On June 4, Illinois Governor Bruce Rauner signed into law the state’s fiscal year (FY) 2019 budget implementation bill, Public Act 100-0587 (the Act). The Act makes a significant change to the Illinois sales/use tax nexus standard by adopting an “economic nexus” standard for a sales/use tax collection obligation. The economic nexus language was added to the budget bill one day before it was passed by the General Assembly. The standard is contrary to the physical presence nexus standard established by the United States Supreme Court in Quill Corp. v. North Dakota, 504 US 298 (1992), the validity of which is currently pending before the Court in South Dakota v. Wayfair, Docket 17-494. The Court is expected to rule on Wayfair by the end of this month (see here for our prior coverage of the Wayfair case).

The Act amends Section 2 of the Use Tax Act to impose a tax collection and remission obligation on an out-of-state retailer making sales of tangible personal property to Illinois customers if the retailer’s gross receipts from sales to Illinois customers are at least $100,000 or the retailer has at least 200 separate sales transactions with Illinois customers. Similarly, it would amend Section 2 of the Service Use Tax Act with respect to out-of-state sellers making sales of services to Illinois customers. These changes mirror the economic nexus standard adopted by South Dakota. See SD Codified Laws § 10-64-2.

In the wake of Wayfair, other states have adopted similar nexus provisions. See, e.g., Conn. SB 417, Ga. HB 61, Haw. HB 2514, Iowa SF 2417, provisions enacted in 2018. By enacting the statute without an escape clause, Illinois, like other states, has put a law on the books that directly conflicts with Quill, and which will be ripe for constitutional challenge if the US Supreme Court affirms the South Dakota Supreme Court’s ruling that the South Dakota statute is unconstitutional.

The Act also amended Section 223 of the Illinois Income Tax Act to extend the tax credit for for-profit hospitals (equal to the lesser of property taxes paid or the cost of charity care provided) to tax years ending on or before December 31, 2022.

The Act made no changes in response to the federal tax reform bill. In particular the General Assembly did not enact Senate Bill 3152 (proposing to add-back the new federal deduction for foreign-derived intangible income (FDII); see here for our prior coverage). The General Assembly also did not enact either of the pending bills (HB 4237 and 4563) proposing to work around the federal $10,000 limitation on the deductibility of state and local taxes by establishing funds/foundations to which taxpayers could make contributions in exchange for tax credits.

Top Hits You May Have Missed

New Mexico Administrative Hearings Office Issues Timely Opinion Regarding State Taxation of Subpart F Income and Dividends from Foreign Affiliates

Oregon Bars Use of Three Factor Apportionment Formula

McDermott Defeats New York False Claims Act Case Alleging Starbucks Failed to Collect and Remit Sales Tax

Looking Forward to June

June 1, 2018: Stephen Kranz presented “Diverse Routes to Resolving SALT Audit Issues” at the Georgetown Law Advanced State and Local Tax Institute in Washington, DC.  Stephen discussed numerous complex audit issues facing tax administrators and taxpayers alike, including avenues for equitable resolution of complex audit issues and evaluation of when litigation is the best means of resolution.

June 5, 2018: Alysse McLoughlin is presenting “Partnership Audit Regulations: The Great Unknown” at the Federation of Tax Administrators Annual Meeting in Nashville, TN.

June 21, 2018: Britt Haxton, Kristen Hazel, Enrica Ma, Jane May, Sandra McGill, Alysse McLoughlin, Maureen O’Brien and Diann Smith are presenting at Tax in the City® New York about the various impacts of tax reform on state and local taxes, digital commerce, cross-border transactions, and compensation structures and fringe benefits. There will also be a CLE/CPE session on the ethical considerations around tax reform. Email Maria Dubinets at mdubinets@mwe.com to register.

June 25, 2018: Alysse McLoughlin is presenting “State Implications of the Federal Partnership Rules” at the Institute for Professionals in Taxation (IPT) Annual Conference in Vancouver, BC.

June 26, 2018: Stephen Kranz is presenting “Taxability of Digital Goods and Services” at the Institute for Professionals in Taxation (IPT) Annual Conference in Vancouver, BC. Stephen will present an overview of US digital taxation, the characterization of tangible personal property, related legislative and administrative developments, and an update on recent litigation in digital tax. He will also provide an overview of best practices, including minimizing sales and use tax on software related transactions as well as audit tips.

June 27, 2018: Jane May is presenting “State Payroll Audits” at the Institute for Professionals in Taxation (IPT) Annual Conference in Vancouver, BC.

June 28, 2018: Stephen Kranz is speaking at the National Conference of State Legislatures (NCSL) Executive Committee Task Force on State and Local Taxation, Lake Tahoe NV, regarding federal tax reform and next steps on the remote sales tax. He will also present an overview of the South Dakota v. Wayfair Supreme Court oral arguments and upcoming decision.

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

This morning, Indiana Governor Eric Holcomb signed a bill into law that will exempt cloud-based software transactions from State Gross Retail and Use Taxes, effective July 1, 2018. The signing took place at the headquarters of Indiana-based cloud service provider DemandJump, Inc.

Specifically, Senate Enrolled Act No. 257 (which was unanimously passed by both chambers of the General Assembly) will add a new section to the Indiana Code chapter on retail transactions that specifically provides that “[a] transaction in which an end user purchases, rents, leases, or licenses the right to remotely access prewritten computer software over the Internet, over private or public networks, or through wireless media: (1) is not considered to be a transaction in which prewritten computer software is delivered electronically; and (2) does not constitute a retail transaction.” The new law will also clarify that the sale, rental, lease or license of prewritten computer software “delivered electronically” (i.e., downloaded software) is subject to the Gross Retail and Use Taxes. Continue Reading BREAKING: Indiana Enacts Cloud Software Tax Exemption

On Tuesday, April 17, 2018, at 10:00 am (EST) the United States Supreme Court will hear oral arguments in South Dakota v. Wayfair, Inc., a state tax case poised to reconsider the dormant Commerce Clause physical presence standard upheld by the Court on stare decisis grounds in the historic mail-order case Quill Corp. v. North Dakota (U.S. 1992), which was litigated by McDermott Will & Emery. The Court is expected to consider whether a 2016 South Dakota law imposing sales and use tax collection obligations on online retailers–and other sellers–with no physical presence in the state is permissible given, among other things, the advances in technology and e-commerce since Quill was decided.

For those that would like to attend the South Dakota v. Wayfair, Inc. oral argument as a member of the public (as opposed to as a member of the US Supreme Court Bar), the Supreme Court Police give out 100–150 numbered tickets between 7:00 am–7:30 am. The doors to the building open at 8:00 am.  Once inside, the line re-forms in the hallway by the Gallery steps and at 9:00 am, the public is allowed upstairs to the Gallery.  The argument will begin at 10:00 am.  Given the popularity of this case, it is anticipated that only around 50 seats will be available to the general public for this argument—so plan to arrive early to ensure you have the best chance to make it in!

After the oral argument concludes, we invite you to join COST, Bloomberg Tax, McDermott Will & Emery, and lawyers involved in many respects of the litigation for a moderated roundtable discussion at the DC office of McDermott Will & Emery, which is just minutes away from the Supreme Court. The roundtable discussion will begin at 12:00 pm (EST) and explore the issues before the Court and opinions regarding the many possible outcomes from the case.

We expect a full house and space will be limited, so please register your interest now so that we can plan to accommodate as many as possible. This case promises to revolutionize the world of SALT, no matter the outcome.

Due to the current impact and the likelihood that states will consider legislation and agency guidance addressing federal tax reform implications for state business taxes, a united, effective, nationwide advocacy effort is needed to ensure the issues are consistently addressed on a multi-state basis. In preparation for anticipated ramifications, a multi-state coalition will need to consider the subjects summarized below. For further coverage, continue reading here.

How McDermott Will & Emery Can Help You:

  • Formation of a coalition of companies and industry trade organizations dedicated to proactively addressing state tax issues raised by federal tax reform on a nationwide basis
  • Identify and track, in real time, proposed state legislative and regulatory responses to federal tax reform
  • Analyze proposed state reforms and develop substantive amendments and comments
  • Develop and implement advocacy campaigns to secure favorable legislative and regulatory outcomes, including
    • Preparation of all advocacy collateral
    • Organization of on the ground advocacy, including retaining in-state advocates where needed
    • Activating allied organizations to ensure broad support
  • Provide support concerning the proper reporting of state responses to federal tax reform on company financial statements

Coalition Goals: 

  • Prevent state legislation expanding tax base through decoupling from federal deductions
  • Support state legislation adopting comprehensive federal reform conformity, with appropriate deviations
  • Identify and remedy Commerce Clause issues
  • Encourage states revenue department to publish guidance on issues such as definitional questions, apportionment approaches and problems with different group calculations
  • Identify and act on opportunities to address related issues through state responses to federal reform
  • Prepare to address potential nexus changes in response to South Dakota v. Wayfair

Continue Reading McDermott’s Take on State Tax after Reform

Wrapping Up January – and Looking Forward to February

You can view all of the topics we discussed over the last month here.

Our lawyers will present at the following state and local tax event in February:

February 27, 2018: Diann Smith will be presenting “What’s Trending in State Sales Tax Audit Perspectives: Issues and Trends and Their Proper Reflection” at the 2018 Sales Tax Conference and Audit Session in New Orleans, LA.

On December 29, 2017, the Illinois Appellate Court issued a ruling reversing the decision of the Illinois Independent Tax Tribunal (Tribunal) in Waste Management of Ill., Inc. v. Ill. Independent Tax Tribunal, 2017 IL App (1st) 162830-U. This is the second appellate court to consider a Tax Tribunal ruling, and the first to overturn a decision of the Tribunal. The appellate court overturned the Tribunal’s grant of summary judgment in favor of the Illinois Department of Revenue (Department) and held that for the time periods at issue, the Motor Fuel Tax Law (Tax) (35 ILCS 505/1 et seq.) did not impose tax on compressed natural gas (CNG). In this case, Waste Management filed monthly returns reporting and paying the Tax on its usage of CNG. Following an amendment to a Department regulation that explicitly provided that CNG was subject to the Tax (see 86 Ill. Admin. Code § 500.200(c)), Waste Management amended its returns and sought a refund of Tax paid on CNG-powered vehicles for time periods prior to the amendment. The Department denied the refund claims, and Waste Management appealed the Department’s denial to the Tribunal. On the parties’ cross motions for summary judgement, the Tribunal found in the Department’s favor, on the basis that CNG was a taxable “motor fuel” under the Tax statutes. A copy of the Tribunal’s Order (Order) is linked here. Continue Reading Illinois Appellate Court Overturns Tax Tribunal Ruling for the First Time

The New California Office of Tax Appeals (OTA) on November 6, 2017, held an interested parties meeting in Sacramento to discuss the contents of a draft of emergency regulations to guide both income tax appeals from the California Franchise Tax Board and sales and use tax appeals from the California Department of Tax and Fee Appeals (CDTFA). The meeting was chaired by Kristen Kane, the newly appointed Chief Counsel and Acting Director of the OTA, and by Zack Morazzini, the Director and Chief Administrative Law Judge (ALJ) in the Office of Administrative Hearings.  Ms. Kane and Mr. Morazzini provided helpful insight on how the new OTA will operate, including the following:

  • The OTA is in the process of hiring 18 new ALJs.
  • Hearings will be held in Sacramento, Los Angeles and Fresno.
  • Hearings are expected to commence in late January, after a crash training program for the new ALJs.
  • Both Ms. Kane and Mr. Morazzini stressed the intention that the hearings be as informal and conversational as possible, bearing in mind that many, if not most, taxpayers will either appear pro per or be represented by non-attorneys.
  • Taxpayers will open the process by making a written submission, and the agencies will file a written brief in response. The procedures may be similar to the current practice before the State Board of Equalization, where the taxpayer submits a statement of facts and discussion of the law, and the facts as stated by the taxpayer are accepted unless the tax agency objects.
  • Where there is a disagreement on the facts, the burden will be on the taxpayer to come forward with supporting evidence.

In an informal discussion after the conclusion of the meeting, Mr. Morazzini said that the Office of Administrative Hearings is proud of their long and successful run at conducting fair hearings in many contexts with flexibility being a paramount concern. At least at the outset, there will be no written rules on the presentation of evidence. Mr. Morazzini said that the Administrative Procedures Act and, generally, the rules of evidence allow ALJs to fashion orders responsive to discovery requests by either or both of the taxpayer or the agency, as required under the circumstance. Either party will have the right to request a preliminary meeting with an ALJ, or the ALJ can order a preliminary meeting. The preliminary meeting is intended to be informal, and will give taxpayers the opportunity to request the production of documents, stipulations and admissions. Note that OTA anticipates that the preliminary meeting will be attended by only one ALJ, although A.B. 102, the authorizing legislation, calls for a panel of three ALJs.

Continue Reading New California Office of Tax Appeals Discusses Emergency Regulations

As part of Governor Jerry Brown’s 2017 budget bill, the California State Board of Equalization (SBE) was stripped of its functions that had been authorized by statute, leaving principally property tax matters deriving from the state constitution. Sales and use tax and fee functions were moved to a newly created California Department of Tax and Fee Administration (CDTFA). Jurisdiction to hear appeals from the Franchise Tax Board (FTB) as well as appeals in sales and use tax and fee matters from CDTFA was vested in a new Office of Tax Appeals (OTA), to become effective January 1, 2018. The OTA is scurrying to adopt rules before opening for business on January 1, 2018. It recently released an early draft of what will become emergency regulations. An informal public discussion meeting of the draft has been scheduled for November 6, 2017, in Sacramento. Continue Reading California’s New Office of Tax Appeals Issues Preliminary Draft of Procedural Rules that Is Silent on Discovery Matters