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Income Tax

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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Pennsylvania Unwraps Final Market-Sourcing Guidance

by Catherine A. Battin | Dec 19, 2014 | Allocation/Apportionment, Income Tax, Pennsylvania

The Pennsylvania Department of Revenue (the Department) recently finalized its Information Notice on sourcing of services for purposes of determining the appropriate net income and capital franchise tax apportionment factors. The guidance also addresses the Department’s views on the sourcing of intangibles under the income producing activity test. Since Pennsylvania is not a member of the Multistate Tax Compact, it is no surprise that the Department did not wait for the Multistate Tax Commission to complete its model market sourcing regulation before it issued its guidance.

Under the Pennsylvania statute (72 Pa. Stat. Ann. § 7401(3)(2)(a)(16.1)(C)), for tax years beginning after December 31, 2013, receipts from services are to be sourced according to the location where the service is delivered. If the service is delivered both to a location in and outside Pennsylvania, the sale is sourced to Pennsylvania based upon the percentage of the total value of services delivered to a location in Pennsylvania. In the case of customers who are individuals (other than sole proprietors), if the state or states of delivery cannot be determined for the customer, the service is deemed to be delivered at the customer’s billing address. In the case of customers who are not individuals or who are sole proprietors, if the state or states of delivery cannot be determined for the customer, the service is deemed to be delivered at the location from which the service was ordered in the customer’s regular course of operations. If the location from which the service was ordered in the customer’s regular course of operations cannot be determined, the service is deemed to be delivered at the customer’s billing address.

The statute generated more questions than it answered. Key terms such as “delivered” and “location” were not defined. The Department’s Information Notice provides answers to many of taxpayers’ questions. However, unlike the draft Information Notice released in June 2014, the final Information Notice shies away from providing a succinct definition of “delivery” and resorts to defining the term through various examples. (For our coverage of the Department’s draft Information Notice, click here.) However, the Information Notice does define “location” stating that “location” generally means the location of the customer and, thus, delivery to a location not representative of where the customer for the service is located does not represent completed delivery of the service.

The Information Notice is chock full of examples to guide taxpayers. The Department’s views relating to various scenarios when services are performed remotely on tangible personal property owned by customers are of interest. If a customer ships a damaged cell phone to a repair facility that repairs and returns it, the Department deems the service to be delivered at the address of the customer. Contrast that with a situation when a customer drops a car off for repair at a garage and later returns to pick it up. One may conclude that the service should also be deemed to be delivered at the address of [...]

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NYS Tax Department Reverses Position on Statutory Residence Rule

by McDermott Will & Emery | Dec 19, 2014 | Income Tax, New York

The New York State Department of Taxation and Finance (the Department) has backed off from an aggressive position that it has been taking in cases involving New York residence issues.

Under New York law, a person who is not domiciled in the state can be treated as a resident for income tax purposes (and, hence, taxed on all of his or her worldwide income) for a taxable year if the person maintains a “permanent place of abode” in the state and is in the state for more than 183 days during the year. This is known as the statutory residence rule. New York City has an identical rule for purposes of taxing individuals as city residents.

The Department has historically taken the position that a house or apartment is a “permanent place of abode” if it is capable of being lived in as a regular residence even though the taxpayer does not so use it. This has presented a significant problem for people who live in the Connecticut and New Jersey suburbs of New York City and work in the city and keep a small apartment that they use occasionally when they work late or attend the theater. The Department has been treating them as residents because the apartment was a “permanent place of abode” even if they used it for only a few nights a year and their presence in the city for more than 183 days was a result of their jobs and had no relationship to the apartment. Similarly, out-of-state residents who commute to New York jobs and keep a vacation home in New York State have been held to be income tax residents even though they only use the vacation home for a few weeks each year.

The Court of Appeals, New York’s highest court, held recently that a person must actually use a dwelling as a residence for it to constitute a “permanent place of abode”. Matter of Gaied v. New York State Tax Appeals Tribunal, 22 N.Y.3d 592 (2014) (see prior coverage here). The taxpayer in that case lived in New Jersey but owned a house in New York City in which his parents lived. He spent a few nights a year in the house when his parents asked him to come over to help with medical problems. When he did so, he slept on a couch in the living room. He kept no personal effects in the house. The Court held, over the Department’s objections, that the purpose of the statutory residence test was to treat as residents people who really lived in New York but claimed that they were domiciled outside the state for the purpose of avoiding taxes. Mr. Gaied, in contrast, really lived in New Jersey, and the New York house could in no sense be viewed as his real residence.

The Department responded to the Gaied case by revising the internal guidelines that it gives to [...]

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Demystifying the Sales Factor: Conduit Receipts

by Catherine A. Battin | Dec 17, 2014 | Allocation/Apportionment, Income Tax, Nationwide Importance

This is the sixth article in a series on the composition of the sales factor and the potential tax saving opportunities hidden within state statutes and regulations. As more states shift to a single or more heavily weighted sales factor, it is important for taxpayers to understand the intricacies of the sales factor and the opportunities that exist in computing it. This article will focus on issues that could arise and opportunities that may be available for conduit receipts.

Read the full article.

Lame-Duck Congress Mulls Laws to Ease State Tax Headaches

by Arthur R. Rosen | Dec 8, 2014 | Constitutional Issues, Income Tax, Nationwide Importance, Nexus, Sales Tax, Transaction Taxes

As it heads into the final weeks of its session, Congress is considering various bills that would restrict or expand states’ taxing authority. Almost every business in the country would be affected by at least some of these bills. While some of these bills have progressed further than others, any could become law—particularly if bundled into legislation that Congress must, as a practical and political matter, pass before the session ends. Businesses thus have an opportunity to ask their Senators and Representatives to take action to rein in some of the problems with state and local taxes.

Read the full article on CFO.com.

Beleaguered D.C. Taxpayers Achieve Another Success in Ongoing Challenges to the Methodology Used in the District’s Transfer Pricing Audit Program

by Diann Smith, Eric D. Carstens and Stephen P. Kranz | Nov 20, 2014 | District of Columbia, Income Tax, Nationwide Importance, Procedure, Transfer Pricing

On Friday, November 14, 2014, an administrative law judge (ALJ) issued three identical orders granting the taxpayer’s motion for summary judgment in Hess v. OTR, Shell v. OTR and ExxonMobil v. OTR. In these orders, the ALJ determined that based on an early ruling that the challenged methodology was fatally flawed, the Office of Tax and Revenue was barred from re-litigating the issue in the current cases under the doctrine of non-mutual collateral estoppel.

Transfer Pricing Implications

The transfer pricing litigation in D.C. has been a frustrating road for taxpayers because the flaws in the methodology OTR applied have been apparent from the outset. The first case to be litigated was Microsoft v. OTR, OAH Case. No. 2010-OTR-00012 (May 1, 2012). In this case, an ALJ ruled that the methodology the District used was fatally flawed because the methodology failed to (i) separate controlled from uncontrolled transactions and (ii) individually analyze different product lines and different functions. As a result, the ALJ concluded that the analysis was flawed, arbitrary and unreasonable. OTR initially appealed the Microsoft order to the D.C. Court of Appeals, only to withdraw shortly after by filing a motion to dismiss its own petition for review.

When Microsoft was decided in 2012, it appeared that the faulty transfer pricing methods used by the District had been permanently debunked. Nevertheless, OTR renewed the contract for the business performing the transfer pricing audits and did not materially modify the assessment methods. As a result, taxpayers continued receiving assessments from the OTR based on the same methodology previously ruled invalid in Microsoft. At least 10 taxpayers have challenged these assessments post-Microsoft, and the orders issued Friday are the first of these challenges to be resolved by the Office of Administrative Hearings (OAH).

The taxpayers in the Hess/Shell/ExxonMobil cases all challenged the substantive validity of the assessment methodology and argued that the Microsoft decision should be controlling. OTR asserted that the doctrine of non-mutual collateral estoppel did not apply to the government and, even if it did, the elements were not met in this case. The ALJ disagreed with OTR’s analysis and found “the failure to apply [non-mutual collateral estoppel] would allow [DC] to keep issuing proposed assessments to taxpayers using the same flawed Chainbridge analysis, with the hope that some taxpayers won’t have the wherewithal to challenge the assessment and will find it economically advantageous to simply pay rather than fight.”

The three orders issued on Friday should provide a definitive signal to OTR that the method is flawed as a matter of law and cannot be validly used to assess D.C. taxpayers going forward. These decisions are essentially decisions on the merits for the pending cases and, assuming no appeal is filed, D.C. should face sanctions if it continues to pursue assessments using the methodology at issue in these cases.

Broad Implications

Perhaps more importantly than the narrow (but important) transfer pricing issue in these decisions, OAH has made is clear that non-mutual collateral estoppel can be applied against OTR [...]

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Take Two: Massachusetts Department of Revenue Releases Revised Market-Based Sourcing Regulation

by Catherine A. Battin | Nov 7, 2014 | Allocation/Apportionment, Income Tax, Massachusetts

Late last week, the Massachusetts Department of Revenue (the Department) released a revised draft regulation on Massachusetts’s new market-based sourcing law. The changes made by the Department to purportedly address practitioner and taxpayer concerns were relatively modest. The rules remain lengthy, complex and cumbersome. There are still various assignment rules that apply to each of the following types of transactions: (1) in-person services, (2) professional services, and (3) services delivered to the customer, or through or on behalf of the customer (described in the new regulation as services delivered to the customer, on behalf of the customer, or delivered electronically through the customer, hereinafter “sales delivered to, by, or through a customer”). For a more detailed discussion of these rules see our State Tax Notes article on market-based sourcing.

The most noteworthy changes from the initial draft relate to the taxpayer’s ability to use a “reasonable approximation” method. The initial draft regulation provided taxpayer’s with the ability to use a “reasonable approximation” when “the state or states of assignment” could not be determined. The new regulation clarifies that a taxpayer must, in good faith, make a reasonable effort to apply the primary rule applicable to the sale (e.g., the specific assignment rules for in-person services, professional services, or sales to, by, or through a customer) before it may reasonably approximate. Additionally, the regulation explicitly states that a method of reasonable approximation “must reflect an attempt to obtain the most accurate assignment of sales consistent with the regulatory standards set forth in [the regulation], rather than an attempt to lower the taxpayer’s tax liability.” There is no guidance as to how a taxpayer would demonstrate that its reasonable approximation attempt was made to “obtain the most accurate assignment of sales.” This raises a number of questions–for example, if a taxpayer determines that there are two equally reasonable methods by which it can reasonably approximate its Massachusetts sales, can it use the method that results in less tax? Additionally, there does not seem to be any converse requirement that the Department make a similar demonstration (i.e., that any modifications to a taxpayer’s sourcing methodology not be an attempt to increase a taxpayer’s liability) when exercising its authority to adjust a taxpayer’s return (as discussed below).

In an attempt to make the regulation more even-handed, the Department’s revisions provide that neither a taxpayer nor the Department may adjust a “proper” method of assignment, including a method of reasonable approximation, unless it is to correct factual or calculation errors. However, the revision isn’t all that meaningful because there are still a broad number of scenarios in which the Department can make changes, one of which is when a taxpayer uses a method of approximation and the Commissioner determines that the method of approximation employed by the taxpayer is not “reasonable.” Additionally, when a taxpayer excludes a sale from both the numerator and denominator of its sales factor because it has determined that the assignment of the sale cannot be reasonably approximated, [...]

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New Jersey Tax Court Finds Two Pennsylvania Taxes Are Not Required To Be Added Back

by Arthur R. Rosen and Richard C. Call | Oct 31, 2014 | Income Tax, New Jersey, Sales Tax, Tax Base

In a Corporation Business Tax (CBT) case, PPL Electric Utilities Corporation v. Director, Division of Taxation, Dkt. No. 000005-2011 (N.J. Tax. Ct. Oct. 2, 2014), the Tax Court of New Jersey found for the taxpayer and held that the Pennsylvania Gross Receipts Tax and Pennsylvania Capital Stock Tax were not required to be added back in computing New Jersey entire net income.

The case involves a 1993 amendment to the CBT statute regarding adding back taxes deducted in computing federal taxable income. Prior to 1993, the New Jersey statutes required taxpayers to add-back only certain federal taxes and the CBT in computing New Jersey entire net income. The amendment added a requirement that taxpayers add-back to federal taxable income taxes paid to states other than New Jersey “on or measured by profits or income, or business presence or business activity.” N.J.S.A. 54:10A-4(k)(2)(C). According to legislative history cited by the court, prior to the amendment “corporations which [did] business in several states [paid] a lower effective rate of tax on their New Jersey activities than [did] corporations which only [did] business in New Jersey.” The court explained that the amendment corrected the inequity “by requiring multi-state taxpayers to add-back state taxes similar to that of the CBT.”

The Tax Court concluded that the Pennsylvania Gross Receipts Tax is not subject to the tax add-back, finding that the tax is: (1) “based solely on the amount of electricity sold, regardless of whether income or profit is realized from such sales and not based upon the taxpayer’s business presence or business activity in Pennsylvania;” and (2) “passed through to the ultimate consumer of electricity.” The court held that the Pennsylvania Capital Stock Tax was not subject to the tax add-back because it was in substance a property tax.

Interestingly, the Tax Court found that the New Jersey Division of Taxation’s (Division) interpretation of the tax add-back was not only incorrect but also discriminatory.

The 1993 amendment was passed because previously, solely New Jersey taxpayers were taxed on a higher tax basis than similarly situated multi-state taxpayers . . . . Here, Taxation’s interpretation of the statute discriminates against multi-state taxpayers because they would be required to add-back the Pennsylvania Corporate Income Tax as well as other non-CBT-type taxes imposed by other states, such as the Pennsylvania Gross Receipts Tax and the Pennsylvania Capital Stock Tax, while solely New Jersey taxpayers are only required to add-back CBT-type taxes. This court finds that the Legislature did not intend to cure one inequity by imposing another.

Given the number of different types of state taxes in existence, this case may have broad ramifications for multi-state taxpayers subject to the CBT. We have seen the Division make similar adjustments to other companies on audit and this decision should be helpful in disputing those adjustments. Additionally, multi-state taxpayers may have refund opportunities for similar taxes that they have previously added back.

New Jersey Division of Taxation’s 2014 Tax Resolution Initiative – Not To Be Confused With An Amnesty

by Arthur R. Rosen and Richard C. Call | Oct 30, 2014 | Income Tax, New Jersey, Property Tax, Tax Base

The New Jersey Division of Taxation (Division) is trying to help taxpayers resolve unpaid tax liabilities for tax periods 2005 through 2013. Through November 17, 2014, the Division is offering taxpayers that pay all tax and interest for the applicable periods a waiver of most penalties (but not penalties related to the 2009 amnesty) and any costs of collection or recovery fees. Notably, this is not an amnesty like those conducted in 2002 and 2009. It is not statutorily mandated and no penalties may be imposed for non‑participation. Because the initiative is not statutorily mandated, the Division is not offering something it could not offer at any other time. However, the Division’s offer to waive most penalties may be a good chance for many taxpayers to resolve issue and move on and is worth considering.

A Very Scary Time of the Year: MTC Joint Audit Selection

by Diann Smith, Eric D. Carstens and Stephen P. Kranz | Oct 23, 2014 | Alabama, District of Columbia, Hawaii, Income Tax, Kentucky, Nationwide Importance, New Jersey, Transfer Pricing

With both Halloween and the Multistate Tax Commission (MTC) Income Tax Audit selection nearing, taxpayers should prepare themselves for the possibility of being spooked in the near future. On Thursday, October 30, from 2-4 pm EST, the MTC Audit Committee—including representatives from the 22 states participating in the upcoming round of joint income tax audits—will be holding a teleconference that will begin with a public comment period. Because of the inevitable disclosure of confidential taxpayer information, the bulk of this meeting—including selecting the various companies to audit—will take place during the second half of the agenda and be closed to the general public. Just because a company has completed an audit in the past does not mean this season will be all treats. The authors have noticed that companies previously audited by the MTC can remain on the list of targets and are often repeat selections.

Unique Complexities

The MTC audit process is not without its share of traps for the unwary. First and foremost is the effort a taxpayer must expend in managing a multistate audit. Issues such as differing statute of limitations, the effects of federal Revenue Agent’s Reports (RAR) and net operating loss (NOL) differences on limitations periods, timing of protests, and tax confidentiality become of heightened importance when one auditor is reviewing a taxpayer for multiple states. Audited taxpayers should also keep in mind that the MTC does not issue the actual deficiency notices – these must come from the states. As a result there may be certain areas such as credits or refunds that the MTC does not review and must be raised directly with a participating state.

On the substantive side, a primary area of inquiry of an MTC audit has been and is likely to continue to be inter-company transactions. Historically MTC audits have taken a variety of approaches to disallow a taxpayer’s intercompany structure, including collapsing separate affiliates, applying the sham transaction doctrine, or using aggressive addback concepts. Another similar concern for taxpayers audited by the MTC is the increased likelihood of transfer pricing issues being raised. This comes in the wake of the creation of the MTC Arm’s-Length Adjustment Service (ALAS) this summer, led by former Montana Department of Revenue Director Dan Bucks. The group recently held a transfer pricing summit at which it designed the MTC services to include third-party economic consultants at every stage. The MTC transfer pricing services are expected to be implemented in mid-2015—just in time for companies selected for an MTC Income Tax Audit to be the test subjects. Notably, of the nine states committing seed money to the development of a multistate transfer pricing audit service, five (Alabama, Hawaii, Kentucky, New Jersey and the District of Columbia) are participating in the MTC Income Tax Joint Audit Program. It is not clear whether the two MTC-sponsored audit programs will be intertwined; however, the option was proposed this past summer and remains a possibility as we approach the upcoming audit selections.

Finally, it remains to [...]

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