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A Very Scary Time of the Year: MTC Joint Audit Selection

by Diann Smith, Eric D. Carstens and Stephen P. Kranz | Oct 23, 2014 | Alabama, District of Columbia, Hawaii, Income Tax, Kentucky, Nationwide Importance, New Jersey, Transfer Pricing

With both Halloween and the Multistate Tax Commission (MTC) Income Tax Audit selection nearing, taxpayers should prepare themselves for the possibility of being spooked in the near future. On Thursday, October 30, from 2-4 pm EST, the MTC Audit Committee—including representatives from the 22 states participating in the upcoming round of joint income tax audits—will be holding a teleconference that will begin with a public comment period. Because of the inevitable disclosure of confidential taxpayer information, the bulk of this meeting—including selecting the various companies to audit—will take place during the second half of the agenda and be closed to the general public. Just because a company has completed an audit in the past does not mean this season will be all treats. The authors have noticed that companies previously audited by the MTC can remain on the list of targets and are often repeat selections.

Unique Complexities

The MTC audit process is not without its share of traps for the unwary. First and foremost is the effort a taxpayer must expend in managing a multistate audit. Issues such as differing statute of limitations, the effects of federal Revenue Agent’s Reports (RAR) and net operating loss (NOL) differences on limitations periods, timing of protests, and tax confidentiality become of heightened importance when one auditor is reviewing a taxpayer for multiple states. Audited taxpayers should also keep in mind that the MTC does not issue the actual deficiency notices – these must come from the states. As a result there may be certain areas such as credits or refunds that the MTC does not review and must be raised directly with a participating state.

On the substantive side, a primary area of inquiry of an MTC audit has been and is likely to continue to be inter-company transactions. Historically MTC audits have taken a variety of approaches to disallow a taxpayer’s intercompany structure, including collapsing separate affiliates, applying the sham transaction doctrine, or using aggressive addback concepts. Another similar concern for taxpayers audited by the MTC is the increased likelihood of transfer pricing issues being raised. This comes in the wake of the creation of the MTC Arm’s-Length Adjustment Service (ALAS) this summer, led by former Montana Department of Revenue Director Dan Bucks. The group recently held a transfer pricing summit at which it designed the MTC services to include third-party economic consultants at every stage. The MTC transfer pricing services are expected to be implemented in mid-2015—just in time for companies selected for an MTC Income Tax Audit to be the test subjects. Notably, of the nine states committing seed money to the development of a multistate transfer pricing audit service, five (Alabama, Hawaii, Kentucky, New Jersey and the District of Columbia) are participating in the MTC Income Tax Joint Audit Program. It is not clear whether the two MTC-sponsored audit programs will be intertwined; however, the option was proposed this past summer and remains a possibility as we approach the upcoming audit selections.

Finally, it remains to [...]

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MTC to Hold Transfer Pricing Group Meeting with Third-Party Contract Auditors

by Diann Smith and Stephen P. Kranz | Sep 23, 2014 | Alabama, District of Columbia, Florida, Georgia, Hawaii, Income Tax, Iowa, Kentucky, Nationwide Importance, New Jersey, North Carolina, Transfer Pricing

On October 6 and 7, 2014, the Multistate Tax Commission (MTC) will hold an Arm’s-Length Adjustment Service (ALAS) Advisory Group Conference at the Atlanta Airport Marriott. On the first day, third-party contract auditors will give presentations on transfer pricing issues. An ALAS Advisory Group meeting will be held on the second day.

This past year, the MTC has been designing a joint transfer pricing program. So far, nine members have committed money to the development of this program: Alabama, the District of Columbia, Florida, Georgia, Hawaii, Iowa, Kentucky, New Jersey and North Carolina.

Dan Bucks, former executive director of the MTC and former director of the Montana Department of Revenue, is the project facilitator. In the lead-up to the event, he discussed arm’s-length issues with numerous third-party contract auditors. On October 6, the contract auditors will explain how they believe a multistate transfer pricing program should work and how the MTC would best use their services to conduct transfer pricing audits on behalf of member states.

The list of contract auditors includes Chainbridge Software, Economics Analysis Group, Economists Incorporated, NERA, Peters Advisors, RoyaltyStat and WTP Advisors. While project facilitator, Dan Bucks, has indicated that this meeting is not an audition for a procurement process, the discussion seems to be headed in that direction and the MTC has not ruled out utilizing third-party audit assistance in the transfer pricing program.

Businesses concerned with the overall direction of the ALAS Advisory Group, including the possibility of subjecting taxpayers to Chainbridge-style audits on a nationwide scale, should contact the authors. For more information on the conference, please visit the MTC ALAS webpage.

New Jersey Issues Ominously Vague Guidance on New Click-Through Nexus Law

by Catherine A. Battin | Aug 11, 2014 | New Jersey, Nexus, Sales Tax, Transaction Taxes

The New Jersey Division of Taxation issued a Notice last week that is hardly reassuring to remote sellers. The Notice basically paraphrases the new click-through statute, noting that the statutory definition of “seller” was amended to create a rebuttable presumption that an out-of-state seller, who makes taxable sales of goods or services, is soliciting business and has nexus in New Jersey if it (1) enters into an agreement with a representative located in New Jersey for compensation in exchange for referring customers via a link on its website and (2) has sales from those referrals to customers in New Jersey in excess of $10,000 for the four prior quarterly periods.

The Notice provides no guidance for sellers on how they can prove that their New Jersey independent contractors or representatives did not engage in any solicitation on their behalf in New Jersey. The Notice states that the out-of-state seller may provide proof that the representative did not engage in solicitation, but it does not include any details on what type of proof will be acceptable to the Division.

More troubling is that the Notice does not provide specific relief to arrangements where affiliates are paid on a cost-per-click basis (compensation based solely on the number of clicks rather than a commission on sales resulting from clicks). States such as California, New York and Pennsylvania have said that such arrangements are indicative of advertising rather than solicitation. The one example given in New Jersey’s Notice describes a commissioned click-through arrangement; the Notice is silent as to cost-per-click advertising.

It is unclear whether New Jersey will issue additional guidance, but given that the Notice does not provide relief for remote sellers with cost-per-click arrangements, they should not simply rely on California’s and New York’s guidance in the interim. Instead, they should obtain documentation from all their New Jersey independent contractors and representatives that they are not soliciting business in New Jersey on their behalf, even if they are only compensated on a cost-per-click basis.

New Jersey’s New Laws — Retroactive for Most Companies

by Emily Townsend | Jul 7, 2014 | Allocation/Apportionment, New Jersey, Nexus, Sales Tax

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

by Emily Townsend | Jun 3, 2014 | Allocation/Apportionment, Nationwide Importance, New Jersey, UDITPA

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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New Jersey Tax Court Issues Important Order on the State’s Throw Out Rule

by Arthur R. Rosen and McDermott Will & Emery | Sep 9, 2013 | New Jersey, Nexus, Sales Tax

The Tax Court of New Jersey recently issued an important order that may have eviscerated the impact of the Throw Out Rule on intangibles holding companies. On its face the order does not appear to address the application of the Throw Out Rule to traditional operating businesses, however the “bottom line” of the order should be applicable to all businesses.

Read the full article.