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In-Depth Coverage of Issues Surrounding State and Local Tax
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Alabama Legislature Rejects (Yet Another) Attempted Digital Tax Expansion

by , and | Mar 21, 2016 | , , , , ,

Last month, a much-anticipated bill drafted by the Alabama Department of Revenue (Department) was introduced in the Alabama Senate that would have expanded the definition of tangible personal property to include “digital goods.”  See Senate Bill 242 (introduced February 16, 2016).  Fortunately, the Senate Finance and Taxation Education Committee (Committee) rejected the bill on March 9, 2016, after hearing testimony from Assistant Department Counsel Christy Edwards and extensively questioning her on the bill’s content and motives.  Notably, the Department continues to take aggressive positions in an effort to tax digital goods and services, without the requisite statutory or legislative approval to back it up.

Background

On February 28 2015, the Department proposed an amendment to Regulation 810-6-5-.09, which would have amended the rental tax on tangible personal property to include “digital transmissions” (broadly defined to include digital content such as streamed audio and video).  After significant opposition from industry representatives, the Joint Legislative Council (composed of leadership from both chambers) wrote a letter to Commissioner Julie Magee in April 2015 requesting that the proposed regulation be withdrawn.  It cited to the fact that the proposal was overly expansive and would in effect be the imposition of a new tax, a determination that rests with the legislature.  See our prior coverage here.  With hesitation and only after continued pushback from the Legislative Council, the Department withdrew the rental tax regulation amendment on July 7, 2015.

In response to the rejection of the proposed regulation, the Department went through its historic revenue rulings and revoked a number of technology rulings in January 2016, noting they will continue attempting to apply the rental tax to streaming services.  Commissioner Magee cited the revocations as a mere “clarification” that did not change the law.  In her comments to the revocations, Commissioner Magee noted that all taxpayers will be collecting and remitting tax in the future “[e]ither legislatively through a digital goods bill or through audits and assessments.”

Senate Bill 242

The digital goods bill arrived just a few weeks later, sponsored by Senator Trip Pittman.  As introduced, the bill would define “tangible personal property” to include “digital goods.”  For these purposes, digital goods include “[s]ounds, images, data, facts, or information, or any combination thereof, transferred electronically, including, but not limited to, specified digital products and any other service transferred electronically that uses one or more software applications.”  As is readily apparent, this language is extremely broad and arguably includes every service delivered over the internet.  The definition also raised concerns because it borrows from Streamlined language (“transferred electronically”; “specified digital products”), but Alabama is not a Streamlined state and does not define those terms elsewhere in the legislation or Code.  As drafted, the bill would have become effective immediately upon passage.

After cancelling a scheduled Committee hearing earlier this month, citing the need for revisions, the sponsor and Department entered the March 9 public hearing with a substitute bill.  Instead of defining “digital [...]

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California Supreme Court Denies BOE Petition for Review in Lucent Technologies

by , and | Jan 26, 2016 | , , , , , ,

Last week, the California Supreme Court denied the State Board of Equalization’s (BOE’s) petition for review in Lucent Technologies, Inc. v. State Bd. of Equalization, No. S230657 (petition for review denied Jan. 20, 2016). This comes just months after the California Court of Appeals held against the BOE and ordered it to pay Lucent’s $25 million sales tax refund. As explained in more detail below, the denial finalizes the favorable precedent of the Court of Appeals in Nortel Networks Inc. v. State Bd. of Equalization, 191 Cal. App. 4th 1259, 119 Cal. Rptr. 3d 905 (2011)—representing a monumental victory for a broad range of taxpayers in California and opening the door for significant refund opportunities. Moreover, the California Supreme Court’s denial affirms the Court of Appeals decision that the BOE’s position was not substantially justified and the taxpayer was entitled to reasonable litigation costs of over $2.6 million.

Background

Lucent and AT&T (collectively Lucent) are and were global suppliers of products and services supporting, among other things, landline and wireless telephone services, the internet, and other public and private data, voice and multimedia communications networks using terrestrial and wireless technologies. Lucent manufactured and sold switching equipment (switches) to their telephone customers, which allowed the customers to provide telephone calling and other services to the end customers. The switches required software, provided on storage media, to operate. Lucent designed the software (both switch-specific and generic) that runs the switches they sell, which was copyrighted because it is an original work of authorship that has been fixed onto tapes. The software also embodies, implements and enables at least one of 18 different patents held by Lucent.

Between January 1, 1995, and September 30, 2000, Lucent entered into contracts with nine different telephone companies to: (1) sell them one or more switches; (2) provide the instructions on how to install and run those switches; (3) develop and produce a copy of the software necessary to operate those switches; and (4) grant the companies the right to copy the software onto their switch’s hard drive and thereafter to use the software (which necessarily results in the software being copied into the switch’s operating memory). Lucent gave the telephone companies the software by sending them magnetic tapes or CDs containing the software. Lucent’s placement of the software onto the tapes or discs, like the addition of any data to such physical media, physically altered those media. The telephone companies paid Lucent over $300 million for a copy of the software and for the licenses to copy and use that software on their switches.

The BOE assessed sales tax on the full amount of the licensing fees paid under the contracts between Lucent and its telephone company customers. Lucent paid the assessment and sued the BOE for a sales tax refund attributable to the software and licenses to copy and use that software at the trial court. The parties filed cross-motions for summary judgment on Lucent’s refund claims, and the Los Angeles [...]

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Michigan Backs Off Cloud Tax, Refund Opportunities Available

by , and | Jan 14, 2016 | , , , , , ,

After refusing to back down on the issue for years, the Michigan Department of Treasury (Department) issued guidance last week to taxpayers announcing a change in its policy on the sales and use taxation of remotely accessed prewritten computer software.  This comes after years of litigating the issue in the Michigan courts, most recently with the precedential taxpayer victory in Auto-Owners Ins. Co. v. Dep’t of Treasury, No. 321505 (Mich. Ct. App. Oct. 27, 2015), in which the Michigan Court of Appeals held that remote access to software did not constitute delivery of tangible personal property.  See our prior coverage here.  The Department has announced it will apply Auto-Owners (and the numerous other favorable decisions) retroactively and thus allow for refunds for all open tax years.  This is a huge victory for taxpayers; however, those that paid the tax (both purchasers and providers alike) must act promptly to coordinate and request a refund prior to the period of limitations expiring.

Implications

In issuing this guidance, the Department specifically adopts the Michigan Court of Appeals interpretation of “delivered by any means” (as required to be considered taxable prewritten computer software).  Going forward, the “mere transfer of information and data that was processed using the software of the third-party businesses does not constitute ‘delivery by any means’” and is not prewritten software subject to sales and use tax.  See Auto-Owners, at 7.  Not only has the Department admitted defeat with respect to the delivery definition, but it also appears to have acquiesced to taxpayers’ arguments with respect to the true object test (or “incidental to services” test in Michigan).  This test was first announced by the Michigan Supreme Court in Catalina Marketing, and provides that a court must objectively analyze the entire transaction using six factors and determine whether the transaction is “principally” the transfer of tangible personal property or the transfer of services with a transfer of tangible personal property that is incidental to the service.[1]  In last week’s guidance, the Department states that if only a portion of a software program is electronically delivered to a customer, the “incidental to service” test will be applied to determine whether the transaction constitutes the rendition of a nontaxable service rather than the sale of tangible personal property.  However, if a software program is electronically downloaded in its entirety, it remains taxable.  This guidance comes in the wake of Department and the taxpayer in Thomson Reuters, Inc. v. Dep’t of Treasury stipulating to the dismissal of a Supreme Court case involving the same issues that had been appealed by the Department.  In light of these developments, it appears that the Department has given up all ongoing litigation over cloud services.

Immediate Action Required for Refunds

Taxpayers who paid sales or use tax on cloud based services are entitled to receive a refund for all open periods.  In Michigan, the period of limitations for filing a refund [...]

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Taxpayers Stand to Lose Under Chicago’s Lease Tax VDA Offer

by , and | Nov 20, 2015 | , , , , ,

Yesterday, the City of Chicago (City) Department of Finance (Department) published an Information Bulletin that provides additional guidance on the Personal Property Lease Transaction Tax (Lease Tax) and extends a new Voluntary Disclosure Agreement (VDA) offer to providers and customers. The updated guidance includes an overview of the Lease Tax, a description of the amendments included in the FY 2016 Revenue Ordinance that passed on October 28, 2015, and answers to 15 FAQs. The details on the Department’s controversial interpretation of the Lease Tax in Ruling #12 and the recent amendments to the Lease Tax have been covered by the authors in prior blog posts, available here and here. The new VDA offer is a significant development that may be enticing to certain providers and customers. However, before providers and customers rush to sign up to pay the Lease Tax for the foreseeable future, they should carefully evaluate whether any Lease Tax obligation is in fact due and whether they qualify under the loose terms outlined in the Bulletin (discussed in detail below). It should be noted at the outset that the guidance (and accompanying VDA offer) do not relate to the City’s amusement tax, which has also been of concern after a ruling was issued this summer interpreting the tax to apply to streamed digital content.

VDA Offer Terms

The most significant component of yesterday’s guidance is the VDA offer beginning on page 6 of the Bulletin. While the VDA may seem enticing, we encourage providers and customers alike to proceed with caution as the practical application of the ambiguous (and discretionary) terms are tainted with uncertainty.

As a threshold to qualifying, the provider or customers must qualify (i.e., be a qualified discloser) for the City standard voluntary disclosure program. Under the standard program, a taxpayer must not be under audit or investigation (i.e., has not received a written notice relating to an audit or investigation for the tax at issue) and must “waive their right to an administrative hearing or claim for refund or credit, and agree not to initiate or join any lawsuits for the payments made under the program.” This is significant because we believe a challenge to the Lease Tax is imminent and those that participate in the VDA program will not benefit if any such challenge is successful.

Even if a taxpayer is considered a qualified discloser under the standard program, to qualify for the more favorable Lease Tax offer providers and customers must file an application by January 1, 2016, and come into compliance with the Lease Tax Ordinance by the same date (or such later date that the Department may agree to). If all of these requirements are met, they will receive the following terms:

  1. As to charges for nonpossessory computer leases that qualified for Exemption 11 under the Department’s interpretation of the exemption before the issuance of Ruling #12, no liability for tax, interest or penalties based on those charges for [...]

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Precedential Cloud Victory in Michigan Court of Appeals

by , and | Oct 30, 2015 | , , , ,

On Tuesday, a three-judge panel sitting for the Michigan Court of Appeals unanimously affirmed a lower court decision finding that the use of cloud-based services in Michigan is not subject to use tax in Auto-Owners Ins. Co. v. Dep’t of Treasury, No. 321505 (Mich. Ct. App. Oct. 27, 2015). While there have been a number of cloud-based use tax victories in the Michigan courts over the past year and a half, this decision marks the first published Court of Appeals opinion (i.e., it has precedential effect under the rule of stare decisis). See Mich. Ct. R. 7.215(C)(2). Therefore, the trial courts and Michigan Court of Appeals are obligated to follow the holdings in this case when presented with similar facts, until the Michigan Supreme Court or Court of Appeals say otherwise. While the ultimate outcome (i.e., not taxable) of the lower court decision was affirmed, the analysis used by the Court of Appeals to get there was slightly different and the court took the time to analyze over a dozen different contracts, as discussed below. Given the fact that a petition for review is currently pending in another Court of Appeals case (Thomson Reuters) decided on similar issues in 2014, it will be interesting to see if this development increases the Michigan Supreme Court’s appetite to hear a use tax case on cloud-based services. The Department of Treasury (Department) has approximately 40 days to request that the Auto-Owners decision be reviewed by the Michigan Supreme Court.

Facts

Auto-Owners is an insurance company based out of Michigan that entered into a variety of contracts with third-parties to provide cloud-based services. These contracts were grouped into six basic categories for purposes of this case: (1) insurance industry specific contracts, (2) technology and communications contracts, (3) online research contracts, (4) payment remittance and processing support contracts, (5) equipment maintenance and software customer support contracts and (6) marketing and advertising contracts.  The contracts all involved, at some level, software accessed through the internet. Michigan audited Auto-Owners and ultimately issued a use tax deficiency assessment based on the cloud-based service contracts it utilized.  In doing so, the Department cited the Michigan use tax statute, which like many states, provides that tax is imposed on the privilege of using tangible personal property in the state. See generally Mich. Comp. Laws Ann. § 205.93. The Department took the position that the software used in Michigan by Auto-Owners was “tangible personal property,” which is defined to include prewritten, non-custom, software that is “delivered by any means” under Michigan law. See Mich. Comp. Laws Ann. § 205.92b(o). The taxpayer paid the tax under protest and filed a refund claim, which was the focus of the Court of Claims decision being appealed.

Procedural History

At the trial court level, the Court of Claims determined that the application of use tax to the software used in Michigan by Auto-Owners would be improper. In doing so, the court issued three separate holdings—all in favor of the taxpayer. First, the court held that use tax [...]

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Illinois Appellate Court Holds City of Chicago Tax on Cars Rented Outside of but Used Within the City Valid

by | Oct 2, 2015 | , , , , , ,

An Illinois Appellate Court, in Hertz Corp. v. City of Chicago, 2015 IL App (1st) 123210 (Sept. 22, 2015), gave the City of Chicago (City) permission to require rental car companies to collect tax on vehicle rentals from locations within three miles of the City, overturning a lower court ruling that found such taxation was an extraterritorial exercise of the City’s authority.  The appellate court granted summary judgment to the City and lifted the permanent injunction enjoining the City from enforcing the tax.

The tax at issue is the City’s Personal Property Lease Transaction Tax (Lease Tax), which is imposed upon “(1) the lease or rental in the city of personal property, or (2) the privilege of using in the city personal property that is leased or rented outside of the city.”  Mun. Code of Chi. § 3-32-030(A).  While the Lease Tax is imposed upon and must be paid by the lessee, the lessor is obligated to collect it at the time the lessee makes a lease payment and remit it to the City.  Mun. Code of Chi. §§ 3-32-030(A), 3-32-070(A).

The subject of this litigation is the City’s application of the Tax in its Personal Property Lease Transaction Tax Second Amended Ruling No. 11 (eff. May 1, 2011) (Ruling 11).  The plaintiffs argued that Ruling 11 is an extraterritorial exercise of the City’s authority because the City lacks nexus with the rental transactions.  The Ruling “concerns [short-term] vehicle rentals to Chicago residents, on or after July 1, 2011, from suburban locations within 3 miles of Chicago’s border … [excluding locations within O’Hare International Airport] by motor vehicle rental companies doing business in the City.”  Ruling 11 § 1.  The Ruling explains that “‘doing business’ in the City includes, for example, having a location in the City or regularly renting vehicles that are used in the City, such that the company is subject to audit by the [City of Chicago Department of Finance] under state and federal law.”  Ruling 11 § 3.  As for taxability of leased property, the Ruling cites the primary use exemption, exempting from Tax “[t]he use in the city of personal property leased or rented outside the city if the property is primarily used (more than 50 percent) outside the city” and stating the taxpayer or tax collector has the burden of proving where the use occurs.  Ruling 11 § 2(c) (quoting Mun. Code of Chi. § 3-32-050(A)(1)).

Ruling 11 contains a rebuttable presumption that motor vehicles rented to customers who are Chicago residents from the suburban locations of rental companies that are otherwise doing business in Chicago are subject to the Lease Tax.  The Ruling applies to companies with suburban addresses located within three miles of the City.   The presumption may be rebutted by any writing disputing the conclusion that the vehicle is is used more than 50 percent of the time in the City.  The opposite is assumed for non-Chicago residents.  Ruling 11 § 3.  The [...]

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In Chicago, Taxing the Cloud Will Wait (Mostly) Until 2016

by | Aug 12, 2015 | , , , ,

The City of Chicago has announced that it will be delaying the effective date for its recent ruling under the Personal Property Lease Transaction Tax until January 1, 2016. Personal Property Lease Transaction Tax Ruling #12 takes a broad view of how the 9 percent tax applies to cloud-based services. It was scheduled to come into effect on September 1, 2015, but after an outcry from the startup community, Chicago has pushed back the date on which it expects cloud-based providers to begin collecting and remitting tax. The additional time will allow the city to further consider potential exemptions for small businesses. Providers of information services, software as a service (SaaS), platform as a service (PaaS), and some forms of infrastructure as a service (IaaS) that have nexus with the city will now have until January 1, 2016, to begin collecting the tax. (See a detailed discussion of Ruling #12 and its implications in a previous post.) The delay could backfire for the city because taxpayers will now have more time to launch challenges to the tax.

Ruling #12 is only part of Chicago’s two-pronged approach to taxing the cloud. The city had at the same time issued Amusement Tax Ruling #5, which provides that charges for video streaming, audio streaming, computer game subscriptions and other forms of online entertainment, as well as temporary download rentals, are subject to the 9 percent Amusement Tax—not the Lease Transaction Tax. That ruling also was issued with a September 1, 2015, effective date.  This effective date for the Amusement Tax Ruling has not been changed, and the city has indicated that no such extension is currently under consideration.



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Chicago, Searching for Tax, Taxes Searchable Websites

by | Jul 1, 2015 | , ,

Taxpayers providing services over the internet need to carefully consider two recent City of Chicago rulings: Lease Transaction Tax Ruling #12 and Amusement Tax Ruling #5. Issued together on June 9, 2015, the rulings extend a 9 percent tax to most services provided online. Charges for video streaming, audio streaming, computer game subscriptions, and other forms of online entertainment are subject to the 9 percent amusement tax. Charges for essentially any other kind of interactive website or online service, with only a handful of exceptions, are subject to the 9 percent lease transaction tax. The lease transaction tax is supposed to be a municipal sales and use tax on the leasing of tangible personal property, but the City is stretching the tax to encompass the deemed use of the provider’s computer in accessing a website or program over the internet. As detailed in this On the Subject, providers of information services and cloud-based services need to evaluate the applicability of the City’s guidance and consider whether to comply or challenge the imposition of tax.

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House Judiciary Committee Approves Three State Tax Bills

by , , and | Jun 18, 2015 | , , , , , ,

Yesterday, on June 17, 2015, three state tax bills were favorably reported to the United States House of Representatives (House) by the House Judiciary Committee (House Judiciary) after considering each during a half-day markup. The bills that were advanced included: (1) the Mobile Workforce State Income Tax Simplification Act (Mobile Workforce, H.R. 2315); (2) the Digital Goods and Services Tax Fairness Act (DGSTFA, H.R. 1643); and (3) the Business Activity Tax Simplification Act (BATSA, H.R. 2584).

Mobile Workforce State Income Tax Simplification Act

The Mobile Workforce bill was the first considered and seeks to establish a clear, uniform framework for when states may tax non-resident employees that travel for work. As advanced, the bill generally allows states to impose income tax compliance burdens on non-resident individuals only when the non-resident works in a state other than their state of residence for more than 30 days in a year. The bill also prevents those states from imposing a withholding requirement on employers for wages paid to such employees. Three proposed amendments seeking to limit the adverse revenue impact to New York were discussed and rejected. The Mobile Workforce bill was then favorably reported to the House by a vote of 23-4.

Digital Goods and Services Tax Fairness Act

DGSTFA would implement a uniform sourcing framework for states and localities seeking to tax digital goods and services. In doing so, the bill prevents any state or locality from imposing multiple or discriminatory taxes. Of the three pieces of legislation considered yesterday, only the DGSTFA was amended. The amendment, offered by the bill’s lead sponsor Representative Lamar Smith, was technical in nature and did not change the basic protections the bill would provide. At the markup, Chairman Goodlatte noted that the National Governors Association (NGA), which had previously voiced objections, was no longer opposed to the legislation after the revisions—though the NGA testimony indicated that the organization could not support the legislation without addressing the remote seller sales tax nexus issue.

The first technical changes in the adopted amendment were to the definitions of delivered or transferred electronically and provided electronically. The amendment added the term digital good and digital service after each respective term of art to clarify that digital goods are delivered or transferred electronically, whereas digital services are provided electronically. The second technical change was to the definition of digital good. In modifying the term, the amendment clarifies that streaming and other similar digital transmissions that do not “result in the delivery to the customer of a complete copy of such software or other good, with the right to use permanently or for a specified period” are not digital goods and would instead fall under the definition of a digital service.

Business Activity Tax Simplification Act

BATSA would codify the prerequisite of physical presence for a state to impose a direct tax on a non-resident business. BATSA would modernize the existing federal protection against state income taxation offered under P.L. 86-272 to include solicitation for sales of intangible property and services [...]

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Remote Transactions Parity Act Introduced in the U.S. House

by , and | Jun 15, 2015 | , , , , ,

Today, Representative Jason Chaffetz introduced H.R. 2775, the Remote Transactions Parity Act of 2015 (RTPA), in the United States House of Representatives (House).

The RTPA addresses the Internet sales tax issue using the structure of the Marketplace Fairness Act (MFA), which passed the Senate in 2013 and was re-introduced earlier this year. Although the RTPA retains many of the features of the MFA, it adds protections for remote sellers and certified software providers.

MFA Authorization Framework Retained

Like the MFA, the RTPA creates two paths for states to impose sales and use taxes on remote sellers. Through the first path, states that are members of the Streamlined Sales and Use Tax Agreement (SSUTA) are authorized to impose sales and use tax collection requirements on remote sellers. Under the second path, a state that is not a member state under the SSTUA would also be authorized to collect and remit sales and use taxes on remote transactions if it implements certain simplification requirements and protections for remote sellers and certified software providers. Many of these are carried over from the MFA, notably: (1) destination sourcing for interstate transactions; (2) a single entity for administration of sales and use tax; (3) a single audit of remote sellers per state; (4) a single return per state; (5) uniform tax base for all state and local sales taxes within the state; and (6) relief for errors, including remote sellers being relieved of errors made by a certified software provider or the state itself, and certified software providers being relieved of errors made by a remote seller or the state itself. Like the MFA, the RTPA would be effective one year from enactment, but not during the period from October through December in the year following enactment.

Changes

The RTPA contains several notable differences from the MFA, discussed below.

Small Seller Exception

Under the MFA, there is a fixed exception for small sellers and states are not authorized to impose a sales and use tax on small sellers, defined as remote sellers making sales of $1 million or less.

Under the RTPA, the small seller exception starts off larger, and subsequently phased out. In the first year, the exception applies for sellers making sales of $10 million or less. In the second and third year, the threshold is $5 million and $1 million, respectively. The exception goes away in the fourth year. Furthermore, under the RTPA sellers utilizing an electronic marketplace are not considered small sellers and are not entitled to the exception, no matter the year.

Protections to Sellers and Certified Software Providers

The RTPA provides additional protections for remote sellers and certified software providers.  The RTPA contains a mechanism to make sure that a state is not authorized to impose a sales and use tax collection requirement on remote sellers until it has certified multiple software providers, and those providers are certified in all other states seeking to impose authorization requirements. This is to ensure that a remote seller can [...]

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