased by the purchaser and (2) be executed only by the purchaser of the real property. The instrument cannot encumber other properties and other property owners cannot be party to the instrument. D.C. Off. Tax Rev., OTR Tax Notice 2022-09 (Nov. 15, 2022).
Washington: The Washington Department of Revenue issued guidance on the application of the preferential business and occupation (B&O) tax rate to qualified international investment management services (IIMS). The guidance provides an overview of the qualification for the IIMS B&O tax rate and explains (1) primarily in the business of providing investment management services, (2) 10% of income derived from qualifying "collective investment fund", (3) more than 25% of the person's employees are located in Washington, (4) 500 full time employees in affiliated group, and (5) qualifications of affiliates. The guidance includes illustrative examples; it does address the qualification for the preferential rate for business activities occurring before the July 1, 2019 law change. Wash. Dept. of Rev., Excise Tax Advisory — ETA 3183.2022 (Oct. 17, 2022).
Wednesday, Dec. 7, 2022. Domestic tax quarterly webcast series: a focus on state tax matters (1:00 p.m. ET). For our fourth quarterly webcast of 2022, please join our panel discussion on the top-of-mind issues impacting state and local taxes, including: (1) federal and state election outcomes — what they may mean for state tax policy; (2) update on state and local revenue and fiscal conditions; (3) overview of 2022 state tax legislative activities; (4) 2023 state tax policy considerations; (5) state tax audit trends and issues related to the Tax Cuts and Jobs Act; (6) discussion of Multistate Tax Commission audits; and (7) update on transactions, with a discussion of market trends and leading practices. Register.
Thursday, Dec. 8, 2022. 2022 employment tax year in review (2:00 p.m. ET). In this webcast, our employment tax professionals will discuss the following common areas of year-end payroll and employment tax concern: (1) 2022 and 2023 federal and state tax rates and limits; (2) considerations for claiming retroactive credit for temporary COVID-19 federal employment tax provisions such as employee retention tax credit, paid sick and family leave tax credit, COBRA premium assistance tax credit, employer Social Security tax deferral; (3) remote worker considerations, including proper sourcing and Form W-4 compliance; (4) forms W-2/1099-NEC reporting changes; (5) noteworthy state developments; (6) state unemployment insurance and the federal unemployment insurance credit reduction; (7) year-end reconciliation and required employee notices; and (8) preparation of the year-end payroll checklist. 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 Hegar v. Sirius XM Radio, Inc., No. 03-18-00575-CV (Tex. Ct. of App., 3rd Dist., Nov. 10, 2022).
2 Tex. Tax Code § 171.103(a)(2).
3 Sirius XM Radio, Inc. v. Hegar, No. 20-0462 (Tex. March 25, 2022).
4 At trial, the Taxpayer's witness, an expert in quantitative business modeling, testified that he "used cost data because it was 'systematic and reliable' in representing where [the Taxpayer] performed its activities" and that since he focused on the "unique aspect of [the Taxpayer's] business" he included expenses from value-producing activities (e.g., content production and transmission) and excluded expenses for general support functions (e.g., sales, administration). The trial court found this analysis and conclusion "a credible method for determining fair value."