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

TOP STORIES

Montana water's-edge election due March 31, 2023, for calendar-year taxpayers

Calendar-year taxpayers that want to make a new Montana water's-edge election, or renew an existing one that expired at the end of 2022, must file Form WE-ELECT by March 31, 2023.

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.

The election is only effective if all affiliated corporations subject to Montana taxes consent. Consent by the common parent of an affiliated group is deemed to be consent by all members of the group. A water's-edge group generally includes corporations organized in the United States that have a unitary relationship and are eligible to be included in a federal consolidated return, except that a greater-than-50% ownership test is substituted for the 80% federal test. Other affiliated corporations that may be included are domestic international sales corporations (DISCs) and foreign sales corporations (FSCs), export trade corporations, foreign corporations that derive gain or loss from real property interests in the United States, corporations incorporated outside the United States that have more than 20% of their average payroll and property assignable to a location inside the United States, and corporations organized in a "tax haven."

Taxpayers must timely file the Form WE-ELECT; if approved, the election is binding for three years unless permission to change the filing methodology is obtained from the Montana Department of Revenue (MT DOR). Taxpayers electing to continue the election for an additional three years must file the Form WE-ELECT within 90 days of the beginning of the new three-year period for which the election is intended to be effective. After an election is filed, the MT DOR will send a letter confirming that the election has been approved or explaining why the election was denied. The MT DOR typically responds to these requests quickly. If a reply is not received within two weeks after submission or within two weeks before the deadline, the taxpayer should contact the MT DOR to ascertain whether there is a problem with the request.

For additional information on this development, see Tax Alert 2023-0392.

Wisconsin Tax Appeals Commission disallows deductions for intercompany royalty and interest expenses

On Feb. 24, 2023, the Wisconsin Tax Appeals Commission (WTAC) issued a ruling¹ disallowing a taxpayer's deduction for certain intercompany royalty and interest expenses the taxpayer paid to an affiliate.

The taxpayer, a California-based corporation, is a seller of branded footwear. In the course of its operations, the taxpayer developed and purchased intellectual property, including trademarks, service marks, copyrights, patents, and patent applications. In 1999, the taxpayer engaged an outside tax advisor to design and implement an intellectual property holding company structure. As part of the restructuring, a wholly owned subsidiary was formed under Delaware law and headquartered in California. The taxpayer contributed its intellectual property to the subsidiary which, in turn, conveyed the intellectual property back to the taxpayer under a licensing agreement. The taxpayer also paid interest to the subsidiary based on unpaid balance of net royalty fees. The taxpayer then took a deduction for these amounts on its Wisconsin income/franchise tax return as Wisconsin was a separate company reporting state in the years at issue.

The Wisconsin Department of Revenue (WI DOR) audited the taxpayer for the years 2000-03 and denied the royalty and interest expense deductions taken by the taxpayer. The assessment reflected the WI DOR's determination that the intercompany transactions² were sham transactions or otherwise lacked a valid business purpose. Under Wisconsin law, the WI DOR is authorized to adjust income or deductions based on discretionary criteria, such as lack of business purpose or economic substance. The taxpayer appealed the assessment, and the WI DOR denied the protest, which the taxpayer appealed to the WTAC.

In affirming the WI DOR's assessment, the WTAC focused on the tax advisor's planning documents, which stressed the reduction of the state tax liability. The WTAC noted that while some of the planning documents included other potential non-tax reasons for implementing the structure, those other reasons were "window dressing" to "obscure" the primary motivation of obtaining a state tax reduction. The WTAC also noted that there were no substantive changes to the taxpayer's business as a result of implementing the strategy. Finally, the WTAC rejected the taxpayer's expert witness testimony that suggested that it was possible to have a valid business purpose other than tax avoidance even if the taxpayer was not aware of such a purpose. The WTAC agreed that not every employee must understand the structure but noted that the record indicated that none of the taxpayer's employees understood any benefit beyond tax minimization.

For more on this development, see Tax Alert 2023-0462.

INCOME/FRANCHISE

Colorado: The Colorado Department of Revenue (CO DOR) is seeking public input on a draft new Rule 39-22-104(3)(r), which is intended to clarify the amount an electing pass-through entity owner is allowed to deduct under IRC §199A. The draft rule would provide that an electing pass-through entity owner who takes a federal qualified business income deduction under IRC §199A and adds that amount back to federal taxable income under C.R.S §39-22-104(3)(o), would not have to make any addition under C.R.S §39-22-104(3)(r). The CO DOR will accept written comments on the draft rule through April 7, 2023. Colo. Dept. of Rev., Request for Public Input — Qualified Business Income Deduction Addback (Feb. 24, 2023).

Minnesota: The Minnesota Department of Revenue (MN DOR) updated its frequently asked questions (FAQs) on the 2023 federal conformity law enacted earlier this year under HF 31 (see Tax Alert 2023-0164). The MN DOR said economic injury disaster loans (EIDL) are not taxable in Minnesota for 2021, noting that the 2023 conformity bill conforms to federal EIDL. The 2023 federal conformity law also conformed to the Shuttered Venue Operators Grants program. In regard to the federal employee retention credit (ERC), the MN DOR explained that while the 2023 conformity bill did not conform to the federal ERC, related business expenses used to calculate the federal ERC may still be subtracted. In addition, taxpayers that claimed the federal ERC and received less wages as a business expense deduction, must include the federal disallowed wages as a retroactive Minnesota modification. The MN DOR also explained that the state did not conform to the federal 100% deduction for meals purchased from restaurants for immediate consumption, but it did enact a modification to state income. Further, because the state did not conform to the COVID/sick pay, taxpayers that claimed the Employer Payroll Credit for Required Paid Family Leave or Medical Leave, should include the amount of credit included in federal gross income as a subtraction. Lastly, the MN DOR added FAQs for individual income tax. Minn. Dept. of Rev., 2023 Federal Conformity FAQs (last accessed March 3, 2023).

Virginia: New law (SB 882) updates Virginia's date of conformity to the Internal Revenue Code to Dec. 31, 2022 (from Dec. 31, 2021). Thus, Virginia conforms to the Inflation Reduction Act of 2022 and the Secure 2.0 provisions of the Consolidated Appropriations Act of 2023. Va. Acts 2023, ch. 1 (SB 882), signed by the governor on Feb. 27, 2023; see also Va. Dept. of Taxn., Tax Bulletin 23-1 (Feb. 27, 2023).

SALES & USE

Illinois: The Illinois Department of Revenue adopted amendments to various Retailers' Occupation Tax regulations, notably to 86 Ill. Adm. Code 270.115 Home Rule Municipal Retailers' Occupation Tax, to "provide uniformity among the various sourcing rules." The requirements in Section 270.115 apply to other Retailers' Occupation taxes (listed below).

Section 270.115 has been amended to clarify that the sourcing rules described within do not apply to remote retailers and marketplace facilitators except as specifically provided in this section, namely in subsections (e), (f) and (g). These subsections apply beginning Jan. 1, 2021, to remote retailers and marketplace facilitators that met either of the tax remittance thresholds set out in 86 Ill. Adm. Code 131.115(a). New subsection 270.115(e) provides that remote retailers are engaged in business of selling at the Illinois location where the tangible personal property is shipped or delivered or where the purchaser takes possession (i.e., destination sourcing). Subsection 270.115(e) further clarifies the effect of inventory in determining a retailer's physical presence in Illinois, noting that a remote retailer's inventory at the location of a marketplace facilitator in Illinois does not create physical presence nexus when the inventory is used exclusively to fulfill orders made on a marketplace that meets the tax remittance threshold. Subsection 270.115(f) describes destination sourcing for sales to Illinois purchasers by marketplace facilitators on behalf of marketplace sellers; this rule applies notwithstanding the presence of a marketplace seller's inventory in Illinois. An exception, however, applies for sales of coal. Subsection 270.115(g) describes sourcing rules for sales made by marketplace facilitators not on behalf of marketplace sellers. A marketplace facilitator located in Illinois applies origin sourcing on its own sales to Illinois purchaser when the sale is fulfilled from inventory in Illinois, or the selling activity otherwise occur at a location in Illinois. A marketplace facilitator applies destination sourcing when it makes its own sale to an Illinois purchaser that is fulfilled from inventory located outside of Illinois and for which the selling activity otherwise occurs outside the state.

Other amendments to the Section 270.115 add an example under subsection (c)(4) discussing secondary selling activities for retailers conducting selling activities in multiple taxing jurisdictions, and apply the sourcing rules for sales of coal or other minerals in subsection (d)(5) to retailers, including marketplace sellers and marketplace facilitators, as of Jan. 1, 2021. Subsection (d)(4) is updated to: (1) provide that on and after July 23, 2015, retailers selling tangible person property to a nominal lessee or bailee under a lease with a dollar or other nominal option to purchase is engaged in the business of selling at the location where the property is first delivered to the lessee or bailee for its intended use; (2) starting Jan. 1, 2021, this provision applies to remote retailers and marketplace sellers that meet the tax remittance threshold; (3) set forth the requirements for maintaining books and records documenting where the property is first delivered to the lessee or bailee for intended use; and (4) update the example.

Amendments to 86 Ill. Adm. Code 220.115 Home Rule County Retailers' Occupation Tax state that "[t]he substance and provisions of 86 Ill. Adm. Code 270.115 of the Home Rule Municipal Retailers' Occupation Tax Regulations which are not incompatible with the Home Rule County Retailers' Occupation Tax Law of the Counties Code, shall apply to this Part." Further, references to "home rule municipality" or "municipality" in 270.115 mean "home rule county" for purposes of Section 220.115, and references to the Home Rule Municipal Retailers' Occupation Tax in 270.115 mean Home Rule County Retailers' Occupation Tax for purposes of Part 220. The requirements of Section 270.115 also apply to the following regulations, which were amended similar to how Section 220.115 was amended: (1) 86 Ill. Adm. Code 320.115 Regional Transportation Authority Retailers' Occupation Tax; (2) 86 Ill. Adm. Code 370.115 Metro East Mass Transit District Retailers' Occupation Tax; (3) 86 Ill. Adm. Code 395.115 Metro-East Park and Recreation District Retailers' Occupation Tax; (4) 86 Ill. Adm. Code 630.115 County Water Commission Retailers' Occupation Tax; (5) 86 Ill. Adm. Code 670.115 Special County Retailers' Occupation Tax for Public Safety; (6) 86 Ill. Adm. Code 690.115 Salem Civic Center Retailers' Occupation Tax; (7) 86 Ill. Adm. Code 693.115 Non-Home Rule Municipal Retailers' Occupation Tax; (8) 86 Ill. Adm. Code 695.115 County Motor Fuel Tax; and (9) 86 Ill. Adm. Code 696.115 Municipal Motor Fuel Tax.

The above changes took effect Feb. 7, 2023, and are discussed in the Illinois Register, Vol. 47, Issue 8, Feb. 24, 2023.

Tennessee: The Tennessee Department of Revenue updated its Sales and Use Tax Manual to state that credit card convenience fees are included in the sales price of the underlying purchase and are subject to sales tax. Tenn. Dept. of Rev., Tax Manual Updates (March 2023).

Wyoming: New law (HB 229) clarifies that the Wyoming Department of Revenue may allow taxpayers to submit the return and pay sales and use tax due electronically. The law also provides that the county treasurer may allow taxes to be paid electronically and it can charge a fee to recoup fees incurred due to the electronic payment. These provisions take effect July 1, 2023. Wy. Laws 2023, ch. 123 (HB 229), signed by the governor on Feb. 27, 2023.

PROPERTY TAX

Arkansas: New law (SB 198) amends the frequency in which a county is required to appraise all real estate at its full fair market value. Under the revised law, each county is required to appraise all market value real estate normally assessed by a county assessor at its full and fair market value every four years (from at least once every three years or every five years). In order to have an equal number of counties undergoing reappraisal each year, the Director of the Assessment Coordination Division may grant an exception to this rule, allowing a county to temporarily remain on a reappraisal cycle of three or five years. The new reappraisal cycle applies the day after the county completes its most recent county-wide reappraisal after the effective date of this Act. The Act takes effect 90 days after the Arkansas Legislature adjourns. Ark. Laws 2023, Act 139 (SB 198), signed by the governor on Feb. 24, 2023.

District of Columbia: New law (L24-0256) provides a real property tax exemption for real property belonging to certain Qualified Low Income Community Businesses (business) that participate in a transaction qualifying for the federal New Markets Tax Credit. The law also clarifies that a nonprofit entity operating alone as a limited liability company and as an owner of local real estate that will serve a charitable purpose can also receive a real property tax exemption. In addition, the District's Chief Financial Officer must issue a decision on the exemption within 60 days of receiving the properly completed application for the exemption and inspect the property within three years to verify that it is being used for the stated purpose. These changes took effect Feb. 23, 2023. D.C. Laws 2023, L24-0256 (B24-0798), became law Feb. 23, 2023.

Louisiana: In response to an opinion request, the Louisiana Attorney General (AG) said property acquired by an agency of the US government is exempt from ad valorem taxes in Orleans Parish. The AG explained that while Louisiana law does not exempt land or property owned by another state (or political subdivision thereof) from ad valorem tax, the US Supreme Court "has long held that states have no authority to tax the federal government without its consent."³ The AG further said that ad valorem taxes for this property should be prorated to the closest half month or 15-day period to the date on which the property was acquired by the federal agency. La. Atty. Gen., Op. 22-0049 (Feb. 28, 2023).

COMPLIANCE & REPORTING

California: Governor Gavin Newsom announced tax relief for those affected by the December and January winter storms. California is extending filing and payment deadlines for businesses and individuals to Oct. 16, 2023; aligning with the IRS. The relief applies to deadlines falling on or after Jan. 8, 2023 and before Oct. 16, 2023, including individual income tax returns and quarterly estimated tax payments. The governor's press release lists the disaster areas eligible for the tax relief and explains how to claim a deduction for disaster losses. Cal. Gov., Press Release "More Time to File State Taxes for Californians Impacted by December and January Winter Storms" (March 2, 2023).

MISCELLANEOUS TAX

Tennessee: The Tennessee Department of Revenue (TN DOR) updated its Business Tax Manual to provide that businesses selling electricity through electric vehicle charging stations should include such sales in their gross receipts for business tax purposes. The TN DOR also updated its Utilities Tax Manual to clarify that gross receipts from such sales are not subject to the utilities tax. Tenn. Dept. of Rev., Tax Manual Updates (March 2023).

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.

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ENDNOTES

¹ Skechers USA, Inc. v. Wisconsin Dep't. of Rev., Docket Nos. 10-I-071, 10-I-072 (Wis. Tax App. Comm'n. Feb. 24, 2023).

² The intercompany transactions were supported by a transfer pricing study, but the WI DOR's challenge did not focus on that and instead focused on the underlying motivation for entering into the arrangements.

³ Citing McCulloch v. Maryland, 17 U.S. 316, 327 (1819).