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Income Tax

New York Corporate Tax Reform: Benefits (and Burdens?) for Qualified New York Manufacturers

by Emily Townsend | Aug 7, 2014 | Incentives, Income Tax, New York

Earlier this year, New York enacted sweeping corporate tax reform that included a number of special benefits for qualified New York manufacturers. (For a discussion of this corporate tax reform, see our Special Report.) Unlike most of the corporate tax reform amendments (which are generally effective for tax years beginning on or after January 1, 2015), some of the benefits for qualified New York manufacturers are effective immediately for tax years beginning on or after January 1, 2014.

The new benefits available to qualified New York manufacturers are:

A 0 percent tax rate for purposes of computing tax on the entire net income base (for 2014) or the business income base (for 2015 and later);
New reduced tax rates for purposes of computing tax on the capital base (with the capital base tax to be fully phased out for all taxpayers by 2021)
- Retention of the $350,000 cap on the capital base tax (while the cap was increased to $5 million for other taxpayers);
Lower fixed dollar minimum tax rates; and
A refundable real property tax credit equal to 20 percent of the real property tax paid during the taxable year on property owned (and in some cases leased) by the taxpayer and principally used in manufacturing.

A corporation or a combined group is a “qualified New York manufacturer” if (1) more than 50 percent of the taxpayer’s or combined group’s gross receipts are from qualifying activities (e.g., manufacturing, processing or assembling) and (2) it has property meeting the Investment Tax Credit (ITC) requirements located in New York State with a basis of at least $1 million. A taxpayer, or combined group, that fails the receipts test may still be a qualified New York manufacturer if it has at least 2,500 New York manufacturing employees and at least $100 million of manufacturing property in New York.

Notwithstanding these tax benefits, the Department’s recently released FAQs highlight a potential negative financial statement consequence for taxpayers with significant deferred tax assets, including New York net operating loss carryforwards. In the FAQs, the Department confirms that the value of the prior net operation loss conversion subtraction for a qualified New York manufacturer “is $0 due to the 0 % ENI rate.” In other words, a qualified New York manufacturer cannot carry forward or use its existing net operating loss carryforwards in future years, which may result in negative financial statement consequences.

Qualified New York manufacturers with significant New York credit carryforwards may also suffer a financial statement impact, but the forecast is not as bleak. They may still have the ability to apply most unused credits against the capital base tax (until it is fully phased out).

Stay tuned for additional guidance regarding qualified New York manufacturers. The Department is preparing a technical memorandum regarding qualified New York manufacturers that is expected to be released by the end of this year.

Favorable Ruling: HMOs Not Taxable Under New York City General Corporation Tax

by McDermott Will & Emery | Jul 28, 2014 | Income Tax, Insurance Tax, Pennsylvania

A New York City Tax Appeals Tribunal Administrative Law Judge (ALJ) recently ruled in favor of Aetna, Inc. (Aetna) on the question of whether a health maintenance organization (HMO) was “doing an insurance business” in New York State, thereby exempting it from the New York City General Corporation Tax (GCT). In Matter of Aetna, Inc., the ALJ determined that the HMO at issue was “doing an insurance business” in New York because insurance risk was present in contracts covering the members of the HMO, the members of the HMO spread the risk of loss due to unforeseen medical expenses to the HMO and the HMO was subject to significant regulation under New York State Insurance Law and Public Health Law. Aetna Health, Inc. (Health), a subsidiary of Aetna, qualified as an HMO under Article 44 of the New York State Public Health Law. Though the New York City Department of Finance (Department) argued that HMOs were subject to the GCT because they do not conduct insurance business, the ALJ engaged in a thorough examination of federal and New York State authorities on HMOs and concluded that Health was doing an insurance business in New York. Of particular note, the ALJ, relying on the United States Supreme Court decision in Rush Prudential HMO v. Moran, noted that HMOs could be (and were) “both insurer[s] and corporation[s] which arrange[] for the provision of medical services.” The Department has 30 days from the determination date to file an appeal.

McDermott is pleased to have represented Aetna, Inc. in this favorable ruling. If you have any questions regarding this determination and its past, present, and future impact on your company, please contact a member of the McDermott State and Local Tax group. For more please see McDermott’s On the Subject regarding this case.

Was It Wirth It? The Pennsylvania Supreme Court Sets a Low Bar for Minimum Contacts

by Diann Smith and Stephen P. Kranz | Jul 28, 2014 | Constitutional Issues, Income Tax, Nexus, Pennsylvania

In Wirth v. Commonwealth, the Supreme Court of Pennsylvania held that Pennsylvania personal income tax applied to non-resident limited partners whose only connection with the state was the ownership of a small interest in a partnership that owned Pennsylvania property. This ruling has weakened the effectiveness of the Due Process Clause as a defense against Pennsylvania taxation.

In 1984 and 1985, the non-resident appellants purchased interests in a Connecticut limited partnership organized solely for the purchase and management of a skyscraper located in Pittsburgh. The appellants each owned between one-quarter of a unit to one unit of the partnership. One unit equated to a 0.151281 percent interest. The opinion does not indicate whether any of the numerous non-appellant partners owned significantly larger shares. Further, all of the appellants were only passive investors and did not take “an active role in managing the [p]roperty.” After 20 years of losses, the lender foreclosed on the property. The appellants lost their entire investments, but the partnership reported a gain on its tax filings consisting of the unpaid balance of the nonrecourse note’s principal and the accrued interest, totaling $2,628,491,551. As a result, the Pennsylvania Department of Revenue assessed personal income tax against the appellants, plus interest and penalties.

The appellants argued that the Commerce and Due Process Clauses prohibited the imposition of the Pennsylvania personal income tax on them. The court did not determine whether the Commerce Clause bars the imposition of the personal income tax on these non-residents because the appellants waived this defense by not sufficiently distinguishing between the Commerce Clause and Due Process Clause arguments.

The court did reach a decision on whether the Due Process Clause would bar relief and held that the limited interest in the partnership amounted to minimum contacts with Pennsylvania. The court agreed with the Department, which argued that the appellants’ interests, while limited, were “hardly passive” because of the large amount of money invested by each appellant, the extensive lifespan of the partnership and the partnership’s ownership of the Pennsylvania skyscraper. (Interestingly, this statement from the court’s opinion echoes the Department’s brief; however, the Department instead describes the appellants’ actions as passive “on a technical level” and describes the appellants’ involvement with the partnership as “hardly trivial.” The Department’s statement works to clear up confusion as to how an interest that is, by definition, passive could not be passive, but does raise the question as to why the court would opt to affirmatively state that the appellants’ involvement was “hardly passive.”) The court was also particularly concerned by the fact that had the appellants not had minimum contacts with Pennsylvania, any income earned by the appellants would escape Pennsylvania tax.

Practice Note: This case does not mean that other non-resident limited partners should accept Pennsylvania taxation. Because the appellants did not adequately argue the Commerce Clause issues, this line of argument remains viable. Further, the court’s concern with the possibility that income related to Pennsylvania property could escape Pennsylvania tax should be a question [...]

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New York Releases Corporate Tax Reform FAQs

by McDermott Will & Emery | Jul 25, 2014 | Incentives, Income Tax, New York, Nexus, Tax Base

Earlier this year, New York enacted sweeping corporate tax reform, generally effective for tax years beginning on or after January 1, 2015, including a new economic nexus standard, changes to New York’s combined reporting regime, changes to the tax base and traditional New York income classifications, changes to the receipts factor computation, and changes to the net operating loss calculation and certain tax credits and incentives. (For a more detailed discussion of these changes, see our Special Report.

While this corporate reform is quite comprehensive, a number of open issues remain so taxpayers and practitioners have been eagerly awaiting additional guidance from the Department of Taxation and Finance. As a first step in providing that much-needed guidance, the Department has released its first set of responses to frequently asked questions on a new “Corporate Tax Reform FAQs” section of its website. Most notably, the responses clarify that the non-unitary presumption based on less than 20 percent stock ownership for purposes of determining exempt investment income is a rebuttable presumption. The responses also clarify that the business capital base includes items of capital that generate exempt income. Other topics addressed include economic nexus, credits, the Metropolitan Transportation Business Tax (MTA surcharge) and net operating losses.

The Department plans to update the Corporate Tax Reform FAQs on an ongoing basis as it continues to receive questions from taxpayers and practitioners, which can be submitted on the Department’s website. We will be submitting questions and comments and can do so on behalf of companies that do not want to be identified. The Department is also in the process of revising its current regulations (which are expected to be released before the end of 2015) and plans to issue two technical memoranda in the interim, one discussing qualified New York manufacturers and one discussing the new expense attribution rules. Stay tuned for updates regarding this additional guidance.

New York’s Revised Nonresident Audit Guidelines: A Tool for Taxpayers?

by McDermott Will & Emery | Jul 21, 2014 | Income Tax, New York, Procedure

The New York State Department of Taxation and Finance recently revised its Nonresident Audit Guidelines, updating the guidelines that had been in place since 2012. Included in the revised guidelines are changes to the Department’s views on both domicile and statutory residency audits. Individuals and practitioners involved in residency audits should be aware that certain of the revisions are taxpayer-friendly and can be employed favorably in audits and litigation.

Read the full article.

Tax Reform in New York: Implications for Corporate America

by Arthur R. Rosen | Jul 17, 2014 | Allocation/Apportionment, Constitutional Issues, Income Tax, New York, Nexus, Tax Base

The corporate tax reform portion of the New York State 2014–15 Budget Bill resulted in major changes for virtually all corporations—even many that are not currently New York taxpayers. In this video (produced by SmartPros), McDermott partners Arthur Rosen, Maria Eberle, Lindsay LaCava and Leah Robinson will discuss the implications of New York State’s sweeping corporate tax reform, including changes to the Article 9-A traditional nexus standards, the combined reporting provisions, the composition of the tax bases and computation of tax, the apportionment provisions and the net operating loss calculation.

For more information on these issues, please click here for our Special Report, “Inside the New York Budget Bill: Corporate Tax Reform Enacted.”

Allied Domecq: Nexus-Combined Reporting

by Diann Smith and Stephen P. Kranz | Jul 16, 2014 | Constitutional Issues, Income Tax, Massachusetts, Nexus

In Allied Domecq Spirits & Wines USA, Inc. v. Commissioner of Revenue, the Massachusetts Court of Appeals held that the parent company of a Massachusetts taxpayer could not be included in the taxpayer’s Massachusetts nexus-combined returns because the parent’s nexus with Massachusetts was a sham. Regardless of the validity of the parent’s presence in the state, an argument exists that the nexus limitation on filing combined returns as it existed during the tax years discriminated against interstate commerce in violation of the Commerce Clause.

The parent company, ADNAC, was incorporated in Delaware and headquartered in Canada. ADNAC carried substantial losses. Beginning in August 1996, ADNAC engaged in activities to create a Massachusetts presence, such as reimbursing an affiliate with Massachusetts nexus for the salaries of insurance and tax employees and renting Massachusetts office space from the affiliate to house the employees. Further, ADNAC’s Massachusetts’ affiliate transferred three internal audit department employees working in Massachusetts to ADNAC. For the years in question, 1996 – 2004, Massachusetts required corporations to have in-state nexus in order to file combined reports and share losses with affiliated entities. Mass. Gen. Laws ch. 63, § 32B. As a result of these transactions, the taxpayer believed ADNAC had established nexus with Massachusetts and included ADNAC in its Massachusetts combined returns.

The Massachusetts Court of Appeals held that, because of the sham transaction doctrine, ADNAC did not have nexus with Massachusetts for tax purposes and could not file on a combined basis in the state. The court ruled, in part, that the transactions involving insurance and tax employees were shams because two memos developed by the taxpayer’s tax department described the plan as a “state tax planning project,” indicated the favorable tax consequences of the transaction, and stated that the plan would have “no impact to the management results.” The court viewed these communications as the taxpayer admitting that the transactions involving tax and insurance employees were conceived of entirely for tax planning purposes and for no business purpose. While the court could not point to any documents stating a tax purpose behind the movement of the internal audit department employees to Massachusetts, the court decided that because no contemporaneous records indicated a business motivation, the court would grant the use of the sham transaction doctrine.

Practice Note: The taxpayer did not argue that Massachusetts’ requirement of in-state nexus to file on a combined basis discriminated against interstate commerce and violated the Commerce Clause. Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977). Allied Domecq is similar to USX Corporation v. Revenue Cabinet, Kentucky, in which a Kentucky Circuit Court declared that a provision of Kentucky’s capital stock tax that limited to domestic corporations the ability to file on a combined basis or exclude investments in subsidiaries from its tax base discriminated against interstate commerce. USX Corp. v. Revenue Cabinet, No. 91-CI-01864 (Ky. Cir. Ct. 1992); see also Hellerstein & Hellerstein, State Taxation 4.14[3][j] (Thomson Reuters/Tax & Accounting, 3rd ed. 2001 & Supp. 2014-1). The court held [...]

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State and Local Tax Supreme Court Update: June 2014

by Diann Smith and Stephen P. Kranz | Jun 25, 2014 | Alabama, Allocation/Apportionment, Colorado, Constitutional Issues, Income Tax, Local Tax, Mississippi, Nationwide Importance, Sales Tax, Transaction Taxes

On June 10, 2014, the Supreme Court of the United States distributed three state and local tax cases for a conference to be held on June 26, 2014: Equifax, Inc. v. Mississippi Department of Revenue, Direct Marketing Association v. Brohl, and Alabama Department of Revenue v. CSX Transportation, Inc. The Supreme Court previously agreed to hear Comptroller of the Treasury v. Wynne and determine whether Maryland’s disallowance of a credit against its county income tax for taxes paid to other jurisdictions violated the Commerce Clause. We are eager to see if the Court will opt to hear the remaining three cases, clarifying answers to questions in the world of state taxation.

The taxpayer in Equifax filed a petition for a writ of certiorari on February 19, 2014, appealing a decision by the Mississippi Supreme Court. The state court upheld the Mississippi Department of Revenue’s application of market-based sourcing as an alternative apportionment formula instead of the statutory cost-of-performance sourcing for apportioning the income of Equifax, a credit reporting company. In making this determination, the court required the Mississippi chancery courts to use a highly deferential standard of review. The Institute for Professionals in Taxation, the Georgia Chamber of Commerce and the Council On State Taxation filed amicus curiae briefs.

The Direct Marketing Association filed a petition for a writ of certiorari on February 25, 2014. The Direct Marketing Association seeks review of a decision by the U.S. Court of Appeals for the Tenth Circuit that held that the Tax Injunction Act barred federal court jurisdiction over the Direct Marketing Association’s challenge to a Colorado sales and use tax reporting law. The law requires remote sellers that do not collect Colorado sales or use tax and have total annual gross sales in Colorado of $100,000 or more to inform the customer at the time of sale of the customer’s use tax obligation, to send annual notices to customers who purchased $500 or more in goods from the seller and to file a report with the state regarding a customer’s total purchases. An amicus curiae brief was filed by the Council On State Taxation. If the Supreme Court were to hear Direct Marketing Association v. Brohl, it would likely clarify the holding of Hibbs v. Winn to better clarify the scope of the TIA’s protection.

On October 30, 2013, the Alabama Department of Revenue filed a petition for a writ of certiorari in CSX Transportation. The Alabama Department of Revenue is challenging the U.S. Court of Appeals for the Eleventh Circuit’s decision that Alabama’s sales tax on diesel fuel discriminates against rail carriers in violation of the Railroad Revitalization and Regulatory Reform Act of 1976 (4-R Act) because motor carriers and interstate water carriers are not required to pay the 4 percent sales tax. The Supreme Court had previously issued a 2011 opinion stating that the taxpayer could challenge sales and use taxes under the 4-R Act, but the Supreme Court remanded the case to determine whether the tax was discriminatory. Amicus [...]

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Pennsylvania Issues Draft Guidance on Market-Based Sourcing of Services

by Catherine A. Battin | Jun 24, 2014 | Allocation/Apportionment, Constitutional Issues, Income Tax, Pennsylvania
The Pennsylvania Department of Revenue (PA Department) released a draft Information Notice containing guidance on how to source services under Pennsylvania’s new market-based sourcing scheme for tax years beginning after December 31, 2013. 72 Pa. Stat. Ann. § 7401(3)(2)(a)(16.1)(C). By statute, service receipts are sourced to Pennsylvania if the service is delivered to a location in Pennsylvania. If the service is delivered both to a location in and outside Pennsylvania, the sale is sourced to Pennsylvania based upon the portion of the total value of the service 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 other customers (e.g., corporations), 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.

Despite the new statutory scheme, taxpayers have been wondering exactly what “delivery” of a service to a Pennsylvania location means. The draft Information Notice released by the PA Department on June 16, 2014, attempts to answer that question.

According to the PA Department, delivery occurs “at a location where a person or entity may use the service.” The PA Department believes that this definition eliminates those parties that simply pay for the service (but do not actually use it) or other intermediaries. The PA Department’s view is that the statute’s use of billing address (for individual customers) and location of purchase or billing address (for corporate customers) are mere “defaults”—neither of which may represent the true marketplace for the service and should only be used as a last resort.

The PA Department’s guidance also addresses delivery in the context of electronically delivered services, stating that delivery may be established through IP address records or other network data. Interestingly, the PA Department’s guidance also provides that delivery of certain electronic data services to “the cloud” or other data storage device does not constitute delivery of those services—because those locations are not considered to be the locations of the user.

While the PA Department’s guidance provides some clarity it also exemplifies the ever divergent market sourcing regimes. See our article discussing the wide variety of market-based sourcing rules. For example, the PA Department draft guidance contains the following example:

Taxpayer is a provider of third-party payroll processing services for Company A. Half of Company A’s employees are located in PA and half are located in New York. Company A’s headquarters and human resources functions are located in PA. Taxpayer sources all of the payroll services to PA. Note in this example that payroll [...]

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Recent Legislation in Virginia Retroactively Amending the Addback Statute Exacerbates a Potentially Unfair Law

by Roy E. Crawford | Jun 13, 2014 | Allocation/Apportionment, Constitutional Issues, Income Tax, Virginia
Separate return state addback statutes, such as the Virginia addback statute, can overreach to produce an unfair and potentially unconstitutional overstatement of income assigned to the state. Recently Virginia amended its addback statute retroactively 10 years to taxable years beginning on or after January 1, 2004. The legislation is intended to codify an administrative interpretation that significantly limited an addback exception to the extent the income received by a related member is subject to taxes based on net income or capital imposed by Virginia, another state, or a foreign government with a comprehensive tax treaty with the United States (H.B. 5001, enacted April 1, 2004). The legislation limits the subject-to-tax exception so that it applies only on a post-apportionment basis, as illustrated in two rulings of the Commissioner, Ruling 07-153 (Oct 2, 2007) and Ruling 13-140 (July 19, 2013).

Taxpayers, in particular taxpayers that have a significant presence in unitary tax states, should not blindly add back legitimate business expenses to income where the result would be an overstatement of income. Consider this common situation as an example: a parent corporation, a manufacturer of high-tech products, pays a royalty for technology licensed to it by an R&D subsidiary. The R&D subsidiary is based in California, a combined report state. The parent corporation has $1,000 in gross receipts, pays $200 in royalties to R&D subsidiary, has $600 of other expenses and a net income of $200. The R&D subsidiary has gross receipts of the $200 in royalties, deductions for R&D expenses of $100 and a net income of $100. Together the federal consolidated income of the two entities (as well as GAAP income) is $300. The R&D subsidiary conducts R&D activities in California and in many foreign countries (some with U.S. tax treaties, some without) and has taxable nexus in one separate return state to which it apportions 1 percent of its net income of $100. Here is how Virginia applies its addback statute: Virginia adds the $200 royalty paid to the R&D subsidiary to the parent corporation’s income, but excepts from the addback 1 percent of the royalty, or $2, to reflect the separate return state. No exception from the addback is provided for the portion of the royalty apportioned to California. Thus, the parent corporation’s taxable income in Virginia is $398, an amount almost equal to the combined net income of the parent and the subsidiary, plus the bona fide amounts paid by the subsidiary in R&D expenses.

Taxpayers should carefully examine returns filed in addback statute states to see if they fail a sanity test, like the result in the hypothetical example. If the State Department of Revenue doesn’t agree to rational exceptions to the expense disallowance, there are multiple grounds for challenge in the courts.

Plain Meaning of the Statute

A typical addback statute provides an exception when the related member is subject to tax on net income in that state, another state, or a foreign government with a comprehensive tax treaty with the United States. Where the [...]

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