On April 9, 2018, the New York State Supreme Court granted Starbucks’ motion to dismiss claims that it had failed to collect more than $10 million of sales tax at its New York stores. Lawyers from McDermott’s State and Local Tax (SALT) group and its White Collar and Securities Defense team handled the matter.

A unique feature of New York law is that the attorney general and private qui tam plaintiffs are permitted to bring New York False Claims Act (NYFCA) actions under New York Financial Law for “claims, records, or statements made under the tax law.” Fin. L. 198(4)(a)(i)-(iii). Under federal law and the law of most states, there is no False Claims Act liability for tax issues. But in New York, the attorney general and private plaintiffs can pursue False Claims Act cases for failure to comply with tax law. There have been numerous large settlements and judgments issued against major companies under the NYFCA, including one settlement for $40 million. See A.G. Schneiderman Announces $40 Million Settlement With Investment Management Company for Tax Abuses, Marking Largest Whistleblower Recovery in Office’s History (April 18, 2017). If successful, qui tam plaintiffs can recover a 25 – 30 percent share of the amount recovered, together with costs and attorneys’ fees. Fin. L. § 190(6)(b).

In this case, two private relator plaintiffs alleged that Starbucks failed to collect sales tax on warmed and “to-go” food items over a 10-year period. The relators filed a complaint, under seal, on or about June 11, 2015, with the New York Attorney General (AG). The AG declined to intervene. On June 30, 2017, the relators elected to proceed on their own with the lawsuit and filed a complaint seeking a judgment for at least $10 million in allegedly unpaid sales tax, as well as treble damages, civil penalties and attorneys’ fees. There was no allegation that Starbucks had failed to properly pay New York taxes that it had previously collected and was holding improperly. The relators’ allegations were solely based on their claim that Starbucks had under-collected sales tax from its New York customers.

On behalf of Starbucks, McDermott filed a motion to dismiss, arguing that Starbucks properly collects and pays its taxes to the State of New York and that Starbucks has consistently worked cooperatively with auditors from the New York State Department of Taxation and Finance. McDermott further argued that the relators “survey” of purchases at Starbucks locations and anecdotal conversations with Starbucks employees failed to properly allege that Starbucks violated the tax law or engaged in any fraud.

On November 10, 2017, the court held oral argument. On April 9, 2018, the Honorable James d’Auguste agreed with McDermott’s arguments and dismissed the case. See State of New York ex rel. James A. Hunter & Keenan D. Kmiec v. Starbucks Corporation, No. 101069/15, Dkt No. 40 (Sup Ct. April 9, 2018). The court held that the relators failed to properly allege that Starbucks had knowingly avoided or recklessly disregarded the law. Id. at 15. The court also opined that “the Survey was not scientifically performed and plaintiffs’ Survey was unsupported by any expert review or report.” Id. at 17. Finally, the court concluded that “plaintiffs’ allegations that Starbucks’ illegal practices were ongoing for a decade before this action was started and that it suffered $10 million in damages are based purely on speculation.” Id. at 17.

McDermott’s SALT and White Collar and Securities Defense teams joined forces in representing Starbucks in connection with this matter. The team consisted of Todd Harrison, Steve Kranz, Mark Yopp, Joseph B. Evans, Kathleen Quinn and Samuel Ashworth.

Full Case Name:          State of New York ex rel. James A. Hunter & Keenan D. Kmiec v. Starbucks Corporation, No. 101069/15 (Sup Ct. April 9, 2018)

Court:                           New York State Supreme Court

Justice:                         James E. d’Auguste

Opposing Counsel:     Hunter and Kmiec

It’s been nearly three months since the federal tax reform bill (commonly referred to as the Tax Cuts and Jobs Act, or “TCJA”) was enacted and states continue to respond to the various provisions of the TCJA. Recently, there have been notable legislative efforts in New York, Idaho, Iowa and Minnesota.

New York

Starting with the release of the Governor’s Budget Bill in January 2018, the 30-day amendments to that Bill on February 15, and the amendments to the Assembly Bill and Senate Bill this month, there has been much action this legislative session concerning the potential response to federal tax reform. The proposed response in the two latest bills—the Assembly Bill (AB 9509) and the Senate Bill (SB 7509)—is discussed below. Continue Reading More States Respond to Federal Tax Reform

A Grain of SALT: March State Focus – New York

On January 19, a New York qui tam complaint was unsealed.  This was unremarkable in and of itself, as there are many qui tam complaints progressing through the courts.  However, what was remarkable was the nature of the suit.  The suit, State of New York ex. rel. Doreen Light v. Myron Melamed, et al., involves a relator alleging that a decedent and his family structured the decedent’s estate to avoid New York personal income and estate taxes.  This is apparently the first estate tax qui tam suit that has been unsealed.  The attorney general declined to intervene in the case.  As per usual, the attorney general declined to comment as to why it did not intervene.

Although an unsealed case where the attorney general declined to intervene is not otherwise remarkable, the case is notable.  It shows that potential relators and their attorneys are looking to expand the tax provisions of the False Claims Act as much as they can.  Even though this case will likely not have an impact on corporate taxpayers, those taxpayers should know that relator’s attorneys are actively looking for cases to bring, and are being creative.  There are no signs, either in the governor’s current proposed budget or otherwise, that the delegation of tax enforcement authority to private citizens is being reconsidered or even restrained.  Taxpayers should be wary.

Top February Hits You May Have Missed

 Connecticut Will Make You Disclose Personal Customer Data!

You’re Invited: COST, Bloomberg Tax and McDermott Will & Emery to Host Post-Oral Argument Roundtable Discussion

Connecticut Responds to the Federal Repatriation Tax

Looking Forward to March

March 6, 2018: Diann Smith will facilitate the “Retail and Hospitality Industry Session” at the Unclaimed Property Professionals Organization Annual Conference in Tampa, FL.

March 7, 2018: Diann Smith will present, and Steve Kranz will serve as the judge, at the interactive and entertaining “Mock Trial”, which will provide a deeper look at an audit that resulted in litigation, at the Unclaimed Property Professionals Organization Annual Conference in Tampa, FL.

March 9, 2018: Alysse McLoughlin will present “State Impacts of Federal Tax Reform” at the Federal Bar Association’s 2018 Tax Law Conference in Washington DC.

March 13, 2018: Alysse McLoughlin and Peter Faber will present “Sales Tax and Miscellaneous Taxes” at Practising Law Institute’s Nuts and Bolts of State and Local Tax 2018 in New York, NY.

March 13, 2018: Peter Faber will presenting “State and Local Taxation of International Business and Mergers & Acquisitions” at Practising Law Institute’s Advanced State and Local Tax 2018 in New York, NY.

March 15, 2018: Catherine Battin, Mary Kay Martire, Alysse McLoughlin and Diann Smith will present a special CLE/CPE on the State and Local Implications of Tax Reform at Tax in the City® in McDermott’s Chicago office.

March 20, 2018: Alysse McLoughlin is presenting “The Kitchen Sink: Unconventional Arguments in Defense of Assertions of Income Tax” at the ABA/IPT Advanced Tax Seminars in New Orleans, LA.

March 23-24, 2018:  Stephen Kranz is presenting “State Implications of Federal Tax Reform” at the National Conference of State Legislatures SALT Task Force meeting in Washington DC.  Congress may have finished its tax overhaul last year, but for state governments, the scramble has just begun.

New York is the latest state to address certain state tax implications of the 2017 federal tax reform bill, the Tax Cuts and Jobs Act. Governor Andrew Cuomo’s 30-day amendments to the Governor’s Budget Bill were released on February 15 and one piece of the amended Bill explicitly addresses the foreign-earnings, deemed federal repatriation provisions in the new section 965 of the Internal Revenue Code (IRC).

Even before the release of the 30-day amendments, we expected the amount of foreign earnings deemed repatriated and brought into the federal income tax base under IRC § 965 would be considered “other exempt income” under the New York Tax Law and, thus, not subject to tax in New York as long as received from a unitary subsidiary. However, the Governor’s 30-day amendments make it clear that any amount included in the federal tax base under the repatriation transition provisions would be excludable from income, even if such amounts were received from a non-unitary subsidiary. This proposed exclusion for amounts deemed received from non-unitary subsidiaries is an expansion of New York’s usual policy. This expansion, however, would apply only with respect to the deemed repatriation of foreign earnings under IRC § 965.

The 30-day amendments also would make clear the federal deduction permitted under IRC § 965(c) (which facilitates a reduction of the effective federal tax rate on the deemed repatriated foreign earnings) would not be allowed in computing New York taxable income. We expected New York would make this proposed change because disallowing the § 965(c) deduction from New York taxable income would be consistent with excluding the deemed repatriation from taxable income.

Unlike other states, i.e., Connecticut, the Governor’s Bill does not address the amount of expenses attributable to the amount deemed repatriated under IRC § 965 and includable in the New York tax base. The Governor’s Bill would, however, provide that no penalties would be imposed for any failure to make sufficient estimated payments if the short-fall in payments is due to the increase in tax resulting from the inability to deduct such expenses from taxable income.

Please reach out to us with any questions about New York’s proposed treatment of the federal repatriation provisions or other questions about the potential law changes in New York.

Inside SALT: Significant State Tax Developments and Opportunities

June 8, 2017 – New York, NY

Lawyers in McDermott Will & Emery’s State and Local Tax Group present an informative half-day program. A wide range of topics will be discussed, including:

  • New York developments, including false claims and budget provisions
  • Nexus updates and developments in digital taxation
  • New developments in apportionment, transfer pricing developments and unclaimed property

You can still register! Click here to view more details and register for the event.

Tax in the City®: A Women’s Tax Roundtable

June 8, 2017 – Chicago, IL

McDermott Will & Emery’s Tax in the City® is a discussion and networking group for women in tax that facilitates in-person connections and roundtable study group events around the country.

At this year’s second edition of Tax in the City®, we will host a CLE/CPE discussion focusing on current developments in professional responsibility and ethics, including a presentation focused on ethical issues arising out of our increasing access to connectivity (such as Facebook, Twitter, and other social media outlets). This will be followed by a substantive lunch program featuring the following topics:

  • Best Practices for Drafting Tax Provisions in Commercial and Other Contracts
  • Getting Ready for 2018 – Taking Steps to Prepare for Rules that Become Effective 01/01/2018
  • Tax Reform – What Can / Should You Be Doing Now?

To find our more information about Tax in the City® and get involved in future events, please email khazel@mwe.com, jmay@mwe.com or smcgill@mwe.com.

On January 16, Governor Cuomo introduced the 2018 New York State Executive Budget Legislation. The bill proposes a number of changes to the New York State sales tax law. Below is a summary of the highlights.

Sales and Use Tax

  • “Marketplace Providers”

The governor’s bill proposes to impose sales tax registration and collection requirements, traditionally imposed on vendors, on “marketplace providers.” This provision is essentially an effort to obtain sales tax on sales to New York customers that make purchases over the internet from companies that have no physical presence in New York and do not collect sales tax in New York when those companies make sales through online marketplaces. In the governor’s Memorandum of Support of this bill, he affirmatively states that “the bill does not expand the rules concerning sales tax nexus”. Although, as noted below, this claim may not be true.

The bill effectively shifts the sales tax collection burden from the traditional vendor to the marketplace provider. The bill defines marketplace provider as “a person who, pursuant to an agreement with a marketplace seller, facilitates sales of tangible personal property by such marketplace seller or sellers.”

A person “facilitates a sale of tangible personal property” if the person meets both of the following conditions:

(i) such person  provides the  forum  by which the sale takes place, including a shop, store, or booth, an  internet  website,  a catalog,  or  a similar  forum;  and

(ii) such person or an affiliate of such person collects the receipts paid by a customer  to  a marketplace  seller  for  a  sale  of  tangible  personal  property.

The bill caveats that “a person who facilitates sales exclusively by means of the internet is not a marketplace provider for a sales tax quarter when such person can show that it has facilitated less than one hundred million dollars of sales annually for every calendar year after [2015].”

Unlike the definition of the term “vendor” in the current Tax Law, the definition of “marketplace provider” does not contain a doing business or physical presence component. Accordingly, despite the governor’s assertion that the bill does not expand the rules concerning sales tax nexus, this provision may expand the sales tax nexus rules by potentially imposing a sales tax collection obligation on marketplace providers that do not have a physical presence in New York.

In an effort to minimize the number of entities with a collection requirement, the bill provides that if a marketplace seller obtains a certificate of collection from the marketplace provider, it is not required to collect sales tax as a vendor.  The bill caveats that if the marketplace provider and the marketplace seller are affiliated parties, and the marketplace provider fails to collect the tax, the marketplace seller will remain liable for the sales tax.  For such purposes, parties are affiliated if they have as little as five percent of common ownership.

The proposed legislation would not permit marketplace sellers that sell to customers in New York through a marketplace provider to collect the sales tax themselves. One suggestion is to include a provision that allows marketplace sellers to collect the tax based on an agreement with the marketplace provider.

The bill provides some protection for marketplace providers if their failure to collect the correct amount of tax is due to incorrect information given to the provider by the marketplace seller.  Again, affiliated parties would not get this protection.

The bill proposes that the act take effect on September 1, 2017 and apply prospectively.

  • Related Entity Sales Tax Issues

The governor’s bill proposes amendments to the resale exclusion in an effort to stop companies from purchasing high-dollar-value property for resale to their affiliates, then leasing the property using a long-term lease or for a small fraction of the property’s fair market value thereby avoiding much of the sales tax on the transaction.

The governor’s bill proposes to solve the problem by eliminating the resale exclusion for (1) sales to a single member LLC or subsidiary that is disregarded for federal tax purposes for resale to its owner or parent company; (2) sales to a partnership for resale to one or more of its partners; and (3) sales to a trustee of a trust for resale to one or more of the beneficiaries of the trust.

This provision is broader than necessary to accomplish its goal since the provision also eliminates the resale exclusion for arms-length, good-faith transactions between related entities, thus potentially subjecting certain transactions to double taxation–once when the property is sold to the single member LLC, for example, and again when it is resold by the LLC to its owner.

The bill proposes that this section take effect immediately.

  • Use Tax Exemption for Nonresidents

In response to the New York State Division of Taxation’s and the Attorney General’s recent focus on sales and use tax issues involving the sale of artwork, the governor’s bill proposes to provide an exception to the use tax exemption for the use of property or services in New York purchased by the user while the user was a nonresident. The governor’s goal is to prevent New York residents from creating foreign entities to purchase property (usually artwork) outside of New York and subsequently bringing the property into New York and avoiding the use tax.

The bill provides that the use tax exemption for nonresidents will not apply if the nonresident business has not been doing business outside the state for at least six months prior to the date that such nonresident brought the property or service into New York. This provision does not apply to individual nonresidents.

Again, this provision may be broader than necessary to “catch” those avoiding tax using the use tax exemption. This provision may impact businesses acting in good-faith without a tax avoidance scheme. A better idea may be to provide that a nonresident company will lose the use tax exemption if the company has no valid business purpose and was created solely to avoid tax.

The bill proposes that this section take effect immediately.

  • Transportation, Transmission or Distribution of Gas or Electric

The governor’s bill also proposes the making of a technical change to NY Tax Law § 1105-C to clarify that sales tax is imposed on charges for transporting, transmitting, or delivering gas or electricity when the company providing the transportation, transmission, or distribution is also the provider of the commodity. This amendment is intended only to clarify the existing law.

The bill proposes that this section take effect immediately.

On April 4, 2016, without warning, the US Department of the Treasury proposed a new set of comprehensive regulations under section 385. There had been no advance indication that regulations were even under consideration. Although the Treasury indicated that the proposed regulations were issued in the context of addressing corporate inversions, their application went well beyond the inversion space and they apply to inter-corporate debt regardless of whether it occurs in an international context. The following is a discussion of the state and local tax consequences of the proposed regulations; for a detailed discussion of the proposed regulations themselves, see this previous article.

Read the full article.

The New York State Department of Taxation and Finance has announced that it would extend the time for certain taxpayers to identify stocks as being held for investment so that income from those stocks would be tax-exempt [TSB M-15(4.1)C, (5.1)I]. Instead of having to make the identification on the date on which the stock is purchased, many corporations will now have a 90-day grace period to make the identification. This relaxation of the identification rules will come as a major relief to many companies that otherwise may have been ambushed by New York’s new rules, particularly out-of-state corporations that start doing business in New York after acquiring investment securities. The announced change is effective immediately.

Under corporate tax reform legislation enacted in 2015, corporations—to treat income from stock held as an investment as tax-exempt investment income—must identify the stock on the date of purchase as being held for investment and follow certain procedures. This requirement has been widely criticized as being unrealistic since a corporation’s investment people are unlikely to know about arcane tax rules on the date that they make trades. Securities dealers, to qualify for tax-free investment income treatment, must identify the stock as being held for investment pursuant to Section 1236 of the Internal Revenue Code (IRC), which requires the identification to be made on the date of purchase. Non-dealers must still make the identification on the date of purchase under the statute, but they need not make the federal election under Section 1236 since that provision applies only to dealers.

The Department’s new rules significantly relax the requirement for many non-dealer corporations. They do not apply to dealers, which will still be subject to the Section 1236 election requirements.

One criticism that has been made of the identification requirement is that a corporation that had not been doing business in New York and, hence, had not been a New York taxpayer and acquired stock as an investment would not have made the New York identification because it would not have cared about, or known about, New York taxes. If such a corporation later starts doing business in New York and becomes subject to New York taxes, it will be too late to make the identification for previously acquired stock and, hence, the income from that stock will not be exempt investment income. Under the Department’s new announcement, a corporation that first becomes a New York taxpayer on or after October 1, 2015, can make the identification within 90 days after becoming a New York taxpayer or, if it became a New York taxpayer before January 7, 2016, by April 6, 2016. Stock purchased after this extended period must still be identified as being held for investment on the date of purchase.

Ordinarily, a corporation becomes taxable in New York on the first day on which it does business, employs capital, owns or leases property, or maintains an office in New York. Under new economic nexus rules, a corporation also becomes taxable in New York on the first day on which it has receipts from the State of $1 million or more. In the case of a corporation that becomes taxable in New York because of the economic nexus receipts requirement, the 90-day period starts with the date on which its receipts first exceed $1 million. This may be hard to calculate because tax managers and investment people may not be aware of the flow of receipts every day. In the case of a unitary group that becomes taxable in the State solely because of the $1 million receipts requirement, the start date for every corporation in the group is the date on which the group in the aggregate first has receipts from New York of $1 million or more. This will require the parent corporation of a unitary group to track the receipts of each of the group’s members.

The application of the identification rules in the corporate acquisition context has been unclear. The new announcement indicates that a corporation whose stock is acquired by a New York taxpayer and, hence, meets the capital stock requirement for being included in a combined return (50 percent) begins the 90-day period on the date on which its stock is acquired. The announcement does not address the question of whether a corporation whose stock is acquired in an IRC Section 338(h)(10) transaction and that elects to have the transaction treated as if it had become a new corporation that purchased its assets from itself must make a new identification. Even though the corporation is the same legal corporate entity, I have been advising clients to make a new identification on the day of closing even if it had made a previous identification because it is treated as a new corporation for many income tax purposes.

A controversial position that has been adopted by the Department is that if a corporate taxpayer invests in an investment partnership and the partnership acquires stock as an investment, the partnership must make the identification. I and others have pointed out that investment partnerships may not know that they have partners that are New York taxpayers and, if the partnership is based outside of New York, it may not know about the New York requirements. We have urged the Department to allow the identification to be made by the corporate partner when it first becomes a partner. The Department has not changed its position in this respect, but it has provided in the new announcement that a partnership that has not itself been doing business in New York, or that has not had corporate partners that were taxable in New York qualifies for the extended 90-day period, starting from the first date on which it does business in New York or has New York receipts of $1 million or more, or from the first date on which it has a partner that is a New York taxpayer. This is still unrealistic, because a partnership that is not otherwise doing business in New York is not likely to know when a corporate partner of the partnership first itself starts doing business in New York and, hence, becomes a New York taxpayer.

For a more detailed discussion of the identification procedures, see Peter L. Faber, “Living With New York’s New Corporate Investment Income Rules,” State Tax Notes, November 2, 2015.

McDermott Will & Emery has released the December 2015 issue of Focus on Tax Controversy, which provides insight into the complex issues surrounding U.S. federal, international, and state and local tax controversies, including Internal Revenue Service audits and appeals, competent authority matters and trial and appellate litigation.

Mark Yopp authored an article entitled “Waiting for Relief from Retroactivity,” which discusses how courts are expanding the ability of state legislatures to retroactively change taxpayer liability going back many years.

View the full issue (PDF).

The New York State Department of Taxation and Finance (Department) has just revised its Guide to Sales Tax in New York State, Publication 750.

The Guide will be particularly useful for companies that are just starting to do business in New York State. It provides a well-organized and easy-to-read outline of the steps that should be taken to register as a vendor selling products that are subject to the sales tax and to collecting and remitting taxes. Small businesses and their advisors will find the Guide particularly useful.

The Guide confirms the State’s required adherence to the United States Supreme Court decision in Quill Corp. v. North Dakota (a case in which the taxpayer was represented by McDermott Will & Emery) to the effect that an out-of-state company must have a physical presence in New York to be required to collect use tax on sales to New York customers. It confirms that a company need not collect use tax on sales to New York buyers if its only contact with the State is the delivery of its products into the State by the U.S. Postal Service or a common carrier. It cautions, however, that use tax must be collected if the company has employees, sales persons, independent agents or service representatives located in, or who enter, New York. Although the law has been clear for many years that a sales representative can create nexus for an out-of-state company even though he or she is an independent contractor and not an employee, some companies still seem to be under the mistaken impression that this is not the case. Moreover, although there is no New York authority directly in point, cases in other states have established the principle that nexus can be created by the presence in the state of a single telecommuting employee, even if the employee’s work is not focused on the state.

The Guide contains a cryptic reference to New York’s click-through nexus rule under which an out-of-state company can be compelled to collect use tax on sales to New York purchasers if people in the state refer customers to the company and are compensated for doing so. Such persons are presumed to be soliciting sales for the company and, although the presumption can be rebutted, that will prove to be impossible in the vast majority of cases. The Guide contains cross-references to Department rulings that explain the presumption and the manner in which it can be rebutted, but it would have been helpful if the Guide could have provided more detail about these rules.

One attractive feature of the Guide is that people accessing it online can use links in the Guide to get to relevant rulings.

In addition to the state-wide sales and use tax, special sales taxes that are imposed only within New York City are discussed. These include taxes on credit rating services and certain localized personal services such as those provided by beauty salons, barber shops, tattoo parlors and tanning salons. Interestingly, the Guide does not address the Department’s position that services provided by credit rating agencies in rating debt and preferred stock offerings are taxable. This represents a reversal of a position that the Department had taken in audits for some 40 years. McDermott Will & Emery represented the industry in negotiating the terms of the change of position with the Department. Under the Department’s new position, offerings after September 1, 2015, are subject to the New York City tax if the invoice address of the issuer or representative is in the city.

The Guide discusses the treatment of taxable business purchases. Although one can argue that all purchases by a business that sells products that are subject to the sales tax should be exempt from tax, the law has never so provided and, while there are exemptions for property purchased for resale and for property directly used in manufacturing goods that are sold, the purchases of many items that contribute to the production of taxable items (e.g., computers, furniture, supplies) are subject to the tax, even though their cost is effectively included in the price of the taxable products that the company sells to its customers.

The discussion of the resale exclusion indicates that the exclusion does not apply if “you later use the property or services rather than reselling them.” This does not address the common situation in which property that was purchased and is being held for resale is incidentally used for other purposes. Companies often pledge their inventory as collateral for loans and the Department has never contended that this use defeats the resale exclusion. It would be helpful if the Department issued guidance on the incidental situation.

Companies and their advisors should be aware that the resale exclusion is just that: an exclusion and not an exemption. It is part of the definition of what constitutes a taxable retail sale. This can be important in audits and litigation, because the law is clear that the Department has the burden of persuasion if the issue involves the interpretation of a statute imposing a tax whereas the taxpayer bears this burden in a case involving the application of an exemption. Since the resale exclusion is part of the definition of a taxable retail sale, the burden with respect to its application is on the Department.

The Guide contains a useful section on procedures for filing sales and use tax returns. Although it mentions that a vendor is “a trustee for the state” in connection with the remittance of sales tax that it collects, it does not mention that the responsible persons at a company can be personally liable for sales taxes that are not remitted. This often comes up in audits and it is common for the Department to ask a company’s officers to agree to extend the statute of limitations on collections of delinquent taxes from them personally. We hope that future editions of the Guide will mention this point.

Unfortunately, the Guide does not discuss the many controversial issues involving cloud computing and internet transactions.