On May 8, Washington’s 1.2% surtax on “specified financial institutions” (banks with at least $1 billion a year in net revenue) was struck down by a King County Superior Court judge. Judge Marshall Ferguson ruled that the tax, which is imposed on top of all other taxes, violates the Commerce Clause of the US Constitution by discriminating against out-of-state banks in both purpose and effect.

In their briefs, attorneys for the Washington Bankers Association and American Bankers Association explained that an out-of-state bank would pay a much higher tax rate (and be at a competitive disadvantage) compared to an in-state bank because its global revenue is sufficient to trigger owing the surtax. The associations presented evidence that every bank meeting the definition of “specified financial institution” was an out-of-state bank, and that no in-state bank met the definition. Further, they pointed to statements by legislators appearing to show an intent to promote “local banks” and address a national wealth disparity and regressive taxation.

The state responded that the surtax is neutral on its face, applying to all businesses with $1 billion regardless of their headquarters location, and that none of the funds were used to subsidize or reduce tax burdens on in-state banks. They also argued that the tax should be presumed constitutional and rejected the plaintiffs’ standing to sue as associations. The actual effect of discrimination seemed especially persuasive to Judge Ferguson, who asked counsel for the state, “If the tax so clearly falls on non-Washington businesses, is that not a discriminatory effect?”

The state may appeal the case, Washington Bankers Association et al. v. State of Washington et al., No. 19-2-29262-8, to the Washington Supreme Court.

Practice Note: The structure of the tax struck down in this case, a surtax imposed only if the company’s global income exceeds a high threshold, has been on the rise. San Francisco’s gross receipts tax on businesses with over $50 million in receipts, Portland’s clean energy surcharge on businesses with over $1 billion in national gross revenue, and Maryland’s proposed digital advertising tax based on a sliding scale of global revenue all come to mind. This ruling may be the first sign that judges will not be afraid to subject such taxes to scrutiny under Commerce Clause analysis.

Yesterday Governor Gavin Newsom turned to a familiar gambit from California’s playbook to help tackle the budgetary hole wrought by COVID-19. In January, the Governor proposed his budget for the 2020-2021 fiscal year, which projected a $5.6 billion surplus. Indeed, revenues through March are reported as having run $1.35 billion above projections. But, as the Governor says in his May Revision to his January Budget, “[t]he COVID-19 pandemic and the resulting recession has changed the fiscal landscape significantly.” Without the various changes proposed by the May Revision, which includes the “revenue solutions” described below, the Governor’s Budget projects a $54 billion deficit.

The May Revision proposes two significant changes to business taxation. The Governor proposes suspending net operating losses for 2020, 2021, and 2022 for medium and large businesses. The Governor also proposes limiting business incentive tax credits from offsetting more than $5 million of tax liability per year for 2020, 2021, and 2022.

While it is not known what parameters were used for the May Revision revenue estimates, and the actual threshold for being a medium or large business subject to NOL suspension will be set during the legislative process should the Governor’s proposal be enacted, standards used for prior NOL suspension periods may provide a guide. For taxable years beginning in 2008 and 2009, California suspended the NOL carryover deduction for taxpayers with a net business income of $500,000 or more. For taxable years beginning in 2010 and 2011, California’s NOL suspension affected taxpayers with a modified adjusted gross income of $300,000 or more. In neither case were disaster losses affected by the NOL suspension rules.

The May Revision also includes two proposals to address the sales and use tax gap: (1) Used car dealers would have to remit sales tax to the Department of Motor Vehicles with the registration fees, and (2) Market value will be used to determine the price paid in private auto sales.

Also tagged as “revenue solutions” in the May Revision are three General Fund proposals from the Governor’s January Budget Proposal: (1) Extending the sales tax exemption for diapers and menstrual products through the end of 2022-23; (2) Extending the carryover period for film credits awarded under Program 2.0 from six years to nine years; and (3) Extending the current exemption from the minimum tax for first year corporations to first year LLCs, partnerships and LLPs. The May revision also maintains a new tax on e-cigarettes based on nicotine content and will be deposited in a new special fund.

Overall, the revenue solutions in the May Revision are projected to net $4.4 billion in 2020-21, $3.3 billion in 2021-22 and $1.4 billion in 2022-23. The Governor states, “These tax measures as a whole are intended to raise revenue, stimulate economic growth, and help those in need.”

He explains that his May Revision revenue solutions “recognize the disproportionate tax relief that has been provided to larger corporations, compared to small businesses, which has resulted in relatively lower tax payments.” And he adds that the proposed thresholds and limits for NOL suspension and utilization are “in recognition of the COVID-19 Recession and its impacts on small businesses.”

California’s bill to authorize tax-based false claims actions—allowing private, profit-motivated parties to bring punitive civil enforcement lawsuits—cleared the Assembly Judiciary Committee on May 11 in a party-line vote. The bill, AB 2570, is sponsored by the committee’s chair, Assemblymember Mark Stone (D), and has strong backing from Attorney General Xavier Becerra. It now goes to the Assembly Appropriations Committee.

Proponents claim the bill only affects “tax cheats” but under similar laws in Illinois and New York, very few cases involve internal whistleblowers, actual fraud or reckless disregard of clear law. Instead, they typically involve inadvertent errors or good-faith interpretations of murky tax law. Moreover, while there often is an erroneous assumption that most tax false claims actions are brought by “by-the-books” whistleblowers acting in the interest of the taxing jurisdiction, claims in the tax realm are primarily developed and driven by a cottage industry of plaintiffs’ law firms with profit-motivated incentives seeking to exploit an area of the law that leans in their favor.

Continue Reading False Claims Bill Advances in California – Taxpayers Beware!

The revived False Claims expansion bill in California, A.B. 2570, is on the agenda to be heard by the Assembly Judiciary Committee on May 11 at 10:00 am PDT. The proposal would authorize tax-based false claims actions, allowing private, profit-motivated parties to bring punitive civil enforcement lawsuits—an abusive practice that is prohibited under current law consistent with the vast majority of other states with similar laws. A nearly identical bill sputtered out last summer but has now been revived, as our colleagues covered in February:

AB 2570 is replete with problematic provisions, including: (1) the imposition of a separate statute of limitations that will arguably trump any shorter limitations periods imposed by the Revenue & Taxation Code (See Cal. Gov’t Code § 12654(a) which permits claims under the CFCA to be pursued for up to 10 years after the date the violation was committed, compared to standard three or four years for tax audits); (2) a more lenient burden of proof for elements of an alleged violation; and, (3) extremely punitive damages—violators are subject to treble damages (i.e., three times the amount of the underreported tax, interest and penalties), an additional civil penalty of $5,500 to $11,000 for each violation, plus the costs of the civil action to recover the damages and penalties including attorney’s fees.

Few of these cases will involve internal whistleblowers, actual fraud, or reckless disregard of clear law. Instead, the cases in Illinois (a state that has adopted false claims expansion to tax) usually involve inadvertent errors or good-faith interpretations of murky tax law. With the party bringing the case able to keep up to 50% of the proceeds, the only winners in the proposal is the cottage industry of money hungry plaintiffs’ attorneys that will descend and harass good-faith taxpayers in an effort to pad their own pockets.

On Tuesday we authored a blog post commending San Francisco County Assessor Carmen Chu for moving the deadline for businesses to file their Business Property Statements (Form 571-L) to June 1 of this year. We noted that California statutory authority provides that if the property tax filing deadline falls on a date when the county assessor’s office is closed for the entire day, a property statement that is mailed and postmarked on the next business day is deemed to have been timely filed. We further explained, however, that despite the fact that most, if not all, county assessor offices across the state are closed due to COVID-19, most assessors have been reluctant to provide relief to the taxpayers struggling to meet the May 7 deadline. Consequently, we urged county assessors to follow the example set by the San Francisco County assessor and to likewise extend the business property tax deadline.

In April, we also authored a blog post encouraging the State Board of Equalization and county officials to issue clear, unambiguous guidance regarding the late-payment penalty waivers being offered to taxpayers who were unable to timely pay the second installment of their secured property taxes by the April 10th deadline due to hardship caused by COVID-19. We stated that although the provision of penalty waivers was an important first step, the ambiguity surrounding how a taxpayer might “prove” that he or she was “impacted by COVID-19” necessitated additional guidance.

Yesterday, on May 6, 2020, Governor Gavin Newsom announced that he had signed a new executive order (Executive Order N-6-20) as a means of providing certain property taxpayers with much-sought relief.

“The COVID-19 pandemic has impacted the lives and livelihoods of many, and as we look toward opening our local communities and economies, we want to make sure that those that have been most impacted have the ability to get back on their feet,” said Governor Newsom.

As a first step, the executive order suspends, until May 6, 2021, penalties for failing to pay certain property taxes that were not delinquent before March 4, 2020, for taxpayers who demonstrate they have experienced financial hardship due to the COVID-19 pandemic. This extension applies to residential property owners and businesses that qualify as a small business under the Small Business Administration’s Regulations Code. To be eligible for the penalty waiver, a taxpayer must demonstrate “to the satisfaction of the tax collector that the taxpayer has suffered economic hardship, or was otherwise unable to tender payment of taxes in a timely fashion due to the COVID-19 pandemic, or any local, state, or federal government response to COVID-19.”

Second, the order also extends the deadline for certain businesses to file their Business Personal Property Tax Statements (Form 571-L) from May 7 to May 31 of this year. Specifically, the order suspends California Revenue and Taxation Code (“RTC”) section 441, subdivision (b) and RTC section 463, subdivision (a) until May 31, 2020, to the extent that either imposes a penalty for failure to file a property tax statement on or before May 7, 2020, such that no penalty shall be imposed upon a taxpayer if the taxpayer files a personal property tax statement as required by RTC section 441(a) on or before May 31, 2020.

Normally, subdivision (a) of RTC section 441 mandates the filing of a signed property tax statement with the assessor by each person owning taxable personal property, other than a manufactured home, having an aggregate cost of one hundred thousand dollars ($100,000) or more for any assessment year. Pursuant to subdivision (b), the signed statement must generally be filed by May 7 or the next business day if May 7 falls on a Saturday, Sunday, or legal holiday.  The extension to May 31, 2020, implemented by the Governor falls on a Sunday.  Thus, this morning, the State Board of Equalization issued a letter to all county assessors (LTA No. 2020/024) stating that assessors “shall accept Property Statements that are filed on or before June 1, 2020, without applying a penalty.”

Although taxpayers now have clarity regarding the due date for business property statements, the order’s penalty waiver provision for failure to timely pay taxes lacks a clear standard for taxpayers to apply when seeking to demonstrate that they “suffered economic hardship” or were “unable to tender payment of taxes in a timely fashion due to the COVID-19 pandemic.” This lack of a clear standard likely will prove problematic going forward as taxpayers seek to uncover exactly how counties will exercise their discretion with regard to the penalty waiver. Consequently, we renew our call for the issuance of unambiguous guidance by county tax officials regarding available relief measures and the standards that apply. This remains a necessary next step to ensure that even more California families and businesses are not displaced.

Once again, San Francisco has shown leadership in addressing property tax relief during the COVID-19 pandemic. On Monday, May 4, 2020, the San Francisco County Assessor announced that she was moving the deadline for businesses to file their Business Property Statements (Form 571-L) to June 1 of this year, due to physical office closure of the San Francisco Office of Assessor-Recorder.

Normally, under state law, a 10 percent penalty automatically attaches when a taxpayer’s business property statement is filed after May 7. But, if May 7 falls on a Saturday, Sunday or legal holiday, then a property statement that is mailed and postmarked on the next business day is deemed to have been timely filed. Under the applicable statue, legal holidays include days when the county’s offices are closed for the entire day.

Continue Reading Last Minute Relief for Filers of Business Property Statements

Through various state and local tax incentives, many businesses have committed to grow their employee count or make substantial capital expenditures. Not surprisingly, companies may fall short on delivering those objectives in the short run. Long-terms plans may also need to change drastically. Companies should carefully consider the terms of their agreements with states to identify whether:

  • Employment targets will be met;
  • Investment targets will be met; and
  • Clawbacks or other damages are a possibility.

If clawbacks are possible, force majeure provisions in incentives agreements should provide protection. When agreements do not specifically contain a force majeure provision, businesses and governments should work together to renegotiate or amend those agreements in a way that protects local business’ long-term viability in a region.

The debate over state marketplace laws may resume again, after the Uniform Law Commission (ULC) announced it has set up a committee to study whether to draft a uniform state law on online sales tax collection, focusing on marketplaces. The study committee is chaired by Utah Sen. Lyle Hillyard. The lead staffer (“reporter”) will be Professor Adam Thimmesch of the University of Nebraska College of Law. The members of the committee are listed here and information to sign up to be notified of developments is available here.

Continue Reading Déjà Vu – Marketplace Model Debate May Resume Again

In a recently issued taxpayer-favorable opinion, the Washington Appellate Court rejected the apportionment methodology used by the Department of Revenue, which sourced service receipts to the location of a taxpayer’s customers’ customers. The Court then affirmed the taxpayer’s methodology, which sourced the receipts to the location of its customers. LendingTree, LLC v. State of Wash. Dep’t of Revenue, no. 80637-8-I (Wash. App. Ct. Mar. 30, 2020) (“LendingTree Op.”).

The dispute concerned the receipts LendingTree, LLC (“LendingTree”) earned from operating its online loan marketplace for purposes of Washington’s Business and Occupation Tax. LendingTree’s business sought to match prospective borrowers and lenders though its website. Prospective borrowers provided LendingTree with requested financial information for no charge, and LendingTree analyzed this data to make referrals to lenders. Lenders paid fees to LendingTree related to its referral services. On audit, the Washington Department of Revenue (“Department”) took the position that LendingTree should have apportioned its service receipts based on the location of potential borrowers rather than its lenders’ locations. Both the Administrative Review and Hearings Division and trial court found for the Department, and LendingTree appealed.

Washington law, like the law of other states, requires multi-state taxpayers earning income from the performance of services to apportion the income to Washington if a customer receives the benefit of the taxpayer’s services in Washington (see Wash. Rev. Code § 82.04.462(3)(b)(i)). A related Washington regulation clarifies where a customer engaged in business receives the benefit of a taxpayer’s service: If the service relates to a customer’s business activities (and the service does not relate to real or tangible property), then the benefit is received where the customer’s related business activities occur. See Wash. Admin. Code 458-20-19402(303)(c). Citing this regulation, the Appellate Court concluded that “taxes are attributed to the state where the lenders conduct their business activity that most closely or directly relates to the services performed by LendingTree” (LendingTree Op. at 5).

The Appellate Court went on to conclude that the services at issue were LendingTree’s referrals of prospective borrowers to lenders, and that the lenders’ related business activities were their receipt and evaluation of the referrals at lender business locations. The Court rejected the Department’s argument that lenders received the benefit of LendingTree’s services where the borrowers (LendingTree’s customers’ customers) were located, reasoning that lenders received no benefit from LendingTree’s services until LendingTree made referrals to lenders identifying prospective borrowers. In support of its conclusion, the Court noted that lenders did not even know the identity of potential borrowers at the onset of the referral evaluation process. (LendingTree Op. at 7).

In reaching its conclusion that service receipts must be apportioned based on where the customers received the benefit of the taxpayer’s services, rather than where the customers’ customers were located, the court relied on its recently published opinion in ARUP Laboratories, Inc. v. State of Washington Department of Revenue, no. 52349-3-II (Wash. App. Ct. Feb. 11, 2020) (“ARUP Op.”). Interpreting the same rules at issue in the LendingTree ruling, the court in ARUP concluded that receipts earned by an out-of-state laboratory for performing tests on fluid and tissue samples it received from Washington medical providers must be apportioned to Washington, where the medical providers were located. The court based its conclusion on “where ARUP’s customers receive the helpful or useful effect of its services” (ARUP Op. at 13) and reasoned that: “ARUP’s services assist medical providers in diagnosing their patients. The medical providers cannot diagnose their patients until they receive the results of the tests they ordered from ARUP” (id.). Consistent with the plain language of Washington’s statute, in both ARUP and LendingTree, while the customer (medical provider and lender) likely received the service (information obtained from testing results and referrals) electronically through the internet, the rulings hold that the benefit of the service (diagnosing patients and evaluating potential borrowers) was received at the customer’s physical business location.

Practice Note: These rulings provide additional support to taxpayers making arguments to a market sourcing state that the “market” the state must apportion to is the taxpayer’s market. Sourcing to a taxpayer’s customer market can be distortive, creating an inaccurate reflection of a taxpayer’s market.

On April 13, S. 8166 was introduced in the New York Senate, which would expand the sales tax base to include receipts from the sale of digital advertising services. The bill would dedicate the revenue raised to student loan relief.

As introduced, “digital advertising services” would be broadly defined as “advertisement services on a digital interface, including advertisements in the form of banner advertising, search engine advertising, interstitial advertising, and other comparable advertising services which markets or promotes a particular good, service, or political candidate or message.” (With the exception of the added last clause, the definition of “digital advertising services” is identical to the definition in the digital advertising tax legislation recently passed by the Maryland General Assembly. The definition differs from the previously introduced New York digital ads tax (S. 8056) in that it is not limited only to targeted advertising.) “Digital interface” would also be defined very broadly as “any type of software, including a website, part of a website, or application, that a user is able to access.”

If enacted, the law would take effect on the 30th day after enactment, and would sunset five (5) years after the effective date.