Constitutional Issues
Subscribe to Constitutional Issues's Posts

US Treasury Issues Guidance on the ARPA Claw-Back Provision

Earlier this week, the US Department of the Treasury (Treasury) issued formal guidance regarding the administration of the American Rescue Plan Act of 2021 (ARPA) claw-back provision. The guidance (Interim Final Rule) provides that the claw-back provision is triggered when there is a reduction in net tax revenue caused by changes in law, regulation or interpretation, and the state cannot identify sufficient funds from sources other than federal relief funds to offset the reduction in net tax revenue. The Interim Final Rule recognizes three sources of funds that may offset a net tax revenue reduction other than federal relief funds—organic growth, increases in revenue (e.g., a tax rate increase) and certain spending cuts (i.e., cuts that are not in an area where the recipient government has spent federal relief funds). According to the Treasury, this framework recognizes that money is fungible and “prevents efforts to use Fiscal Recovery Funds to indirectly offset reductions in net tax revenue.”

The Interim Final Rule also provides guidance on what is considered a change in law, regulation or interpretation that could trigger the claw-back (called covered changes), but that point remains somewhat ambiguous. The Rule provides that:

The offset provision is triggered by a reduction in net tax revenue resulting from ‘a change in law, regulation, or administrative interpretation.’ A covered change includes any final legislative or regulatory action, a new or changed administrative interpretation, and the phase-in or taking effect of any statute or rule where the phase-in or taking effect was not prescribed prior to the start of the covered period. [The covered period is March 3, 2021 through December 31, 2024.] Changed administrative interpretations would not include corrections to replace prior inaccurate interpretations; such corrections would instead be treated as changes implementing legislation enacted or regulations issued prior to the covered period; the operative change in those circumstances is the underlying legislation or regulation that occurred prior to the covered period. Moreover, only the changes within the control of the State or territory are considered covered changes. Covered changes do not include a change in rate that is triggered automatically and based on statutory or regulatory criteria in effect prior to the covered period. For example, a state law that sets its earned income tax credit (EITC) at a fixed percentage of the Federal EITC will see its EITC payments automatically increase—and thus its tax revenue reduced—because of the Federal government’s expansion of the EITC in the ARPA. This would not be considered a covered change. In addition, the offset provision applies only to actions for which the change in policy occurs during the covered period; it excludes regulations or other actions that implement a change or law substantively enacted prior to March 3, 2021. Finally, Treasury has determined and previously announced that income tax changes—even those made during the covered period—that simply conform with recent changes in Federal law (including those to conform to recent changes in Federal taxation of unemployment insurance benefits and taxation of loan [...]

Continue Reading




The US Department of the Treasury Says State IRC Conformity Bills Do Not Trigger Federal Relief Claw-Back Provision

As we’ve blogged about in the past, the recently enacted American Rescue Plan Act of 2021 (ARPA) includes an ambiguous claw-back provision. If broadly interpreted, it could result in states losing relief funding provided under the APRA if there is any state legislative or administrative change that results in the reduction of state revenue. This provision is causing havoc in the state tax world, rightfully so.

After much yelling and screaming from state attorneys general and those in the tax world, including McDermott (see McDermott letter to Treasury Secretary Janet Yellen attached), the US Department of the Treasury issued a press release announcing forthcoming “comprehensive guidance” on this provision. Treasury also addressed a question that has been on the top of our minds since the provision was enacted: Could state legislation addressing state conformity to the Internal Revenue Code trigger the claw-back? States routinely conform to and decouple from changes to the Internal Revenue Code, so if such actions could trigger the claw-back, state legislatures would be reluctant to consider them. We were so concerned about this issue that we specifically addressed it in our letter to Secretary Yellen.

This week, we received the Treasury’s guidance on this issue: Conformity bills will not trigger the claw-back. In its press release, Treasury stated:

… Treasury has decided to address a question that has arisen frequently: whether income tax changes that simply conform a State or territory’s tax law with recent changes in federal income tax law are subject to the offset provision of section 602(c)(2)(A) of the Social Security Act, as added by the American Rescue Plan Act of 2021. Regardless of the particular method of conformity and the effect on net tax revenue, Treasury views such changes as permissible under the offset provision.

This is a step in the right direction and should ease concerns of state legislatures. Passing a conformity bill will not cause any loss of federal funding. Treasury’s guidance, because it applies to all “methods of conformity,” should cover any legislation that either couples with or decouples from the Internal Revenue Code.

But our work is not done. In our letter to Secretary Yellen we also asked for guidance confirming that state actions in other areas will not trigger the claw-back. Specifically, we made concrete suggestions that actions to correcting tax statutes or rules that are either unconstitutional or barred by or violate federal law also should not trigger the claw-back. Treasury’s recent press release gives us a glimmer of hope that Treasury will exclude such actions from the clutches of the claw-back provision as well. Stay tuned for more!




McDermott Provides Treasury Department with Concrete Suggestions for Guidance on the American Rescue Plan Act’s Claw-Back Provision

The recently enacted American Rescue Plan Act of 2021 (ARPA) includes an ambiguous claw-back provision that has brought the world of state and local tax policymaking to a grinding halt. Because ARPA’s adoption occurred during the final weeks of many states’ legislative sessions, rapid issuance of guidance from the US Department of the Treasury is needed before the sessions adjourn to prevent the irreversible damage that will occur if a state foregoes enacting policies aimed at alleviating the economic disruption caused by COVID-19 out of fear of facing claw-back of federal relief.

McDermott recently sent a letter to Treasury Secretary Janet Yellen, urging the issuance of guidance giving a balanced interpretation of the claw-back provision. This guidance is necessary to avoid putting state legislatures, governors and tax administrators across the country in an untenable situation where every tax change or adjustment being considered—no matter how innocuous or routine—will carry the risk of a reduction to their state’s share of federal funding for the next three years.

In the letter, we provided concrete suggestions on areas where the ARPA left room for such balanced interpretation. We suggested that Treasury interpret the claw-back provision as either inapplicable to or provide a safe harbor for:

  • Changes addressing state conformity to the Internal Revenue Code (IRC)
  • Corrections of unconstitutional tax statutes or rules
  • Corrections of tax provisions barred by or that violate federal law
  • Actions in which there is no or only a weak connection between the law change reducing net revenue and the use of federal relief funds
  • Changes in the law announced before the enactment of ARPA
  • Reductions in net revenue related to purposes that further ARPA’s objectives.

The letter pointed out that states need concrete guidance, whether formal or informal, addressing these areas. Such guidance will alleviate the concerns of state governments and allow state policymakers to function and continue the orderly administration of state taxes.




Federal COVID-19 Relief Bill Brings State Tax Policy to a Grinding Halt

On March 11, 2021, US President Joe Biden signed the American Rescue Plan Act of 2021 (ARPA), the COVID-19 relief bill that includes $350 billion in relief to states and localities. To prevent states from using federal relief funds to finance tax cuts, Congress included a clawback provision requiring that any relief funds used to offset tax cuts during the next three years be returned to the federal government. Here is the text of the provision:

  • A State or territory shall not use the funds provided under this section or transferred pursuant to section 603(c)(4) to either directly or indirectly offset a reduction in the net tax revenue of such State or territory resulting from a change in law, regulation or administrative interpretation during the covered period that reduces any tax (by providing for a reduction in a rate, a rebate, a deduction, a credit or otherwise) or delays the imposition of any tax or tax increase.

This language broadly prohibits states from taking legislative or administrative action through the end of 2024 that reduces state tax revenues by any means (deduction, credit, delay, rate change, etc.) if doing so could be characterized as the use of federal relief funds to offset, directly or indirectly, the tax reduction. Practically speaking, this limitation will completely hamstring state and local governments from the normal ebb and flow of tax policy changes, adjustments and interpretations. Taken to its logical conclusion, this language freezes state legislative and administrative tax policy development out of fear anything they may do would require the return of federal relief funds. We expect the US Department of the Treasury will issue guidance clarifying this provision in the coming weeks.

Practice Note: This provision of ARPA is, in our view, the most significant federal pre-emption of state tax policy in history. For the next three years, legislators and tax administrators alike will be scrutinized as their tax policy decisions are evaluated through the lens of this prohibition. This level of congressional control over state tax policy decisions and fiscal autonomy likely violates the Tenth Amendment of the US Constitution and would dismay the framers’ basic notions of federalism.

While Congress has the ability to limit the use of federal funds in ensuring its policy goals are accomplished, the overly broad state tax limitation adopted by Congress goes far beyond its stated purpose and prevents states from furthering ARPA’s goals by using tax policy to craft their own COVID-19 relief measures. Any regulation or administrative interpretation that reduces state tax revenue or delays the implementation of a tax is, effectively, barred by the unprecedented intrusion into state tax policy-making.

The effects of ARPA’s state tax limitation are immediate and far-reaching. It will chill continuing state efforts to couple/decouple state tax codes to or from the Tax Cuts and Jobs Act of 2017. Additionally, ARPA already stalled legislation pending in Maryland that would delay, for one year, implementation of its digital advertising services gross receipts tax, restoring return filing and tax [...]

Continue Reading




Maryland Digital Advertising Services Tax—Implementation Delay Likely

On the morning of Friday, February 26, 2021, the Maryland Senate Budget and Taxation Committee added a new item to its agenda for the hearing later that morning. The new item was proposed amendments to Senate Bill 787, a bill that would amend the Maryland Digital Advertising Tax by excluding broadcasters and news media and preventing service providers from directly passing the tax through to customers. One of the amendments would change the tax years to which the tax applies from tax years beginning after December 31, 2020, to tax years beginning after December 31, 2021. The amendment passed on a voice vote.

The amendment was sponsored by the bill’s author, Senate President Bill Ferguson. Senator Ferguson was also the chief proponent of the Digital Advertising Services Tax. A companion bill, House Bill 1200, sponsored by House Majority Leader Eric Luedtke, came up for a hearing in the House Ways and Means Committee later that day, but only testimony from supporters of the two carve-outs was received. No amendments were offered, and no votes were taken.

Because the amendment delaying the implementation of the Digital Advertising Services Tax is coming from the Senate’s president, we believe its passage a near certainty. This amendment, if passed, would not delay the effective date of the tax, it would only change the tax year to which it first applies from 2021 to 2022.




Maryland Sued over Digital Advertising “Tax”

Today, McDermott Will & Emery filed suit in Maryland federal court on behalf of a number of leading trade associations against Maryland Comptroller Peter Franchot, challenging the state’s recently enacted 10% gross receipts “tax” applicable to digital advertising revenue. The plaintiffs in the suit are the US Chamber of Commerce, the Internet Association, NetChoice and the Computer and Communications Industry Association. The suit asks that the court invalidate Maryland’s punitive imposition as violating several provisions of the US Constitution and the Internet Tax Freedom Act.

A file-stamped copy of the complaint is available below:



The complaint alleges that Maryland’s focus on internet advertising services (the tax does not apply to traditional advertising) discriminates against the internet, violating the Internet Tax Freedom Act. Next, because Maryland’s new law burdens and penalizes conduct occurring outside Maryland, it violates the Commerce and Due Process Clauses of the US Constitution. The complaint alleges that the characteristics of the imposition and the circumstances surrounding its enactment demonstrate a clear purpose and intent to punish out-of-state digital advertising companies for their extraterritorial activities.

The case is Civil No. 21-cv-410 (D. Md., filed February 18, 2021). Michael B. Kimberly, Paul W. Hughes, Stephen P. Kranz and Sarah P. Hogarth of McDermott, Will & Emery’s Washington, DC, office represent the plaintiffs.

Practice Note: The filing of this suit sends a signal to other states, like New York, Connecticut and Montana, where similar proposals are under consideration. Policymakers in those other states should recognize that following Maryland’s lead will only lead to the courthouse.




Maryland Enacts First Digital Advertising Services Gross Receipts Tax: Now What?

General Assembly Veto Override

On February 12, 2021, the Maryland General Assembly overrode Governor Larry Hogan’s veto of HB 732 (2020) (the Act), a bill enacting a first-of-its-kind digital advertising services tax on the annual gross receipts from the provision of digital advertising services in Maryland. The tax only applies to companies having annual gross revenues (without deduction of any expenses) from all sources of $100 million or more. The rate of the tax varies, depending on the level of global annual gross revenues, from 2.5% (for companies with $1 billion or less in global annual gross revenues) to 10% (for companies with more than $15 billion in global annual gross revenue). The rate applies to gross revenues from the performance of digital advertising services in Maryland. For instance, a company subject to the 10% rate having $100 million of revenue attributable to the performance of digital advertising services in Maryland would owe an annual tax of $10 million that will be reported and paid on a quarterly basis throughout the year.



Effective Date

Even though the legislation says the tax is effective July 1, 2020, under the Maryland Constitution, vetoed legislation becomes effective the later of the effective date in the bill or 30 days after the veto is overridden. Based on today’s veto override, the bill should become effective on or about March 14, 2021. However, because the legislation is “applicable to all taxable years beginning after December 31, 2020,” the digital advertising services tax will be retroactive to the beginning of this year.

Looming Compliance Deadlines

The digital advertising services tax applies on an annual basis with a return due on or before April 15 of the following year. However, the tax also requires quarterly filing and payment for certain taxpayers. On or before April 15 of the current year, persons subject to the tax are required to file a declaration of estimated tax showing how much Maryland digital advertising services tax they expect they will owe for the calendar year. As part of the declaration and quarterly with returns filed thereafter, the Act requires that they pay at least 25% of the estimated annual tax shown on the declaration. There is a penalty of up to 25% of the amount of any underestimate of the tax. The Act also creates a fine of up to $5,000 and criminal penalties of up to five years’ imprisonment for willfully failing to file the annual return.

Filing and Guidance TBD

At the time of writing, the Maryland Office of the Comptroller has not published any of the forms necessary for making the declaration of estimated tax or the return due on April 15 of the current year. The comptroller’s office also has not adopted regulations as required by the Act, providing guidance on when advertising revenue is derived in Maryland, likely a daunting and complicated task since this is a novel question that other states have not addressed. Many aspects of the Act are vague at best [...]

Continue Reading




Washington Department of Revenue Announces LendingTree Decision Does Not Prevent Sourcing of Services to Customer’s Customer Location

The Washington State Department of Revenue (the “Department”) recently announced its interpretation of the Washington Court of Appeals’ March 30, 2020, adverse ruling in LendingTree, LLC v. Dep’t of Revenue, no. 80637-8-I (Wash. App. Ct. Mar. 30, 2020). See here for our prior analysis of the LendingTree opinion. In its interpretation, the Department takes the view that the LendingTree opinion “does not represent a new legal framework,” but rather that the court simply followed the applicable business and occupation tax apportionment rules in sourcing service receipts to the customer’s location and rejecting the Department’s methodology sourcing to the customers’ customers’ location.

The Department’s response suggests that it intends to narrowly apply LendingTree‘s holding. The Department admits that the court agreed with LendingTree in designating the service at issue to be LendingTree’s referral services (lenders pay a fee to receive referrals of potential borrowers) and rejected the Department’s characterization of the service as marketing and outreach to potential borrowers. Under this characterization, the Department observes, in accordance with a Washington regulation sourcing services to where the customer’s related business activity occurs, the referral services are sourced to the lender’s location, where lenders evaluate the referrals received by LendingTree.

The response goes on to emphasize, however, that there are circumstances where the Department will continue to source service receipts to a customer’s customers’ location. The Department announced that one such circumstance would be for taxpayers who have revenues from the sale of marketing or advertising services to a customer engaged in the business of selling.

Taxpayers should be forewarned that despite the LendingTree ruling, they may still have to battle Department efforts to source service receipts based on the location of their customers’ customers (particularly if they are engaged in the sale of marketing or advertising services), despite a Washington statute requiring service receipts to be sourced to the customer and federal constitutional principles requiring that an apportionment method reflect a taxpayer’s in-state activity. (See: e.g., Oklahoma Tax Commission v. Jefferson Lines, 514 U.S. 175 (1995); Container Corp. of America v. Franchise Tax Board, 463 U.S. 159 (1983).) Unfortunately, it appears that “look through” sourcing disputes between taxpayers and the Department will continue.




New State Digital Ad Taxes? Will Maryland’s Take Effect? Which States Will Follow? Litigation Guaranteed!

On March 18, 2020, Maryland legislature sent a massive new tax on digital advertising services to Governor Hogan for consideration. The tax imposes a rate of up to 10% on annual gross revenue in the state derived from digital advertising services. This tax is on a sliding scale based on companies’ global revenues and would take effect with tax year 2021. There are many legal problems with the legislation, including the violations of the Internet Tax Freedom Act, the Commerce Clause and the First Amendment. Other states have considered and are considering similar proposals. It is imperative that companies know how broadly this new tax will apply.

Click below to watch our recent webinar on this new tax. We discuss the legal challenges that can be made and how to protect your company from the unlawful reach of such laws.




Maryland General Assembly Sends Digital Advertising Tax to Governor; Nearly Identical Bill Pending in New York

With gatherings larger than 50 people banned and the State House cleared of visitors, on March 18, 2020, Maryland’s legislature approved HB 732, which contains a massive new punitive tax on digital advertising services, and sent it to Governor Larry Hogan (R) for his consideration.

Digital Advertising Gross Revenues Tax

Contradicting the clear legislative trend in the advertising space to exempt the facilitation of advertising services (but tax the consumer transactions that may result therefrom), HB 732 would impose a new, one-of-a-kind tax on the annual gross revenue of digital advertising services that are deemed to be provided in the State. The proposed tax contains a tiered tax rate structure (arbitrarily determined based on the advertising service provider’s global annual gross revenues) that would allow for a tax rate of up to a whopping 10% of the annual gross revenue in the State derived from digital advertising services. As passed, HB 732 would take effect July 1, 2020, and the new tax would apply to all taxable years beginning after December 31, 2020.

(more…)




STAY CONNECTED

TOPICS

ARCHIVES