Wrapping Up January – and Looking Forward to February

You can view all of the topics we discussed over the last month here.

Our lawyers will present at the following state and local tax event in February:

February 27, 2018: Diann Smith will be presenting “What’s Trending in State Sales Tax Audit Perspectives: Issues and Trends and Their Proper Reflection” at the 2018 Sales Tax Conference and Audit Session in New Orleans, LA.

On December 4, 2017, the US Court of Appeals for the Third Circuit issued its much-anticipated precedential opinion in Marathon Petroleum Corp. et al., v. Secretary of Finance et al., No. 16-4011. The opinion affirms the Third Circuit’s existing view (described in its 2012 New Jersey Retailers Association decision) that US Supreme Court precedent permits a private cause of action to enforce the federal priority rules, overruling the federal district court’s conclusion (in this case and Temple-Inland) that the priority rules only apply to disputes between states. Continue Reading Litigation Alert | Third Circuit Reaffirms Scope of Federal Priority Rules

On October 1, 2017, the Delaware Department of Finance published final regulations in the Register of Regulations repealing its former unclaimed property regulations and promulgating a new reporting and examination manual.  See 21 DE Reg 336 (Oct. 1, 2017).  The final reporting and examination regulation contains no substantive changes from the revised version that was re-proposed on August 1, 2017.  As published, the regulations are set to be adopted and take effect on October 11, 2017. Continue Reading Get Ready for the Countdown: Final Delaware Unclaimed Property Regulations Published

In two weeks, the Delaware Secretary of State (SOS) will begin mailing notices to holders who have been identified as likely being out of compliance with Delaware unclaimed property law. Holders that do not enroll in the SOS Voluntary Disclosure Agreement Program (VDA Program) within 60 days of the mailing of this notice will be referred to the State Escheator for examination. Once an audit notice is issued, the SOS will have no legal ability to accept a holder into its VDA Program.

The VDA Program was put in place to respond to concerns about Delaware’s audit program and allow holders to come into compliance through a “self-audit” that is administered by the holder, as opposed to the State Escheator. The audit is overseen by a third-party provider that must approve the steps taken by the holder, but allows more flexibility in terms of the details and deadlines than a traditional audit. Delaware law requires that every company be provided with an opportunity to voluntarily comply prior to being issued an audit notice. For holders that receive a notice from the SOS in a little over two weeks, this letter will be their one opportunity to voluntarily come forward and enroll in the VDA Program and requires prompt decision making and evaluation, given the 60 days deadline and potentially significant implications.

It is still expected that the final Department of Finance (DOF) regulation required by SB 13 will be included in the October 1, 2017 Register of Regulations. If this holds true, companies currently under a Delaware audit authorized by the State Escheator on or before July 22, 2015, will have 60 days from October 1 (i.e., until November 30, 2017) to convert to the SOS VDA Program. Again, the same analysis and implications are at stake.

Practice Note

There is a lot for holders to consider in a very short period of time. Holders should be aware that there are may be more than the single, historic third-party provider in charge of administering the SOS VDA Program. Adding new providers creates uncertainty in the process and it is not clear how holders will be assigned to each provider.

Holders in need of advice on whether to enroll in the SOS VDA Program should reach out to the authors to discuss their options. Stay tuned for our analysis of the final DOF regulation, which will be posted shortly after publication.

On August 1, the Delaware Department of Finance (DOF) published a revised version of its proposed reporting and examination manual regulation addressing audit procedures and method of estimation.  See 21 DE Reg 123 (Aug. 1, 2017). The revised proposed regulation is substantially similar to the first draft proposed earlier this year, but contains a dozen or so notable differences (described in more detail below). Because the former draft of the regulation was never finalized, the 60-day time period for eligible holders to convert to the Voluntary Disclosure Agreement (VDA) Program (administered by the Secretary of State) or an expedited audit has not started to run, and will not commence until the final DOF regulation is published in the monthly Register of Regulations. Based on the fact that the DOF is accepted comments through August 31, 2017 (and likely needs at least a month to take them into consideration), the final regulation is not expected to be published before October 1, 2017, giving eligible holders at least three more months before the looming conversion deadline.

Our summary of the initial regulations proposed by the DOF and Secretary of State (SOS) on April 1, 2017 is available here. The final SOS VDA estimation regulation was published on July 1, 2017, without substantive amendments. See 21 DE Reg 50 (July 1, 2017). Below is a brief summary of the key differences between the old and new proposed DOF reporting and examination manual that holder’s should be aware of.

Continue Reading Delaware (Re)Proposes Unclaimed Property Reporting and Examination Manual Regulation

On August 9, 2017, the US Court of Appeals for the Third Circuit (Third Circuit), overruling the US District Court for the District of Delaware (District Court), allowed a claim by a holder seeking to prevent an unclaimed property audit by Delaware on due process grounds to proceed. See Plains All American Pipeline L.P. v. Cook et al., No. 16-3631 (3d Cir. Aug. 9, 2017).  The procedural due process claim challenges Delaware’s use of auditors that have a stake in the assessment. Consistent with the District Court decision, the Third Circuit held that challenges to Delaware’s estimation methodology were ruled not ripe. The case has been remanded to the District Court for further proceedings.

Continue Reading Resistance is not Always Futile: New Decision in Ongoing Delaware Unclaimed Property Audit Litigation

The No Regulation Without Representation Act of 2017 (NRWRA) is scheduled for a hearing before the House Judiciary Subcommittee on Regulatory Reform, Commercial and Antitrust Law on Tuesday, July 25 at 10:00 am EDT in 2141 Rayburn House Office Building. The bill was introduced by Congressman Jim Sensenbrenner (R-WI) last month with House Judiciary Chairman Bob Goodlatte (R-VA) as one of seven original co-sponsors. As described in more detail below, the bill would codify the Bellas Hess “physical presence” requirement upheld by the US Supreme Court in Quill and make that requirement applicable to sales, use and other similar transactional taxes, notice and reporting requirements, net income taxes and other business activity taxes. Extending the concept to an area far beyond state taxation, the bill would also require the same physical presence for a state or locality to regulate the out-of-state production, manufacturing or post-sale disposal of any good or service sold to locations within its jurisdictional borders.

In the last Congress, the Business Activity Tax Simplification Act of 2015 (BATSA) would have codified a physical presence requirement in the context of business activity taxes (e.g., net income and gross receipts taxes). However, the scope of NRWRA’s limitations on interstate regulation and tax differs from the standard set forth in BATSA. Specifically, under BATSA, assigning an employee to a state constitutes physical presence, whereas under NRWRA a company does not have physical presence until it employs more than two employees in the state (or a single employee if he or she is in the state and provides design, installation or repair services or “substantially assists” in establishing or maintaining a market). Under NRWRA, activities related to the potential or actual purchase of goods or services in the state or locality are not a physical presence if the final decision to purchase is made outside of the jurisdiction. Continue Reading House Judiciary Subcommittee to Consider Sensenbrenner Bill Tomorrow

In a recent decision, the New Jersey Tax Court provided some long-awaited guidance on the “unreasonable” exception to the state’s related-party intangible expense add-back provision. In BMC Software, Inc v. Div. of Taxation, No 000403-2012 (2017), the Tax Court held that payments made by a subsidiary to its parent for a software distribution license were intangible expenses that were subject to the add-back provision, but that the statutory exception for “unreasonable” adjustments applied so that the subsidiary was able to deduct the expenses in computing its Corporation Business Tax (CBT). The court first determined that the expense was an intangible expense and not the sale of tangible personal property between the entities because the contract specifically called the fee a royalty, the parent reported the income as royalty income and the parent retained full ownership of the intellectual property rights indicating that no sale had taken place. Thus, the court determined that the intangible expense add-back provision did apply. The most interesting aspect of this case, however, was the court’s application of the “unreasonable” exception to the intangible expense add-back provision because that had not yet been addressed by the courts in New Jersey.

The Tax Court established two critical points with respect to the add-back of related-party intangible expenses: first, that the “unreasonable” exception does not require a showing that the related-party recipient paid CBT on the income from the taxpayer; and secondly, that a showing that the related-party transaction was “substantively equivalent” to a transaction with an unrelated party is sufficient evidence that the add-back is “unreasonable.” Continue Reading Favorable Guidance from the New Jersey Tax Court on the ‘Unreasonable’ Exception to the Related-Party Intangible Expense Add-back

On, June 12, 2017, the No Regulation Without Representation Act of 2017 was introduced by Congressman Jim Sensenbrenner (R-WI) with House Judiciary Chairman Bob Goodlatte (R-VA) as one of seven original co-sponsors. As described in detail below, the scope and applicability of the “physical presence” requirement in the 2017 bill is significantly broader than the first iteration of the bill that was introduced last year. Not only does the bill expand the physical presence rule to all taxes, it expands the rule to all regulations.

2016 Bill

In July 2016, Congressman Sensenbrenner introduced the No Regulation Without Representation Act of 2016 (H.R. 5893) in the US House of Representatives. The bill provided that states and localities could not: (1) obligate a person to collect a sales, use or similar tax; (2) obligate a person to report sales; (3) assess a tax on a person; or (4) treat the person as doing business in a state or locality for purposes of such tax unless the person has a physical presence in the jurisdiction during the calendar quarter that the obligation or assessment is imposed. “Similar tax” meant a tax that is imposed on the sale or use of a product or service.

Under the 2016 bill, persons would have a physical presence only if the person: (1) owns or leases real or tangible personal property (other than software) in the state; (2) has one or more employees, agents or independent contractors in the state specifically soliciting product or service orders from customers in the state or providing design, installation or repair services there; or (3) maintains an office in-state with three or more employees for any purpose. The bill provided that “physical presence” did not include the following: (1) click-through referral agreements with in-state persons who receive commissions for referring customers to the seller; (2) presence for less than 15 days in a taxable year; (3) product delivery provided by a common carrier; or (4) internet advertising services not exclusively directed towards, or exclusively soliciting in-state customers.

The bill did not define the term “seller,” but did provide that “seller” did not include a: (1) marketplace provider (specifically defined); (2) referrer (specifically defined); (3) carrier, in which the seller does not have an ownership interest, providing transportation or delivery of tangible personal property; or (4) credit card issuer, transaction billing processor or other financial intermediary. Under the 2016 bill, persons not considered “sellers” (e.g., marketplace providers) were protected as well because the bill provided that a state may not impose a collection or reporting obligation or assess tax on “any person other than a purchaser or seller having a physical presence in the State.”

2017 Bill

The scope of the 2017 bill is significantly broader than the bill introduced in 2016 and would require a person to have “physical presence” in a state before the state can “tax or regulate [the] person’s activity in interstate commerce.” (emphasis added) The new bill applies the “physical presence” requirement to sales and use tax, as well as net income and other business activities taxes, and also the states’ ability to “regulate” interstate commerce. “Regulate” means “to impose a standard or requirement on the production, manufacture or post-sale disposal of any product sold or offered for sale in interstate commerce as a condition of sale in a state when: (1) such production or manufacture occurs outside the state; (2) such requirement is in addition to the requirements applicable to such production or manufacture pursuant to federal law and the laws of the state and locality in which the production or manufacture occurs; (3) such imposition is not otherwise expressly permitted by federal law; and (4) such requirement is enforced by a state’s executive branch or its agents or contractors.”

The definition of “physical presence” in the 2017 bill is different from the definition in the 2016 bill. Under the 2017 bill, a person would have a “physical presence” in a state if during the calendar year the person: (1) maintained its commercial or legal domicile in the state; (2) owned or leased real or tangible personal property (other than software) in the state; (3) has one or more employees, agents or independent contractors in the state providing design, installation or repair services on behalf of a remote seller; (4) has one or more employees, exclusive agents or exclusive independent contracts in the state who engage in activities that substantially assist the person to establish or maintain a market in the state; or (5) regularly employs three or more employees in the state.

The 2016 bill did not include maintaining a commercial or legal domicile in the state in the definition of “physical presence.” Additionally, under the 2016 bill, a person who had three or more employees performing activities (other than solicitation of sales, design, installation or repair services) in a state was physically present in the state only if the person also maintained an office in the state. Under the 2017 bill, there is no requirement that the person also maintain an office in the state.  Additionally, the 2017 bill provides that a person has “physical presence” in a state if it has one or more employees, exclusive agents or exclusive independent contracts in the state who engage in activities that substantially assist the person to establish or maintain a market in the state. The 2016 bill did not require that the agents and independent contractors be “exclusive”—thus, the 2017 bill limits the scope of this provision. The 2017 bill also requires that the employees, agents or independent contractors “maintain a marketplace” for the seller in the state (rather than solicit the sale of product or service orders as in the 2016 bill).

In addition to the activities not considered “physical presence” under the 2016 bill, the 2017 bill also provides that “physical presence” does not include the following: (1) ownership by a person outside of the state of an interest in a LLC or similar entity organized or with a physical presence in the state; (2) the furnishing of information to people in the state or the gathering of information from people in the state, provided the information is used or disseminated from outside of the state; and (3) activities related to the person’s potential or actual purchase of goods or services in the state if the final decision to purchase is made out of the state. Additionally, the 2017 bill provides that product delivery by a carrier or other service provider (not just a common carrier as in the 2016 bill) will not be considered “physical presence.”

The 2017 bill has the same protections for non-sellers as the 2016 bill.  While the 2017 bill still excludes “marketplace providers” (defined substantially the same) from the definition of “seller” (protecting them from a tax or collection obligation as a non-seller), it adds a new carve out for sales through the marketplace of products owned by the marketplace provider. In this instance, the marketplace provider would be the “seller,” and a tax or collection obligation would be permitted if the marketplace provider has a “physical presence” in the jurisdiction.

As introduced, the 2017 bill would apply to calendar quarters beginning on or after January 1, 2018.

Practice Note

If passed, the 2017 bill would have an enormous impact not just on taxes, but on all regulation of business activities by states. Last year’s bill was an attempt to codify and define the Quill physical presence rule and preempt state nexus legislation. The 2017 bill does the same; it codifies the Quill physical presence rule which would not only legislatively enact and define Quill, but also preempt many of the state attempts to expand physical presence nexus, including click-through, marketplace nexus and economic nexus.

However, the 2017 bill goes even further. It would expand the physical presence rule to all other taxes, including business activity and net income taxes. This is similar to the rule that would have been established under the Business Activity Tax Simplification Act (BATSA) introduced as H.R. 2584 in the last congressional session.

But the 2017 bill goes even beyond BATSA, prohibiting any regulation by a state over a person or business unless that person or business has physical presence in the state. This expansion is likely related to a fight between states that has been progressing through the courts. California has a law that requires eggs sold in California to be laid by hens in cages that are of a specific size. Missouri and other states sued to invalidate California’s law, but lost in the 9th Circuit and certiorari was denied by the US Supreme Court on May 30, 2017. Thus, the 2017 bill is unlike anything seen before in the tax context—and the impact, whether enacted or not, remains to be seen.

Last Friday, the Delaware Senate released a substituted version of the bill (Senate Bill 79) introduced last month as a technical corrections bill to Senate Bill 13—the unclaimed property rewrite legislation enacted earlier this year.

The Senate substitute differs from the introduced version of Senate Bill 79 as follows:

  1. It does not strike § 1147(a)—the provision that limits the ability of a holder to assign or otherwise transfer its obligation to pay or deliver property or to comply with the unclaimed property law to others (aside from a parent, subsidiary or affiliate of the holder).
  2. It would delay the timeline that Delaware must promulgate regulations to December 1, 2017.
  3. It would make changes to the State Escheator’s authority to grant waivers of interest and penalties under § 1185 as follows:
    1. Removes the language in the introduced bill that made the discretionary waiver of penalties only applicable to late filed property remitted while under examination.
    2. Gives State Escheator the following waiver authority for property remitted before January 1, 2019:
      1. Waive, in whole or in part, the calculable interest under § 1183 of this title for unclaimed property remitted to the State with a required report under § 1142 (the general holder report section) or § 1170 (the compliance review section) of this title.
      2. Waive, in whole or in part, the calculable interest under § 1183 of this title for unclaimed property remitted to the State as a result of securities examinations in which estimation is not required under §§ 1171 and 1172 of this title.
      3. Waive up to 50 percent of the calculable interest under § 1183 of this title for all unclaimed property remitted to the State and not provided for in paragraphs (b)(1) or (b)(2) of this section.
    3. Gives State Escheator the following waiver authority for property remitted on or after January 1, 2019:
      1. Waive, in whole or in part, the calculable interest under § 1183 of this title for unclaimed property remitted to the State with a required report under § 1142 (the general holder report section) or § 1170 (the compliance review section) of this title.
      2. Except for examinations expedited under § 1172(c) of this title, waive up to 50 percent of the calculable interest under § 1183 of this title for all unclaimed property remitted to the State and not provided for in paragraph (c)(1) of this section.

Continue Reading Substitute Alert ‒ Delaware Technical Corrections Bill