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New York State Department Intends to Finalize Corporate Tax Regulations This Fall

Almost seven years after it started releasing draft regulations concerning sweeping corporate tax reforms that went into effect back in 2015, the New York State Department of Taxation and Finance (Department) has issued guidance, stating that “the Department intends to begin the State Administrative Procedure Act (SAPA) process to formally propose and adopt” its draft corporate tax regulations this fall.

The Department has released many versions of “draft” regulations addressing corporate tax reform since September 2015. However, these draft regulations have been introduced outside of the SAPA process because the Department intended to formally propose and adopt all draft regulations at the same time. In the meantime, the Department warned taxpayers that so long as the regulations remain in draft form, they are not “final and should not be relied upon.”

Now, the Department has given its first public signal that it is prepared to formally adopt the draft regulations later this year. On April 29, 2022, the Department released “final drafts” of regulations that address a variety of topics, including nexus and net operating losses, and indicated that it will release final draft regulations addressing “apportionment, including rules for digital products/services and services and other business receipts” this summer.

Notably, the draft regulations released on April 29 include new provisions, “largely modeled after the [Multistate Tax Commission (MTC)] model statute . . . to address PL 86-272 and activities conducted via the internet.” Like the MTC model statute, the new draft regulations take a broad view of internet activities that would cause a company to lose PL 86-272 protection. In one example, the draft regulations state that providing customer assistance “either by email or electronic ‘chat’ that customers initiate by clicking on an icon on the corporation’s website” would exceed the scope of protections provided under PL 86-272.

As it intends to formally propose the draft regulations this fall, the Department is “strongly” encouraging “timely feedback” on all final draft regulations. With respect to the final draft regulations released on April 29, the Department is asking for comments by June 30, 2022.




Washington State Capital Gains Tax Held Unconstitutional

The Washington State capital gains tax, which went into effect on January 1, 2022, has been held unconstitutional by the Douglas County Superior Court. Created in 2021, the tax was ostensibly labeled an “excise” tax in an effort by the Washington State Legislature (Legislature) to avoid difficulties associated with implementing an income tax in the state of Washington. The judge, however, was not persuaded.

Citing to authority from the Washington State Supreme Court, the trial judge held that courts must look through any labels the state has used to describe the statute and analyze the incidents of the tax to determine its true character. Here, the judge reviewed the most significant incidents of the new tax, including:

  • It relies on federal income tax returns that Washington residents must file and is thus derived from a taxpayer’s annual federal income tax reporting;
  • It levies a tax on the same long-term capital gains that the Internal Revenue Service (IRS) characterizes as “income” under federal law;
  • It is levied annually (like an income tax), not at the time of each transaction (like an excise tax);
  • It is levied on an individual’s net capital gain (like an income tax), not on the gross value of the property sold in a transaction (like an excise tax);
  • Like an income tax, it is based on an aggregate calculation of an individual’s capital gains over the course of a year from all sources, taking into consideration various deductions and exclusions, to arrive at a single annual taxable dollar figure;
  • Like an income tax, it is levied on all long-term capital gains of an individual, regardless of whether those gains were earned within Washington and thus without concern of whether the state conferred any right or privilege to facilitate the underlying transfer that would entitle the state to charge an excise;
  • Like an income tax and unlike an excise tax, the new tax statute includes a deduction for certain charitable donations the taxpayer has made during the tax year; and
  • Unlike most excise taxes, if the legal owner of the asset who transfers title or ownership is not an individual, then the legal owner is not liable for the tax generated in connection with the transaction.

The court found that these incidents show the hallmarks of an income tax rather than an excise tax, and because the new capital gains tax did not meet the uniformity and limitation requirements of the Washington State Constitution, it was unconstitutional.

The Washington State Attorney General has already indicated that the ruling will be appealed; in all likelihood, this issue will ultimately be decided by the Washington State Supreme Court. In the meantime, if you have questions about the Washington State capital gains tax, please contact Troy Van Dongen.




CDTFA Proposes Significant Revisions to Chapters 4 and 13 of the Sales Tax Audit Manual

On February 2, 2022, the California Department of Tax and Fee Administration (CDTFA) held an interested parties meeting (IPM) to discuss proposed amendments to sales tax audit manual (AM) Chapter 13, “Statistical Sampling,” and Chapter 4, “General Audit.”

Prior to the IPM, the CDTFA released a lengthy discussion paper outlining the extensive proposed changes to the AM, which includes:

1. Removing the three error rule. The current text of AM 1308.05 explains that when a sample produces only one or two errors, the auditor must evaluate whether these errors are representative or whether it is possible they indicate problems in certain areas that could be examined separately. Under the proposed amendment, the same evaluation standards would still be in place without the minimum error requirement. According to the CDTFA, the proposed removal of the three error rule is because of the fact that “the number of errors identified in a sample does not give any indication whether the sample is representative or not…If the combined evaluation evaluates within Department [CDTFA] standards, it is justified to project the results even if one or two errors are found.”

2. Requiring 300 minimum sample items per stratum unless the auditor obtained approval from CAS to select fewer than 300. Currently, the “minimum sample size of at least 300 items of interest is to be used in all tests, except where the auditor can support a smaller sample size and it evaluates well.” (AM 1303.05) Under the new subsection titled “Materiality,” a minimum of 300 sample items per test stratum is recommended. Computer Audit Specialist (CAS) approval is required for selecting less than 300 sample items per test stratum.

3. Refunding Populations: A minimum of 100 sample items per stratum is required. In the section addressing sampling refund populations (AM 1305.10), the proposed amendment would permit auditors to select as few as 100 sample items per test stratum without CAS approval, provided the expected error rate is sufficiently high (greater than 20%). No such rule exists under the current text of Chapter 13.

4. Contacting CAS when the prior audit had 300 hours charged to it is now mandatory. In contrast, under the current rule, it is mandatory that CAS be contacted when the prior audit expended 400 or more hours or if CAS was involved in the prior audit.

5. Replacing Credit Methods 1, 2 and 3 with one recommended approach to handling credits in a statistical sample. The subsection (AM 1303.25) currently lists three types of credit methods that can be used for a statistical sample. The CDTFA now only recommends one credit method for use in a stratified statistical sample, which is referred to as “Method 1” in the current AM text. When auditors review electronic data, attempts should be made to match credit invoices to original invoices (including partially) if it is certain that the credit invoices are related to the original invoice. For all credit memos that are not matched to original invoices, those credits will be removed from [...]

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Washington State’s Mandatory Withholding for Long-Term Care Put on Hold

In 2019, the Washington State Legislature (Legislature) established the Long-Term Services and Supports Trust Program (LTSS Trust Program) to provide funding for eligible beneficiaries that they can apply to the cost of their long-term care. The LTSS Trust Program is funded through a 0.58% payroll tax on employee wages, which went into effect on January 1, 2022.

Though the LTSS Trust Program was intended to provide a baseline of benefits to Washingtonians lacking private long-term care insurance, the program drew public criticism in recent months because, among other things, employees had no easy way to opt out of it. The legislation provided that individuals could opt out by purchasing private long-term care insurance before November 1, 2021, and applying for an exemption by the end of 2021. However, shortly after the program went into law, most (if not all) private long-term care insurance providers pulled out of the state.

When the Legislature convened earlier this month, it fast-tracked new legislation to put the LTSS Trust Program on hold. Though many lawmakers were calling for an outright repeal of the program, the majority ultimately passed a bill to delay its implementation until July 2023. Washington Governor Jay Inslee is expected to sign the measure by Friday, January 28.

Since this delay comes after employers have already started withholding the tax from their employees’ wages and, in some cases, after the tax has been remitted to the Employment Security Department (ESD), refunds will be necessary. Under the new law, employers are required to provide refunds to their employees within 120 days of the collection. If the employer already remitted the tax to the ESD, the ESD is required to refund that money to the employer who is then required to pass it on to the employee.

If you have questions about the LTSS Trust Program or its delayed implementation, please contact the author of this article.




Massachusetts Department of Revenue Stops Applying COVID-19 Telecommuting Policy, Returns to Location of Work Performed

In a recently issued guidance, the Massachusetts Department of Revenue indicated that the emergency telecommuting rules it put in place during the Massachusetts COVID-19 state of emergency would cease to be in effect as of September 13, 2021. Under the telecommuting rules, which were effective beginning March 10, 2020, wages paid to a non-resident employee who worked remotely (i.e., working from home or a location other than their usual work location) because of the COVID-19 pandemic were sourced based on where the employee worked prior to the state of emergency. Effective September 13, 2021, wages will generally be sourced based on where the employee’s work is actually performed.




Texas Comptroller Announces Medical or Dental Billing Services are Not Taxable, Effective Immediately

On June 4, 2021, the Texas Comptroller issued a policy statement (Accession No. 202106003L) announcing that it is not going to enforce its previously stated policy of taxing medical billing services. This guidance comes in response to a sales and use tax bill that was signed into law April 30, 2021, which excluded “medical or dental billing services” performed prior to the original submission of a medical or dental insurance claim from insurance services. The Comptroller states that it will immediately treat medical or dental billing services as excluded from the definition of insurance services even though the bill is not effective until January 1, 2022. It remains to be seen if the Comptroller’s interpretation of medical billing services, which has been defined through decades of policy and guidance, is aligned with the legislature’s view of “medical or dental billing services.” Some commentators have suggested there may be points of divergence that will need to be worked out over time. For additional information on this topic, please see our prior blog post.




Nebraska District Court Holds That GIL 24-19-1 is Not Afforded Deference

Last week, the Lancaster County District Court granted the state’s motion to dismiss in COST v. Nebraska Department of Revenue. COST brought this declaratory judgment action to invalidate GIL 24-19-1, in which the department determined that earnings deemed repatriated under IRC § 965 are not eligible for the state’s dividends-received deduction and are thus subject to Nebraska corporate income tax. COST has until July 19, 2021, to appeal the judge’s decision.

The state’s motion was brought on procedural grounds, one of which was that the GIL is a guidance document and not a “rule” such that a declaratory judgment was not permitted under Nebraska law. COST argued that although the GIL is labeled a guidance document, it is in substance a rule because it establishes a legal standard and explicitly penalizes taxpayers that do not comply. The district court determined that the GIL is not a rule and granted the state’s motion. The district court did not address the substantive issue of whether 965 income is eligible for the dividends received deduction.

While on its face this decision may seem to be a taxpayer loss, the language of the judge’s order suggests otherwise. In finding that the GIL is not a “rule,” the judge determined that the GIL was a mere interpretation of the law that was not binding on the taxpayer and not entitled to any deference by the Nebraska courts. This strengthens an already strong taxpayer case on the merits.

The department’s position that 965 income is not eligible for the dividends-received deduction is inconsistent with the legislative history of the deduction and the nature of 965 income. The fact that a judge stated that this position is now afforded no deference only makes the taxpayer case stronger.

As a practical matter, taxpayers that have appealed assessments on 965 income should consider including the deference argument in their appeals, and taxpayers that have followed the GIL and paid tax on 965 income may consider filing refund claims. The substance of this issue will be litigated one way or another, and the district court’s finding that the GIL is not afforded deference can only help the taxpayer case.




Massachusetts Supreme Judicial Court Approves Sales Tax Apportionment for Software

On May 21, 2021, the Massachusetts Supreme Judicial Court issued a decision affirming the Massachusetts Tax Appeal Board’s decision in favor of Microsoft and Oracle, ruling that the companies may apportion sales tax to other states on software purchased by a Massachusetts company from which the software was accessed and seek a tax refund.

The case involved a claim by vendors for abatement of sales tax collected on software delivered to a location in Massachusetts but accessible from multiple states. The Massachusetts Department of Revenue (DOR) claimed that the statute gave it the sole right to decide whether the sales price of the software could be apportioned and, if so, the methods the buyer and seller had to use to claim apportionment. Under rules promulgated by the DOR, there are three methods to choose from, such as the purchaser giving the seller an exemption certificate claiming the software would be used in multiple states, none of which the purchaser used. The DOR argued that if a taxpayer did not use one of the methods specified in the rule, no apportionment was permitted. The vendors sought abatement of the tax on the portion of the sales price that could have been apportioned to other states had one of the methods specified under the rule been used. The DOR claimed the abatement procedure was not a permissible method of claiming apportionment.

The court held: (1) the statute gave the purchaser the right of apportionment and it was not up to the DOR to decide whether apportionment was permitted; (2) the abatement procedure is an available method for claiming the apportionment; and (3) the taxpayer was not limited to the procedures specified in the rule for claiming sales price apportionment.

The court’s decision was based in part on separation of powers: “Under the commissioner’s reading of [the statute], the Legislature has delegated to the commissioner the ultimate authority to decide whether to allow apportionment of sales tax on software sold in the Commonwealth and transferred for use outside the Commonwealth.” The court found such a determination represented “a fundamental policy decision that cannot be delegated.”

The Massachusetts rules reviewed by the court have their genesis in amendments to the Streamlined Sales and Use Tax Agreement (SSUTA) (that never became effective) providing special sourcing rules for, among other things, computer software concurrently available for use in more than one location. Even though Massachusetts is not a member of the SSUTA, officials from the DOR participate in the Streamlined process and apparently brought those amendments home with them and had them promulgated into the Commonwealth’s sales tax rules.

Practice Notes: This case addresses one of the issues with taxing business models in the digital space. This important decision makes clear, at least in Massachusetts, that taxpayers have post-sale opportunities to reduce sales tax liability on sales/purchases of software accessible from other states where tax on the full sales price initially was collected and remitted by the seller.

Taxpayers may have refund opportunities related to this [...]

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Indiana Tax Court Upholds Pharmacy Benefit Management Costs of Performance Approach

The Indiana Tax Court held that a “pharmacy benefit management company” sold services as opposed to tangible personal property for tax years 2011 through 2013. The company’s receipts were properly sourced as revenue from services under the income producing activity/costs of performance rule, which in this case meant that all receipts were sourced outside of Indiana.

The Indiana Department of Revenue (Department) argued that the pharmacy benefit management company’s “receipts from its sale of prescription drugs should have been sourced to Indiana as required for sales of tangible personal property under Indiana Code” because the company’s “primary ‘revenue stream’ was attributable to buying, selling, and delivering prescription drugs in transactions which occurred within [Indiana].”

The court disagreed with the Department, finding “[the pharmacy benefit management company’s] income was derived from providing pharmacy benefit management services and not from selling prescription drugs during the years at issue.” The court looked to the company’s Securities and Exchange Commission (SEC) Form 10-K filing, observing “[n]one of the emphasized words [in the Form] describe a sale of goods, but instead, describe services. Indeed, nowhere in the designated portion of [the company’s] Form 10-K does the text state that the [company’s] revenue is from the sale of prescription drugs, focusing on facilitating delivery as its discrete service, not as a function of selling a good” (emphasis in the original). On May 1, 2019, Indiana switched from its historical cost of performance sourcing methodology to a market-based sourcing for services, retroactive to January 1, 2019.




US Treasury Issues Guidance on the ARPA Claw-Back Provision

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

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

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

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