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In-Depth Coverage of Issues Surrounding State and Local Tax
INSIDE SALT
In-Depth Coverage of Issues Surrounding State and Local Tax
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New Market-Based Sourcing in DC: Major Compliance Date Problem Fixed… For Now

by , and | Feb 5, 2015 | , , , , ,

The Problem

On September 23, 2014, the District of Columbia Council enacted market-based sourcing provisions for sales of intangibles and services as part of the 2015 Budget Support Act (BSA), as we previously discussed in more detail here.  Most notably the BSA adopts a single sales factor formula for the DC franchise tax, which is applicable for tax years beginning after December 31, 2014.  But the market-based sourcing provisions in the BSA did not align with the rest of the tax legislation.  Specifically, the BSA market-based sourcing provisions were made applicable as of October 1, 2014—creating instant tax implications on 2014 returns.  Absent a legislative fix, this seemingly minor discrepancy will trigger a giant compliance burden that will require a part-year calculation for both taxpayers and the Office of Tax and Revenue (OTR) before the 2014 franchise return deadline on March 15.  For example, taxpayers filing based on the new BSA provisions, as originally enacted in September, will have to use the cost-of-performance approach for the first nine months of the 2014 tax year and the new market-based sourcing approach for the remaining three.

The Fix

Citing to the unintended compliance burden, the Council recently enacted emergency legislation to temporarily fix the unintended compliance burden.  However they have not solved the problem going forward.  On December 17, 2014, Finance and Revenue Committee Chairman Jack Evans introduced identical pieces of legislation that included both a temporary and emergency amendment to quickly fix on the problem (both pieces of legislation share the name “The Market-Based Sourcing Inter Alia Clarification Act of 2014”).  These legislative amendments explicitly make the applicability of market-based sourcing provisions synonymous with the other provisions of the BSA, beginning for tax years after December 31, 2014.  In DC, “emergency” legislation may be enacted without the typical 30-day congressional review period required of all other legislation, but is limited to an effective period of no longer than 90 days.  Because the emergency market-based sourcing legislation was signed by Mayor Muriel Bowser on January 13, it will expire on April 13.  Important to DC franchise taxpayers, this date is before the September 15 deadline for extended filers.

The second piece of legislation was introduced on a “temporary” basis.  Unlike emergency legislation, temporary legislation simply bypasses assignment to a committee but must still undergo a second reading, mayoral review and the 30-day congressional review period.  The review period is 30 days that Congress is in session (not 30 calendar days).  Because the temporary Act is still awaiting Mayor Bowser’s approval at the moment, which is due by this Friday (February 6), it will not become effective until after the 2014 DC Franchise Tax regular filing deadline of March 15—even if it is approved by the Mayor and not subjected to a joint-resolution by Congress.  Neither the House nor Senate is in session the week of February 15, which pushes the 30-day review period to roughly April 1 (assuming it is immediately submitted to Congress).  However, once passed, [...]

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Pennsylvania Unwraps Final Market-Sourcing Guidance

by | Dec 19, 2014 | , ,

The Pennsylvania Department of Revenue (the Department) recently finalized its Information Notice on sourcing of services for purposes of determining the appropriate net income and capital franchise tax apportionment factors.  The guidance also addresses the Department’s views on the sourcing of intangibles under the income producing activity test.  Since Pennsylvania is not a member of the Multistate Tax Compact, it is no surprise that the Department did not wait for the Multistate Tax Commission to complete its model market sourcing regulation before it issued its guidance.

Under the Pennsylvania statute (72 Pa. Stat. Ann. § 7401(3)(2)(a)(16.1)(C)), for tax years beginning after December 31, 2013, receipts from services are to be sourced according to the location where the service is delivered.  If the service is delivered both to a location in and outside Pennsylvania, the sale is sourced to Pennsylvania based upon the percentage of the total value of services 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 customers who are not individuals or who are sole proprietors, 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.

The statute generated more questions than it answered.  Key terms such as “delivered” and “location” were not defined.  The Department’s Information Notice provides answers to many of taxpayers’ questions.  However, unlike the draft Information Notice released in June 2014, the final Information Notice shies away from providing a succinct definition of “delivery” and resorts to defining the term through various examples.  (For our coverage of the Department’s draft Information Notice, click here.)  However, the Information Notice does define “location” stating that “location” generally means the location of the customer and, thus, delivery to a location not representative of where the customer for the service is located does not represent completed delivery of the service.

The Information Notice is chock full of examples to guide taxpayers.  The Department’s views relating to various scenarios when services are performed remotely on tangible personal property owned by customers are of interest.  If a customer ships a damaged cell phone to a repair facility that repairs and returns it, the Department deems the service to be delivered at the address of the customer.  Contrast that with a situation when a customer drops a car off for repair at a garage and later returns to pick it up.  One may conclude that the service should also be deemed to be delivered at the address of [...]

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Take Two: Massachusetts Department of Revenue Releases Revised Market-Based Sourcing Regulation

by | Nov 7, 2014 | , ,

Late last week, the Massachusetts Department of Revenue (the Department) released a revised draft regulation on Massachusetts’s new market-based sourcing law.  The changes made by the Department to purportedly address practitioner and taxpayer concerns were relatively modest.  The rules remain lengthy, complex and cumbersome.  There are still various assignment rules that apply to each of the following types of transactions: (1) in-person services, (2) professional services, and (3) services delivered to the customer, or through or on behalf of the customer (described in the new regulation as services delivered to the customer, on behalf of the customer, or delivered electronically through the customer, hereinafter “sales delivered to, by, or through a customer”).  For a more detailed discussion of these rules see our State Tax Notes article on market-based sourcing. 

The most noteworthy changes from the initial draft relate to the taxpayer’s ability to use a “reasonable approximation” method.  The initial draft regulation provided taxpayer’s with the ability to use a “reasonable approximation” when “the state or states of assignment” could not be determined.  The new regulation clarifies that a taxpayer must, in good faith, make a reasonable effort to apply the primary rule applicable to the sale (e.g., the specific assignment rules for in-person services, professional services, or sales to, by, or through a customer) before it may reasonably approximate.  Additionally, the regulation explicitly states that a method of reasonable approximation “must reflect an attempt to obtain the most accurate assignment of sales consistent with the regulatory standards set forth in [the regulation], rather than an attempt to lower the taxpayer’s tax liability.”  There is no guidance as to how a taxpayer would demonstrate that its reasonable approximation attempt was made to “obtain the most accurate assignment of sales.”  This raises a number of questions–for example, if a taxpayer determines that there are two equally reasonable methods by which it can reasonably approximate its Massachusetts sales, can it use the method that results in less tax?  Additionally, there does not seem to be any converse requirement that the Department make a similar demonstration (i.e., that any modifications to a taxpayer’s sourcing methodology not be an attempt to increase a taxpayer’s liability) when exercising its authority to adjust a taxpayer’s return (as discussed below).

In an attempt to make the regulation more even-handed, the Department’s revisions provide that neither a taxpayer nor the Department may adjust a “proper” method of assignment, including a method of reasonable approximation, unless it is to correct factual or calculation errors.  However, the revision isn’t all that meaningful because there are still a broad number of scenarios in which the Department can make changes, one of which is when a taxpayer uses a method of approximation and the Commissioner determines that the method of approximation employed by the taxpayer is not “reasonable.”  Additionally, when a taxpayer excludes a sale from both the numerator and denominator of its sales factor because it has determined that the assignment of the sale cannot be reasonably approximated, [...]

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

by , and | Oct 23, 2014 | , , , , , , ,

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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Multistate Taxpayers Take Note! Recap of the First Day of the MTC Pricing Summit

by and | Oct 7, 2014 | , ,

On October 6, 2014, the Multistate Tax Commission (MTC) held the first day of a two-day meeting intended to educate state revenue authorities on corporate income tax issues surrounding intercompany transactions, and further refine a path forward for states interested in collaborating on audit and compliance strategies.  This first day focused entirely on presentations by specialists in transfer pricing and related intercompany transaction issues.  Two important themes and one blatant omission regarding future enforcement emerged from the first day:  (1) suggestions for increased disclosure and substantiation requirements; (2) safe harbor options and (3) a lack of discussion of how to prevent the risk of double taxation.

Taxpayers should be particularly concerned with the stress placed by the specialists on increased disclosure and substantiation requirements.  Most of the specialists emphasized the importance of getting information into the hands of revenue authorities.  Several suggested adding questions to the tax return itself such as “does the taxpayer use intangible property owned by an affiliate?”  These questions would be used to identify potential audit targets and focus audit inquiries.  Separately – but in a similar vein – several specialists suggested that taxpayers be required to create contemporaneous documentation substantiating their intercompany pricing at the state level.  An example provided was the Organisation for Economic Co-operation and Development proposal that a taxpayer provide a country-by-country analysis.  This example provoked at least one attendee to compare it to the infamous “50-state spreadsheet.”  Some specialists even suggested that states create special penalties for failure to properly disclose or create the required substantiation.

As some commentators acknowledged, a substantial concern with both the disclosure and substantiation suggestions is the risk of a significant increase in the cost of compliance for taxpayers.  State authorities should carefully consider the risk/rewards of any such action.  Increased state disclosure requirements, such as modeling the federal uncertain tax position rule, have not yet widely caught on among the states despite spurts of activity.  This is partially because of the administrative burden on taxpayers and partially because states receive a great deal of information from the Internal Revenue Service.  It is clear, however, that the states continue to be frustrated with the perceived tax planning problem.  The specialists expressed near-unanimous agreement that states need more information to properly enforce intercompany transaction issues.

The second theme of the day was the concept of safe harbors.  This theme took different forms but could be something that both taxpayers and state revenue authorities would support.  For example, some specialists suggested that for low-value transactions, safe harbor rules be created to provide increased certainty to taxpayers.  This might include providing limits on the percentage profit that could be made from certain types of intercompany transactions.  Other commentators and some states suggested, however, that additional safe harbor protections are unnecessary because state add-back statutes effectively provide safe harbor protection.

In a glaring omission, specialists failed to recognize or address the need to avoid double taxation.  Although several specialists noted that in the international area, most of the action happens [...]

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

by and | Sep 23, 2014 | , , , , , , , , , , ,

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.



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MTC’s Market-Based Sourcing Recommendations for UDITPA: Too Little, Too Late?

by | Sep 3, 2014 | , , ,

Member states of the Multistate Tax Commission (MTC) voted to adopt proposed amendments to Article IV of the Multistate Tax Compact during their annual meeting in late July.  The proposed amendments likely to have the most widespread impact on taxpayers are the amendments to the Uniform Division of Income for Tax Purposes Act (UDITPA) Article IV section 17 sourcing rules that change the sales factor sourcing methodology for services and intangibles from a costs of performance (COP) method to a market-based sourcing method. 

The MTC’s recommended market approach provides that sales of services and intangibles “are in [the] State if the taxpayer’s market for the sales is in [the] state.”  In the case of services, a taxpayer’s market for sales is in the state “if and to the extent the service is delivered to a location in the state.”  The proposed amendments also provide that if the state of delivery cannot be determined, taxpayers are permitted to use a reasonable approximation.  At this point, there is no additional guidance from the MTC on the meaning of “delivered,” how to determine the location of delivery in the event that a service is delivered to multiple jurisdictions, or what constitutes a reasonable approximation.

While the proposed amendments may be touted by some as the death knell of COP sourcing, for these changes to take effect, they will still need to be adopted individually by legislatures in Compact member states or in any other states that may choose to adopt them.  As we have seen over the last several years, many states have already forged their own paths in this area.  (See our article discussing the wide variety of market-based sourcing rules.)  Moreover, while many states have enacted market-based sourcing provisions with respect to the sale of services, certain states, unlike the MTC proposed amendments, have declined to convert to market-based sourcing for intangibles (e.g., Pennsylvania).

The proposed amendments leave taxpayers with many unanswered questions.  For example, assume a corporate taxpayer (Corporation A) is in the business of offering a payroll processing service.  Corporation A provides this service to Corporation B.  Corporation B’s management of the contractual arrangement with Corporation A occurs in Massachusetts, which is also the location of Corporation B’s human resources function.  Corporation B has 10,000 employees, 2,000 of whom are located in a jurisdiction that has adopted the MTC’s market-based sourcing recommendation (State X).  What portion of Corporation A’s receipts from the performance of its payroll processing service for Corporation B should be sourced to State X?

One can reasonably argue that the service is delivered to Corporation B as a corporation (i.e., that the human resources function is the true beneficiary) and not individually to Corporation B’s employees—leaving State X with nothing.  However, does the MTC’s language “if and to the extent the service is delivered” create an opportunity for State X to argue that it should receive 1/5 (2,000 employees/10,000 employees) of Corporation A’s receipts?

In late August, the MTC launched a project to [...]

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Retailers Caught in the Middle: To Tax or Not to Tax Delivery Fees

by | Jun 12, 2014 | , , , , , , , ,

Over the past decade we have seen a large increase in the number of third party tax enforcement claims against retailers involving transaction taxes (see Multistate Tax Commission Memorandum regarding survey of class action refund claims and false action claims, dated July 12, 2013, describing such actions).  The lawsuits typically are brought either as proposed class actions, alleging an over-collection of tax, or as whistleblower claims on behalf of state governments, alleging a fraudulent under-collection of tax owed to the state or municipality.  With respect to certain issues, including shipping and handling charges, retailers have been whipsawed with lawsuits alleging both under- and over-collection of tax.

On April 3, a proposed class action lawsuit was filed in Florida alleging that Papa John’s Pizza was improperly collecting tax on its delivery fees (Schojan v. Papa John’s International, Inc., No. 14-CA-003491 (Circuit Court Hillsboro County, Florida)).  The lawsuit is similar to an action filed in Illinois that resulted in an Illinois Supreme Court ruling rejecting a proposed class action claim that a retailer was improperly collecting tax on its shipping charges (Kean v. Wal-Mart Stores, Inc., 919 N.E.2d 926 (Illinois 2009)).

Both Florida and Illinois impose sales tax on services that are inseparably linked to the sale of tangible personal property (see, e.g., 86 Ill. Admin. Code § 130.415(b) & Fla. Admin. Code Ann. r. 12A-1.045(2)).  The regulations provide that whether a customer has separately contracted for shipping charges, or has an option to avoid shipping charges by picking up the property at the retailer’s location, can be used as a proxy to determine whether the services are separate and thus not taxable (86 Ill. Admin. Code § 130.415(d); Fla. Admin. Code Ann. r. 12A-1.045(4)(a), (b)).

In Kean, the Illinois Supreme Court held that shipping charges were a taxable part of an internet sale in which the customer had no option but to pay shipping charges.  After the ruling, the Illinois Department of Revenue made no announced change to its commonly understood audit position that sales tax was not owed on separately stated shipping charges that were assessed at a retailer’s actual cost.

Seeking to capitalize on the Kean ruling, an Illinois law firm has filed upwards of 150 lawsuits under the Illinois False Claims Act against retailers that do not collect tax on the shipping and handling charges associated with their internet sales, alleging an intentional failure to collect tax and seeking treble damages, attorneys’ fees and associated penalties.  The suits were filed without regard to whether the retailers had been audited and found not to owe tax on their shipping and handling charges.  The State has declined to intervene in the majority of these cases, permitting the Relator to proceed with the prosecution.  Because the amounts at issue are small (6.25 percent tax on shipping and handling charges), the lawsuits force many retailers to choose between paying an (entirely undeserved) settlement to resolve the litigation or bearing the expense of litigation.  For reasons not entirely clear, the Illinois General Assembly [...]

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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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Multistate Tax Commission Appoints Keith Getschel as Director of Joint Audit Program

by and | May 6, 2014 | , , ,

Beginning June 16, Keith Getschel will succeed Les Koenig as the Director of the Multistate Tax Commission (MTC) Joint Audit Program.  Les Koenig is retiring as of July 31.  Mr. Getschel comes from the Minnesota Department of Revenue, having held the position of Assistant Commissioner for Business Taxes since 2012.  Mr. Getschel has worked in the Minnesota Department of Revenue for over 30 years, holding such positions as Director of Corporate Tax and Assistant Director in the Corporate and Sales Tax Division.  He also has experience as a supervisor in the Tax Operations Division, a tax policy manager, a revenue tax specialist in the Amended Returns Unit, and an appeals officer in the Appeals and Legal Services Division.

The MTC Joint Audit Program performs audits on behalf of participating states.  The program engages in audits of taxpayers simultaneously across multiple states, conserving state funds and time.  Mr. Getschel’s reputation as a tax administrator in the Minnesota Department of Revenue makes him a great fit for this position.  He has been viewed as taxpayer friendly and willing to work cooperatively with taxpayers to resolve issues.  We hope he continues this trend at the MTC.



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