INSIDE SALT

ITFA Is Alive and Well: New York Advisory Opinion Reaffirms Sales Tax Exemption for Internet Access Services

by Eric D. Carstens and Jonathan C. Hague | Oct 2, 2024 | Constitutional Issues, Local Tax, Nationwide Importance, New York, Sales Tax

In its latest Advisory Opinion, TSB-A-24(4)S (June 26, 2024), the New York State Department of Taxation and Finance (the Department) reaffirmed the broad protections offered by the Internet Tax Freedom Act (ITFA) against state and local taxation of internet access. The Petitioner, a New York-based business, sought clarity on whether its subscription to a secure hosted exchange service, which facilitates critical email functions without requiring internal IT infrastructure, would be subject to New York State sales tax.

KEY FACTS AND BACKGROUND

The Petitioner subscribes to a secure hosted exchange service from a provider located in Florida. This service offers comprehensive email management, including mobile device synchronization and Microsoft Exchange functionalities. The service includes (1) unlimited mailbox storage, (2) premium email security protection, (3) anti-virus protection, and (4) live phone support. The service relies on the Petitioner maintaining its own internet connection, with software licensing obligations dictated by agreements with third-party vendors.

THE DEPARTMENT’S RULING

After acknowledging that email service qualifies as taxable telephony or telegraphy service under New York Tax Law § 1105(b)(1), the Department concluded unequivocally that “[e]lectronic mail services are included in the ITFA definition of Internet access, regardless of whether such services are provided independently or packaged with Internet access” and are, therefore, not subject to New York State sales tax. This decision hinges on the protections established by ITFA, which precludes state and local governments from imposing taxes on Internet Access.

ITFA: A CRITICAL SAFEGUARD AGAINST STATE TAXATION

ITFA, enacted in 1998 and made permanent in 2016, has consistently served as a bulwark against state efforts to impose tax on Internet Access and multiple or discriminatory taxes on electronic commerce. See ITFA § 1101(a). Under ITFA’s Internet Access prong, services that enable users to access content, information, email, or other services offered over the internet are shielded from state and local sales taxes.[1] The Advisory Opinion underscores this federal protection, categorizing the Petitioner’s email services as an Internet access service, which is exempt from New York State sales tax under ITFA.

REINFORCING ITFA’S PREEMPTIVE POWER: RECENT CASES

This is not an isolated application of ITFA. ITFA has recently been at the center of significant legal challenges, reinforcing its importance in protecting digital services from state taxation. For example, in Petition of Verizon New York Inc., DTA No. 829240 (N.Y. Div. Tax App. May 4, 2023), an administrative law judge (ALJ) ruled that the gross receipts tax on transportation and transmission corporations could not be applied to revenues from asymmetric digital subscriber line and fiber broadband services because these services are federally preempted under ITFA as Internet Access. In rejecting the Department’s narrow interpretation of internet access services, which only included services provided to end-user consumers, the ALJ emphasized that US Congress intended ITFA’s prohibition on taxing Internet Access to be broad, using the definition from ITFA rather than state tax law.

ITFA’S ONGOING RELEVANCE

New York’s Advisory Opinion highlights the continued importance of ITFA in today’s digital economy. As businesses increasingly [...]

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Texas Comptroller Proposes Rule Changes Cementing Tax on 130% of Marketplace Sales

by Stephen P. Kranz, Mark Nebergall and Jonathan C. Hague | Sep 17, 2024 | Audits, Nationwide Importance, Sales Tax, Tax Base, Texas, Transaction Taxes

In a controversial move, the Texas Comptroller is poised to amend Rule 3.330, Data Processing Services, effectively rewriting the rules to favor the contentious stance it has adopted in recent audits and litigation. This proposed amendment, which aims to cement the aggressive stance the Comptroller has taken in audits and litigation that a marketplace provider’s commission-based earnings are taxable “data processing services,” represents a significant departure from long-standing practices and highlights a disturbing trend of what is effectively a retroactive regulatory adjustment.

A LOOK AT THE PROPOSED CHANGES

The crux of the proposed amendment is the addition of paragraph (b)(5) to Rule 3.330, which the Comptroller explains is being added “to clarify that marketplace providers provide data processing services to their customers as they enter, retrieve, search, manipulate, and store data or information in the course of their business.” New paragraph (b)(5) provides that:

Marketplace provider services may be included in taxable data processing services when they involve the computerized entry, retrieval, search, compilation, manipulation, or storage of data or information provided by the purchaser or the purchaser’s designee. For example, services to store product listings and photographs, maintain records of transactions, and to compile analytics are taxable data processing services.

This new paragraph specifically targets the commissions that marketplace providers charge for facilitating sales, taxing them separately from the underlying transactions themselves. This is not just an expansion of the tax base; it’s a redefinition of what constitutes a taxable service, applying it in ways that were never intended under previous interpretations of the law that considered such commissions nontaxable auctioneer/brokerage fees.

WHY THIS AMENDMENT IS PROBLEMATIC

The Comptroller’s approach is problematic for several reasons, including:

Effective Retroactivity. The proposed amendment seeks to justify an aggressive (and questionable) agency position that the Comptroller has only recently begun to assert in audits and litigation after it quietly revoked a long-standing administrative ruling in 2020. The revocation of this ruling in 2020, without public notice or legislative approval, was a stark deviation from established practices. By changing the rules after the fact, the proposed amendment undermines the stability and predictability of the law.
Double Taxation. If a marketplace facilitates a sale where a consumer pays $100 and the marketplace earns a $30 commission, the proposed amendment would not only tax the $100 transaction but also the $30 commission. This results in an effective tax on 130% of marketplace sales, with the additional 30% a double tax on the portion of the sales proceeds paid to the marketplace provider as a commission. Under this scheme, the Comptroller is demanding that marketplace providers pay tax on 130% of the sales price and charge the consumer for tax on the 100% and the seller for the 30%.
Discriminatory Tax Under ITFA. The proposed amendment subjects commissions earned by online marketplace providers to taxation as data processing services while similar services provided offline, such as commissions earned by auctioneers of oil and gas leases, consignment stores, and real estate agents using [...]

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California Legislatively Overturns Recent Office of Tax Appeals Taxpayer Win

by Stephen P. Kranz, Michael J. Hilkin and David Jasphy | Jul 3, 2024 | Allocation/Apportionment, California, Federal Tax, Income Tax, Nationwide Importance, Tax Base

The California State Legislature overturned Microsoft’s recent win at the Office of Tax Appeals, which held that the gross amount of dividends received from foreign affiliates outside its water’s-edge group should be included in its sales factor denominator, regardless of the application of a dividends-received deduction excluding 75% of such dividends from its taxable base.

The legislation declares that FTB Legal Ruling 2006-1 “shall apply with respect to apportionment factors attributable to income exempt from income tax under the Corporation Tax Law,” and it claims that the declaration “does not constitute a change in, but is declaratory of, existing law.” Consistent with the FTB’s position in the Microsoft case, Legal Ruling 2006-1 would limit the sales factor denominator to the net dividends included in the tax base.

Governor Murphy Saddles Taxpayers With the Nation’s Highest Corporate Tax Rate

by Stephen P. Kranz, Michael J. Hilkin and David Jasphy | Jul 2, 2024 | Income Tax, New Jersey

New Jersey Governor Phil Murphy’s proposed flip-flop, which reneges on his promise to allow the state’s 2.5% corporate business tax surtax to expire, has now passed both the New Jersey State Assembly and Senate and been signed by the governor. As a result, New Jersey will once again have the highest corporate income tax rate in the nation at 11.5%. The surtax will now apply to corporate taxpayers with “allocated taxable net income in excess of” $10 million a year, and it applies to tax years beginning in 2024. The legislation would allow the tax to expire after 2028 – but as surtax payers know, any expiration date is subject to extension.

Good News for SALT Taxpayers? Supreme Court Overturns Federal Agency Deference

by Stephen P. Kranz, Diann Smith and Michael J. Hilkin | Jun 28, 2024 | Nationwide Importance

On June 28, 2024, in Loper Bright Enterprises v. Secretary of Commerce, the Supreme Court of the United States ruled to overturn its four-decade-old decision in Chevron USA Inc. v. Natural Resources Defense Counsel. While the Loper case addressed deference to administrative agencies under the federal Administrative Procedure Act (APA), its outcome may give state and local taxpayers a better chance of persuading state courts that a tax authority’s interpretation of a tax statute is invalid. This is because many states have relied on the Chevron doctrine when deciding that state administrative procedure acts require deference to an agency action. State courts must now reconsider whether the eradication of Chevron deference at the federal level also applies at the state level.

BACKGROUND

Chevron set the standard that federal courts must apply binding deference to a government agency’s interpretation of the law in the absence of a clear answer within the statute itself. Under the Chevron doctrine, if a federal statute was silent or ambiguous on a question of law, and the federal agency charged with enforcing the law had provided an interpretation of that statute, a court was required to defer to the relevant federal agency’s interpretation (even if the court on its own would have reached a different result). For decades, Chevron prevented entities challenging agency action from receiving a balanced review of an issue by courts. The Chevron doctrine has historically presented significant hurdles to plaintiffs, including taxpayers, seeking to challenge actions of federal agencies (such as the Internal Revenue Service).

But in Loper, the Supreme Court decided that the holding in Chevron is inconsistent with the APA and the historical and constitutional role of the judicial branch, and thus explicitly overturned the Chevron deference standard. This means that, with respect to federal agency interpretations of law, the thumb has been taken off the scale. (Of course, there are still lots of other thumbs on this scale, such as the burden of proof is always on the taxpayer and the preference of judges to favor the state for fiscal reasons, but let’s take a win when we can!).

EFFECT ON STATE TAX CONTROVERSIES

The holding in Loper should impact the scope of state court review of state and local tax authority interpretations of law in many circumstances. This is because (a) many states have adopted language substantially similar to the federal APA at issue in Loper and (b) many state courts have specifically cited to Chevron in deferring to a tax authority’s interpretation of the law.

The potential application to states is clear based on several statements in the Loper opinion. The Supreme Court stated, “Chevron cannot be reconciled with the APA” and “[a]gencies have no special competence in resolving statutory ambiguities. Courts do.” In states that do not have specific statutory provisions providing for deference to a tax authority or specifically delegating authority for interpretation of a specific statute to a tax authority, taxpayers should raise the decision in Loper in an action challenging tax authority regulations. [...]

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