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New Jersey’s New Laws — Retroactive for Most Companies

by | Jul 7, 2014 | , , ,

A newly passed New Jersey law is interesting both for what it does and for what it does not do.  Assembly bill 3486/Senate bill 2268, attempts to “clarify” four aspects of New Jersey law (retroactively for three of the four!).  The four areas affected by the law change are:  (1) the business/non-business income distinction (called “operational/non-operational income” in New Jersey); (2) a limited partner’s eligibility for a refund of Corporation Business Tax paid on its behalf by a limited partnership; (3) net operating losses involving certain amounts related to bankruptcies, insolvencies, and qualified farm indebtedness; and (4) click-through nexus for sales and use tax purposes.

Business/Non-Business Income Distinction

The distinction between business and non-business income (called “operational” and “non-operational” income in New Jersey) is critical as it determines whether certain income (such as gain from the sale of an asset) can be apportioned among the states or instead much be allocated to only one state.  The law change expands the definition of “operational income” so that many more transactions will result in the generation of apportionable income.  In fact, the law change is estimated to increase revenue by $25 million annually.

Historically, New Jersey’s definition of business (“operational”) income included gain from sale of property “if the acquisition, management, and disposition of the property constitute integral parts of the taxpayer’s regular trade or business operations. . .”  N.J.S.A. 54:10A-6.1(5)(a) (emphasis added).  Use of the conjunction “and” caused New Jersey courts to determine that all three activities (“the acquisition, management, and disposition”) must each have been integral parts of the taxpayer’s regular trade or business in order for the gain from the asset to be apportionable business (“operational”) income.  This could be overcome by demonstrating that one of the activities—usually the disposition of an asset—was not an integral part of a taxpayer’s regular trade or business.

The definition was changed, however, to replace the conjunctive “and” with the disjunctive “or” such that it will now read “the acquisition, management, and or disposition of the property constitute an integral parts of the taxpayer’s regular trade or business operations. . .”  Thus, because engaging in any one (or more) of those three activities as part of a taxpayer’s regular trade or business is sufficient, many more transactions will generate apportionable business income.

This provision takes effect for tax years ending after July 1, 2014.  This means that for a calendar year filer the provision takes effect retroactively for the tax year starting January 1, 2014, since the end of the year (December 1, 2014) is after July 1, 2014.  Interestingly, while the legislation refers to this change as a “clarification,” the fact that it is anticipated to increase revenue by $25 million indicates that it is, indeed, a change of law, reiterating that for the test really is a conjunctive one for prior periods.

Overturning the Result of BIS LP v. Director

There has been (and continues to be) a substantial amount of litigation in New Jersey courts regarding tax payments and tax [...]

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State and Local Tax Supreme Court Update: June 2014

by and | Jun 25, 2014 | , , , , , , , , ,

On June 10, 2014, the Supreme Court of the United States distributed three state and local tax cases for a conference to be held on June 26, 2014: Equifax, Inc. v. Mississippi Department of Revenue, Direct Marketing Association v. Brohl, and Alabama Department of Revenue v. CSX Transportation, Inc.  The Supreme Court previously agreed to hear Comptroller of the Treasury v. Wynne and determine whether Maryland’s disallowance of a credit against its county income tax for taxes paid to other jurisdictions violated the Commerce Clause.  We are eager to see if the Court will opt to hear the remaining three cases, clarifying answers to questions in the world of state taxation.

The taxpayer in Equifax filed a petition for a writ of certiorari on February 19, 2014, appealing a decision by the Mississippi Supreme Court.  The state court upheld the Mississippi Department of Revenue’s application of market-based sourcing as an alternative apportionment formula instead of the statutory cost-of-performance sourcing for apportioning the income of Equifax, a credit reporting company.  In making this determination, the court required the Mississippi chancery courts to use a highly deferential standard of review.  The Institute for Professionals in Taxation, the Georgia Chamber of Commerce and the Council On State Taxation filed amicus curiae briefs.

The Direct Marketing Association filed a petition for a writ of certiorari on February 25, 2014.  The Direct Marketing Association seeks review of a decision by the U.S. Court of Appeals for the Tenth Circuit that held that the Tax Injunction Act barred federal court jurisdiction over the Direct Marketing Association’s challenge to a Colorado sales and use tax reporting law.  The law requires remote sellers that do not collect Colorado sales or use tax and have total annual gross sales in Colorado of $100,000 or more to inform the customer at the time of sale of the customer’s use tax obligation, to send annual notices to customers who purchased $500 or more in goods from the seller and to file a report with the state regarding a customer’s total purchases.  An amicus curiae brief was filed by the Council On State Taxation.  If the Supreme Court were to hear Direct Marketing Association v. Brohl, it would likely clarify the holding of Hibbs v. Winn to better clarify the scope of the TIA’s protection.

On October 30, 2013, the Alabama Department of Revenue filed a petition for a writ of certiorari in CSX Transportation.  The Alabama Department of Revenue is challenging the U.S. Court of Appeals for the Eleventh Circuit’s decision that Alabama’s sales tax on diesel fuel discriminates against rail carriers in violation of the Railroad Revitalization and Regulatory Reform Act of 1976 (4-R Act) because motor carriers and interstate water carriers are not required to pay the 4 percent sales tax.  The Supreme Court had previously issued a 2011 opinion stating that the taxpayer could challenge sales and use taxes under the 4-R Act, but the Supreme Court remanded the case to determine whether the tax was discriminatory.  Amicus [...]

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Pennsylvania Issues Draft Guidance on Market-Based Sourcing of Services

by | Jun 24, 2014 | , , ,

The Pennsylvania Department of Revenue (PA Department) released a draft Information Notice containing guidance on how to source services under Pennsylvania’s new market-based sourcing scheme for tax years beginning after December 31, 2013. 72 Pa. Stat. Ann. § 7401(3)(2)(a)(16.1)(C).  By statute, service receipts are sourced to Pennsylvania if the service is delivered to a location in Pennsylvania.  If the service is delivered both to a location in and outside Pennsylvania, the sale is sourced to Pennsylvania based upon the portion of the total value of the service delivered to a location in Pennsylvania.  In the case of customers who are individuals (other than sole proprietors), if the state or states of delivery cannot be determined for the customer, the service is deemed to be delivered at the customer’s billing address.  In the case of other customers (e.g., corporations), if the state or states of delivery cannot be determined for the customer, the service is deemed to be delivered at the location from which the service was ordered in the customer’s regular course of operations.  If the location from which the service was ordered in the customer’s regular course of operations cannot be determined, the service is deemed to be delivered at the customer’s billing address.

Despite the new statutory scheme, taxpayers have been wondering exactly what “delivery” of a service to a Pennsylvania location means.  The draft Information Notice released by the PA Department on June 16, 2014, attempts to answer that question.

According to the PA Department, delivery occurs “at a location where a person or entity may use the service.”  The PA Department believes that this definition eliminates those parties that simply pay for the service (but do not actually use it) or other intermediaries.  The PA Department’s view is that the statute’s use of billing address (for individual customers) and location of purchase or billing address (for corporate customers) are mere “defaults”—neither of which may represent the true marketplace for the service and should only be used as a last resort.

The PA Department’s guidance also addresses delivery in the context of electronically delivered services, stating that delivery may be established through IP address records or other network data.  Interestingly, the PA Department’s guidance also provides that delivery of certain electronic data services to “the cloud” or other data storage device does not constitute delivery of those services—because those locations are not considered to be the locations of the user.

While the PA Department’s guidance provides some clarity it also exemplifies the ever divergent market sourcing regimes.  See our article discussing the wide variety of market-based sourcing rules.  For example, the PA Department draft guidance contains the following example:

Taxpayer is a provider of third-party payroll processing services for Company A. Half of Company A’s employees are located in PA and half are located in New York. Company A’s headquarters and human resources functions are located in PA. Taxpayer sources all of the payroll services to PA.  Note in this example that payroll [...]

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Recent Legislation in Virginia Retroactively Amending the Addback Statute Exacerbates a Potentially Unfair Law

by | Jun 13, 2014 | , , ,

Separate return state addback statutes, such as the Virginia addback statute, can overreach to produce an unfair and potentially unconstitutional overstatement of income assigned to the state.  Recently Virginia amended its addback statute retroactively 10 years to taxable years beginning on or after January 1, 2004.  The legislation is intended to codify an administrative interpretation that significantly limited an addback exception to the extent the income received by a related member is subject to taxes based on net income or capital imposed by Virginia, another state, or a foreign government with a comprehensive tax treaty with the United States (H.B. 5001, enacted April 1, 2004).  The legislation limits the subject-to-tax exception so that it applies only on a post-apportionment basis, as illustrated in two rulings of the Commissioner, Ruling 07-153 (Oct 2, 2007) and Ruling 13-140 (July 19, 2013).

Taxpayers, in particular taxpayers that have a significant presence in unitary tax states, should not blindly add back legitimate business expenses to income where the result would be an overstatement of income.  Consider this common situation as an example: a parent corporation, a manufacturer of high-tech products, pays a royalty for technology licensed to it by an R&D subsidiary.  The R&D subsidiary is based in California, a combined report state.  The parent corporation has $1,000 in gross receipts, pays $200 in royalties to R&D subsidiary, has $600 of other expenses and a net income of $200.  The R&D subsidiary has gross receipts of the $200 in royalties, deductions for R&D expenses of $100 and a net income of $100.  Together the federal consolidated income of the two entities (as well as GAAP income) is $300.  The R&D subsidiary conducts R&D activities in California and in many foreign countries (some with U.S. tax treaties, some without) and has taxable nexus in one separate return state to which it apportions 1 percent of its net income of $100.  Here is how Virginia applies its addback statute:  Virginia adds the $200 royalty paid to the R&D subsidiary to the parent corporation’s income, but excepts from the addback 1 percent of the royalty, or $2, to reflect the separate return state.  No exception from the addback is provided for the portion of the royalty apportioned to California.  Thus, the parent corporation’s taxable income in Virginia is $398, an amount almost equal to the combined net income of the parent and the subsidiary, plus the bona fide amounts paid by the subsidiary in R&D expenses. 

Taxpayers should carefully examine returns filed in addback statute states to see if they fail a sanity test, like the result in the hypothetical example.  If the State Department of Revenue doesn’t agree to rational exceptions to the expense disallowance, there are multiple grounds for challenge in the courts. 

Plain Meaning of the Statute

A typical addback statute provides an exception when the related member is subject to tax on net income in that state, another state, or a foreign government with a comprehensive tax treaty with the United States.  Where the [...]

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One Thing’s Consistent—There’s No Duty of Consistency

by | Jun 3, 2014 | , , ,

Taxpayers resisting audit requests for tax returns filed in other states, or requests for details about the treatment of an item in another state, now have another quill in their arsenal besides the 2010 Oregon Tax Court decision in Oracle Corp. v. Dep’t of Rev., 2010 Ore. Tax LEXIS 32 (Or. T.C. 2-11-10).  The New Jersey Tax Court recently issued a letter opinion in Elan Pharmaceuticals, Inc. v. Director, Division of Taxation, Tax Court Dkt. 010589-2010 (May 1, 2014), reiterating that a taxpayer is not required to treat an item in exactly the same way it treats it in another state.

Like Oracle, Elan Pharmaceuticals involves the business/non-business distinction (called the operational/non-operational distinction in New Jersey vernacular).  Apparently, the company reported its gain from the sale of certain operations as business (i.e., “operational”) income on its California Franchise Tax Return, but reported the same gain as nonbusiness (i.e., “nonoperational”) income on its New Jersey Corporation Business Tax Return.  These facts largely mirror those in Oracle, except that the state involved was Oregon, not New Jersey.

During the Division of Taxation’s audit of the company, the gain was recharacterized as business income, which resulted in a substantial deficiency.  While the Division’s position was based on a number of factors, including its determination that the company never ceased conducting the line of business it purportedly disposed of, the Division was clearly influenced by the company’s treatment of the gain in California.  In fact, the Division asserted that because the company treated the gain as apportionable business income in California, it could not treat it as non-apportionable nonbusiness income elsewhere.

Like the Oregon Tax Court, the New Jersey Tax Court rejected such a purported duty of consistency.  The Court stated that a requirement of consistency, while “appealing under pure common sense, and in light of the purpose of the UDIPTA, . . . does not mean that [the company] is barred from seeking application of New Jersey law when challenging a New Jersey tax assessment.”  The Court continued:  “this court should be guided by N.J.S.A. 54:10A-6.1(a), New Jersey’s basis for taxing operational income, and the binding law construing that statute, not the consequent result of such treatment in another State.”

Ultimately, the Tax Court agreed with the Division of Taxation that the company’s gain was apportionable business income, relying largely on the unitary business principle (an aspect of the matter that appears not to have been fully developed on the record or addressed by the parties during briefing).  Still, the Court’s mandate that the actual treatment of an item in another state not be binding for New Jersey purposes is important.  It’s also entirely consistent with another recent Tax Court decision—Lorillard Licensing Co., LLC v. Director, Division of Taxation, N.J. Tax Ct. Dkt. A-2033-13T1 (Jan. 14, 2014), in which the Tax Court determined that whether or not another state actually imposes income tax on receipts is irrelevant for purposes of computing New Jersey’s now-defunct “throw out rule” so long as the other state [...]

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2015 D.C. Budget Bill Includes Several Significant Business Tax Changes

by , and | May 21, 2014 | , , ,

The FY 2015 District of Columbia Budget Request Act (BRA, Bill 20-749) is currently being reviewed by the D.C. Council after being introduced on April 3 at the request of Mayor Vincent Gray. This year’s Budget Support Act (BSA, Bill 20-750), the supplementary bill implementing changes based on the BRA, contains several significant modifications to the tax provisions of the D.C. Code. The changes include provisions recently recommended by the D.C. Tax Revision Commission (TRC), an independent body created by the Council to evaluate possible changes to tax policy in the District with a focus on broadening the tax base and providing “fairness in tax apportionment.” In particular, the BSA proposes to adopt a single sales factor formula for the apportionment of business income and to reduce business income tax rates (both corporate and unincorporated) from nearly 10 to 9.4 percent. Two additional amendments are pulled directly from the Multistate Tax Commission (MTC) rewrite of the Uniform Division of Income for Tax Purposes Act (UDITPA), including a change to the District’s definition of “sale” and the elimination of cost-of-performance sourcing.

Under the District’s existing apportionment statute, all businesses must apportion business income using a four factor formula consisting of property, payroll and double weighted sales factors. If the BSA is enacted, the statute would be amended to also apportion all business income using a single sales factor. While it is clear that the intent of the BSA provision is to adopt a single sales factor in D.C. going forward, a major ambiguity exists in drafting that would require apportionment using both a single sales and double weighted sales factor formula for taxable years starting after December 31, 2014—which of course is impossible. Thus, without a legislative amendments by the D.C. Council prior to passage on May 28, it is unclear whether the single sales factor formula will be optional or mandatory (as recommended by the TRC) for FY 2015. The budget projection released by Mayor Gray in conjunction with the legislation suggests that the single sales factor would be mandatory, since it is projected that this change would raise an additional $20 million in tax revenue for the District for FY 2015. If the single sales factor were optional, it is unlikely the provision would raise that much revenue.

In addition to statutory modifications to the apportionment formula, the BSA also would reduce the tax rate imposed on corporate and unincorporated businesses from 9.975 percent to 9.4 percent.  This is still higher than Maryland (8.25 percent) and Virginia (6 percent).

Picking up where the MTC left off with its ongoing UDITPA rewrite, the District would adopt the MTC draft definition of “sale” to explicitly exclude receipts from hedging transactions and other investment related activity (including the sale, exchange or other disposition of cash or securities).

In addition, BSA would adopt market-based sourcing for sales of intangibles and services, using the language of the MTC draft to do so.  The BSA does not pick up the remaining provisions of the MTC [...]

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Show Me the Nonbusiness Income? Missouri Supreme Court Expansively Interprets Functional Test to Conclude Rabbi Trust Income is Business Income

by | May 19, 2014 | , , ,

On April 15, 2014, the Supreme Court of Missouri held that income from a trust used to fund an executive deferred compensation plan (a “rabbi trust”) was apportionable business income.  MINACT, Inc. v. Director of Revenue, No. SC93162 (Mo. Apr. 15, 2014).  The taxpayer, MINACT, Inc., is a Mississippi-based corporation that contracts with the federal government to manage its education and job training programs.

MINACT reported the trust income as nonbusiness income on its 2007 Missouri corporate income tax return, allocating all the income to Mississippi.  The Missouri director of revenue disagreed with the taxpayer and determined that the trust income was business income.  MINACT appealed to the Administrative Hearing Commission, which overturned the director’s decision, finding that the trust income was nonbusiness income “because it was ‘not attributable to the acquisition, management, and disposition of property constituting an integral part of MINACT’s regular business. …’”  (Opinion at 3.)  The director appealed the decision to the Missouri Supreme Court.

The Missouri Supreme Court analyzed whether the trust income was business income under the state’s statutory UDITPA definition of “business income,” which Missouri interprets to include both a transactional and a functional test.  (Opinion at 4-5.)  See, e.g., ABB C-E Nuclear Power Inc. v. Dir. of Revenue, 215 S.W.3d 85 (Mo. 2007) (income must fail to satisfy both tests to be nonbusiness income).  The Supreme Court agreed with the Commission that the trust income was not business income under the transactional test (MINACT earned the income from investing, not from its regular business of managing job training programs), but it found that the income was business income under the functional test because MINACT established its executive deferred compensation plan to attract and retain key employees who were engaged in MINACT’s regular business operations.  (Opinion at 5.)  The Court cited California and United States Tax Court cases for the notion that “attracting and retaining key employees is an important business purpose” and found that the employees who benefitted from the rabbi trust furthered MINACT’s business by providing capable leadership. (Opinion at 5, 7.)  Using this same reasoning, the Court also rejected MINACT’s constitutional challenges.

This is the third ruling of which we are aware finding that income earned from investments in employee-related funds meet the functional test for business income.  In Va. Tax Comm’r Ruling, No. 03-60 (Aug. 8, 2003), the Virginia Tax Commissioner held that rabbi trust income as nonbusiness income because “attracting and retaining quality corporate officers is an integral part of the operations of any business . . .”  Similarly, in Hoechst Celanese Corp. v. Franchise Tax Bd., 106 Cal. Rptr. 2d 548, 570-71 (Cal. 2001), the California Supreme Court held that income from an employer’s reversion of pension plan assets was business income under the functional test because the employer created the plan to retain and attract employees, which the court found integral to the employer’s business operations.



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Alenia Decision May Benefit D.C. Corporate Taxpayers

by and | May 13, 2014 | , , , ,

The recent decision in Alenia N. America, Inc. v. District of Columbia Office of Tax and Revenue in the District of Columbia Office of Administrative Hearings (OAH) could present opportunities for District taxpayers to receive corporate franchise tax refunds by including their joint ventures’ apportionment factors in the taxpayers’ District apportionment percentage calculation.  Alenia N. America v. District of Columbia Office of Tax and Revenue, Dkt. 2012-OTR-00015 (D.C. O.A.H.  Mar. 11, 2014).

Through an unwritten, internal policy, the District of Columbia Office of Tax and Revenue (OTR) prohibited separate filers from including the apportionment factors of joint ventures in which a taxpayer was a member/partner in the apportionment percentage calculation while permitting consolidated filers to do so.  Alenia N. America challenged this interpretation of the District’s apportionment formula, filing a protest in OAH.  Alenia is a separate filer C Corporation headquartered in the District.  A portion of Alenia’s 2010 tax year income resulted from its 51 percent ownership in a Mississippi LLC, Global Military Aircraft Systems (GMAS).  Because OTR required Alenia to include the income resulting from ownership of GMAS in its apportionable tax base but exclude the apportionment factors of GMAS, Alenia’s District apportionment percentage increased from 55.1899 percent to 86.1993 percent.  OTR effectively asserted the power of taxation over income derived from sources outside of the District.

OAH granted a summary decision in favor of Alenia, holding that GMAS’ apportionment factors could be included by Alenia because Alenia and GMAS were unitary and the District’s apportionment statute was designed with the purpose to create uniformity; most states applying formulaic apportionment allow for the inclusion of the apportionment factors (see Homart Development Co. v. Norberg, 529 A.2d 115 (R.I. 1987); Malpass v. Dep’t of Treasury, 494 Mich. 237, 833 N.W.2d 272 (2013)); and factor inclusion was necessary to reflect the source of the GMAS income.  Reading the District’s apportionment statute, D.C. Code § 47-1810.02, “consistently with its constitutional underpinnings and its general purpose to promote uniformity” overcame the silence as to whether the inclusion of factors applied to separate filers.  OTR’s misinterpretation of District law was “in conflict with the statute.” Alenia, Dkt. 2012-OTR-00015 at *26.

In light of the holding in Alenia allowing for the inclusion of the apportionment factors of joint ventures, taxpayers should consider whether District refunds are now available to them.  Further, an argument can be made that the holding in Alenia continues to apply despite the District’s switch to a combined reporting regime because of the court’s insistence that factor inclusion is necessary to reflect the source of the taxpayer’s income.

For a copy of the decision, contact one of the authors.



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Inside the New York Budget Bill – Corporate Tax Reform Enacted

by | Apr 3, 2014 | , , ,

Governor Andrew Cuomo has signed into law a budget bill containing major corporate tax reform.  This new law results in significant changes for many corporate taxpayers, including a complete repeal of Article 32 and changes to the Article 9-A traditional nexus standards, combined reporting provisions, composition of tax bases and computation of tax, apportionment provisions, net operating loss calculation and certain tax credits.  Most of the provisions discussed in this Special Report will take effect for tax years beginning on or after January 1, 2015.  Corporations should note that this New York State law does not automatically change New York City’s regime, resulting in additional differences between New York State and New York City tax filings.

Read the Special Report here.



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