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Income Tax

Inside the New York Budget Bill: Tax Base and Income Classifications

by McDermott Will & Emery | Apr 2, 2015 | Allocation/Apportionment, Income Tax, New York, Tax Base

The New York Legislature has passed bills related to the 2015–2016 budget (S2009-B/A3009-B and S4610-A/A6721-A, collectively referred to herein as the Budget Bill) containing several significant “technical corrections” to the New York State corporate income tax reform enacted in 2014, along with sales tax provisions and amendments to reform New York City’s General Corporation Tax. The Budget Bill’s technical corrections to last year’s corporate income tax reform include changes to the economic nexus, tax base and income classification, tax rate (including clarifications to rules applicable to certain taxpayers, such as qualified New York manufacturers), apportionment, combined reporting, net operating loss and tax credit provisions. The technical corrections are effective on the same date as last year’s corporate income tax reform, which was generally effective for tax years beginning on or after January 1, 2015.

This post is the second in a series analyzing the New York Budget Bill, and summarizes the technical corrections to New York’s tax base and income classifications.

Although the modifications are described as “corrections” to last year’s corporate tax reform provisions, the Budget Bill makes a number of substantive changes with respect to the income classification rules.

Investment Capital

Last year’s corporate tax reform narrowed the definition of investment capital to mean investments in stocks held by a taxpayer for more than six consecutive months but not held for sale to customers in the regular course of business, and excluding stock that is a “qualified financial instrument” for which the taxpayer has elected to use the 8 percent apportionment sourcing rule, stock in a unitary business, stock in a business that is included in a combined report with the taxpayer, and stock issued by the taxpayer.

This year’s Budget Bill further narrows the definition of investment capital by extending the holding period from six months to one year, by tying the definition of investment capital to certain Internal Revenue Code provisions, and by requiring taxpayers to separately identify stock held as investment capital in their books and records. Investment capital now means investments in stocks that meet the following criteria:

Satisfy the definition of a “capital asset” under section 1221 of the Internal Revenue Code at all times the taxpayer owned the stock during the taxable year;
Are held for investment for more than one year;
The dispositions of which are, or would be, treated by the taxpayer as generating long-term capital gains or losses under the Internal Revenue Code;
For stocks acquired on or after January 1, 2015, have never been held for sale to customers in the regular course of business at any time after the close of the day on which they are acquired; and
Before the close of the day on which the stock was acquired, are clearly identified in the taxpayer’s books and records as stock held for investment in the same manner as required under section 1236(a)(1) of the Internal Revenue Code for the stock of a dealer in securities to be eligible for capital gain treatment (for [...]

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Inside the New York Budget Bill: Economic Nexus

by McDermott Will & Emery | Apr 2, 2015 | Income Tax, New York, Nexus

The New York Legislature has passed bills related to the 2015–2016 budget (S2009-B/A3009-B and S4610-A/A6721-A, collectively referred to herein as the “Budget Bill”) containing several significant “technical corrections” to the New York State corporate income tax reform enacted in 2014, along with sales tax provisions and amendments to reform New York City’s General Corporation Tax. The Budget Bill’s technical corrections to last year’s corporate income tax reform include changes to the economic nexus, tax base and income classification, tax rate (including clarifications to rules applicable to certain taxpayers, such as qualified New York manufacturers), apportionment, combined reporting, net operating loss and tax credit provisions. The technical corrections are effective on the same date as last year’s corporate income tax reform, which was generally effective for tax years beginning on or after January 1, 2015.

This post is the first in a series analyzing the New York Budget Bill, and summarizes the technical corrections to New York’s economic nexus provisions.

The New York Tax Law provides that a corporation is subject to corporate income tax if it is “deriving receipts from activity in [New York].” A corporation is deemed to be “deriving receipts from activity in [New York]” if it has $1 million or more of receipts included in the numerator of its apportionment factor, as determined under the Tax Law’s apportionment sourcing rules (New York receipts). Furthermore, a credit card company is deemed to be doing business in New York if it has issued credit cards to 1,000 or more New York customers; has contracts covering at least 1,000 merchant locations; or has at least 1,000 New York customers and New York merchant locations. The Tax Law also has special rules (aggregation rules) for corporations included in combined reporting groups. This year’s Budget Bill slightly modified those aggregation rules.

Under the Tax Law as originally amended by last year’s corporate income tax reform, if a corporation did not meet the $1 million threshold itself, but had at least $10,000 of New York receipts, the $1 million test was to be applied to that corporation by aggregating the New York receipts of all members of the corporation’s combined reporting group having at least $10,000 of New York receipts. Similarly, a credit card corporation that did not meet the 1,000 customer and/or merchant location threshold by itself, but had at least 10 New York customers, at least 10 New York merchant locations or at least 10 New York customers plus merchant locations, would have been subject to tax in New York if all members of its combined reporting group with 10 such customers and/or locations, on an aggregated basis, had at least 1,000 New York customers, 1,000 New York merchant locations or 1,000 New York customers plus merchant locations.

As a result of the technical corrections, the $1 million New York receipts and 1,000 New York customers/merchant locations aggregation tests now apply to a corporation that is part of a unitary group meeting the ownership test of Tax Law section 210-C (more [...]

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U.S. Tax Court Finds Refundable State Credits Result in Taxable Income

by McDermott Will & Emery | Mar 17, 2015 | Incentives, Income Tax, New York, Property Tax

The United States Tax Court recently determined that certain refundable tax credits issued by New York in connection with economic development activities (EZ Credits) constituted taxable income to the recipients for federal tax purposes. Maines v. Comm’r, 144 T.C. No. 8 (Mar. 11, 2015). In reaching this determination, the Court noted that the characterization of certain of the EZ Credits as refundable taxes for New York purposes “is not necessarily controlling for federal tax purposes;” instead, the Court looked at the substance of the EZ Credits and determined that the credits were not actually a refund of previously paid state taxes, and, instead, the credits were a taxable accession to wealth since they were “just transfers from New York to the taxpayer—subsidies essentially.” The Court also considered one other refundable tax credit (the QEZE Credit), which was a credit against income tax liability for the amount of real property taxes paid, and determined that, while the amount of QEZE Credits refunded did not constitute a “taxable accession to wealth” as did the EZ Credits, the application of the tax benefit rule mandated that the refundable portion was subject to federal taxable income.

The taxpayers received the EZ Credits from New York for engaging in specific economic development activities in the state through their pass-through business entities. As the Court noted, New York labels the EZ Credits “credits” and treats them as refunds for “overpayments” of state income tax; the taxpayers in Maines received refunds of their state income tax based on their claim for the EZ Credits. Despite New York’s characterization of the EZ Credits, the Commissioner asserted that they were nothing more than cash subsidies, and thus should be treated as taxable income to the taxpayers. On the other hand, the taxpayers argued that New York’s label of the EZ Credits as overpayments was binding for purposes of federal law. The Court, noting President Lincoln’s famous quip that “if New York called a tail a leg, we’d have to conclude that a dog has five legs in New York as a matter of federal law. . . . Calling the tail a leg would not make it a leg,” agreed with the Commissioner, observing that federal law looks to the substance of legal interests created by state law, not to the labels the state affixes to those interests.

As for the QEZE Credit, the Tax Court agreed that it did not result in a taxable accession to wealth since it was really a refund of real property taxes that the taxpayer had paid to the state. However, the Court still determined that the refunded amounts would be taxable due to the tax benefit rule to the extent that a deduction had been claimed for the real property taxes paid. Under the tax benefit rule, to the extent a taxpayer obtains a refund of payments for which it received a tax benefit (such as a deduction), such refund should be taxable.

The Maines decision is one of the first Tax [...]

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Let the Training Begin: MTC Transfer Pricing Audits Draw Near

by McDermott Will & Emery, Diann Smith, Eric D. Carstens and Stephen P. Kranz | Mar 6, 2015 | Income Tax, Nationwide Importance, North Carolina, Tax Base, Transfer Pricing

Deputy Executive Director Greg Matson (a nice guy at heart) announced this week that the Multistate Tax Commission (MTC) has hired its first transfer pricing training consultant and is scheduled to begin training state auditors. The training, titled “Identifying Related Party Issues in Corporate Tax Audits” will be hosted by the North Carolina Department of Revenue from March 31 to April 1, 2015 in Raleigh, North Carolina. While the much anticipated Arm’s Length Adjustment Service (ALAS, discussed in more depth in our February 6, 2015 blog post, available here) is still pending approval of the MTC Executive Committee and ratification at the annual meeting this summer, it has not stopped MTC officials from moving forward with training state auditors on transfer pricing. This training (and any subsequent training offered before the annual meeting) will be conducted as part of the MTC’s “regular training” schedule (and is not directly tied to the ALAS program since authority to train for that program has not vested). Nonetheless, Executive Director Joe Huddleston made it clear in a recent letter to the states that “[t]his course will preview the training to be provided through the Arm’s-Length Adjustment Service.”

The kickoff training session at the end of this month will be conducted by former Internal Revenue Service Office of Chief Counsel senior economic advisor, Ednaldo Silva. He is the founder of RoyaltyStat LLC, one of the transfer pricing consulting firms that is being considered by the MTC to provide their services for the ALAS. During yesterday’s teleconference of the ALAS Advisory Group, Matson and Huddleston were optimistic that additional training sessions would be offered by the MTC before the ALAS is finalized. It remains to be seen whether this training will be offered by Silva or another participant from the October 2014 Advisory Group meeting that has submitted a bid to be the contract firm for the ALAS. Because these trainings are a fundamental threshold step to commencing ALAS audits (projected to begin December 2015), they provide a strong signal that the MTC is optimistic that they will have sufficient support from the states to continue the ALAS program.

Too Soon?

In a letter distributed to 46 states and Washington, D.C. in February 2015, the MTC officially solicited state commitments to the ALAS program. States were given until the end of March 2015 to respond. By the terms of the ALAS proposal, the MTC will need a commitment from at least seven states for the program to move forward. MTC officials announced at yesterday’s Advisory Group teleconference that the current count is zero (with one state declining). While there is still time to respond, several revenue department officials voiced concern about making a commitment without more detailed estimates of costs. Others voiced uncertainty about the ability to enter into a contract for such a long period under state law (the program requests that each state commit to four years). While there was no significant undertone of opposition to [...]

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Inside the New York Budget Bill: Guidance Released Regarding Transitional Compliance and Qualified New York Manufacturers

by Emily Townsend | Mar 2, 2015 | Allocation/Apportionment, Income Tax, Interest and Penalties, New York, Tax Base

On March 31, 2014, Governor Andrew Cuomo signed into law a budget bill containing major corporate tax reform. That new law resulted in significant changes for many corporate taxpayers, including a complete repeal of Article 32 and changes to the Article 9-A traditional nexus standards, combined reporting provisions, composition of tax bases and computation of tax, apportionment provisions, net operating loss calculation and certain tax credits. Most of the provisions took effect on January 1, 2015.

Due to the sweeping nature of this corporate tax reform, taxpayers have been awaiting official guidance from the New York State Department of Taxation and Finance on many areas of the reform. On January 26, 2015, the Department started releasing Technical Memoranda on certain aspects of the corporate tax reform.

The first Technical Memoranda, TSB-M-15(2)C, provides guidance on many transitional compliance issues, including, but not limited to, (1) clarifying the filing requirements for Article 32 and Article 9-A taxpayers with fiscal years that span both 2014 and 2015, (2) addressing the inclusion in a combined report of a member with a tax year end that is different from the designated agent, (3) addressing compliance issues involving short periods and corporate dissolutions, (4) clarifying the filing dates and estimated tax payment obligations for 2015 Article 9-A taxpayers.

The second Technical Memoranda, TSB-M-15(3)C, (3)I, addresses the benefits available to qualified New York manufacturers.

Transitional Compliance Issues

Taxpayers and tax return preparers should be particularly careful when preparing 2015 Article 9-A tax returns, as the Department’s guidance on transitional compliance issues indicates that returns submitted on incorrect forms or on prior year forms will not be processed by the Department and will not be considered timely filed, which could result in the imposition of penalties.

Fiscal Years Spanning 2014 and 2015

The Department’s guidance makes it clear that for any 12-month tax year that began before January 1, 2015, taxpayers must complete the relevant 2014 return (e.g., an Article 32 taxpayer must file a 2014 Article 32 franchise tax return and, if applicable, a MTA surcharge return) according to the Tax Law that was in effect before January 1, 2015. Fiscal year taxpayers, both Article 32 and Article 9-A, with a 12-month tax year that began in 2014, but will end in 2015, will not be permitted to file short period returns solely as a result of corporate reform.

Combined Reports that Include Taxpayers with Different Year Ends

For tax years beginning on or after January 1, 2015, a taxpayer is required to file a combined report with other corporations engaged in a unitary business with the taxpayer if a more-than-50-percent common ownership (direct or indirect) test is met, with ownership being measured by voting power of capital stock. Under the Tax Law, a combined report must be filed by the designated agent of the combined group. The “designated agent” must have nexus with New York and is generally the parent corporation of the combined group. If there is no such parent corporation or if the parent [...]

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ALJ: New York NOL Deduction Does Not Apply When Tax Is Not Paid on Income Base

by Arthur R. Rosen | Feb 17, 2015 | Income Tax, New York

A New York State Division of Tax Appeals administrative law judge (ALJ) recently determined that a banking corporation was not required to hypothetically use a net operating loss (NOL) deduction to decrease its entire net income in a year in which its banking corporation franchise tax liability under Article 32 of the New York Tax Law (bank tax) was not measured by the entire net income base. Matter of TD Holdings II, Inc., DTA No. 825329 (N.Y. Div. Tax App. Jan. 22, 2015). This case is a sterling example of how long-held and long-applied state tax audit policies can be successfully challenged. Taxpayers – in several states at least – can rely on the state’s adjudicatory process to ensure that logical results that are consistent with legislative intent are ultimately applied. McDermott represented the taxpayer in this case.

Though the bank tax has been repealed effective January 1, 2015, during the years at issue, the tax was imposed on one of four alternate bases, whichever resulted in the highest tax:

A tax on entire net income;
A tax on taxable assets;
A tax on alternative entire net income; or
A minimum tax.

Note that New York’s current general business franchise tax is similarly imposed on a number of alternative bases, and that banking corporations are now subject to that tax. See N.Y. Tax Law § 210.

In the case at issue, TD Holdings II, Inc., and certain of its disregarded subsidiaries (collectively, TD) had approximately $9 million of New York NOLs available to carry forward to its 2006 tax year. However, for 2006, TD’s bank tax liability on its asset base was greater than its bank tax liability computed using its entire net income base—even without application of an NOL deduction. Therefore, because TD was not required to pay tax based on the income base, it argued that it should not have to hypothetically use any portion of its available New York NOLs to reduce its entire net income base in the 2006 tax year, thereby reducing its New York NOLs available for carry forward to later years.

The Division of Taxation, arguing that because the Tax Law provided that a corporation’s New York NOL deduction in a given tax year is “presumably the same as” its federal NOL deduction for that same year, asserted that TD had to take a New York NOL deduction in 2006 that equaled its federal NOL deduction despite the fact that TD was not required to pay bank tax on the income base.

The ALJ agreed with TD, holding that TD “was not required by the plain language of the statute to hypothetically apply [its] New York NOL to an entire net income that was already sufficiently low enough to cause the use of an alternative tax base,” and that there is no statutory prohibition against a taxpayer using a New York NOL deduction that is less than its corresponding federal deduction notwithstanding statutory language that prevents a taxpayer from taking [...]

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MTC Puts Designs on Increasing State Transfer Pricing Revenues

by Diann Smith and Stephen P. Kranz | Feb 6, 2015 | Income Tax, Transfer Pricing

This past December, the Multistate Tax Commission’s (MTC) transfer pricing advisory committee and its project facilitator Dan Bucks recommended what it calls the “preliminary design” approach for a proposed Arm’s Length Adjustment Services (ALAS) program. While still subject to approval, states already anticipate that the program will increase their state transfer pricing revenues.

The MTC ALAS is an attempt to bring to state governments a comprehensive and coordinated program to address income shifting and the loss of state tax revenues, much along the lines of what the United States and other foreign governments have been trying to do, most recently in their Base Erosion and Profit Shifting (BEPS) initiative. The ALAS program is intended to address both interstate income shifting, which is never addressed at the federal level, and international income shifting, which the MTC believes is massively under-audited at the federal level. According to some estimates, state revenue losses from transfer pricing total as high as $20 billion a year.

Fundamental to the preliminary design will be the hiring of a mix of MTC in-house and contract consulting expertise for advanced economic and technical analysis of taxpayer-provided transfer pricing studies, including providing alternative recommendations to taxpayer positions. This approach (in contrast to a fully outsourced or in-house approach) recognizes the highly specialized and interdisciplinary nature of transfer pricing analysis, and the need to both quickly and effectively address and resolve immediate cases, as well as to build the capabilities and capacity (through training, information exchange, process improvements, etc.) to support state transfer pricing needs for the long-term.

Set to be voted on by the MTC’s Executive Committee at its May meeting, the ALAS program would kick-off in July 2015 with the hiring of an in-house tax manager, followed shortly thereafter with the engagement of one or more private economic consulting firms and an in-house senior economist by the end of the year. The program would begin transfer pricing analyses by December 2015, with the completion of up to 18 joint economic studies by the end of 2017.

The focus of the initial stages of the ALAS approach will be on reviewing and analyzing the taxpayer’s existing transfer pricing study—questioning, critiquing and (re)-computing the taxpayer’s results– rather than attempting to re-create the transfer price whole cloth. The effect is likely to produce a more rigorous, sophisticated and traditional analysis, one that paradoxically is likely to corroborate those taxpayer studies that are both thorough and orthodox in their approach, but at the same time pose a serious challenge to those that are not.

To the extent taxpayers don’t have formal documentation, they would be well-served to get it, or at least develop external third party benchmarks to corroborate their cross-border intercompany pricing.

The MTC’s proposed ALAS program is quite ambitious, not only in terms of its operational goals and timing, but also in its conception. Preliminary or not, the programs’ combination of outside expert consultants with coordinated state resources, should cause taxpayers to reexamine the “designs” of their state transfer pricing [...]

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New Market-Based Sourcing in DC: Major Compliance Date Problem Fixed… For Now

by Diann Smith, Eric D. Carstens and Stephen P. Kranz | Feb 5, 2015 | Allocation/Apportionment, District of Columbia, Income Tax, Massachusetts, Tax Base, UDITPA

The Problem

On September 23, 2014, the District of Columbia Council enacted market-based sourcing provisions for sales of intangibles and services as part of the 2015 Budget Support Act (BSA), as we previously discussed in more detail here. Most notably the BSA adopts a single sales factor formula for the DC franchise tax, which is applicable for tax years beginning after December 31, 2014. But the market-based sourcing provisions in the BSA did not align with the rest of the tax legislation. Specifically, the BSA market-based sourcing provisions were made applicable as of October 1, 2014—creating instant tax implications on 2014 returns. Absent a legislative fix, this seemingly minor discrepancy will trigger a giant compliance burden that will require a part-year calculation for both taxpayers and the Office of Tax and Revenue (OTR) before the 2014 franchise return deadline on March 15. For example, taxpayers filing based on the new BSA provisions, as originally enacted in September, will have to use the cost-of-performance approach for the first nine months of the 2014 tax year and the new market-based sourcing approach for the remaining three.

The Fix

Citing to the unintended compliance burden, the Council recently enacted emergency legislation to temporarily fix the unintended compliance burden. However they have not solved the problem going forward. On December 17, 2014, Finance and Revenue Committee Chairman Jack Evans introduced identical pieces of legislation that included both a temporary and emergency amendment to quickly fix on the problem (both pieces of legislation share the name “The Market-Based Sourcing Inter Alia Clarification Act of 2014”). These legislative amendments explicitly make the applicability of market-based sourcing provisions synonymous with the other provisions of the BSA, beginning for tax years after December 31, 2014. In DC, “emergency” legislation may be enacted without the typical 30-day congressional review period required of all other legislation, but is limited to an effective period of no longer than 90 days. Because the emergency market-based sourcing legislation was signed by Mayor Muriel Bowser on January 13, it will expire on April 13. Important to DC franchise taxpayers, this date is before the September 15 deadline for extended filers.

The second piece of legislation was introduced on a “temporary” basis. Unlike emergency legislation, temporary legislation simply bypasses assignment to a committee but must still undergo a second reading, mayoral review and the 30-day congressional review period. The review period is 30 days that Congress is in session (not 30 calendar days). Because the temporary Act is still awaiting Mayor Bowser’s approval at the moment, which is due by this Friday (February 6), it will not become effective until after the 2014 DC Franchise Tax regular filing deadline of March 15—even if it is approved by the Mayor and not subjected to a joint-resolution by Congress. Neither the House nor Senate is in session the week of February 15, which pushes the 30-day review period to roughly April 1 (assuming it is immediately submitted to Congress). However, once passed, [...]

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Indiana Department of Revenue Rules Forced Disposition is Nonbusiness Income

by McDermott Will & Emery | Jan 21, 2015 | Allocation/Apportionment, Income Tax, Indiana, UDITPA

In Letter of Finding No. 02-20140306 (Dec. 31, 2014), the Indiana Department of Revenue (Department) determined that income from the sale of two operating divisions of a business pursuant to an order of the Federal Trade Commission (FTC) was non-business income under Indiana law. Following the reasoning of the Indiana Tax Court in May Department Stores Co. v. Ind. Dep’t of State Revenue, 749 N.E.2d 651 (2001), the Department held that the gain constituted non-business income because the forced divestiture was not an integral part of the taxpayer’s business. Taxpayers facing the consequences of forced divestitures should consider whether similar positions can be taken, both in Indiana and in other Uniform Division of Income for Tax Purposes Act (UDITPA) jurisdictions.

Like many states that base their income apportionment provisions on UDITPA, Indiana defines “non-business income” as all income that is not business income. Indiana employs both the “functional test” and the “transactional test” to determine if a particular item of income qualifies as “business income.” Income may qualify as business income under either test; it is not required that both tests be met.

The functional test considers whether the income derives from the acquisition, management or disposition of property constituting an integral part of the taxpayer’s regular trade or business. Simply put, if a piece of property is used in the taxpayer’s regular course of business, a transaction involving that property will often result in business income. The transactional test, meanwhile, considers whether the income derives from a transaction or activity in which the taxpayer regularly engages.

In the Letter of Finding, the Department considered a taxpayer that sought to acquire, by merger, one of its competitors (“Target”), which consisted of four primary business divisions. The taxpayer and Target were part of a concentrated industry with very few competitors, so the acquisition created antitrust concerns. The taxpayer and Target sought advice from the FTC, which ordered that two of Target’s divisions be sold to a competitor if the merger were to take place. The taxpayer and Target complied with the FTC’s order, and Target sold the divisions to a competitor in 2006, prior to the merger. It classified its resulting income as non-business income. On audit, the Department reclassified the Target’s gain as business income, reducing the taxpayer’s Indiana net operating losses available for use in 2008-2010. The taxpayer appealed.

In examining the transaction, the Department first noted that the income from the sale of the divisions could not meet the transactional test because Target did not engage in the regular sale of business divisions. The Department then turned to the functional test. Arguably, the sale of the two operational business divisions should have resulted in business income because the divisions were used in the regular course of Target’s business. However, the Department observed that this fact alone was not enough to meet the functional test—“[t]he disposition too must be an integral part of the taxpayer’s regular trade or business operations.” Relying [...]

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Currency Conversion Concerns: New York Issues Guidance on Virtual Currencies

by McDermott Will & Emery | Dec 23, 2014 | Income Tax, Nationwide Importance, New York, Sales Tax, Tax Base, Unclaimed Property

On December 5, 2014, the New York Department of Taxation and Finance (Department) released TSB-M-14(5)C, (7)I, (17)S. This (relatively short) bulletin sets forth the treatment of convertible virtual currency for sales, corporation and personal income tax purposes. The bulletin follows on a notice released by the Internal Revenue Service (IRS) in March of this year, Notice 2014-21.

The IRS Notice indicates that, for federal tax purposes, the IRS will treat virtual currency as property, and will not treat it as currency for purposes of foreign currency gains or losses. Taxpayers must convert virtual currency into U.S. dollars when determining whether there has been a gain or loss on transactions involving the currency. When receiving virtual currency as payment, either for goods and services or as compensation, the virtual currency is converted into U.S. dollars (based on the fair market value of the virtual currency at the time of receipt) to determine the value of the payment.

The IRS Notice only relates to “convertible virtual currency.” Virtual currency is defined as a “digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value.” Convertible virtual currency is virtual currency that “has an equivalent value in real currency, or that acts as a substitute for real currency.”

The Department’s bulletin also addresses only convertible virtual currency, and uses a definition identical to the IRS definition. The Department indicates that it will follow the federal treatment of virtual currency for purposes of the corporation tax and personal income tax.

For sales and use tax purposes, the bulletin states that convertible virtual currency is intangible property and therefore not subject to tax. Thus, the transfer of virtual currency itself is not subject to tax. However, the exchange of virtual currency for products and services will be treated as a barter transaction, and the amount of tax due is calculated based on the fair market value of the virtual currency at the time of the exchange.

The Department should be applauded for issuing guidance on virtual currency. It appears that these types of currencies will be used more and more in the future, and may present difficult tax issues.

However, the Department’s guidance is incomplete. There are a couple of unanswered questions that taxpayers will still need to ponder.

First, the definition of convertible virtual currency is somewhat broad and unclear. The Department and the IRS define “convertible” virtual currency as currency that has an “equivalent” value in real currency, but equivalent is not defined in either the IRS Notice or the bulletin. Many digital products and services use virtual currency or points that cannot be legally exchanged for currency to reward users, and the IRS and the Department should be clearer about the tax treatment of those currencies.

Second, although the Department will follow the federal treatment for characterization and income recognition purposes, the bulletin does not discuss apportionment. This is likely a very small issue at this point in time, but the Department will, [...]

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