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INSIDE SALT
In-Depth Coverage of Issues Surrounding State and Local Tax
INSIDE SALT
In-Depth Coverage of Issues Surrounding State and Local Tax
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Tax Breaks for Data Centers: The Numbers Might Be Cloudy

by | Dec 23, 2015 | , , , ,

States are competing aggressively to attract data centers with various tax incentives. Data center companies and their business customers are taking them up on their offers. But are these incentives really a good deal for the businesses? Tax incentives that seem attractive at first glance may not be beneficial when they are examined in the context of the entire tax picture, especially in the unique, uncertain, and developing world of state taxation of technology and computer services.

With the rise of global commerce, cloud computing, streaming video and a wide array of other internet-related businesses, data centers have become big businesses.  In 2014, the colocation data center industry reached $25 billion in annual revenue globally, with North American companies accounting for 43 percent of that revenue.[1]

To get in on the action, states have been trying to outdo one another by offering a slew of competing tax breaks to the industry. According to the Associated Press, states have provided about $1.5 billion in data center tax breaks over the past 10 years.[2]   Some states have gone even further, providing tax incentives to the entire data center industry through changes in the tax laws themselves. Such incentives can include reductions or exemptions from sales and use taxes on data center products or services, favorable income tax rates for data center companies and favorable property tax rules for data center assets. According to a recent analysis by the Associated Press, at least 23 states provide such statutory data center tax incentives.[3] Just a few of the most recent examples include a sales tax exemption for data center equipment in Michigan,[4] a broadening of the sales tax exemption for data center electricity and equipment in North Carolina[5] and a favorable apportionment formula for data centers in Virginia.[6]  Importantly, many of these incentives apply not only to the data centers themselves, but also to their customers.

Businesses considering whether to take advantage of these incentives would be well advised to consider not only the potential benefit from any particular tax incentive, but also whether the decision would affect their tax picture as a whole. Because of the current uncertain and changing landscape for state and local taxation of technology and computer services, the analysis of these incentives for data centers and their customers can be particularly complex.

One item that a taxpayer might overlook when considering whether to take advantage of an incentive program is what affect, if any, the choice of location might have on the taxpayer’s property factor for income tax apportionment purposes. Obviously, location of a company’s technology equipment in a data center under a colocation agreement will cause the company’s in-state property factor to increase due to its equipment being located in the state. However, data center customers also should be aware that local tax authorities might also argue that the colocation payments themselves constitute consideration for the use of real or tangible personal property and thus the [...]

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Financial Statement Countdown for Remote Sellers Selling into Alabama

by , and | Dec 16, 2015 | , , ,

Remote sellers making sales into Alabama have until January 1, 2016, to begin collecting sales tax regardless of their physical presence in the state or consider whether there is any impact on financial statement issues as a result of non-collection.

This summer, the Alabama Department of Revenue issued a surprising new regulation, § 810-6-2-.90.03. This rule specifically provides that a remote seller with more than $250,000 of sales into the state that also meets the provisions of the “doing business” statute must register for a license and collect and remit sales/use tax to the state. Notably, the list of activities that are considered “doing business” includes solicitation of sales using cable television advertising; substantial solicitation of sales plus benefitting from any banking; financing; debt collection; telecommunication; or marketing activities occurring in this state; any contact with the state sufficient to allow Alabama to impose a sales and use tax collection requirement under the U.S. Constitution. Ala. Code § 40-23-68(b)(9). The rule goes into effect January 1, 2016.

If this had happened 10 years ago, the response would be simple – Alabama’s economic nexus threshold is clearly unconstitutional under Quill. However, several developments, both legal and environmental, have made the analysis more complex. First, the Alabama legislature has provided an option to remote sellers to use the “Simplified Sellers Use Tax Remittance” process. This program creates almost the simplest tax calculation and remittance process possible: one rate, no exemptions, single jurisdiction filing. Alabama is surely counting on the Supreme Court of the United States to find that this simplified process removes the burden which concerned the Court in Quill. There are, of course, numerous arguments against this scenario; many of them quite strong. Nevertheless, Alabama’s clever, parallel compliance juggernaut does mandate some respect.

Second, Justice Anthony Kennedy clearly feels it is high time for the holding in Quill to be relegated to an era when only academics knew of the internet. One justice’s comments do not mean that sculptors should begin carving Quill’s headstone, but the Court already has at least two justices that do not believe the dormant commerce clause exists at all. Today, there is clearly the highest risk ever of some type of melting of the Quill iceberg.

So what does this mean for remote sellers with Alabama customers?  First—of course such sellers could begin collecting, but, some sellers philosophically believe in the underpinnings of Quill and other sellers may find collection, even under the simplified system, financially oppressive and/or administratively difficult. For those sellers that will not or cannot comply, the immediate questions that must be answered are: (1) What are the risks of not collecting; and (2) Do those risks rise to the level of financial statement issues?  Obviously the first risk is that with every sale, the seller may be incurring tax liability that it otherwise could have passed on to its customers. How real this risk is dovetails with the second issue. In determining the risk of probable loss (or other financial statement standard), [...]

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McDermott Partner Featured on The Kojo Nnamdi Show

by | Dec 16, 2015 | ,

Yesterday, McDermott Will & Emery partner Steve Kranz was a featured guest on WAMU 88.5’s The Kojo Nnamdi Show, one of NPR’s most prestigious talk radio shows in the greater Washington, DC area. Kranz participated in this week’s Tech Tuesday segment titled “Taxing Your Online Shopping Spree” which focused on the current state of internet sales tax impositions in the United States and various proposals to tax e-commerce that are currently being considered by Congress and state legislatures. Kranz was joined by fellow guests Steve DelBianco, Executive Director at NetChoice, and Bill Fox, Director of the Center for Business and Economic Research at the University of Tennessee.

A permanent link to this informative discussion is available here.



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D.C. Council Holds Hearing on New Tax to Fund Unprecedented Family Leave Benefits

by , and | Dec 3, 2015 | , , ,

Yesterday, the D.C. Council Committee of the Whole held an advocates-only hearing on the Universal Paid Leave Act of 2015 (Act), which was introduced on October 6, 2015 by a majority of councilmembers. As introduced, this bill establishes a paid leave system for all District of Columbia (District) residents and all workers employed in the District. It allows for up to 16 weeks of paid family and medical leave, which would more than double the amount of weeks (and dollar cap) of any U.S. state-sponsored paid-leave program. While other state paid family and medical leave programs are paid by the employees themselves, the benefits for employees of a “covered employer” (i.e., private companies in the District) would be funded by a one percent payroll tax on the employer. There has been talk of setting a minimum threshold of employees (i.e., 15-20 employee minimum) for an employer to be covered by the Act, although such a requirement does not exist in the current draft. Because the District cannot tax the federal government or employers outside its borders, District residents working for one of these entities are required to contribute to the fund individually. This would result in a strange dynamic that taxes District residents differently based on whether they work for a covered employer or not. Self-employed District residents have the ability to opt-out altogether (and not contribute to the fund or receive benefits) under the Act.

The definition of “covered employee” is drafted in such a way that temporary and transitory employees (i.e., “employed during some or all the 52 calendar weeks immediately preceding the qualifying event”) could claim the full 16 weeks of benefits and have no obligation to return to the job. The Act does exclude employees that spend more than 50 percent of their time working in a state other than District; however, this exclusion would not apply to employees that do not spend a majority of their time in any one state.

A qualifying individual is one who becomes unable to perform their job functions because of a serious health condition or to care for a family member with a serious health condition or a new child. Claims are filed with the District Government and the District must notify the employer within five business days of a claim being filed. Beneficiaries will receive 100 percent of their average weekly wages (up to $1,000 per week) plus 50 percent of their average weekly wages in excess, with a weekly cap of $3,000.

Practice Note:

Advocates testifying yesterday expressed concerns that the proposed one percent rate (considered high by many) is unrealistic and would fall significantly short of funding the generous benefits—although no definitive data is available at this time. Aside from highlighting the unprecedented breadth of the benefits, many advocates also noted the significant loopholes in the current draft that could lead to unintended—and potentially unconstitutional—consequences, if passed. At this point, it appears that the Council has [...]

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Delaware Court Denies Most of Defendants’ Motion to Dismiss Unclaimed Property Gift Card False Claims Action

by and | Dec 1, 2015 | , , , , ,

Two years ago, a former employee of Card Fact, LLC (subsequently purchased by Card Compliant), a company providing gift card issuance and management services to retailers, filed a false claims action in Delaware alleging that his former company and its retailer clients concocted a scheme to avoid remitting unclaimed gift card funds to Delaware. Last week, the judge in the case issued a memorandum opinion on the defendants’ Motion to Dismiss.  State of Delaware ex rel. French v. Card Compliant LLC, et al., C.A. No.: N13C-06-289 FSS [CCLD] (Del Sup. Ct. Nov. 23, 2015). While the opinion is likely disappointing to most of the defendants, it should not be read as a final victory for the state. There is still much to be decided in the case, as this was just a motion to dismiss and not a decision as to whether the plaintiffs will ultimately prevail.

The judge did however make several legal conclusions that are of import to Delaware companies. First, the judge determined that as to gift card liability that was initially incurred by the retailers but subsequently transferred to Card Fact (and its affiliates), the retailers remained the debtors with respect to the card owners, unless the customers consented to the delegation of debt. The judge found that the contractual agreements between the retailers and the Card Fact companies were not controlling. However, the judge did not specifically rule on gift card liabilities that were never transferred from the retailers to Card Fact, but instead were incurred directly by Card Fact after its relationship with the retailers began.

Second, the judge found that for defendants that were not C corporations, the second priority rule was to be applied based on the state of formation, not the principal place of business. This is contrary to most state laws and sets up a direct conflict between the states.

Finally, the judge found that because one of the retailers had previously been audited by Delaware (through Kelmar), it could not be a defendant in this false claims action. The judge dismissed this defendant entirely, even for claims that arose subsequent to the audit conclusion. The judge noted that “[i]f the auditor has given [the retailer] a bye, that is between the escheater and the auditor.” This is very good news for any company that has previously been audited by the state regarding the risk of a false claims action.

Practice Notes

  1. For companies that have been audited by Delaware, the risk of a false claims action has likely been significantly reduced if not eliminated;
  2. Unincorporated entities should investigate the indemnification provisions between their state of formation and state of principal place of business to determine the risk of choosing which state to remit to;
  3. Companies using gift card entities or other liability allocation arrangements should review their disclosures and agreements with customers to verify appropriate consent and understanding regarding which entity holds the actual liability.


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Happy Holidays from McDermott’s SALT Practice

by | Dec 1, 2015 |

In our holiday tradition, as a thank you to all of our Inside SALT readers and subscribers, we are pleased to present our annual Inside SALT Crossword Puzzle Contest. We hope you’ll enjoy this little diversion that tests your knowledge of key state and local tax developments this year. To enter, please download and print the puzzle by clicking on the image below. After you complete the puzzle, please send it as a PDF file to skranz@mwe.com no later than December 31, 2015, at 11:59 pm EST. The first eligible entrant to submit a complete and correct puzzle wins a $200 Amazon gift card. The contest is open to registered Inside SALT email subscribers from the United States and District of Columbia who are age of majority or older. (To become a subscriber, please enter your email address in the box on the right side of your screen.) Contest ends at 11:59 pm EST on December 31, 2015. Participation is subject to the Official Rules. For complete details, click here to view the Official Rules.) This contest is void outside the U.S. and D.C. and where prohibited, restricted or taxed. Please also share your feedback about what topics you would like to hear more about in the comments section below. We look forward to hearing from you and to bringing you timely SALT updates and analysis in the coming year! Click puzzle to enlarge and download.



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A Steep Slope — Vermont Supreme Court Finds AIG Not Unitary With a Ski Resort Based On a Clear and Cogent Evidence Burden of Proof

by and | Nov 30, 2015 | , , , , , ,

In the first Vermont Supreme Court decision addressing combined unitary reporting since Vermont’s combined reporting regime became effective in 2006, the court affirmed a lower court’s decision that AIG, the multinational insurance company, was not unitary with a ski resort operated by a subsidiary in Vermont; accordingly, a combined report covering the two businesses was not required. The decision is important because it lays the foundation for future unitary cases in Vermont.

The court agreed with AIG that there were no economies of scale between the operations of AIG and the ski resort. “Because [the entity] is a ski resort and therefore its business type is not similar to AIG’s insurance and financial service business, there is no opportunity for common centralized distribution or sales, and no economy of scale realized by their operations.” On centralization of management, the court noted that although AIG controlled the appointments to the ski resort’s board and management, this did not translate into “actual control” over the ski resort’s operations. Lastly, the Vermont Department of Taxes attempted to argue functional integration based primarily on AIG’s influx of working capital to the ski resort. The court rejected this assertion stating the funding “served an investment rather than operational function. The financing was not part of an AIG operational goal to grow part of its business. Further, there is no operational integration between AIG’s insurance and financial businesses and the ski resort operated by [the resort].”

The case is interesting because it involved whether an instate entity was unitary with its parent. For the year at issue, Vermont had a three factor apportionment formula with a double-weighted sales factor. Presumably, the ski resort had a high Vermont apportionment factor and relatively little income, so including AIG in the combined group increased AIG’s Vermont apportionment factor without significantly  diluting its income.

Interestingly, the court addressed AIG’s burden of proof on the unitary issue. The taxpayer argued that a preponderance of the evidence standard should apply. The Vermont Supreme Court disagreed. Looking to the United States Supreme Court’s decision in Container Corp. as well as to decisions of other states, the taxpayer has the burden of proving by “clear and cogent” evidence that its operations are not unitary.  Interestingly, the court suggested that one California court decision that applied a preponderance of the evidence standard to a unitary question was distinguishable because that case involved a taxpayer claiming that unity existed — and AIG was claiming that unity did not exist. This disparate burden depending on the direction of the unitary argument may prove important to taxpayers seeking to bring entities or operations into a combined report in Vermont.

State tax professionals may react to this decision in a manner similar to the way many reacted when the Court of Appeals of Arizona decided Talley Industries and Woolworth. Those decisions engendered substantial hope that courts — and, ultimately, state revenue agencies — would analyze unitariness not on the basis of a “checklist” or as a knee-jerk reaction to [...]

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Precedential Cloud Victory in Michigan Court of Appeals

by , and | Oct 30, 2015 | , , , ,

On Tuesday, a three-judge panel sitting for the Michigan Court of Appeals unanimously affirmed a lower court decision finding that the use of cloud-based services in Michigan is not subject to use tax in Auto-Owners Ins. Co. v. Dep’t of Treasury, No. 321505 (Mich. Ct. App. Oct. 27, 2015). While there have been a number of cloud-based use tax victories in the Michigan courts over the past year and a half, this decision marks the first published Court of Appeals opinion (i.e., it has precedential effect under the rule of stare decisis). See Mich. Ct. R. 7.215(C)(2). Therefore, the trial courts and Michigan Court of Appeals are obligated to follow the holdings in this case when presented with similar facts, until the Michigan Supreme Court or Court of Appeals say otherwise. While the ultimate outcome (i.e., not taxable) of the lower court decision was affirmed, the analysis used by the Court of Appeals to get there was slightly different and the court took the time to analyze over a dozen different contracts, as discussed below. Given the fact that a petition for review is currently pending in another Court of Appeals case (Thomson Reuters) decided on similar issues in 2014, it will be interesting to see if this development increases the Michigan Supreme Court’s appetite to hear a use tax case on cloud-based services. The Department of Treasury (Department) has approximately 40 days to request that the Auto-Owners decision be reviewed by the Michigan Supreme Court.

Facts

Auto-Owners is an insurance company based out of Michigan that entered into a variety of contracts with third-parties to provide cloud-based services. These contracts were grouped into six basic categories for purposes of this case: (1) insurance industry specific contracts, (2) technology and communications contracts, (3) online research contracts, (4) payment remittance and processing support contracts, (5) equipment maintenance and software customer support contracts and (6) marketing and advertising contracts.  The contracts all involved, at some level, software accessed through the internet. Michigan audited Auto-Owners and ultimately issued a use tax deficiency assessment based on the cloud-based service contracts it utilized.  In doing so, the Department cited the Michigan use tax statute, which like many states, provides that tax is imposed on the privilege of using tangible personal property in the state. See generally Mich. Comp. Laws Ann. § 205.93. The Department took the position that the software used in Michigan by Auto-Owners was “tangible personal property,” which is defined to include prewritten, non-custom, software that is “delivered by any means” under Michigan law. See Mich. Comp. Laws Ann. § 205.92b(o). The taxpayer paid the tax under protest and filed a refund claim, which was the focus of the Court of Claims decision being appealed.

Procedural History

At the trial court level, the Court of Claims determined that the application of use tax to the software used in Michigan by Auto-Owners would be improper. In doing so, the court issued three separate holdings—all in favor of the taxpayer. First, the court held that use tax [...]

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Taking a Stand Against Retroactive State Legislation

by | Sep 9, 2015 | ,

Changing the past: Serious scientists, talented fantasists, regretful Ashley Madison members and many other segments of humanity have considered, and even longed for, the ability to rewrite history. One group has apparently succeeded – state legislatures that backdate tax law changes.

Such success may be short lived, however, as experts identify significant legal and policy faults with retroactively changing tax obligations.  Two recent articles in State Tax Today explain why retroactive tax laws should not be passed and if they are, should be invalidated by the courts – and invalidated retroactively. In “Retroactive Tax Laws Are Just Wrong” David Brunori (Deputy Publisher, State Tax Today) describes the fairness problem with retroactive tax legislation.  In a second article, the monthly interview column “Raising the Bar,” McDermott’s Steve Kranz and Diann L. Smith, Joe Crosby (MultiState Associates) and Kendall Houghton (Alston & Bird LLP) provide details on recent cases addressing retroactive tax changes.

The Council On State Taxation (COST) is also offering a discussion of this issue at its 46th Annual Meeting/Fall Audit Session in Chicago, Illinois (October 20-23, 2015).   McDermott’s Diann L. Smith, Catie Oryl (COST) and Scott Brandman (Baker & McKenzie) will discuss “Retroactive Legislation: Just a ‘Clarification’?”  If you are interested in receiving a copy of the COST outline following the event, please contact Diann at dlsmith@mwe.com.



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Post-DMA, Federal Court of Appeals Broadly Interprets Jurisdictional Limitations of Anti-Injunction Act

by , and | Sep 3, 2015 | , , ,

Earlier this month, the United States Court of Appeals for the D.C. Circuit held in Florida Bankers Ass’n v. U.S. Dep’t of the Treasury, No. 14-5036 (D.C. Cir. Aug. 14, 2015) that the Anti-Injunction Act (AIA, codified at 26 U.S.C. § 7421(a)) barred two state banking associations from challenging Treasury regulations that: (1) required banks to annually report interest paid to certain foreign account-holders, and (2) imposed a penalty on banks that fail to do so.  Notwithstanding attempts to reconcile the holding with recent precedent, the majority’s decision directly conflicts with the recent unanimous Supreme Court decision in Direct Mktg. Ass’n v. Brohl, 135 S. Ct. 1124 (March 3, 2015) (DMA), which found that the Tax Injunction Act (TIA, codified at 28 U.S.C. § 1341) did not bar a retail association’s challenge to comparable Colorado notice and reporting requirements (and accompanying penalty) imposed on out-of-state retailers.  The TIA is modeled off of, and has consistently been interpreted to apply in the same fashion as its federal companion, the AIA. Given the striking similarities between the two cases, it is hard to reconcile the expansive application of the AIA in Florida Bankers with the narrow analysis of the TIA in DMA.

Majority Opinion

The majority opinion begins by highlighting the fact that the penalty imposed on the banks is technically a “tax” for purposes of the AIA because it is found in a specific section of the Internal Revenue Code (IRC, Ch. 68, Subchapter B) that states as much. See 26 U.S.C. § 6671(a). The majority emphasized that the Supreme Court recently confirmed that these types of penalties are treated as taxes when analyzing the application of the AIA, citing to the Nat’l Fed. of Indep. Bus. v. Sebelius decision. The majority distinguishes DMA on the basis that, unlike the tax-penalty in Chapter 68B of the IRC, the Colorado penalty imposed on out of state retailers that failed to report was not—or at least the parties never argued or suggested that it was—itself a tax. The majority was clear that “[i]f the penalty here were not itself a tax, the Anti-Injunction Act would not bar this suit.” Because the penalty was a “tax”, a favorable ruling for the plaintiffs “would invalidate the reporting requirement and restrain (indeed eliminate) the assessment and collection of the tax paid for not complying with the reporting requirement.”  Because of this, the majority held that the banking associations’ challenge to the reporting requirements was barred by the AIA.

Practice Note: The majority relies heavily on the technical tax-penalty distinction in reaching their holding that the AIA applied. In making this distinction, the majority suggests that the label given to a penalty is controlling in determining whether the AIA and TIA apply to shut the door to federal district court. While at first glance it would appear that the holding is limited in scope to federal tax issues, it has the potential to spill over into the state tax world since many states have specifically conformed to [...]

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