Earlier this month, Connecticut Governor Dan Malloy released his Governor’s Bill addressing the various state tax implications of the federal tax reform bill enacted by Congress in December 2017, commonly referred to as the “Tax Cuts and Jobs Act.” Among other things, the Governor’s Bill addresses Connecticut’s treatment of the foreign earning deemed repatriation tax provisions of amended section 965 of the Internal Revenue Code (IRC). While the Governor’s Bill does not explicitly provide that the addition to federal income under IRC section 965 is an actual dividend for purposes of Connecticut’s dividend received deduction, the bill does protect Connecticut’s ability to tax at least part of the income brought into the federal tax base under the federal deemed repatriation tax provisions by defining nondeductible “expenses related to dividends” as 10 percent of the amount of the dividend. Continue Reading Connecticut Responds to the Federal Repatriation Tax
The Connecticut Department of Revenue Services (DRS) recently issued demand letters to many remote sellers requiring that they either: (a) provide electronic sales records for all individual sales shipped to a Connecticut address over the past three calendar years; or (b) register to collect and remit Connecticut sales and use tax. This action is consistent with statements made by DRS Commissioner, Kevin Sullivan, via a press release in March and more recently at a Federation of Tax Administrator’s (FTA) presentation on the topic two weeks ago. Sullivan’s comments at the FTA meeting indicated that state tax administrators “will move from hoping Congress will help” to taking action into their own hands.
For remote sellers with no physical presence in Connecticut that don’t wish to voluntarily collect and remit sales and use tax (consistent with the US Supreme Court’s precedent in Quill and Bellas Hess), they are given only one option–provide DRS with a semi-colon delimited text file containing 16 fields of data–including customer names, customer addresses, ship to addresses, item descriptions and quantities sold. But supplying such personal data about customers intrudes upon the privacy and First Amendment rights of the customer, and unconstitutionally deprives remote sellers of their property right in the data set without due process of law. Of equal concern, some sellers question whether DRS is appropriately limited in its ability to disclose or share the customer data it seeks.
First, disclosure of the records DRS is requesting from remote sellers would be a significant intrusion on their customers’ privacy. The records requested include disclosure of customer names, addresses, shipping state, sales price and specific product(s) purchased. This can be highly sensitive information. Merely linking a particular online retailer to a specific customer may reveal information about the customer’s health issues, political leanings, sexual orientation, personal tastes and financial circumstances. By collecting shipping addresses, DRS will learn when an individual has a gift purchase delivered to a different address, revealing what could be a personal (and highly private) relationship. Moreover, some sellers question whether Connecticut law adequately protects the confidentiality of the information DRS is attempting to collect, leaving the possibility that the information could be shared with other government agencies and potentially used for purposes other than collection of sales and use tax.
Second, for remote sellers that offer books, music, videos and other forms of expressive content, the DRS request violates the customers’ First Amendment protections. In 2010, a US District Court held that an online retailer’s North Carolina customers’ First Amendment rights were implicated by a similar content disclosure requirement on audit. See Amazon.com LLC v. Lay, 758 F. Supp. 2d 1154, 1169 (W.D. Wash. 2010). The First Amendment protects a buyer from having the expressive content of that buyer’s purchase of books, music and audiovisual material disclosed to the government. Thus, First Amendment rights are implicated when the government seeks disclosure of reading, listening and viewing habits. As a result, the North Carolina Department of Revenue was enjoined from requesting customer identifying information from the online retailer. The same prohibition upheld by the federal district court should apply to DRS here. Beyond the First Amendment, the Connecticut Constitution itself offers similar protections that speak against the state’s ability to obtain such information. See Conn. Const. art. I, §§ 4-5.
Third, Section 1 of the Fourteenth Amendment to the US Constitution and Article I, Section 8 of the Connecticut Constitution prohibit DRS from depriving any person of property without due process of law. The required disclosure by remote sellers of their proprietary list of Connecticut purchasers compromises the value of the customer list and deprives the disclosing retailer of its protected property right in the list without due process of law. For remote sellers, these lists are valuable, highly exclusive trade secrets, in which such retailers make a substantial investment and in which they have a protected property right. By forcing remote sellers to turn over their confidential customer lists and subsequently not having an obligation to protect the list from the public realm, DRS is depriving the remote sellers of valuable property without due process of law. Would the state be able to protect a customer list from a Freedom of Information Act (FOIA) request submitted by a remote seller’s competitor?
Last, but certainly not least, Connecticut law requires that each state agency “[m]aintain only that information about a person which is relevant and necessary to accomplish the lawful purposes of the agency.” Conn. Gen. Stat. Ann. § 4-193(e). The amount of information being required by DRS goes well beyond what is required to enforce Connecticut tax law. Some number of a remote seller’s customers undoubtedly paid use tax on their purchases. Ignoring that reality the DRS targets all sales to Connecticut consumers when they should instead be looking for information only on consumers who have not already paid the appropriate use tax. This broad fishing expedition is therefore not targeted to the agency’s necessary and appropriate role but is instead designed to burden the seller and cause remote sellers to register to collect and remit sales and use tax.
Practice Note: Remote sellers who receive communication from the DRS should evaluate their legal rights and obligations and take appropriate steps to protect their customers’ data. We encourage remote sellers to contact the authors should they be concerned about the course of action taken by the Connecticut DRS.
In June of 2015, Connecticut passed legislation that implements combined reporting for tax years beginning on, or after January 1, 2016. Part of the new regime, which is codified by Conn. Gen. Stat. P.A. 15-5, § 144 (2015), requires water’s-edge combined groups to include entities incorporated in tax havens in the combined group. Just before the holidays, the Connecticut General Assembly passed legislation that narrowed the definition of a “tax haven” from the originally adopted definition. Under the originally passed combined reporting law, the determination of whether a jurisdiction was a “tax haven” was made using five different definitions. If any one definition was satisfied, the jurisdiction was a “tax haven.” None of the five definitions is entirely clear and each generally required an analysis of facts related to the jurisdiction’s government rather than the activities of a taxpayer in the jurisdiction. The original definition of tax haven was similar, but not identical to the Multistate Tax Commission Proposed Model Statute for Combined Reporting. The new law required the commissioner of revenue to publish a list of jurisdictions determined to be tax havens by September 30, 2016. In December, the Connecticut General Assembly convened a special session and passed Public Act 15-1, which amends the newly enacted tax haven law in section 37. As amended, the Connecticut statute still contains the five different definitions. However, the amended law excludes from the definition of a tax haven “a jurisdiction that has entered into a comprehensive income tax treaty with the United States” and which meets certain other requirements. Additionally, the December legislation also repealed the requirement for the commissioner to publish a list of tax havens. In sum, the limiting amendment to the tax haven law should provide taxpayers with some clarity, although that will be somewhat offset by the lack of a formal list. Connecticut is one of four New England states that considered and/or passed legislation adding tax haven provisions to their combined reporting regimes. Tax haven legislation passed in Rhode Island in 2015, as part of Rhode Island’s adoption of combined reporting effective for tax years beginning on or after January 1, 2015. The Maine and Massachusetts legislatures considered tax haven provisions, but ultimately did not pass such laws in 2015.
On May 18, the U.S. Supreme Court issued its decision in Comptroller of the Treasury of Maryland v. Wynne. In short, the Court, in a five-to-four decision written by Justice Alito, handed the taxpayer a victory by holding that the county income tax portion of Maryland’s personal income tax scheme violated the dormant U.S. Constitution’s Commerce Clause.
Specifically, the Court concluded that the county income tax imposed under Maryland law failed the internal consistency test under the dormant Commerce Clause, because it is imposed on both residents and non-residents with Maryland residents not getting a credit against that Maryland local tax for income taxes paid to other jurisdictions (residents are given a credit against the Maryland state income tax for taxes paid to other jurisdictions).
The Supreme Court emphatically held (as emphatically as the Court can be in a five-to-four decision) that the dormant Commerce Clause’s internal consistency test applies to individual income taxes. The Court’s holding does create a perilous situation for any state or local income taxes that either do not provide a credit for taxes paid to other jurisdictions or limit the scope of such a credit in some way.
The internal consistency test—one of the methods used by the Supreme Court to examine whether a state tax imposition discriminates against interstate commerce in violation of the dormant Commerce Clause—starts by assuming that every state has the same tax structure as the state with the tax at issue. If that hypothetical scenario places interstate commerce at a disadvantage compared to intrastate commerce by imposing a risk of multiple taxation, then the tax fails the internal consistency test and is unconstitutional.
Although the Wynne decision does not address the validity of other taxes beyond the Maryland county personal income tax, the decision does create significant doubt as to the validity of certain other state and local taxes such as the New York State personal income tax in the way it defines “resident.” New York State imposes its income tax on residents on all of their income and on non-residents on their income earned in the state; this is similar to the Maryland county income tax at issue in Wynne.
“Resident” is defined as either a domiciliary of New York or a person who is not a domiciliary of New York but has a permanent place of abode in New York and spends more than 183 days in New York during the tax year. N.Y. Tax Law § 605. (New York City has a comparable definition of resident.) N.Y.C. Administrative Code § 11-1705. Thus a person may be taxed as a statutory resident solely because they maintain living quarters in the state and spend more than 183 days in the state, even if those days have absolutely nothing to do with the living quarters; this category of non-domiciliary resident is commonly referred to a “statutory resident.” As such, under New York’s tax scheme, a person can be a resident of two states—where domiciled and where a statutory resident—and thus be subject to taxation on all of their income in both states.
Although New York State grants a credit to residents for taxes paid to another jurisdiction, that credit is only for taxes paid “upon income derived” from those other jurisdictions. N.Y. Tax Law § 620. As such, New York State does not grant a credit for taxes paid to another jurisdiction on income earned from intangible property, such as stocks, because income earned from intangible property is not ‘derived from’ any specific jurisdiction.
To illustrate using an example, suppose an investment banker is unquestionably a domiciliary of New Jersey and has an apartment, i.e., permanent place of abode, in New York that he uses only occasionally. Further, suppose that the investment banker spends more than 183 days in New York during a tax year by going to his office in New York on most workdays. In such a case, the investment banker is a resident of both New Jersey and New York and subject to tax as a resident in both states on his entire worldwide income. New York does not give a credit for taxes paid to New Jersey on income derived from intangible property, and thus the investment banker pays tax on this income twice, once to New Jersey and once to New York, clearly disadvantaging interstate commerce and resulting in double taxation.
This is not some hypothetical example. This is actually the fact pattern in In the Matter of John Tamagni v. Tax Appeals Tribunal of the State of New York, 91 N.Y.2d 530 (1998). In that case, the New York Court of Appeals (New York State’s highest court) held that New York State’s taxing scheme did not violate the dormant Commerce Clause and did not fail the internal consistency test. The validity of the Court of Appeals’ decision is seriously called into question under the Wynne case.
The Court of Appeals, relying upon Goldberg v. Sweet, held that the dormant Commerce Clause did not apply to residency-based taxes because those taxes were not taxing commerce, but rather a person’s status as a resident. However, the U.S. Supreme Court’s decision in Wynne not only repudiates the very dicta from Goldberg v. Sweet cited by the New York Court of Appeals in Tamagni, but the U.S. Supreme Court also determined that even if a state has the power to impose tax on the full amount of a resident’s income, “the fact that a State has the jurisdictional power to impose a tax [under the Due Process clause of the Constitution] says nothing about whether that tax violates the Commerce Clause.” After Wynne, it is clear that the dormant Commerce Clause applies to residency-based personal income taxes.
The second reason that the vitality of the Tamagni decision is in question is its application of the internal consistency test. The Court of Appeals held that even if the dormant Commerce Clause applied, the internal consistency test was not violated because the tax at issue was imposed upon a purely local activity and thus could not violate the Complete Auto tests. However, as discussed above, New York State’s lack of a credit for taxes paid to other jurisdictions mirrors the lack of a credit under Maryland’s county income tax scheme.
New York State taxpayers should be cognizant of the Wynne decision and should consider filing refund claims if they have paid— or will pay—tax to New York State as a statutory resident (i.e., not as a New York domiciliary). One would expect the New York State Department of Taxation and Finance to be quite resistant to granting such refunds and likely to vigorously defend the existing taxing scheme.
It may be worthwhile to note that this problem of double taxation was acknowledged and addressed in an agreement executed in October 1996 by the heads of the revenue agencies of Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New Jersey, New York, Pennsylvania, Rhode Island, and Vermont. Under that agreement, the “statutory resident” state would provide a credit for the taxes paid by the individual on his or her investment income to his/her state of domicile. Unfortunately, that agreement was never implemented through legislation— maybe now is the time for that to be done.
Finally, a word about New York City: New York City imposes a personal income tax on residents, allowing no credit for taxes paid to other jurisdictions. However, New York City does not impose a tax on non-residents, making its personal income tax different than the Maryland county income tax. Thus, the constitutionality of the New York City personal income tax is not specifically addressed by the U.S. Supreme Court’s decision. However, similar to the New York State definition of resident, a person can be a resident in two different jurisdictions under the New York City definition of resident. As such, New York City’s personal income tax could be imposed twice on a person if the person is a domiciliary of one state and a statutory resident in another. Thus, the tax potentially fails the internal consistency test.
On July 15, 2014, the Connecticut Department of Revenue Services awarded Chainbridge Software LLC a contract worth $50,000 for on-site and remotely supported training for transfer pricing audits. Chainbridge is infamous for being the contract auditor hired by the District of Columbia Office of Tax and Revenue to manufacture transfer pricing-based assessments. In 2012, the District of Columbia Office of Administrative Hearings denounced Chainbridge’s methodology in Microsoft Corp. v. Office of Tax and Revenue. Numerous other cases are in litigation following D.C.’s refusal to abide by that decision.
We have reviewed the Connecticut request for proposal drafted by the Department of Revenue Services. While we do not yet have access to the final contract, it will likely be similar to the request for proposal. The solicitation requests two to three days of training per week over the course of three months. According to the RFP, Chainbridge will teach the Department’s employees about transfer pricing principles and methodologies, taxpayer planning, economic analysis of transactions between related parties, pre- and post-audit planning, and other related topics.
In light of the Connecticut Department of Revenue Services’ expected contract with Chainbridge, we anticipate that the Department will become more active in evaluating transfer pricing. What is not certain is whether the analysis will follow the debunked method still being used in D.C.