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Income Tax

Massachusetts Court Holds Department of Revenue’s Guidance to Be Unreasonable

by Richard C. Call and Scott M. Susko | Apr 22, 2016 | Incentives, Income Tax, Massachusetts, Procedure

Northeastern University, the Trustees of Boston University, Wellesley College and 131 Willow Avenue, LLC prevailed in their appeal of the Massachusetts Department of Revenue’s (the Department) rejection of their Brownfields tax credit applications in Massachusetts Superior Court. 131 Willow Avenue, LLC v. Comm’r of Revenue, 2015 WL 6447310 (2015). The taxpayers argued, and the court agreed, that the Department improperly denied their applications based on the unlawful use of Directive 13-4 issued by the commissioner of revenue (the Commissioner). At issue was the validity of Directive 13-4’s prohibition on nonprofit and transfer Brownfields tax credit applicants from receiving or transferring credits based on documentation submitted in a taxable year that commenced before the effective date of a 2006 amendment expanding the Brownfields tax credit statute to include nonprofit organizations and allow for credit transfers. The court held that the directive was “unreasonable and [the Department’s] denial of the applications based on that directive was unlawful.” (more…)

Retailers, Such as IT and Pharmaceutical Vendors, Among Businesses Targeted by Texas Comptroller’s Proposed Rule Change

by Diann Smith and Stephen P. Kranz | Apr 19, 2016 | Audits, Income Tax, Texas, Transaction Taxes

The Texas Comptroller of Public Accounts recently proposed amendments to 34 Tex. Admin. Code 3.584 relating to the reduced rate available under the Texas Franchise Tax for retailers and wholesalers. These proposed revisions, which appear to formalize elements of informal guidance issued in August of 2015, have the potential to substantially impact a great number of businesses, specifically in the information technology and pharmaceutical industries.

The Texas Franchise Tax is imposed on taxable business entities, including corporations, partnerships and limited liability companies, doing business in the state of Texas. The generally applicable tax rate is 0.75 percent of “taxable margin”—which is itself computed under a complex set of statutes and regulations—however, the rate is reduced to 0.375 percent for entities “primarily engaged in retail or wholesale trade. To qualify for the reduced rate, a business must meet two statutory thresholds: first, it must earn more revenue from retail or wholesale trade activities than it earns from all other business activities; and second, it must earn less than 50 percent of its retail or wholesale trade revenues from the sale of products it or an affiliate entity produces. Tex. Tax Code § 171.002(c). The current version of Rule 3.584 (the Rule) clarifies that, for purposes of the second statutory threshold, a product is not considered to be produced by the retailer if “modifications made to the acquired product do not increase its sales price by more than 10 percent.” In other words, there is a safe harbor under the Rule for retailers who make some modifications to products they sell; so long as those modifications do not increase the product’s sale price by more than 10 percent, the sales of those products will not factor into the second statutory threshold. This is currently the only guidance provided by regulation regarding the scope of the “primarily engaged in” standard.

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MTC Arm’s-Length Adjustment Service (Part II): “An Expression of Grief, Pity, or Concern”

by Diann Smith and Stephen P. Kranz | Apr 8, 2016 | Audits, Income Tax, Nationwide Importance, Transfer Pricing

Executive Summary

Multistate Tax Commission (MTC) transfer pricing program moving forward in some fashion;
Priority includes information sharing among participating states (and possibly their third party vendors) on transfer pricing issues. Because a formal agreement was found necessary, the scope of the information shared is presumed to include taxpayer specific information; and
States currently have significant inventory of transfer pricing audits that they admit they do not have the expertise to properly examine or defend in a protest.

The inaugural meeting (via conference call) of the Multistate Tax Commission’s Committee (Committee) addressing transfer pricing issues (ALAS) took place on April 7, 2016, and was certainly interesting. A predecessor Working Group had created an extensive plan that is intended to be implemented by the Committee over 4 years. The plan initially anticipated that approximately 10 states (at least) would agree to fund the cost of the multi-year program, but meeting that goal has not materialized. Instead, the Committee is moving forward hoping to add more states (or limit services provided) as the plan progresses. The anticipated program has multiple parts such as training, additional MTC staff resources and multistate transfer pricing audit and litigation support for participating states.

Ten states identified themselves on the call – only Pennsylvania was new to the process; the rest of the states on the call had all been involved in the predecessor Working Group. Also on the call was Eric Cook, co-founder of Chainbridge, the company that is currently involved in the controversial transfer pricing approach adopted by the District of Columbia (and previously by some other states). To no one’s surprise, all of the states agreed that Joe Garrett, Deputy Co-Commissioner of Revenue of Alabama, should be Chair of the Committee (he was the chair of the Working Group as well). The group will have monthly calls which are open for the public to listen in on. (more…)

California FTB to Discuss Apportionment of Combined Group Income

by Roy E. Crawford | Mar 24, 2016 | Allocation/Apportionment, California, Income Tax, Unitary Business

The California Franchise Tax Board (FTB) will hold a second Interested Parties Meeting at their office in Rancho Cordova on April 20, 2016, dealing with the apportionment of income for combined reporting groups with both financial and non-financial members. The Notice of Interested Parties meeting provides a description of the sourcing methods used in other states and solicits comments on four specific proposals.

The current statute and regulations, applied literally, in effect assign the majority of combined income of bank(s) and broker-dealer(s) to the location of the bank(s) or broker-dealer(s) and its customers. This can produce an issue worth many hundreds of millions of dollars to the bank or broker dealer. We understand that the California FTB has issued ad hoc Notices of Proposed Assessment to some taxpayers based on a distortion theory; some of these cases have gone to the Settlement Bureau, where both the FTB and the taxpayers have settled and executed confidentiality agreements.

The FTB takes these Interested Parties Meetings very seriously. They have an unusual format in that there is not a record of who said what, the goal being to have a full and frank discussion on a non-attribution basis. An early example of collaboration between the FTB and interested parties produced what is now Reg. 25137-10. Before the regulation, many years ago Sears argued that it was not engaged in a unitary business with a finance company subsidiary. Sears lost in the trial court on that issue, but the court also held that Sears was entitled to include intangible personal property in the property factor, and the situs of that property was Illinois, resulting in a refund for Sears. Regulation 25137-10 represented an effort to harmonize the income-producing character of intangible personal property with tangible property in the property factor, and the outcome was that intangible property would be included in the property factor at 20 percent of face value. This regulation and the bank regulation 25137-4.2 provide the current regulatory basis for modification of the statutory formula where high volume, low profit activity is combined with other activity in a combined return, but Reg. 24137-10 only applies where the principal business activity of the combined group is not financial.

Taxpayers should follow these regulatory activities carefully, as evidenced by the adoption of a regulation a few years ago on sourcing income of mutual fund service providers, which was favorable to California-based taxpayers. The statute provided for sourcing income from services at the location of income-producing activities, measured by cost of performance. The adopted regulation instead provides for a form of market sourcing.

Massachusetts Department of Revenue Introduces Pilot Voluntary Disclosure Program

by Richard C. Call and Scott M. Susko | Feb 8, 2016 | Audits, Income Tax, Local Tax, Massachusetts, Procedure, Sales Tax

The Massachusetts Department of Revenue (the Department) released a draft administrative procedure introducing a pilot Voluntary Disclosure Program (the Program) for the settlement of uncertain tax issues for business taxpayers on January 19. The Department introduced this Program in response to a suggestion made by Scott Susko, an author of this article, and another practitioner, both of whom serve as taxpayer professional representatives on the Department’s Advisory Council. We commend the Department for reacting to this suggestion in such a proactive manner.

The Program will provide “a process through which uncertain tax issues may be resolved on an expedited basis, generally within four months” (All quotations in this post are from the Department’s draft administrative procedure).

We think this Program will be particularly helpful to public companies in resolving issues related to their financial statement reserves.

The Program defines an “uncertain tax issue” as an issue “for which there is no clear statutory guidance or controlling case law, and which has not been addressed by the Department in a regulation, letter ruling, or other public written statement,” and “for which a taxpayer would be required to maintain a reserve in accordance with ASC 740: Accounting for Uncertainty in Income Taxes (formerly Fin 48).” The issue also “must not have been addressed as part of a prior audit of the taxpayer, a prior application for abatement or amended return filed by the taxpayer, or a prior ruling request made by the taxpayer.”

To qualify for the Program, “any potential tax liability attributable to the uncertain tax issue(s) must be $100,000 or more, exclusive of interest and penalties.” A taxpayer that is under audit or has received notice of an impending audit is not eligible for the Program. The Department has the “discretion to determine that the Program is not appropriate for specific cases.”

The Department “will consider settlement of an uncertain tax issue(s) where: (1) the taxpayer has presented its position on the issue(s) and the Department agrees that the tax treatment of the issue(s) is uncertain; and (2) the taxpayer has fully disclosed and documented the issue(s) and the facts associated with that issue(s).”

A taxpayer may initiate the process by submitting an anonymous letter to the Department, which will respond to the taxpayer within 30 days. If the Department accepts the taxpayer into the Program, the taxpayer may submit an application, including a settlement proposal and identifying the taxpayer, within 45 days of receiving the Department’s acceptance letter.

The Department will waive penalties related to the uncertain tax issue for a taxpayer that reaches an agreement with the Department pursuant to the Program, as well as for a taxpayer that does not reach an agreement with the Department “provided the taxpayer acted in good faith.”

The Department requested practitioner comments on the draft administrative procedure by February 1, and MWE submitted two technical comments.

Our first comment was that following the initial evaluation, the Department should issue to the taxpayer a one-page technical position explaining whether it does or [...]

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Connecticut Limits New Tax Haven Law

by Nick Furtwengler, Richard C. Call and Scott M. Susko | Jan 13, 2016 | Connecticut, Income Tax, Tax Base

In June of 2015, Connecticut passed legislation that implements combined reporting for tax years beginning on, or after January 1, 2016. Part of the new regime, which is codified by Conn. Gen. Stat. P.A. 15-5, § 144 (2015), requires water’s-edge combined groups to include entities incorporated in tax havens in the combined group. Just before the holidays, the Connecticut General Assembly passed legislation that narrowed the definition of a “tax haven” from the originally adopted definition. Under the originally passed combined reporting law, the determination of whether a jurisdiction was a “tax haven” was made using five different definitions. If any one definition was satisfied, the jurisdiction was a “tax haven.” None of the five definitions is entirely clear and each generally required an analysis of facts related to the jurisdiction’s government rather than the activities of a taxpayer in the jurisdiction. The original definition of tax haven was similar, but not identical to the Multistate Tax Commission Proposed Model Statute for Combined Reporting. The new law required the commissioner of revenue to publish a list of jurisdictions determined to be tax havens by September 30, 2016. In December, the Connecticut General Assembly convened a special session and passed Public Act 15-1, which amends the newly enacted tax haven law in section 37. As amended, the Connecticut statute still contains the five different definitions. However, the amended law excludes from the definition of a tax haven “a jurisdiction that has entered into a comprehensive income tax treaty with the United States” and which meets certain other requirements. Additionally, the December legislation also repealed the requirement for the commissioner to publish a list of tax havens. In sum, the limiting amendment to the tax haven law should provide taxpayers with some clarity, although that will be somewhat offset by the lack of a formal list. Connecticut is one of four New England states that considered and/or passed legislation adding tax haven provisions to their combined reporting regimes. Tax haven legislation passed in Rhode Island in 2015, as part of Rhode Island’s adoption of combined reporting effective for tax years beginning on or after January 1, 2015. The Maine and Massachusetts legislatures considered tax haven provisions, but ultimately did not pass such laws in 2015.

NYS Tax Department Relaxes Investment Income Identification Rules

by McDermott Will & Emery | Jan 11, 2016 | Income Tax, New York

The New York State Department of Taxation and Finance has announced that it would extend the time for certain taxpayers to identify stocks as being held for investment so that income from those stocks would be tax-exempt [TSB M-15(4.1)C, (5.1)I]. Instead of having to make the identification on the date on which the stock is purchased, many corporations will now have a 90-day grace period to make the identification. This relaxation of the identification rules will come as a major relief to many companies that otherwise may have been ambushed by New York’s new rules, particularly out-of-state corporations that start doing business in New York after acquiring investment securities. The announced change is effective immediately.

Under corporate tax reform legislation enacted in 2015, corporations—to treat income from stock held as an investment as tax-exempt investment income—must identify the stock on the date of purchase as being held for investment and follow certain procedures. This requirement has been widely criticized as being unrealistic since a corporation’s investment people are unlikely to know about arcane tax rules on the date that they make trades. Securities dealers, to qualify for tax-free investment income treatment, must identify the stock as being held for investment pursuant to Section 1236 of the Internal Revenue Code (IRC), which requires the identification to be made on the date of purchase. Non-dealers must still make the identification on the date of purchase under the statute, but they need not make the federal election under Section 1236 since that provision applies only to dealers.

The Department’s new rules significantly relax the requirement for many non-dealer corporations. They do not apply to dealers, which will still be subject to the Section 1236 election requirements.

One criticism that has been made of the identification requirement is that a corporation that had not been doing business in New York and, hence, had not been a New York taxpayer and acquired stock as an investment would not have made the New York identification because it would not have cared about, or known about, New York taxes. If such a corporation later starts doing business in New York and becomes subject to New York taxes, it will be too late to make the identification for previously acquired stock and, hence, the income from that stock will not be exempt investment income. Under the Department’s new announcement, a corporation that first becomes a New York taxpayer on or after October 1, 2015, can make the identification within 90 days after becoming a New York taxpayer or, if it became a New York taxpayer before January 7, 2016, by April 6, 2016. Stock purchased after this extended period must still be identified as being held for investment on the date of purchase.

Ordinarily, a corporation becomes taxable in New York on the first day on which it does business, employs capital, owns or leases property, or maintains an office in New York. Under new economic nexus rules, a corporation also becomes taxable in New York on [...]

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Focus on Tax Controversy – December 2015

by McDermott Will & Emery | Jan 4, 2016 | Income Tax, Insurance Tax, Local Tax, Michigan, New Jersey, New York, Sales Tax, Tax Base, Virginia, Washington

McDermott Will & Emery has released the December 2015 issue of Focus on Tax Controversy, which provides insight into the complex issues surrounding U.S. federal, international, and state and local tax controversies, including Internal Revenue Service audits and appeals, competent authority matters and trial and appellate litigation.

Mark Yopp authored an article entitled “Waiting for Relief from Retroactivity,” which discusses how courts are expanding the ability of state legislatures to retroactively change taxpayer liability going back many years.

View the full issue (PDF).

Tax Breaks for Data Centers: The Numbers Might Be Cloudy

by McDermott Will & Emery | Dec 23, 2015 | Incentives, Income Tax, Nationwide Importance, Property Tax, Sales Tax

States are competing aggressively to attract data centers with various tax incentives. Data center companies and their business customers are taking them up on their offers. But are these incentives really a good deal for the businesses? Tax incentives that seem attractive at first glance may not be beneficial when they are examined in the context of the entire tax picture, especially in the unique, uncertain, and developing world of state taxation of technology and computer services.

With the rise of global commerce, cloud computing, streaming video and a wide array of other internet-related businesses, data centers have become big businesses. In 2014, the colocation data center industry reached $25 billion in annual revenue globally, with North American companies accounting for 43 percent of that revenue.[1]

To get in on the action, states have been trying to outdo one another by offering a slew of competing tax breaks to the industry. According to the Associated Press, states have provided about $1.5 billion in data center tax breaks over the past 10 years.[2] Some states have gone even further, providing tax incentives to the entire data center industry through changes in the tax laws themselves. Such incentives can include reductions or exemptions from sales and use taxes on data center products or services, favorable income tax rates for data center companies and favorable property tax rules for data center assets. According to a recent analysis by the Associated Press, at least 23 states provide such statutory data center tax incentives.[3] Just a few of the most recent examples include a sales tax exemption for data center equipment in Michigan,[4] a broadening of the sales tax exemption for data center electricity and equipment in North Carolina[5] and a favorable apportionment formula for data centers in Virginia.[6] Importantly, many of these incentives apply not only to the data centers themselves, but also to their customers.

Businesses considering whether to take advantage of these incentives would be well advised to consider not only the potential benefit from any particular tax incentive, but also whether the decision would affect their tax picture as a whole. Because of the current uncertain and changing landscape for state and local taxation of technology and computer services, the analysis of these incentives for data centers and their customers can be particularly complex.

One item that a taxpayer might overlook when considering whether to take advantage of an incentive program is what affect, if any, the choice of location might have on the taxpayer’s property factor for income tax apportionment purposes. Obviously, location of a company’s technology equipment in a data center under a colocation agreement will cause the company’s in-state property factor to increase due to its equipment being located in the state. However, data center customers also should be aware that local tax authorities might also argue that the colocation payments themselves constitute consideration for the use of real or tangible personal property and thus the [...]

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A Steep Slope — Vermont Supreme Court Finds AIG Not Unitary With a Ski Resort Based On a Clear and Cogent Evidence Burden of Proof

by Arthur R. Rosen and Richard C. Call | Nov 30, 2015 | Allocation/Apportionment, Constitutional Issues, Income Tax, Nationwide Importance, Tax Base, Unitary Business, Vermont

In the first Vermont Supreme Court decision addressing combined unitary reporting since Vermont’s combined reporting regime became effective in 2006, the court affirmed a lower court’s decision that AIG, the multinational insurance company, was not unitary with a ski resort operated by a subsidiary in Vermont; accordingly, a combined report covering the two businesses was not required. The decision is important because it lays the foundation for future unitary cases in Vermont.

The court agreed with AIG that there were no economies of scale between the operations of AIG and the ski resort. “Because [the entity] is a ski resort and therefore its business type is not similar to AIG’s insurance and financial service business, there is no opportunity for common centralized distribution or sales, and no economy of scale realized by their operations.” On centralization of management, the court noted that although AIG controlled the appointments to the ski resort’s board and management, this did not translate into “actual control” over the ski resort’s operations. Lastly, the Vermont Department of Taxes attempted to argue functional integration based primarily on AIG’s influx of working capital to the ski resort. The court rejected this assertion stating the funding “served an investment rather than operational function. The financing was not part of an AIG operational goal to grow part of its business. Further, there is no operational integration between AIG’s insurance and financial businesses and the ski resort operated by [the resort].”

The case is interesting because it involved whether an instate entity was unitary with its parent. For the year at issue, Vermont had a three factor apportionment formula with a double-weighted sales factor. Presumably, the ski resort had a high Vermont apportionment factor and relatively little income, so including AIG in the combined group increased AIG’s Vermont apportionment factor without significantly diluting its income.

Interestingly, the court addressed AIG’s burden of proof on the unitary issue. The taxpayer argued that a preponderance of the evidence standard should apply. The Vermont Supreme Court disagreed. Looking to the United States Supreme Court’s decision in Container Corp. as well as to decisions of other states, the taxpayer has the burden of proving by “clear and cogent” evidence that its operations are not unitary. Interestingly, the court suggested that one California court decision that applied a preponderance of the evidence standard to a unitary question was distinguishable because that case involved a taxpayer claiming that unity existed — and AIG was claiming that unity did not exist. This disparate burden depending on the direction of the unitary argument may prove important to taxpayers seeking to bring entities or operations into a combined report in Vermont.

State tax professionals may react to this decision in a manner similar to the way many reacted when the Court of Appeals of Arizona decided Talley Industries and Woolworth. Those decisions engendered substantial hope that courts — and, ultimately, state revenue agencies — would analyze unitariness not on the basis of a “checklist” or as a knee-jerk reaction to [...]

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