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Nationwide Importance

At the 10-Yard Line: New York Formally Proposes Corporate Tax Reform Regulations

by Stephen P. Kranz, Richard C. Call, Michael J. Hilkin and David Jasphy | Aug 11, 2023 | Allocation/Apportionment, Income Tax, Local Tax, Nationwide Importance, New York, Nexus, Unitary Business

On August 9, 2023, the New York State Department of Taxation and Finance (Department) released 417 pages of proposed regulations, an important step toward concluding a now almost decade-long process to implement corporate tax reform.

The journey began in 2014 with the enactment of legislation modernizing the state’s corporate tax law. Thereafter, the Department released several versions of draft regulations while warning taxpayers that the drafts were “not final and should not be relied upon.” Even though the Department announced last spring that it intended to formally propose and adopt such regulations in fall 2022, taxpayers had to wait another year.

Comments on the proposed regulations must be provided to the Department by October 10, and the regulations will be finalized thereafter. In this article, we’re taking a closer look at a few of the items included in the proposed regulations.

ADOPTION OF THE MULTISTATE TAX COMMISSION’S INTERPRETATION OF P.L. 86-272

Consistent with the Department’s final version of the draft regulations, the proposed regulations contain rules based on model regulations adopted by the Multistate Tax Commission, which narrowly interpret P.L. 86-272. Under the proposed regulations, “interacting with customers or potential customers through the corporation’s website or computer application” exceeds P.L. 86-272 protection. By contrast, “a corporation will not be made taxable solely by presenting static text or images on its website.” This sweeping change remains surprising because P.L. 86-272 is a federal law, the scope of which is not addressed by the state’s corporate tax reform.

THE ELIMINATION OF THE “UNUSUAL EVENTS” RULE

The proposed regulations omit the “unusual events” rule contained in the 2016 draft regulations. Generally consistent with Department regulations long predating the state’s corporate tax reform legislation, the 2016 draft stated that “business receipts from sales of real, personal, or intangible property that arose from unusual events” were not included in the business apportionment factor. For example, a consulting firm that sold its office building for a gain would not have included the gain in its apportionment factor because the sale was considered to be from an unusual event. The Department claims to have abandoned the rule “because Tax Reform provided significantly more detailed sourcing rules, including guidelines for those transactions that might have been excluded under pre-reform policy.”

SAFE HARBOR SOURCING FOR DIGITAL PRODUCTS AND SERVICES

Post-reform corporate tax law sources receipts from digital products and digital services to New York if the location the customers derive value from is in New York as determined by a complicated hierarchy of methods. The proposed regulations provide a simplified safe harbor in applying this sourcing rule, where “if the corporation has more than 250 business customers purchasing substantially similar digital products or digital services as purchased by the particular customer . . . and no more than 5% of receipts from such digital products or digital services are from that particular customer, then the primary use location of the digital product or digital service is [...]

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As Minnesota Moves Toward GILTI Taxation, New Jersey May Be Moving Away from It

by Stephen P. Kranz, Michael J. Hilkin and Diann Smith | May 23, 2023 | Allocation/Apportionment, Federal Tax, Income Tax, Minnesota, Nationwide Importance, New Jersey, Tax Base, Unitary Business

We previously reported that the Minnesota Legislature was considering imposing mandatory worldwide combined reporting through an omnibus tax bill. Subsequent to our report and in the face of numerous criticisms, Minnesota Senate leaders backed away from the proposal. But ominously, those same leaders said they would examine other tax increases to make up for the (potentially hypothetical) revenue left on the table by moving away from mandatory worldwide combined reporting.

After a series of negotiations, an updated omnibus tax bill (HF 1938) emerged from the Minnesota Legislature conference committee over the weekend, which has already been passed by both the Minnesota House and Senate. Most notably for corporate taxpayers, the legislation:

Recouples Minnesota with the Internal Revenue Code provision providing for the inclusion of global intangible low-taxed income (GILTI) (under IRC § 951A) in the corporate tax base while providing a 50% dividends received deduction (but no deduction under IRC § 250)
Reduces the dividends received deduction from 80% to 50% for corporations in which the recipient owns 20% or more of the stock and from 70% to 40% for corporations in which the recipient owns less than 20% of the stock and
Decreases a corporation’s maximum net operating loss deduction from 80% to 70% of taxable net income each year.

As no prior bills proposing these tax increases had been introduced in the Minnesota Legislature, these tax increases have been passed without any public hearing or public testimony. The rush to put these proposals together may explain why the legislation fails to address how income from GILTI must be accounted for in determining a taxpayer’s apportionment factor.

Minnesota’s move toward GILTI taxation is out of step with legislation introduced in New Jersey, which would increase the state’s GILTI deduction to 95% from 50%. The proposal, which is part of a broader legislative compromise package negotiated by New Jersey government officials and businesses, has the support of the chair of the New Jersey Senate Budget and Appropriations Committee and has been publicly called “win-win” legislation by a New Jersey Division of Taxation representative.

As litigation addressing the constitutionality of taxing GILTI is already percolating through administrative appeals in numerous states, it is likely that New Jersey’s potential move away from GILTI taxation will prove to be the more fiscally prudent way to go.

Be Careful What You Wish For: Minnesota May Be on the Precipice of Enacting Worldwide Combined Reporting at the Worst Possible Time

by Stephen P. Kranz, Michael J. Hilkin and Diann Smith | May 4, 2023 | Federal Tax, Income Tax, Local Tax, Minnesota, Nationwide Importance, Tax Base, Unitary Business

It has been widely reported that the Minnesota Legislature has advanced an omnibus tax bill that would require the inclusion of the “entire worldwide income” of combined corporate income tax filers engaging in a unitary business. Tax press outlets have made the broad claim that mandatory worldwide combined reporting will “add foreign subsidiaries’ profits” to Minnesota corporate tax returns. But these claims disregard how such a change in Minnesota’s tax regime would also bring worldwide losses into a combined filing group’s income (or loss) calculation. If Minnesota passes mandatory worldwide combined reporting legislation this year and economic expert predictions of an impending global recession come true, the state could see a significant decrease in revenue from its corporate income tax.

Claims that worldwide combined reporting will bring additional profits into the corporate tax base presuppose foreign subsidiaries added to a combined group are always profitable. But if the entities added to a combined group are unprofitable, the opposite would be true. Instead, the foreign entities would either decrease income subject to state corporate income taxation or increase losses that generate net operating loss carryforwards that will decrease state corporate income taxation in future years.

This isn’t just a hypothetical concern. Tax specialists who practiced in the wake of the 2008 global recession recall that states with combined reporting regimes often sought to force unitary groups of corporations to “decombine” in order to remove entities generating losses from the state corporate tax base. When attempts to decombine were unsuccessful (as many were), states were often forced to walk away from large assessments or pay large refunds to corporate taxpayers. Such experiences should serve as a reminder that combined reporting often can decrease a state’s revenues from a corporate income tax. In Minnesota’s case, the potential for lost tax revenues may only balloon if its legislature imposes worldwide combined reporting during a recession.

No state currently has a true mandatory worldwide combined reporting regime (Alaska only imposes it on specific industries), and concerns about bringing foreign loss companies into the combined group is one of many reasons why. If Minnesota were to break state ranks by imposing worldwide combined reporting and a US parent corporation determined the regime could cause its Minnesota taxable income to increase, the corporation would have every incentive to either avoid or decrease connections with the state—potentially causing the state to lose out on capital investments that bring jobs with high wages and benefits.

Further, any attempt to impose mandatory worldwide combined reporting is likely to cause an international backlash, along with potential federal action and litigation challenging Minnesota’s regime. In the immediate wake of a 1983 U.S. Supreme Court decision indicating, to a limited degree, that a state mandatory worldwide combined reporting regime could pass constitutional muster, the US Department of the Treasury completed a study outlining state taxing principles supported by “state, [...]

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California Supreme Court Lets It Stand That CDTFA Can Decide Who Is and Is Not a Retailer

by Charles Moll, III, Troy M. Van Dongen and Elle Kaiser | Apr 28, 2023 | California, Local Tax, Nationwide Importance, Sales Tax

On April 26, 2023, the Supreme Court of California declined to review the Second District Court of Appeal’s decision in Grosz v. California Dep’t of Tax & Fee Admin. In the underlying case, Stanley Grosz, a business owner based in Fresno, California, filed suit seeking a declaration that the California Department of Tax and Fee Administration (CDTFA) has a mandatory duty to collect sales and use tax from an internet retailer for sales that were made by third-party merchants on the retailer’s website, but fulfilled by the retailer. Grosz also sought an injunction requiring the CDTFA to collect the sales and use tax.

The internet retailer’s service allows third-party merchants to outsource their order fulfillment to the retailer. As part of the service, the internet retailer stores the merchants’ products at one of its fulfillment centers. According to Grosz, the provision of these services necessarily defined the internet retailer as a “consignment retailer” responsible for remitting sales tax on transactions facilitated through its website. (18 CCR § 1569.) The CDTFA disagreed and counter-argued that the determination of who constitutes a “retailer” under California sales and use tax law is a decision that is within its sole discretion to make.

The Second District Court of Appeal, in analyzing the statutory definition of “retailer” contained in Section 6015(a) of the Revenue and Taxation Code, concluded that it was “clear” that both the internet retailer and the third-party merchants could be regarded as retailers for purposes of transactions conducted under the service. The Court then agreed that the CDTFA has broad discretion to determine who constitutes a “retailer” under California’s sales and use tax laws.

It is important to note that the facts in this case occurred before the enactment of California’s Marketplace Facilitator Act (MFA). Under current law, marketplace facilitators generally are responsible for collecting, reporting and paying the tax on retail sales made through their marketplace for delivery to California customers. Thus, the current statutory scheme has greater clarity concerning the sales tax collection and reporting requirements for marketplace facilitators and sellers. Nevertheless, this case highlights the exposure some sellers may have for sales made before the MFA went into effect if tax was not properly collected and remitted.

Massachusetts Department of Revenue Releases Guidance on a De Minimis Exception for Use Tax on Rolling Stock

by Richard C. Call, Stephen P. Kranz and Jonathan C. Hague | Mar 28, 2023 | Audits, Local Tax, Massachusetts, Nationwide Importance, Sales Tax

The Massachusetts Department of Revenue (DOR) recently released Directive 23-1, which outlines the conditions for a de minimis exception where the Commissioner will not require a taxpayer to pay the use tax for rolling stock used or stored within the state. This directive comes at a time when the DOR is auditing many companies that use trucks and trailers and is currently assessing use tax on rolling stock if no sales tax was collected at the time of sale.

Directive 23-1 provides that “the Commissioner will consider the in-state use [of rolling stock] to be de minimis and will neither impose, nor require the taxpayer to pay, use tax on the use or storage of the rolling stock” where the taxpayer can prove “that the rolling stock that it owns or leases for 12 months or longer was used or stored in Massachusetts for no more than six days during a 12-month period” (emphasis added).

Companies “can demonstrate the frequency with which rolling stock was used or stored in Massachusetts through sufficient records that show the dates of travel into and in Massachusetts, such as GPS logs.” Additionally, a credit against the Massachusetts use tax is allowed if the taxpayer has paid a sales tax legally due to another state and that state allows a corresponding credit for sales or use tax paid to Massachusetts.

Meaningful Statute of Limitations for Unclaimed Property Audits and Enforcement Actions? Michigan Court of Appeals Says Yes!

by Eric D. Carstens, Stephen P. Kranz and Diann Smith | Mar 10, 2023 | Audits, Michigan, Nationwide Importance, Procedure, Unclaimed Property

On January 19, 2023, the Michigan Court of Appeals affirmed two 2022 trial court orders, holding that initiating an unclaimed property audit does not toll (or freeze) the running of the statute of limitations (time-bar) for the Michigan State Treasurer to commence “an action or proceeding” with respect to a duty of a holder.[1] As most holders are well aware, unclaimed property audits are extremely invasive and burdensome and, unlike other types of audits conducted by states, often drag on for a decade or more before the state will issue a formal notice and demand—covering multiple years and looking back from the date of the original audit notice (often 10 or 15 years). This dynamic has created an audit framework that sets holders up for failure (really, who has complete books and records that far back?) and results in millions of unclaimed property being reported to states because of record limitations alone and third-party audit firms being handsomely paid for their time spent.

The Michigan Court of Appeals’ decision calls this entire model (some would say scheme) into question and could drastically change how holder audits look, feel and proceed in the unclaimed property world going forward. Even more importantly for holders currently under audit, these decisions could drastically narrow the scope of the open periods covered by the audit for Michigan and other states with similar unclaimed property statute of limitations.

Practice Note: While the common sense holding in this case is well established in the tax realm, it has long been the position of unclaimed property administrators and their third-party audit firms that the commencement of an audit alone freezes the statute of limitations and allows them to enforce the duties of holders looking back from that date. This (now precedential) Michigan Court of Appeals decision flies in the face of that long-standing view and calls into question whether peer states with similar unclaimed property statute of limitations are barred from enforcing transaction years being reviewed under pending audits. Because the Michigan unclaimed property statute of limitations is modeled off a provision contained in the 1981 Uniform Unclaimed Property Act (which has been adopted by many states and incorporated in the Revised Uniform Unclaimed Property Act approved in 2016), this is not a Michigan-specific victory and one that should be explored further for holders under audit by other states as well. Showing the nationwide importance of these Michigan cases, the National Association of State Treasurers filed an amicus brief through its affiliate, the National Association of Unclaimed Property Administrators, with the Michigan Court of Appeals in July 2022; however, their arguments were not enough to convince the Court to modify the trial court decision interpreting the plain language of the statute of limitations and uphold the trial court ruling in favor of the holders.

The State Treasurer filed an application for leave to appeal the Michigan Court of Appeals opinion to the Michigan Supreme Court (the state court of last resort, which has [...]

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Is California Picking the Pockets of Other States?

by Charles Moll, III, Elle Kaiser, Michael J. Hilkin and Marcy Jo Mandel | Oct 21, 2022 | California, Local Tax, Nationwide Importance, Sales Tax, Transaction Taxes

In Matter of Body Wise International LLC (OTA Case No. 19125567; 2022 – OTA – 340P), a California-based retailer collected amounts designated as “tax” related to jurisdictions where it was not registered to collect tax. The California Office of Tax Appeals (OTA) held that the retailer must remit those amounts to California, even though the sales were not taxable in California, because the retailer did not actually pay the “tax” amounts it collected to the other states nor did it refund those amounts to its customers.

Body Wise International, LLC sold weight loss supplements to customers across the country and shipped the products directly to customers via common carrier from its warehouse in California. During the periods at issue, Body Wise’s tax software program charged a “Tax Amount” on all sales to customers located in various states based upon the respective tax rates in those other states. In states where Body Wise had not registered to charge or collect tax, Body Wise did not remit the “tax” collected to those states.

On audit, the California Department of Tax and Fee Administration (CDTFA) determined that the “Tax Amounts” Body Wise collected in those other states constituted excess sales tax reimbursements under California Revenue & Taxation Code (R&TC) section 6901.5, which provides that a retailer who collects a sales tax reimbursement exceeding the amount of the sales tax liability imposed upon the sale must remit the excess to the customer or to the state. CDTFA concluded that those amounts collected but not paid over to the other states must either be returned to the customer or remitted to California.

Upon appeal, the OTA agreed with CDTFA. OTA first observed, “it is not necessary for a sale, purchase, or any other type of transfer for consideration to be subject to California’s sales tax in order for the excess tax reimbursement provisions of R&TC section 6901.5 to apply.” Rather, OTA then stated, the requirement to remit or refund excess sales tax reimbursement to CDTFA applied to Body Wise even where the underlying transaction was nontaxable or exempt in California. Based upon this, OTA concluded that Body Wise must remit those amounts collected to California. OTA supported its conclusion by observing that Body Wise was not registered to collect sales tax in some or all of the other states.

However, logically, the excess tax reimbursement covered by the statute must be excess California tax reimbursement in the first instance. Indeed, the statute by its own terms expressly applies to “taxes due under this part [the California Sales and Use Tax Law].” (Cal. Rev. & Tax. Code § 6901.5.) Because these were not taxes due to California but ostensibly to the other states, California’s attempt to abscond with revenues belonging to another state would appear to be unconstitutional as violating the sovereignty of that other state.

The OTA’s conclusion would seem to be at odds with the important maxim of statutory construction to avoid an interpretation of the statute that would render it [...]

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Tax That DC?!?! FCA Suit on Residency Brings Business Intelligence Company into the Crosshairs

by Eric D. Carstens, Stephen P. Kranz, Michael J. Hilkin and Diann Smith | Sep 2, 2022 | Constitutional Issues, District of Columbia, False Claims Act, Income Tax, Local Tax, Nationwide Importance, Tax Base

For the first time since the enactment of the False Claims Amendment Act of 2020, the DC Attorney General’s (AG’s) Office has used its new tax enforcement powers to pursue an alleged personal income tax deficiency. This development brings to the forefront a long-simmering constitutional problem with DC’s statutory residency law and offers a stern warning to businesses that assist key employees and executives with their personal tax obligations.

The press rapidly and widely reported on DC’s lawsuit against MicroStrategy Co-Founder, Executive Chairman and former CEO Michael Saylor for alleged evasion of D.C. personal income taxes, which was made public this week. The case alleges that Saylor wrongly claimed that he was a resident of Virginia or Florida (rather than DC) since at least 2012.

The case was originally brought under seal by a relator under DC’s False Claims Act in April 2021—less than one month after the False Claims Amendment Act took effect. Using its new tax authority, the DC AG’s Office filed a complaint last week to intervene (taking over the case going forward). Interestingly, when the DC AG’s Office took over the case, it added MicroStrategy as a defendant under the theory that the company conspired to help Saylor evade DC personal income taxes. Under DC’s False Claims Act, both Saylor and MicroStrategy could be liable for treble damages if a court rules in favor of the DC AG’s Office.

ISSUES WITH DC’S “STATUTORY RESIDENCY” TEST

While determining where an individual is a resident for state and local tax purposes generally requires a fact-intensive analysis, the case against Saylor also implicates DC’s unique (and likely unconstitutional) statutory residency standard. DC’s statute is fundamentally different than statutory residency standards in other states. Most states only tax individuals having their domicile in the state as residents, while some states also have a “statutory residency” test to classify individuals as taxable residents. In most states, a person is classified as a statutory resident if they (1) maintain a permanent place of abode in the jurisdiction and (2) spend more than a specific number of days (typically 183 days) in the jurisdiction.

DC truncates this standard and classifies someone as a statutory resident if they merely maintain a personal place of abode in DC for more than 183 days. Thus, no amount of actual presence of the individual in DC is required. The problem created by this one-of-a-kind standard should be obvious: someone can (as many high-net-worth individuals often do) maintain a residence for 183 days in more than one jurisdiction. Thus, the plain language of the statute would violate the Commerce Clause of the US Constitution because it runs afoul of the internal consistency test. Under this test, a statute is unconstitutional if under a hypothetical situation in which every jurisdiction has the same law as the one being challenged, more than 100% of the tax base would be subject to tax. Here, if every state had a statutory residency test applicable to anyone who had a [...]

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Fatally Flawed? Illinois Municipal League’s Model Streaming Subscription Tax

by Stephen P. Kranz, Mark Nebergall, Catherine A. Battin and Jonathan C. Hague | Aug 24, 2022 | Illinois, Local Tax, Nationwide Importance

The Illinois Municipal League (IML) represents the interests of 219 home rule municipalities in Illinois.[1] The IML recently released a revised draft model, “Municipal Streaming Tax Ordinance,” (the model) for use by the home rule municipalities in imposing an “amusement tax” on, inter alia, music and video streaming services and online gaming.[2] If the subscriber’s residential street address is within the corporate limits of the municipality, the subscription fee would be subject to the tax.[3] However, the tax proposed by the model has at least two fatal flaws: it is barred by the Internet Tax Freedom Act (ITFA) as a discriminatory tax on electronic commerce and is an unconstitutional extraterritorial tax under the home rule article of the Illinois Constitution.[4]

NATURE OF THE STREAMING TAX

The model proposes a tax on the privilege of viewing an amusement, including electronic amusements that either “take place within the” municipality or are delivered to subscribers “with a primary place of use within the jurisdictional boundaries of” the municipality.[5] The model incorporates the definition of “place of primary use” from the Illinois Mobile Telecommunications Sourcing Conformity Act.[6] That statute requires sourcing to the subscriber’s “residential street address.”[7] The streaming tax operates like a familiar sales tax in that it is imposed on the subscriber but collected by the streaming provider and remitted to the municipality.[8] The model tax would also be imposed on “paid television programming” (sat TV), but not paid radio programming (sat radio), transmitted by satellite.[9] The tax is not imposed on transactions that confer “the rights for permanent use of an electronic amusement” on the customer.[10]

THE NATURE OF MUSIC AND VIDEO STREAMING AND ONLINE GAMING SUBSCRIPTIONS

There are many service providers that allow internet access to the databases of music, videos and games (content). Customers typically enter into an automatically renewing subscription agreement with the provider that allows access to a database such that the subscriber can “stream” the content from any fixed or mobile device with internet connectivity. Subscribers are able to access the content from anywhere at anytime so long as their subscription is current and they have internet access.

Because the subscription fees are paid in advance, there is no way for either the provider or the subscriber to know where and when the subscriber might access the content, if at all, during the month. Also, because the streaming tax proposed under the model is on the subscription fee, the tax must be collected before any streaming occurs. It may be that the subscriber doesn’t access the content either from within the corporate limits of the municipality or at all during the subscription period.

FATAL FLAWS

1. Barred Discriminatory Tax on Electronic Commerce

The ITFA generally bars state and local taxes that discriminate against electronic commerce.[11] A tax discriminates against electronic commerce if it is imposed on transactions that occur over the internet but not [...]

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New Mexico Proposes Regulations Addressing Gross Receipts Tax Treatment of Digital Advertising Services

by Eric D. Carstens, Stephen P. Kranz, Michael J. Hilkin, Mark Nebergall and Jonathan C. Hague | Aug 11, 2022 | Allocation/Apportionment, Constitutional Issues, Local Tax, Nationwide Importance, New Mexico, Sales Tax, Tax Base, Transaction Taxes

On August 9, 2022, the New Mexico Taxation and Revenue Department published proposed regulations addressing the gross receipts tax (New Mexico’s version of a sales tax) treatment of digital advertising services. The Department states the proposed regulations do not reflect a change in policy but instead ensure the rules are consistent for all advertising platforms.

While the proposed regulations provide some clarity regarding the taxation of digital advertising services under preexisting rules, they introduce several inconsistencies and other gaps, particularly with respect to the finer details of the sourcing provisions. For example, we believe the proposed regulations leave ambiguity regarding whether gross receipts from the provision of digital advertising services should be sourced to:

The purchaser’s address
The server’s location
The viewer’s location

Separately, the proposed regulations would allow a deduction for gross receipts from national or regional advertising. However, the deduction is not allowed if the purchaser is incorporated in or has its principal place of business in New Mexico. While this significantly narrows the base for the tax, it injects complexity by requiring that the seller know the state in which its purchaser is incorporated or has its principal place of business, information not likely available in the context of internet-based advertising platforms.

Collectively, these inconsistencies and lack of clarity could lead to future compliance issues, which we hope will be mitigated as part of the Department’s regulatory approval process.

The Department scheduled a public hearing on the proposed rules for September 8, 2022, at 10:00 am MDT, which also is the due date for submission of written comments. The proposed regulations would be effective upon publication in the New Mexico Register, which could happen as soon as October 11, 2022 (or thereabout).

Please contact the McDermott Will & Emery State & Local Tax team if you have any questions about the potential impact of these proposed regulations on your company. In the meantime, we will be monitoring the regulation approval process and participating in next month’s public hearing.

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