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US Treasury Issues Guidance on the ARPA Claw-Back Provision

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

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

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

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The US Department of the Treasury Says State IRC Conformity Bills Do Not Trigger Federal Relief Claw-Back Provision

As we’ve blogged about in the past, the recently enacted American Rescue Plan Act of 2021 (ARPA) includes an ambiguous claw-back provision. If broadly interpreted, it could result in states losing relief funding provided under the APRA if there is any state legislative or administrative change that results in the reduction of state revenue. This provision is causing havoc in the state tax world, rightfully so.

After much yelling and screaming from state attorneys general and those in the tax world, including McDermott (see McDermott letter to Treasury Secretary Janet Yellen attached), the US Department of the Treasury issued a press release announcing forthcoming “comprehensive guidance” on this provision. Treasury also addressed a question that has been on the top of our minds since the provision was enacted: Could state legislation addressing state conformity to the Internal Revenue Code trigger the claw-back? States routinely conform to and decouple from changes to the Internal Revenue Code, so if such actions could trigger the claw-back, state legislatures would be reluctant to consider them. We were so concerned about this issue that we specifically addressed it in our letter to Secretary Yellen.

This week, we received the Treasury’s guidance on this issue: Conformity bills will not trigger the claw-back. In its press release, Treasury stated:

… Treasury has decided to address a question that has arisen frequently: whether income tax changes that simply conform a State or territory’s tax law with recent changes in federal income tax law are subject to the offset provision of section 602(c)(2)(A) of the Social Security Act, as added by the American Rescue Plan Act of 2021. Regardless of the particular method of conformity and the effect on net tax revenue, Treasury views such changes as permissible under the offset provision.

This is a step in the right direction and should ease concerns of state legislatures. Passing a conformity bill will not cause any loss of federal funding. Treasury’s guidance, because it applies to all “methods of conformity,” should cover any legislation that either couples with or decouples from the Internal Revenue Code.

But our work is not done. In our letter to Secretary Yellen we also asked for guidance confirming that state actions in other areas will not trigger the claw-back. Specifically, we made concrete suggestions that actions to correcting tax statutes or rules that are either unconstitutional or barred by or violate federal law also should not trigger the claw-back. Treasury’s recent press release gives us a glimmer of hope that Treasury will exclude such actions from the clutches of the claw-back provision as well. Stay tuned for more!




McDermott Provides Treasury Department with Concrete Suggestions for Guidance on the American Rescue Plan Act’s Claw-Back Provision

The recently enacted American Rescue Plan Act of 2021 (ARPA) includes an ambiguous claw-back provision that has brought the world of state and local tax policymaking to a grinding halt. Because ARPA’s adoption occurred during the final weeks of many states’ legislative sessions, rapid issuance of guidance from the US Department of the Treasury is needed before the sessions adjourn to prevent the irreversible damage that will occur if a state foregoes enacting policies aimed at alleviating the economic disruption caused by COVID-19 out of fear of facing claw-back of federal relief.

McDermott recently sent a letter to Treasury Secretary Janet Yellen, urging the issuance of guidance giving a balanced interpretation of the claw-back provision. This guidance is necessary to avoid putting state legislatures, governors and tax administrators across the country in an untenable situation where every tax change or adjustment being considered—no matter how innocuous or routine—will carry the risk of a reduction to their state’s share of federal funding for the next three years.

In the letter, we provided concrete suggestions on areas where the ARPA left room for such balanced interpretation. We suggested that Treasury interpret the claw-back provision as either inapplicable to or provide a safe harbor for:

  • Changes addressing state conformity to the Internal Revenue Code (IRC)
  • Corrections of unconstitutional tax statutes or rules
  • Corrections of tax provisions barred by or that violate federal law
  • Actions in which there is no or only a weak connection between the law change reducing net revenue and the use of federal relief funds
  • Changes in the law announced before the enactment of ARPA
  • Reductions in net revenue related to purposes that further ARPA’s objectives.

The letter pointed out that states need concrete guidance, whether formal or informal, addressing these areas. Such guidance will alleviate the concerns of state governments and allow state policymakers to function and continue the orderly administration of state taxes.




New Jersey Reconsiders Financial Transaction Tax

A troubling New Jersey financial transaction tax proposal, which appeared to be gaining in popularity over the last few months, has reportedly been left out of the 2021 budget deal Governor Phil Murphy struck with legislative leaders last week. The decision to drop the transaction tax from the deal came days after the Wall Street Journal reported that prominent stock exchanges with data centers in New Jersey were prepared to exit the state if the tax plan was adopted. Although the financial transaction tax may be off the table this round, Governor Murphy still likes the idea and we are hearing that the concept is not permanently dead.

S2902/A4402 would impose a financial transaction tax on persons or entities that process 10,000 or more financial transactions through electronic infrastructure located in New Jersey during the year. According to the bill, there are reportedly billions of financial transactions processed daily, and many of those are processed through infrastructure located in New Jersey. The tax would be a quarter of a cent per financial transaction processed in the state and be levied on the processor.

Many well-known New York stock exchanges maintain their electronic infrastructure in New Jersey and have expressed their intention to leave New Jersey before becoming subject to the tax, which they argue harms not only their customers but also ordinary investors because the costs of the tax are passed down from the exchanges to everyone else in the market. Many US stock exchanges already maintain backup facilities in the Midwest. An industry-wide effort to test those Midwestern facilities is scheduled for September 26 to demonstrate their preparedness, and willingness, to relocate.

New Jersey’s financial transaction tax proposal may drive data center businesses out of the state before it is even adopted or formally considered by the state legislature, which teaches a valuable lesson: In a post-coronavirus world, states looking to make up billions in deficits by aggressively taxing businesses that survived the economic crisis risk finding out just how mobile businesses have become.




Déjà Vu – Marketplace Model Debate May Resume Again

The debate over state marketplace laws may resume again, after the Uniform Law Commission (ULC) announced it has set up a committee to study whether to draft a uniform state law on online sales tax collection, focusing on marketplaces. The study committee is chaired by Utah Sen. Lyle Hillyard. The lead staffer (“reporter”) will be Professor Adam Thimmesch of the University of Nebraska College of Law. The members of the committee are listed here and information to sign up to be notified of developments is available here.

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The Digital Advertising Tax Trend Continues: New York Introduces Another Bill

On April 13, S. 8166 was introduced in the New York Senate, which would expand the sales tax base to include receipts from the sale of digital advertising services. The bill would dedicate the revenue raised to student loan relief.

As introduced, “digital advertising services” would be broadly defined as “advertisement services on a digital interface, including advertisements in the form of banner advertising, search engine advertising, interstitial advertising, and other comparable advertising services which markets or promotes a particular good, service, or political candidate or message.” (With the exception of the added last clause, the definition of “digital advertising services” is identical to the definition in the digital advertising tax legislation recently passed by the Maryland General Assembly. The definition differs from the previously introduced New York digital ads tax (S. 8056) in that it is not limited only to targeted advertising.) “Digital interface” would also be defined very broadly as “any type of software, including a website, part of a website, or application, that a user is able to access.”

If enacted, the law would take effect on the 30th day after enactment, and would sunset five (5) years after the effective date.

 




New State Digital Ad Taxes? Will Maryland’s Take Effect? Which States Will Follow? Litigation Guaranteed!

On March 18, 2020, Maryland legislature sent a massive new tax on digital advertising services to Governor Hogan for consideration. The tax imposes a rate of up to 10% on annual gross revenue in the state derived from digital advertising services. This tax is on a sliding scale based on companies’ global revenues and would take effect with tax year 2021. There are many legal problems with the legislation, including the violations of the Internet Tax Freedom Act, the Commerce Clause and the First Amendment. Other states have considered and are considering similar proposals. It is imperative that companies know how broadly this new tax will apply.

Click below to watch our recent webinar on this new tax. We discuss the legal challenges that can be made and how to protect your company from the unlawful reach of such laws.




Maryland General Assembly Sends Digital Advertising Tax to Governor; Nearly Identical Bill Pending in New York

With gatherings larger than 50 people banned and the State House cleared of visitors, on March 18, 2020, Maryland’s legislature approved HB 732, which contains a massive new punitive tax on digital advertising services, and sent it to Governor Larry Hogan (R) for his consideration.

Digital Advertising Gross Revenues Tax

Contradicting the clear legislative trend in the advertising space to exempt the facilitation of advertising services (but tax the consumer transactions that may result therefrom), HB 732 would impose a new, one-of-a-kind tax on the annual gross revenue of digital advertising services that are deemed to be provided in the State. The proposed tax contains a tiered tax rate structure (arbitrarily determined based on the advertising service provider’s global annual gross revenues) that would allow for a tax rate of up to a whopping 10% of the annual gross revenue in the State derived from digital advertising services. As passed, HB 732 would take effect July 1, 2020, and the new tax would apply to all taxable years beginning after December 31, 2020.

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New Trend Developing? Another Digital Advertising Tax Proposal

On January 14, LB 989 was introduced in the Nebraska Legislature, which would impose sales and use tax on “the retail sale of digital advertisements.” The bill defines “digital advertisement” as “an advertising message delivered over the Internet that markets or promotes a particular good, service, or political candidate or message” (see pages 5-6 of the bill). The definition is a sweeping one, but the exact scope is unclear as the terms used are not further defined. It is also unclear how a taxable digital advertising transaction would be sourced if the proposed legislation is enacted.

The digital advertising tax proposed in the bill would have an effective date of October 1, 2020. Nebraska’s state sales tax rate is 5.5%, with local sales taxes up to an additional 2%.

Similar to Maryland’s SB 2 proposal, because Nebraska would tax digital advertising but not tax non-digital advertising, the proposed tax raises a series of legal concerns (above and beyond the obvious policy concerns).  For example, the tax would be a “discriminatory tax” prohibited by the Permanent Internet Tax Freedom Act (PITFA). The proposal also raises serious First Amendment (singling out digital commercial speech for tax) and Equal Protection (lack of rational basis for tax only on digital advertising) issues.

Practice Note: If enacted, LB 989 would create an uncharted and sweeping tax on digital platforms and advertisers. While this bill will have an uphill battle in 2020 (for example, Nebraska has a short, 60-day legislative session this year and Nebraska has a filibuster rule) the repeated introduction of digital advertising tax bills early in 2020 state legislative sessions may be the start of an alarming trend of legally suspect tax proposals that we are keeping a close eye on.  Businesses impacted by the Maryland and Nebraska digital advertising tax proposals are encouraged to contact the authors to discuss these legislative developments further.




BREAKING NEWS: Maryland Proposes (French) Tax on Advertising – Digital Platforms and Advertisers Beware!

On January 8, SB 2 was introduced to establish a new digital advertising gross revenue tax of up to 10% on “annual gross revenues of a person derived from digital advertising services in the state.” This uncharted new tax would make Maryland the first state or locality in the United States to impose a targeted tax on the gross revenue of digital advertising services.

The bill defines “in the state” as appearing on the user’s device located in the state (determined based on either the user’s IP address or reasonable knowledge). “Digital advertising services” is defined as “advertisement services on a digital interface, including advertisements in the form of banner advertising, search engine advertising, interstitial advertising, and other comparable advertising services.” The definition uses the word “includes” rather than “means,” enabling the definition to be read even more broadly. “Digital interface” is defined as “any type of software, including a website, part of a website, or application, that a user is able to access.”

The tax applies at a sliding scale:

  • 2.5% for person with global annual gross revenues of $100 million or more
  • 5% for person with global annual gross revenues of $1 billion or more
  • 7.5% for person with global annual gross revenues of $5 billion or more
  • 10% for person with global annual gross revenues of $15 billion or more

The bill would require quarterly estimated tax payments and an annual return and provides that willful failure to file a digital advertising gross revenues tax return is a misdemeanor subject to a $5,000 fine and 5 years’ imprisonment.

The bill is co-sponsored by Senator Thomas Miller (D), the outgoing Senate President, and Senator William Ferguson (D), the incoming Senate President. Maryland legislative leaders have been hinting at new taxes on the digital economy, digital downloads, and streaming subscriptions as they decide how to fund a proposed $825 million per year education spending increase. Governor Hogan (R) opposes the education spending increase as too expensive, amounting to a $6,000 per family tax increase, and in response Democrats last week ruled out raising income, sales, or property tax rates. We therefore may see additional digital taxation bills aside from this one.

Because Maryland would tax digital advertising but not tax non-digital advertising, the tax is a “discriminatory tax” prohibited by the Permanent Internet Tax Freedom Act (PITFA). The use of an arbitrary threshold of global annual gross revenues, while perhaps politically popular, serves to tax larger global advertising service providers at a higher tax rate than their domestic counterparts, in violation of the Commerce Clause of the US Constitution.

The proposal also raises serious First Amendment (singling out digital commercial speech for a punitive tax) and Equal Protection (lack of rational basis for punitive tax on digital advertising) issues. For example, the Maryland Court of Appeals has held that municipal taxes on advertising media were unconstitutional for singling out for taxation newspapers and radio and television stations entitled to first amendment immunities.  See City of Baltimore [...]

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