Income Tax
Subscribe to Income Tax's Posts

Colorado Changes Rules for Determining Members of Combined Filing Group

Colorado Governor Jared Polis has signed legislation that would replace Colorado’s unique “3 of 6” rule for determining the members of a unitary group for combined reporting purposes and instead adopt what Legislative Council Staff has called “the Multistate Tax Commission’s standard” for determining the members of a combined filing group.

Under current law, a combined report may only contain those members of an affiliated group of corporations as to which three of the following six facts have been in existence in the tax return year and the two preceding years:

  1. Sales or leases between one affiliate and another constitute 50% or more of the gross operating receipts or cost of goods sold of the entity making the sales/leases
  2. Certain back-office services are provided by one affiliate for the benefit of another
  3. Twenty percent or more of the long-term debt of one affiliate is owed to or guaranteed by another affiliate
  4. One affiliate substantially uses certain intellectual property of another affiliate
  5. Fifty percent or more of the board of one affiliate are members of the board or are corporate officers of another affiliate
  6. Twenty-five percent or more of the 20 highest ranking officers of an affiliate are members of the board or are corporate officers of another affiliate.

Under the new law all members of a “unitary business” will be required to file a combined report. A “unitary business” is defined as an affiliated group of entities “that are sufficiently interdependent, integrated, and interrelated through their activities so as to provide a synergy and mutual benefit that produces a sharing or exchange of value among them and a significant flow of value to the separate parts.”

The new law keeps Colorado’s water’s-edge rule in place, but it’s notable that said rule provides an exception for any entity “incorporated in a foreign jurisdiction for the purpose of tax avoidance” while identifying a list of nations where a corporation will be presumed to be incorporated for tax avoidance purposes (including the Cayman Islands, Luxembourg, Monaco, etc.).

Presuming Colorado voters don’t file a referendum petition and get the legislation overturned in November, the new standard would go into effect for tax years beginning on or after January 1, 2026.




read more

Microsoft Scores Massive Win in California, Opens the Door for Others Nationwide

The Office of Tax Appeals (OTA) handed Microsoft an enormous win in its controversy with the California Franchise Tax Board (FTB) over the inclusion of qualifying dividends in the sales factor denominator for which it also claimed a dividends received deduction (DRD).

Microsoft filed a water’s-edge combined report for the years at issue and deducted 75% of qualifying dividends received from foreign affiliates outside its water’s-edge group. Initially, Microsoft only included the 25% net amount of dividends received in its sales factor denominator. Subsequently, Microsoft filed a refund claim asserting that the gross amount of dividends received should be included in the sales factor denominator, which would have resulted in a nearly $100 million refund.

The FTB argued that its own legal ruling (Ruling 2006-01) limiting the denominator to net dividends was dispositive of the issue. In its opinion, qualifying dividends should be excluded like eliminated intercompany dividends that were previously reported as income. The FTB also argued that a “matching principle” should apply to exclude the dividends like other items expressly excluded for allegedly not contributing to the tax base.

However, the OTA did not defer to FTB’s legal ruling because it was not a formal regulation. It was interpreting a statute, and its interpretation was inconsistent with the law. The OTA also disagreed with the comparison to eliminated intercompany dividends as there is no similar express exclusion in the DRD statute. Furthermore, the OTA found that “the legislative history” did not support the FTB’s “matching principle” because if the legislature intended the list of exclusions to be non-exhaustive, it would have used language like “such as” or “and other similar transactions.”

In its petition for rehearing, the FTB raised new arguments that the legislative history supported its interpretation and that qualifying dividends should be excluded from the denominator because they are qualitatively different from Microsoft’s main line of business. The OTA again rejected “the same or similar arguments that were considered and rejected in the Opinion” and stated that “new theories that could have been raised, but were not, is not one of the causes that permits a new hearing.” Accordingly, the OTA found that Microsoft was entitled to the nearly $100 million refund.

*          *          *

Corporate taxpayers should consider this decision as the basis for similar claims both in California and nationwide. While the Microsoft case involved dividends resulting from the Section 965 inclusion regime, it should apply to any type of dividend. The position is not conceptually different from including the factors of a unitary business entity that is in a loss while simultaneously using the loss for a net operating loss deduction. Therefore, in states where taxpayers are including only dividends in the denominator to the extent included in the base, there may be a position to instead include all dividends – even those subject to a deduction from the base. Depending on the statutory language in any given state, this could be true even if 100% of the dividends are deducted. [...]

Continue Reading




read more

ALJ Rules That a Taxpayer Is a Qualified New York Manufacturer Even Though Qualifying Property Was Operated by a Third Party

The New York State Division of Tax Appeals determined that E. & J. Gallo Winery is a qualified New York manufacturer (QNYM) even though its only property in New York that could allow it to qualify for QNYM classification – a vineyard – was operated by a third-party contractor and Gallo did not have any of its own employees involved in the operation of the vineyard.

Gallo is a multinational manufacturer of table wines that acquired a vineyard in New York and hired a third-party contractor to maintain and farm the vineyard “so as to produce the quantity and quality of grapes” that Gallo’s significant winemaking operations needed. “The service agreement [between Gallo and the third-party contractor] was not a lease,” but instead gave the contractor the responsibility of the “full and complete management, supervision and control of the development and operation of the . . . vineyard.” In this role, the contractor was required to hire employees and subcontractors. The service agreement with Gallo confirmed that the contractor was to be treated “in all respects [as] the sole employer of such persons, employer of such persons, employees, duly licensed contractors, or firms.”

Gallo claimed it was a QNYM during the years at issue (2016 to 2019) under New York Tax Law §§ 210(1)(a)(vi) and 210-B(1)(b)(i)(A), which the administrative law judge (ALJ) summarized as requiring a taxpayer or combined group to have:

  • Been “principally engaged” (derived more than 50% of its gross receipts) in the production of goods by manufacturing, processing, assembling, refining, mining, extracting, farming, agriculture, horticulture, floriculture, viticulture or commercial fishing
  • Owned property in New York that had an adjusted basis of at least $1 million at the close of each taxable year or had all of its real and personal property located in New York
  • [Whereby] such property is principally used by the taxpayer in the production of goods by the same list of activities noted above, including manufacturing and viticulture.

The New York State Department of Taxation and Finance agreed that Gallo satisfied the first two requirements, but claimed, pursuant to TSB-M-15(3)C, that Gallo failed to meet the third requirement because it did not have any employees related to the vineyard and, therefore, it did not actually use the relevant New York-located property in the production of goods.

The ALJ, however, pointed out that “TSB-Ms are informational statements of the Division of Taxation’s policies” and “do not have legal force or effect.” And because the QNYM statute is a rate reduction and not an exemption, “it is to be construed most strongly against the government and in favor of the taxpayer.”

In analyzing the statute, the ALJ found that there was no “employee requirement” like that in the alternative test (i.e., having 2,500 manufacturing employees and $100 million of manufacturing property in New York) to be considered a QNYM. Therefore, the ALJ stated, “there is no basis to import the requirements from one test to the other when the Legislature could have easily done [...]

Continue Reading




read more

New Jersey Governor Flip-Flops on Corporate Business Tax Surtax Expiration

After months of insisting that he would not allow New Jersey’s 2.5% corporate business tax surtax to be extended – and previously having allowed it to lapse for tax years beginning on January 1, 2024 – New Jersey Governor Phil Murphy is now proposing that the surtax be revived for companies earning profits that exceed $10 million a year (up from the prior threshold of $1 million). The proposal appears to apply retroactively to January 1, 2024.

This will cause New Jersey to once again have the highest corporate income tax rate in the nation at 11.5%. According to the New York Times, Governor Murphy is selling the revival of the surtax as a “corporate transit fee” because the extra revenue will be earmarked for New Jersey Transit.

The governor’s proposed flip-flop is expected to receive significant pushback from the business community. The New Jersey Chamber of Commerce, which has already called the governor’s proposal a “nightmare scenario for New Jersey,” has indicated that it will be meeting with the Murphy administration and legislative leaders to voice their opposition.




read more

Remote Retailers Held Responsible for Tax Collection in Washington

If there’s a lesson to be learned from the Washington Court of Appeals’ recent holding in Orthotic Shop Inc. and S&F Corporation v. Department of Revenue, No. 39321-6-III (Jan. 23, 2024), it’s that the use of a marketplace does not eliminate a remote seller’s tax responsibilities, particularly for pre-Wayfair periods.

The dispute in Orthotic Shop involved a retailing business and occupation tax (B&O tax) and a retailing sales tax assessment against two merchants for sales they made on an online retailer’s website. The audit report asserted that the merchants were “retailers” who maintained a nexus to Washington because they maintained a stock of goods in the online retailer’s warehouses located in the state. As such, the audit report concluded that the merchants were liable for retailing B&O tax and sales tax on sales to Washington customers made via the online retailer’s website.

The merchants admitted before the Court of Appeals that they sold their goods to consumers and not to the online retailer. However, the merchants challenged the assessment and argued that the online retailer’s provision of fulfillment services necessarily rendered it a “consignee” responsible for remitting retailing B&O tax and sales tax on transactions facilitated through its website in accordance with WAC 458-20-159. The merchants also asserted that the assessment was unfair because they lacked an understanding that they could incur a tax collection liability in Washington through the storage of their merchandise in an in-state warehouse.

The Court of Appeals determined that the merchants failed to show that the online retailer was a consignee with sole responsibility for tax collection. “A consignee,” the Court of Appeals explained, “makes sales on behalf of the consignor.” By contrast, the merchants’ product pages on the marketplace’s website listed the merchants as the sellers, not the online retailer. Accordingly, the Court of Appeals concluded: “[s]ince the merchants sold to buyers, they are liable for retailing B&O tax on those sales.”

The merchants’ failure to list the online retailer as the “seller” on their respective sales pages was also fatal to their argument that they were not liable for retailing sales tax on sales made via the online retailer’s website. The Department of Revenue’s administrative rules explain that while a consignee is responsible for collecting and remitting sales tax on sales made in its own name, when the consignee is selling in the name of the consignor, the consignor may instead report and remit the retail sales tax. Here, the Court of Appeals noted that while the online retailer’s agreement with the merchants provided that it would remit the sales tax if the merchants asked it to do so, neither merchant made such a request.

The Court of Appeals also was unimpressed by the merchants’ assertions that they did not understand that they could establish physical presence nexus and incur a tax liability based on the storage of their goods at a warehouse in the state. The Court of Appeals explained that ignorance of the law, was not an acceptable defense.

CASE TAKEAWAYS

Although Orthotic Shop [...]

Continue Reading




read more

Vermont Considers Imposing Mandatory Worldwide Combined Reporting

The Vermont House Committee on Ways and Means is actively exploring a proposal to become the first state to enact mandatory worldwide combined reporting for corporate income tax purposes. While legislation has not been formally proposed, the Committee has examined a working draft that could be embedded into a broader tax legislation package.

In Committee testimony supporting the adoption of mandatory worldwide combined reporting, Don Griswold, a senior fellow at the Center on Budget and Policy Priorities, argued that multinational corporations “pay huge fees to sophisticated advisers to develop an endless variety of complex schemes that shift their profits offshore.” According to him, mandatory worldwide combined reporting would be “the complete solution” to stopping what he perceives as a “loophole for massive tax avoidance.” He also intimated that several companies are among those he believes are currently engaging in “tax avoidance,” even though he freely acknowledged that he worked in a “Big 4 accounting firm’s 600-person ‘state tax minimization’ group” for most of his career.

On the other hand, at least one representative from the Vermont Department of Taxes has suggested that worldwide mandatory combined reporting is not the panacea that Griswold claims it would be. In Committee testimony, Will Baker, assistant attorney general and general counsel at the Department of Taxes, pointed out that a corporation’s Vermont taxable income could increase or decrease under worldwide combined reporting depending on the profitability of the corporation’s domestic and overseas subsidiaries and the locations of the corporate unitary group’s sales throughout the world. Baker also suggested that the Department of Taxes would face practical challenges calculating the income of subsidiaries that are not part of a corporate filing at the US federal level. Finally, he added that “small states” should generally “have the same rules that other states have” to make it easier for taxpayers to comply with Vermont law.

The McDermott state & local tax team will be closely monitoring this legislative proposal to see whether the Vermont General Assembly takes heed of the advice of its own officials at the Department of Taxes.




read more

At the 10-Yard Line: New York Formally Proposes Corporate Tax Reform Regulations

On August 9, 2023, the New York State Department of Taxation and Finance (Department) released 417 pages of proposed regulations, an important step toward concluding a now almost decade-long process to implement corporate tax reform.

The journey began in 2014 with the enactment of legislation modernizing the state’s corporate tax law. Thereafter, the Department released several versions of draft regulations while warning taxpayers that the drafts were “not final and should not be relied upon.” Even though the Department announced last spring that it intended to formally propose and adopt such regulations in fall 2022, taxpayers had to wait another year.

Comments on the proposed regulations must be provided to the Department by October 10, and the regulations will be finalized thereafter. In this article, we’re taking a closer look at a few of the items included in the proposed regulations.

ADOPTION OF THE MULTISTATE TAX COMMISSION’S INTERPRETATION OF P.L. 86-272

Consistent with the Department’s final version of the draft regulations, the proposed regulations contain rules based on model regulations adopted by the Multistate Tax Commission, which narrowly interpret P.L. 86-272. Under the proposed regulations, “interacting with customers or potential customers through the corporation’s website or computer application” exceeds P.L. 86-272 protection. By contrast, “a corporation will not be made taxable solely by presenting static text or images on its website.” This sweeping change remains surprising because P.L. 86-272 is a federal law, the scope of which is not addressed by the state’s corporate tax reform.

THE ELIMINATION OF THE “UNUSUAL EVENTS” RULE

The proposed regulations omit the “unusual events” rule contained in the 2016 draft regulations. Generally consistent with Department regulations long predating the state’s corporate tax reform legislation, the 2016 draft stated that “business receipts from sales of real, personal, or intangible property that arose from unusual events” were not included in the business apportionment factor. For example, a consulting firm that sold its office building for a gain would not have included the gain in its apportionment factor because the sale was considered to be from an unusual event. The Department claims to have abandoned the rule “because Tax Reform provided significantly more detailed sourcing rules, including guidelines for those transactions that might have been excluded under pre-reform policy.”

SAFE HARBOR SOURCING FOR DIGITAL PRODUCTS AND SERVICES

Post-reform corporate tax law sources receipts from digital products and digital services to New York if the location the customers derive value from is in New York as determined by a complicated hierarchy of methods. The proposed regulations provide a simplified safe harbor in applying this sourcing rule, where “if the corporation has more than 250 business customers purchasing substantially similar digital products or digital services as purchased by the particular customer . . . and no more than 5% of receipts from such digital products or digital services are from that particular customer, then the primary use location of the digital product or digital service is [...]

Continue Reading




read more

As Minnesota Moves Toward GILTI Taxation, New Jersey May Be Moving Away from It

We previously reported that the Minnesota Legislature was considering imposing mandatory worldwide combined reporting through an omnibus tax bill. Subsequent to our report and in the face of numerous criticisms, Minnesota Senate leaders backed away from the proposal. But ominously, those same leaders said they would examine other tax increases to make up for the (potentially hypothetical) revenue left on the table by moving away from mandatory worldwide combined reporting.

After a series of negotiations, an updated omnibus tax bill (HF 1938) emerged from the Minnesota Legislature conference committee over the weekend, which has already been passed by both the Minnesota House and Senate. Most notably for corporate taxpayers, the legislation:

  • Recouples Minnesota with the Internal Revenue Code provision providing for the inclusion of global intangible low-taxed income (GILTI) (under IRC § 951A) in the corporate tax base while providing a 50% dividends received deduction (but no deduction under IRC § 250)
  • Reduces the dividends received deduction from 80% to 50% for corporations in which the recipient owns 20% or more of the stock and from 70% to 40% for corporations in which the recipient owns less than 20% of the stock and
  • Decreases a corporation’s maximum net operating loss deduction from 80% to 70% of taxable net income each year.

As no prior bills proposing these tax increases had been introduced in the Minnesota Legislature, these tax increases have been passed without any public hearing or public testimony. The rush to put these proposals together may explain why the legislation fails to address how income from GILTI must be accounted for in determining a taxpayer’s apportionment factor.

Minnesota’s move toward GILTI taxation is out of step with legislation introduced in New Jersey, which would increase the state’s GILTI deduction to 95% from 50%. The proposal, which is part of a broader legislative compromise package negotiated by New Jersey government officials and businesses, has the support of the chair of the New Jersey Senate Budget and Appropriations Committee and has been publicly called “win-win” legislation by a New Jersey Division of Taxation representative.

As litigation addressing the constitutionality of taxing GILTI is already percolating through administrative appeals in numerous states, it is likely that New Jersey’s potential move away from GILTI taxation will prove to be the more fiscally prudent way to go.




read more

Buehler Doesn’t Get a Day Off from Double Taxation

The California Office of Tax Appeals (OTA) recently held that a California resident’s income tax paid to Massachusetts from the sale of his membership interest in a limited liability company (LLC) doing business in Massachusetts was not eligible for California’s other state tax credit. The OTA reached this conclusion while acknowledging that it “will result in the income” from the sale of the membership interest “being double taxed.”

The taxpayer in the case, Mr. Buehler, was one of three managing members of an LLC that had an office in Massachusetts and provided portfolio management services for pooled investment vehicles. Buehler “was actively involved in” the LLC’s management and operations. After selling his membership interest in the LLC, Buehler filed a Massachusetts nonresident tax return and reported and paid tax on a share of the net gain from the sale of the membership interest, using the LLC’s Massachusetts apportionment factors.

The OTA’s decision did not question whether Buehler properly determined, under Massachusetts law, the tax owed to Massachusetts from the sale of his LLC membership interest. At that time, the Massachusetts Department of Revenue took the position that such sales of pass-through entity interests were taxable in Massachusetts where the entity conducted business regardless of whether the seller was “unitary” with the entity. (See, e.g., VAS Holdings & Investments LLC v. Comm’r of Revenue, 489 Mass. 669 (2022).) Instead, the OTA focused on the language of California’s other state tax credit, which applies to income taxes paid to another state on “income derived from sources within that state.” As stated by the OTA, “in order for a California taxpayer to be entitled” to a credit, “income taxes paid to the nonresident state (here, Massachusetts) must be based on income sourced to that nonresident state using California’s nonresident sourcing rules.” (Emphasis in original).

The OTA determined that under Cal. Rev. & Tax. Code § 17952, the LLC interest was not sourced to Massachusetts because Buehler’s LLC membership interest had not acquired a “business situs” in Massachusetts. According to the OTA, Buehler’s activities as a managing member of the LLC did not cause the “membership interest itself” to be “integrated into the business activities” of the LLC “in Massachusetts.” (Emphasis in original). In other words, while Buehler’s “services for” the LLC “as one of its three managing partners may connect him with” the LLC’s “Massachusetts business activities, that fact alone does not show that [Buehler’s] membership interest was localized in Massachusetts.”

The OTA also rejected Buehler’s alternative argument that his active involvement in the LLC caused him to “become unitary” with the LLC’s business, allowing for combination and apportionment under California Tax Regulation § 17951-4(d). The OTA explained that Buehler did not establish that he was “operating a sole proprietorship or any kind of business activity” separate and apart from the LLC “that could be considered unitary with” the LLC.

The OTA acknowledged that its decision would lead to double taxation of income from the sale of the LLC membership interest but concluded [...]

Continue Reading




read more

Be Careful What You Wish For: Minnesota May Be on the Precipice of Enacting Worldwide Combined Reporting at the Worst Possible Time

It has been widely reported that the Minnesota Legislature has advanced an omnibus tax bill that would require the inclusion of the “entire worldwide income” of combined corporate income tax filers engaging in a unitary business. Tax press outlets have made the broad claim that mandatory worldwide combined reporting will “add foreign subsidiaries’ profits” to Minnesota corporate tax returns. But these claims disregard how such a change in Minnesota’s tax regime would also bring worldwide losses into a combined filing group’s income (or loss) calculation. If Minnesota passes mandatory worldwide combined reporting legislation this year and economic expert predictions of an impending global recession come true, the state could see a significant decrease in revenue from its corporate income tax.

Claims that worldwide combined reporting will bring additional profits into the corporate tax base presuppose foreign subsidiaries added to a combined group are always profitable. But if the entities added to a combined group are unprofitable, the opposite would be true. Instead, the foreign entities would either decrease income subject to state corporate income taxation or increase losses that generate net operating loss carryforwards that will decrease state corporate income taxation in future years.

This isn’t just a hypothetical concern. Tax specialists who practiced in the wake of the 2008 global recession recall that states with combined reporting regimes often sought to force unitary groups of corporations to “decombine” in order to remove entities generating losses from the state corporate tax base. When attempts to decombine were unsuccessful (as many were), states were often forced to walk away from large assessments or pay large refunds to corporate taxpayers. Such experiences should serve as a reminder that combined reporting often can decrease a state’s revenues from a corporate income tax. In Minnesota’s case, the potential for lost tax revenues may only balloon if its legislature imposes worldwide combined reporting during a recession.

No state currently has a true mandatory worldwide combined reporting regime (Alaska only imposes it on specific industries), and concerns about bringing foreign loss companies into the combined group is one of many reasons why. If Minnesota were to break state ranks by imposing worldwide combined reporting and a US parent corporation determined the regime could cause its Minnesota taxable income to increase, the corporation would have every incentive to either avoid or decrease connections with the state—potentially causing the state to lose out on capital investments that bring jobs with high wages and benefits.

Further, any attempt to impose mandatory worldwide combined reporting is likely to cause an international backlash, along with potential federal action and litigation challenging Minnesota’s regime. In the immediate wake of a 1983 U.S. Supreme Court decision indicating, to a limited degree, that a state mandatory worldwide combined reporting regime could pass constitutional muster, the US Department of the Treasury completed a study outlining state taxing principles supported by “state, [...]

Continue Reading




read more

STAY CONNECTED

TOPICS

ARCHIVES

jd supra readers choice top firm 2023 badge