The first New York meeting of McDermott’s Tax in the City® initiative in 2018 coincided with the June 21 issuance of the US Supreme Court’s (SCOTUS) highly anticipated Wayfair decision. Just before our meeting, SCOTUS issued its opinion determining that remote sellers that do not have a physical presence in a state can be required to collect sales tax on sales to customers in that state. McDermott SALT partner Diann Smith relayed the decision and its impact on online retailers to a captivated audience. Click here to read McDermott’s insight about the decision.
Many provisions of the House and Senate tax reform proposals would affect state and local tax regimes. SALT practitioners should monitor the progress of this legislation and consider contacting their state tax administrators and legislative bodies to voice their opinions.
Another Effort at False Claims Act Reform: Bills Introduced to Amend Illinois Act to Restrict Tax-Related Claims
Illinois Legislators have recently introduced three bills that would amend the Illinois False Claims Act (“Act”) to restrict the ability to bring tax-related claims. Senate Bill 9, the proposed “grand bargain” to resolve Illinois’ budget stalemate, includes language that would eliminate the ability to use the Act to bring tax claims. In addition, Representative Frank Wheeler and Senator Pam Althoff have introduced House Bill 1814 and Senate Bill 1250, respectively, which are identical pieces of legislation that would significantly restrict a private citizen’s right to bring tax-related claims. Senate Bill 9, if adopted in its current form, would eliminate the ability to bring a tax-related claim under the Act. Currently, the Act only excludes the right to bring income tax-related claims. 740 ILCS 175/3(c). This would effectively conform the Act to the federal False Claims Act, which does not extend to tax claims. Rather, tax-related claims are brought before the Internal Revenue Service’s Whistleblower Office as whistleblower claims. House Bill 1814 and Senate Bill 1250 (“Bills 1814/1250”) preserve the right to bring tax claims under the Act, and they maintain the prohibition against income tax claims. However, in a significant improvement over current practice, the Bills would amend the Act to restrict the ability of a whistleblower or its counsel to control or profit from the filing of tax claims. In addition, they enhance the role played by the Department of Revenue (“Department”) in determining whether a whistleblower’s tax claim should be pursued. Effectively, the Bills make the filing of state tax-related whistleblower claims more like the procedure for bringing a federal tax violation before the IRS. Currently, the Act authorizes private citizens, termed “relators,” to initiate litigation to force payment of tax allegedly owed to the State. 740 ILCS 175/4(b). Hundreds of such claims have been filed in Illinois by whistleblowers claiming a failure to collect and remit sales tax on internet sales. Relators file a complaint under seal with the circuit court and serve the complaint on the State. Id. 175/4(b)(2). The Illinois Attorney General’s office then has the opportunity to review the allegations and decide whether to intervene in the litigation. Id. 175/4(b)(2), (3). The Department is not named as a Defendant and there is no requirement to involve the Department in the litigation. If the Attorney General declines to proceed with the litigation, the relator may proceed with the lawsuit on its own and, if successful, is entitled to an award of 25 percent to 30 percent of the proceeds or settlement of the action, plus its attorneys’ fees and costs. Id. 175/4(d)(2). Even if the State intervenes and proceeds with the litigation, eliminating the relator’s day-to-day involvement, the relator is entitled to an award of 15 percent to 25 percent of the proceeds of settlement, plus attorneys’ fees and costs. Id. 175/4(d)(1). In contrast, Bills 1814/1250 provide that only the Attorney General (“AG”) and the Department have the right to initiate claims under [...]
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.
District of Columbia’s Transfer Pricing Enforcement Program and Combined Reporting Regime: Taking Two Bites of the Same Apple
In his recent article, “A Cursory Analysis of the Impact of Combined Reporting in the District”, Dr. Eric Cook claims that the District of Columbia’s (D.C. or the District) newly implemented combined reporting tax regime is an effective means of increasing tax revenue from corporate taxpayers, but it will have little overlap with D.C.’s ongoing federal-style section 482 tax enforcement. Dr. Cook is chief executive officer of Chainbridge Software LLC, whose company’s product and services have been utilized by the District to analyze corporations’ inter-company transactions and enforce arm’s length transfer pricing principles. Combined reporting, (i.e., formulary apportionment, as it is known in international tax circles) and the arm’s length standard, are effectively polar opposites in the treatment of inter-company taxation. It is inappropriate for the District (and other taxing jurisdictions) to simultaneously pursue both. To do so seriously risks overtaxing District business taxpayers and questions the coherence of the District’s tax regime.
Both combined reporting and 482 adjustments have had a renaissance in the past decade. Several tax jurisdictions, including the District, enacted new combined reporting requirements to increase tax revenue and combat perceived tax planning by businesses. At the same time, some tax jurisdictions, once again including the District, have stepped up audit changes based on use of transfer pricing adjustment authority. This change is due in part to new availability of third-party consultants and the interest in the issue by the Multistate Tax Commission (MTC). States have engaged consultants, such as Chainbridge, to augment state capabilities in the transfer pricing area. At the request of some states, the MTC is hoping to launch its Arm’s Length Audit Services (ALAS) program. States thus have increasing external resources available for transfer-pricing audits.
A similar discussion regarding how to address inter-company income shifting is occurring at the international level, but with a fundamentally important different conclusion. The national governments of the Organization for Economic Cooperation and Development (OECD) and the G-20 are preparing to complete (on a more or less consensual basis) their Base Erosion and Profit Shifting action plan. This plan will reject formulary apportionment as a means of evaluating and taxing inter-company transactions. Thus, in the international context, formulary apportionment and transfer pricing adjustment authority are not seen as complementary, but instead are seen as mutually exclusive alternatives. The history of formulary apportionment in international context sheds light on why states make a mistake when they seek to use both combined reporting and transfer pricing adjustments.
A combined reporting basis of taxation seeks to treat the members of a consolidated group as a single entity, consolidating financial accounts of the member entities and allocating a portion of the consolidated income to the taxing jurisdiction based on some formula or one or more apportionment factors. Under the arm’s length approach, individual entities of a consolidated group within a single jurisdiction are treated (generally) as stand-alone entities and taxed according to the arm’s length value (the value that would be realized by independent, [...]
On December 5, 2014, the New York Department of Taxation and Finance (Department) released TSB-M-14(5)C, (7)I, (17)S. This (relatively short) bulletin sets forth the treatment of convertible virtual currency for sales, corporation and personal income tax purposes. The bulletin follows on a notice released by the Internal Revenue Service (IRS) in March of this year, Notice 2014-21.
The IRS Notice indicates that, for federal tax purposes, the IRS will treat virtual currency as property, and will not treat it as currency for purposes of foreign currency gains or losses. Taxpayers must convert virtual currency into U.S. dollars when determining whether there has been a gain or loss on transactions involving the currency. When receiving virtual currency as payment, either for goods and services or as compensation, the virtual currency is converted into U.S. dollars (based on the fair market value of the virtual currency at the time of receipt) to determine the value of the payment.
The IRS Notice only relates to “convertible virtual currency.” Virtual currency is defined as a “digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value.” Convertible virtual currency is virtual currency that “has an equivalent value in real currency, or that acts as a substitute for real currency.”
The Department’s bulletin also addresses only convertible virtual currency, and uses a definition identical to the IRS definition. The Department indicates that it will follow the federal treatment of virtual currency for purposes of the corporation tax and personal income tax.
For sales and use tax purposes, the bulletin states that convertible virtual currency is intangible property and therefore not subject to tax. Thus, the transfer of virtual currency itself is not subject to tax. However, the exchange of virtual currency for products and services will be treated as a barter transaction, and the amount of tax due is calculated based on the fair market value of the virtual currency at the time of the exchange.
The Department should be applauded for issuing guidance on virtual currency. It appears that these types of currencies will be used more and more in the future, and may present difficult tax issues.
However, the Department’s guidance is incomplete. There are a couple of unanswered questions that taxpayers will still need to ponder.
First, the definition of convertible virtual currency is somewhat broad and unclear. The Department and the IRS define “convertible” virtual currency as currency that has an “equivalent” value in real currency, but equivalent is not defined in either the IRS Notice or the bulletin. Many digital products and services use virtual currency or points that cannot be legally exchanged for currency to reward users, and the IRS and the Department should be clearer about the tax treatment of those currencies.
Second, although the Department will follow the federal treatment for characterization and income recognition purposes, the bulletin does not discuss apportionment. This is likely a very small issue at this point in time, but the Department will, [...]