Earlier today, the Tennessee Department of Revenue (DOR) submitted a new sales and use tax regulation for publication titled “Out-of-State Dealers” (Rule 1320-06-01-.129) that would administratively create an economic nexus threshold. With the submission, Tennessee becomes the most recent addition to the growing list of states seeking to directly attack the Quill physical presence standard. As detailed in our prior blog, both Alabama and South Dakota are already litigating whether their economic nexus standards are sufficient to satisfy the dormant commerce clause substantial nexus requirement. Additionally, at least 11 different bills in eight different states have been introduced in state legislatures so far in 2016. With states continuing to attack Quill from all angles, remote sellers are scrambling to keep up with the increasingly volatile nexus landscape. Continue Reading
On May 31, 2016, the Washington Department of Revenue (DOR) Appeals Division released a Determination (No. 15-0251, 35 WTD 230) denying a German pharmaceutical company’s business and occupation tax (B&O) protest. The administrative law judge (ALJ) ruled that while the nondiscrimination provisions contained in Article 24 of the US-Germany Income tax Treaty (Treaty) “may apply,” the B&O does not discriminate against non-US businesses because it is imposed on any business deriving royalty income from Washington sources and applies equally to foreign and US companies. The ALJ also found that the company could avoid double taxation of the royalty income by excluding income taxed by Washington from its German tax base. While the company also challenged the constitutionality of the 2010 B&O economic nexus law, the ALJ declined to entertain it—citing a lack of authority to rule on the constitutionality of Washington statutes.
Ever since Alabama’s new economic nexus regulation went into effect, litigation over its constitutionality has been expected given that Alabama Commissioner Julie Magee and Governor Bentley said as much when announcing it (Rule 810-6-2-.90.03, effective January 1, 2016). It appears that they finally got their wish. On June 8, 2016, Newegg Inc. (Newegg) filed a Notice of Appeal in the Alabama Tax Tribunal challenging the Alabama Department of Revenue (DOR) Notice of Final Assessment of Sellers Use Tax (Assessment) that was entered on May 12, 2016. The Assessment is for seller’s use tax, interest and penalties for the months of January and February 2016 (the Assessment Period), which represent the first two months the new regulation was in effect.
The Alabama litigation comes on the heels of the litigation in South Dakota, which also involves Newegg and other retailers. Although the critical issue in both is whether economic nexus is constitutional, given that the Alabama imposition is through a regulation and not a statute, the arguments in each state’s litigation may not be parallel.
DOR Explanation of the Assessment
The DOR asserts that under the new regulation Newegg has a “substantial economic presence” in Alabama. According to Newegg, the DOR “has offered no basis for its determination” that the regulation’s requirements were satisfied during the Assessment Period. Specifically, Newegg notes that the DOR “conclusion appears to be based solely upon the fact that Newegg had ‘significant sales into Alabama,’ i.e., more than $250,000 of retail sales to Alabama customers.”
Newegg’s Grounds for Appeal
Newegg requests that the Tax Tribunal cancel the Assessment, citing the following grounds as the primary basis:
- The application of the new regulation to Newegg (and the Assessment) are unconstitutional because Newegg did not (and does not) have the necessary physical presence required to satisfy the “substantial nexus” standard for sales and use taxes under the Commerce Clause, as described by the US Supreme Court in Quill.
- The new regulation is invalid because retailers must “lack an Alabama physical presence” for it to apply. Therefore, it conflicts with both the Alabama sales and use tax statutes and the US Constitution, each of which requires a physical presence in the state by (or on behalf of) the retailer.
- The application of the new regulation to an internet retailer with no physical presence in Alabama is inconsistent with the authorizing seller’s use tax statute. Specifically, none of the provisions of the sales and use tax statutes (or any other provision in the Alabama Code) authorize the DOR to impose seller’s use tax collection obligations on internet retailers with no physical presence in the state.
The State of Nexus in Other States
The Alabama litigation represents the third prominent nexus case that involves Newegg. Not only is the company involved in South Dakota (see our prior coverage of the South Dakota lawsuits here), but it is also one of the three taxpayers involved in the Ohio Commercial Activity Tax (CAT) litigation (see our prior coverage of the Ohio lawsuits here). All three cases involve the imposition of nexus on a company without physical presence in the taxing state, one with respect to a gross receipts tax (the Ohio CAT), and the others with respect to sales and use taxes.
On May 25, 2016, the fast-tracked lawsuit filed by South Dakota was (at least temporarily) slowed down when defendants filed a Notice of Removal (Notice) in the US District Court for the District of South Dakota. Under the Federal Rules of Civil Procedure, the plaintiff (South Dakota here) has 30 days (i.e., until June 24, 2016) to file a motion to remand based on a defect in the removal procedure. However, a claim based on lack of subject matter jurisdiction can be raised at any time. According to the Notice and accompanying documentation, the basis for removal is federal question jurisdiction. Because the defendants notified the state court, the state court is likely deprived of jurisdiction to act unless the federal court remands the case back to state court. If South Dakota proceeds with the litigation in federal court, it will lose the benefits of the expedited state court appeal process enacted by Senate Bill 106. Only time will tell how the case proceeds.
As judicial challenges to the continued viability of Quill move further along (with Alabama now joining South Dakota as a state with potential Quill litigation pending), the impact on the status of federal legislation remains to be seen. Speaking before the Federation of Tax Administrators (FTA) yesterday, Commissioner Magee pointed out that 41 remote sellers have signed up for Alabama’s Simplified Sellers Use Tax Program, which allows them to avoid the application of the new economic nexus regulation. The Commissioner proudly touted revenue raised in excess of $1 million in the first calendar quarter of 2016 alone. Although we only know of the Newegg case at this point, it’s likely that there are many other assessments and suits to come in Alabama.
During yesterday’s FTA panel presentation on the topic (by Commissioner Magee, South Dakota Secretary Andy Gerlach, COST’s Fred Nicely and Steve Kranz) and conversations that followed, tax administrators in a number of states expressed a willingness to accept prospective voluntary disclosure agreements (VDA’s) from remote retailers. See our prior article explaining why taxpayers should say no to standard VDA lookback periods. In states where a risk of retroactive application exists (or where the taxpayer is going to begin filing anyway) it makes sense to explore the possibility of a prospective arrangement and ensure the state does not seek backward-looking compliance with their new law or position. It should be noted that, unlike South Dakota, the Alabama regulation does not contain any provisions regarding retroactivity. The regulation took effect as of January 1, 2016, and, ostensibly, liability for retailers not collecting and remitting is accumulating. Retailers should review their positions regarding Alabama and determine the potential liability. Retroactivity was a significant issue in the Quill case and, unlike South Dakota, there is no statute limiting the effect of a judicial decision to a prospective basis. How this will affect the litigation remains to be seen.
As detailed in our blog last month, MoneyGram Payment Systems, Inc. (MoneyGram) is stuck in between a rock and a hard place as states continue to duel with Delaware over the proper classification of (and priority rules applicable to) MoneyGram’s escheat liability for uncashed “official checks.” The dispute hinges on whether the official checks are properly classified as third-party bank checks (as Delaware directed MoneyGram to remit them as) or are more similar to “money orders” (as alleged by Pennsylvania, Wisconsin and numerous other states participating in a recent audit of the official checks by third-party auditor TSG). If classified as third-party bank checks, the official checks would be subject to the federal common law priority rules set forth in Texas v. New Jersey, 379 U.S. 674 (1965) and escheat to MoneyGram’s state of incorporation (Delaware) since the company’s books and records do not indicate the apparent owner’s last known address under the first priority rule. However, if the official checks are classified as more akin to money orders under the federal Disposition of Abandoned Money Orders and Traveler’s Checks Act of 1974 (Act), as determined by TSG and demanded by Pennsylvania, Wisconsin and the other states, they would be subject to the special statutory priority rules enacted by Congress in response the Supreme Court of the United States’ Pennsylvania v. New York decision and escheat to the state where they were purchased. See 12 U.S.C. § 2503(1) (providing that where any sum is payable on a money order on which a business association is directly liable, the state in which the money order was purchased shall be entitled exclusively to escheat or take custody of the sum payable on such instrument).
In addition to the suit filed by the Pennsylvania Treasury Department seeking more than $10 million from Delaware covered in our prior blog, the Wisconsin Department of Revenue recently filed a similar complaint in federal district court in Wisconsin, alleging Delaware owes the state in excess of $13 million. Other states participating in the TSG audit (such as Arkansas, Colorado and Texas) also recently made demands to MoneyGram and Delaware.
It is interesting to note that in 2015, Minnesota (MoneyGram’s former state of incorporation) turned over in excess of $200,000 to Pennsylvania upon its demand for amounts previously remitted to Minnesota for MoneyGram official checks. Apparently not only do the states in which the transaction occurred disagree with but even a former state of incorporation took the majority path. Continue Reading
At a hearing yesterday, Cook County Circuit Judge James Snyder granted the State of Illinois’ (State) Motion to Dismiss 201 Illinois False Claims Act (FCA) cases filed by the law firm of Stephen B. Diamond, PC (Relator) against out-of-state liquor retailers. The lawsuits alleged that the defendants were obligated to collect and remit sales tax on their internet sales of alcohol shipped to Illinois customers. The complaints admitted that the defendants lacked any physical presence in the state, and would not qualify for any Illinois liquor retail license, but nevertheless asserted a tax collection obligation for sales and a tax remission obligation for gallonage tax arising under the 21st Amendment of the US Constitution and the Supreme Court’s decision in Granholm v. Heald, 544 U.S. 460 (2005).
In its motion to dismiss and at oral argument, the State relied upon the favorable standard for consideration of motions to dismiss False Claims Act cases filed by the State established by the Illinois Appellate Court in two prior cases: State ex rel. Beeler, Schad & Diamond v. Burlington Coat Factory Warehouse Corp., 369 Ill. App. 3d 507 (1st Dist. 2006) and State ex rel. Schad, Diamond & Shedden, P.C. v. QVC, Inc., 2015 IL App (1st) 132999 (Apr. 21, 2015). In both cases, the appellate court held that when the State moves to dismiss a qui tam action allegedly filed on its behalf, its motion should be granted absence evidence of “glaring bad faith” on the part of the State in moving to dismiss. The State argued that it had concluded that the Relator’s claims were weak, based in part on the Relator’s admission that the defendants lacked nexus. In response, the Relator argued that the State had acted in bad faith by relying on Quill Corp. v. North Dakota, 504 U.S. 298 (1992) and other commerce clauses nexus rulings and, according to the Relator, ignoring the 21st Amendment and Granholm, which the Relator alleged supplanted any nexus analysis (a point the State and the defendants vigorously disputed in briefing prior to argument).
After hearing argument, Judge Snyder ruled from the bench that the Diamond firm had failed to meet its burden of proving bad faith by the State in moving to dismiss the 201 lawsuits.
The Diamond firm will have 30 days from the date of entry of the Circuit Court’s dismissal orders to either seek reconsideration or appeal from the trial court’s ruling.
On May 20, 2016, the Texas Comptroller of Public Accounts published proposed amendments to 34 Tex. Admin. Code 3.584 – relating to the reduced rate available under the Texas Franchise Tax for retailers and wholesalers – in the Texas Register. As previously reported, these proposed revisions have the potential to double the tax rate for a substantial number of businesses – namely those in the information technology and pharmaceutical industries.
The proposed changes to Rule 3.584 were first circulated as draft amendments to interested parties in April. Although some interested parties opposed the draft, the official published version has remained unchanged after that initial informal review. To summarize, entities “primarily engaged in retail or wholesale trade” are subject to a Texas Franchise Tax rate that is half the rate imposed on other businesses – 0.375 percent versus 0.75 percent for reports originally due on or after January 1, 2016. To qualify for this reduced rate, a business must (among other statutory requirements) 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). In a substantial change from the current version of Rule 3.584, the proposed amendments – which have a retroactive effective date of January 1, 2008 – provide that a retailer is considered to produce the products it sells if the business “manufactures, develops, or creates tangible personal property that is incorporated into, installed in, or becomes a component part of the product that it sells.” See proposed Rule 3.584(b)(2)(C)(ii). The proposed Rule offers two examples of businesses that will now be considered “producers” rather than retailers: (1) a business that produces a computer program, such as an application or operating system, that is installed in a device that is manufactured by a third party; and (2) a business that produces the active ingredient in a drug that is manufactured by an unrelated party. As discussed in prior coverage, these proposed changes create a regulation that is neither consistent with the language of the statute it purports to interpret nor supported by the common sense understanding of what it means to be a “producer” versus a “retailer.”
Although the proposed changes to Rule 3.584 have the potential to double the tax rate for those retailers and wholesalers who also engage in “development” activities and a retroactivity period of over eight years, the Chief Revenue Estimator, Tom Currah, has determined that “for the first five-year period the rule will be in effect, there will be no significant revenue impact on the state or units of local government” – and there is “no significant anticipated economic cost to individuals who are required to comply with the proposed rule.” Mr. Currah also has determined that for each year of the first five years the rule is in effect, the anticipated public benefit will be “conforming the rule to current legislation and policy.” No statement of fiscal implications for small businesses is required.
The publication of the proposed revisions in the Texas Register has started the clock for the submission of public comments. Comments must be received no later than 30 days from the date of publication; i.e., by Monday, June 20, 2016. Comments may be submitted to Teresa G. Bostick, Director, Tax Policy Division, P.O. Box 13528, Austin, Texas 78711-3528.
In this article, the authors examine recent judicial and administrative developments related to the “subject-to-tax” exception of state addback statutes and present avenues for potential challenge.
On April 4, 2016, without warning, the US Department of the Treasury proposed a new set of comprehensive regulations under section 385. There had been no advance indication that regulations were even under consideration. Although the Treasury indicated that the proposed regulations were issued in the context of addressing corporate inversions, their application went well beyond the inversion space and they apply to inter-corporate debt regardless of whether it occurs in an international context. The following is a discussion of the state and local tax consequences of the proposed regulations; for a detailed discussion of the proposed regulations themselves, see this previous article.
Litigation over unclaimed property rules and obligations continues to accelerate. The first quarter of 2016 brought developments in several cases, including a much-watched contest over merchandise credits and a new battle between the states over which state gets the money.
California Merchandise Credits Not Subject to Remittance as Unclaimed Property; Implicit Application of Derivative Rights Doctrine Prevails
On March 4, 2016, a California superior court held in Bed Bath & Beyond, Inc. v John Chiang that unredeemed merchandise return certificates (certificates) issued by Bed Bath & Beyond (BB&B) to tis California customers are exempt “gift certificates” under the California Unclaimed Property Law—and not “intangible personal property” under the California catch-all provision. Like many retail stores, BB&B provides the certificates as credits to customers who return items without a receipt. While the certificates may be redeemed for merchandise at BB&B or one of its affiliates, they cannot be redeemed for cash. BB&B took the position that it mistakenly reported and remitted the unclaimed certificates from 2004 to 2012 and filed a refund claim with the California State Controller’s Office (Controller) in 2013 for the full amount remitted during that time period (amounting to over $1.8 million). The Controller denied the claim, and BB&B proceeded to sue John Chiang, both individually and in his official capacity as former California state controller. The relief sought by BB&B was the full refund request, plus interest. Continue Reading
Last Friday, the Alabama Court of Civil Appeals handed the Department of Revenue (Department) a significant loss in their continued attempt to tax non-enumerated services and tangible property provided in conjunction with those services under the sales tax. See State Dep’t of Revenue v. Omni Studio, LLC, No. 2140889 (Ala. Civ. App. Apr. 29, 2016). Specifically, the appellate court affirmed the taxpayer’s motion for summary judgment granted by the trial court, which set aside the Department’s assessment on the basis that photographs provided by a photography studio are merely incidental to the nontaxable photography services provided by the studio. While the prospective effect of the holding in the photography context is unclear due to recent amendments to the photography regulation (effective January 4, 2016), the case is significant in that it strengthens the “incidental to service” (or “true object”) precedent in Alabama and should be seen as a rebuke to the Department for ignoring judicial precedent in favor of their own administrative practices and guidance.
This decision is important in analyzing the taxability of mixed/bundled sales to Alabamans (i.e., where services and some degree of tangible personal property are provided as part of the same transaction). As with any decision, taxpayers should consider potential refund claims. Continue Reading