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.

Recently, the Massachusetts Department of Revenue (Department) sent letters to several companies regarding Directive 17-1. The Directive announces a “rule” requiring remote internet sellers to register for and begin collecting Massachusetts sales and use tax (sales tax) by July 1, 2017, if they had more than $500,000 in Massachusetts sales during the preceding year. The legal premise behind the rule is that the Department believes sellers with more than $500,000 in annual Massachusetts sales must have more than a de minimis physical presence so that requiring sales tax collection would not be prohibited by Quill Corp v. North Dakota, 504 US 298 (1992). The Directive’s examples of such physical presence include the presence of cookies on purchasers’ computers, use of third-party carriers to make white-glove deliveries and the use of online marketplaces to sell products. The Directive also states that sellers who fail to collect tax beginning July 1, 2017 will be subject to interest and penalties (plus, of course, any uncollected taxes).

We think the Directive is contrary to law on three main grounds. First, we believe that the items that the Department asserts create physical presence are insufficient to establish more than a de minimis physical presence. For example, the presence of cookies on computers in a state appears to be less of a physical presence than the floppy disks the seller in Quill sent into North Dakota (which were used by its customers to place orders) that the United States Supreme Court viewed as de minimis. Second, the Directive violates the state administrative procedures act because it constitutes an administrative rule that was not validly adopted. Third, the Directive’s rule violates the Internet Tax Freedom Act, a federal statute, because the rule discriminates against internet sellers.

By its own terms, the Directive applies only prospectively. The Directive does not assert a blanket rule that internet sellers are liable for sales tax for periods prior to July 1, 2017, if they met a certain sales threshold. The risks from non-collection for such periods are dependent on a company’s specific facts. The letters advise sellers that they may be eligible for voluntary disclosure for such prior periods.

Companies have two general options: (1) register and begin collecting or (2) not register or collect. Litigation has been brought on behalf of a number of sellers to challenge the Directive on the grounds identified above. One important aspect of that litigation is the request for an injunction barring the enforcement of the Directive pending a court decision; an injunction would likely prompt many sellers to take a “wait and see” approach. Ultimately, sellers must make a business decision based on their own facts and business circumstances.

On Monday, October 17, the Illinois Appellate Court issued another taxpayer-friendly opinion in an Illinois False Claims Act case alleging a failure to collect and remit sales tax on internet and catalog sales to customers in Illinois (People ex. rel. Beeler, Schad & Diamond, P.C. v. Relax the Back Corp., 2016 IL App. (1st) 151580)). The opinion, partially overturned a Circuit Court trial verdict in favor of the Relator, Beeler, Schad & Diamond, PC (currently named Stephen B. Diamond, PC).

Continue Reading Illinois Appellate Court Delivers Another Blow to Relator in False Claims Act Litigation

The Fiscal Year 2016 Budget Support Act of 2015 (BSA), introduced by the Washington, D.C. Council at the request of Mayor Muriel Bowser on April 2, 2015, contains a subtitle (see Title VII, Subtitle G, page 66-67) that would give the Office and Tax and Revenue (OTR) complete discretion to indefinitely suspend the period of limitation on assessment and collection of all D.C. taxes—other than real property taxes, which contain a separate set of rules and procedures. The change to the statute of limitation provision would eliminate a fundamental taxpayer protection that exists today in all states. Those concerned should reach out to members of the D.C. Council to discourage adoption of this subtitle of the BSA.

Current Law

Under current law, the amount of tax imposed must be assessed (in other words, a final assessment must be issued) within three (3) years of the taxpayer’s return being filed. See D.C. Code § 47-4301(a). Practically speaking, this requires the mayor to issue a notice of proposed assessment no later than two (2) years and 11 months after the return is filed—to allow the taxpayer the requisite 30 days to file a protest with the Office of Administrative Hearings (OAH). See D.C. Code § 47-4312(a). As the law reads today, the running of the period of limitation is suspended between the filing of a protest and the issuance of a final order by OAH, plus an additional 60 days thereafter. See D.C. Code § 47-4303. The District has 10 years after the final assessment to levy or begin a court proceeding for collections. See D.C. Code § 47-4302(a).

Proposed Changes

The BSA would extend the limitation period for assessment and collection, as follows:

  1. The BSA would add a new provision to statutorily require the chief financial officer (CFO, the executive branch official overseeing the OTR) to send a notice of proposed audit changes at least 30 days before the notice of proposed assessment is sent; and
  2. The BSA would toll the running of the statute of limitation on assessment and collection during the period after the CFO/OTR issues the aforementioned notice of proposed audit changes until the issuance of a final assessment or order by OAH.

The BSA does not indicate an applicable date for these changes. As a result, the provision likely would be applicable to any open tax period, effectively making the change retroactive to returns already filed.

Effect

By changing the law to toll the statute of limitation for the period after OTR issues a notice of proposed audit changes, the BSA would allow OTR to unilaterally control whether the three-year statute of limitation is running. The current statute requires that OTR issue its notice of proposed assessment before the expiration of the three-year statute—and gives taxpayers the ability to protest such notices before the OAH. By tolling the statute upon issuance of a notice of proposed audit changes, which is not subject to review by OAH, the BSA would strip taxpayers of the protection offered by a three-year statute of limitations closing the tax year. Instead, OTR would be able to indefinitely toll the statute by issuing a notice of proposed audit changes—an undefined document with no current statutory basis, which is not subject to judicial review. The end result for taxpayers will be indefinite audits and a disruption of the timely and efficient closing of tax years. We note that the approach is also inconsistent with the OTR’s own ‘Taxpayer Rights’ promise of “prompt treatment.” 

Starting September 1, 2015, the Comptroller of Maryland (Comptroller) will offer qualifying taxpayers that failed to file or pay certain taxes an opportunity to remit tax under very attractive penalty and interest terms.  The 2015 Tax Amnesty Program (Program) is the first offered in Maryland since 2009, when the state raised nearly $30 million, not including approximately $20 million collected the following year under approved payment plans.  The amnesty program offered before that (in 2001) brought in $39.4 million.  Consistent with the Maryland amnesty programs offered in the past, the Program will apply to the state and local individual income tax, corporate income tax, withholding taxes, sales and use taxes, and admissions and amusement taxes.

The Program was made law by Governor Larry Hogan when he signed Senate Bill 763, available here, after two months of deliberation in the legislature.  While the Program is scheduled to run through October 30, 2015, the Comptroller has a history of informally extending these programs beyond their codified period.  For companies that are nervous about potential assessments following the Gore and ConAgra decisions, the amnesty offers an opportunity that should be evaluated.

Perks  

The Program’s main benefits include:

  1. Waiver of 50 percent of the interest;
  2. Waiver of all civil penalties (except previously assessed fraud penalties); and
  3. A bar on all criminal prosecutions arising from filing the delinquent return unless the charge is already pending or under investigation by a state prosecutor.

Qualification

The Program is open to almost all businesses, even if under audit or in litigation.  The statute provides for only two classifications of taxpayers that do not qualify:

  1. Taxpayers granted amnesty under a Maryland Amnesty Program held between 1999-2014; and
  2. Taxpayers eligible for the 2004 post-SYL settlement period relating to Delaware Holding Companies.

Because the Program’s enacting statute does not prohibit participants from being under audit, or even those engaged in litigation with the Comptroller, even taxpayers with known issues and controversy may find the amnesty an attractive vehicle to reach resolution of a controversy with the state.

Practice Note

Because the range of taxpayers eligible for the Program is so broad, we encourage all businesses to evaluate whether participation will benefit them.  Given that past Maryland amnesty programs excluded taxpayers over a certain size (based on employee count), large companies who were not able to resolve uncertain exposure in the state should evaluate this new offering.  If your business is currently under audit (or concerned about any tax obligations from previous years), please contact the authors to evaluate whether the Program is right for you.

Governor Andrew Cuomo’s 2015-2016 New York State Executive Budget Bill (Budget Bill) contains several important revenue measures, including, but not limited to, technical corrections to the 2014 overhaul of New York State’s Corporate Franchise Tax, conformity of the New York City General Corporation Tax to the revised New York State Corporate Franchise Tax, and several significant changes to New York’s sales and use tax statutes.  This article will address the Budget Bill’s proposed sales and use tax changes.  Several of these changes, while touted by Governor Cuomo as “closing certain sales and use tax avoidance strategies” are much broader and, if enacted, will have a significant impact on the sales and use tax liabilities resulting from routine corporate and partnership formations and reorganizations.

Read the full article.

On Friday, February 20, 2015, Governor Andrew Cuomo’s office released the 30-Day Amendments to the 2015–2016 New York State Executive Budget Legislation (Budget Bill).  This year, instead of the usual set of corrections and minor changes to the Budget Bill, the 30-Day Amendments focused primarily on the governor’s five-point ethics reform plan, with only very few corrections and minor changes included with respect to the Revenue Bill.  Those few corrections and changes focused on credits and incentives (e.g., technical corrections and clarifications to the New York State School Tax Relief (STAR) Program, the real property tax credit, the Brownfield Cleanup Program, and the credit for alternative fuel and electric vehicles) leaving any changes to the proposed sales tax provisions, corporate franchise tax technical correction provisions and New York City conformity provisions to the legislative process.  Please see our On the Subject related to the Budget Bill’s proposed significant changes to New York’s sales and use tax statutes.

Governor Andrew Cuomo’s 2015–2016 New York State Executive Budget Bill proposes several significant changes to New York’s sales and use tax statutes. Several of these changes, while touted by the governor as “closing certain sales and use tax avoidance strategies,” are much broader and, if enacted, will have a significant impact on the sales and use tax liabilities resulting from routine corporate and partnership formations and reorganizations.

Read the full article.

If the Department of Treasury (Treasury) was hoping that the Michigan courts would simply overlook the previous two cloud computing losses this year in Thomson Reuters (previously covered here) and Auto-Owners (discussed here), they appear to have been mistaken.  Last Wednesday’s Court of Claims opinion in Rehmann Robson & Co. v. Department of Treasury marked the third Michigan decision this year to rule that cloud-based services are not subject to use tax in the state.  In Rehmann Robson, the Court of Claims found that the use of Checkpoint (a web-based tax and accounting research tool) by a large accounting firm was properly characterized as a non-taxable information service, despite Treasury’s continued effort to impose use tax and litigate similar cloud-based transactions.  This taxpayer victory comes just six months after the Michigan Court of Appeals in Thomson Reuters found that a subscription to Checkpoint was primarily the sale of a service under the Catalina Marketing test, Michigan’s version of the “true object” test, which looks to whether the use of tangible personal property was incidental to the provision of services when both are provided in the same transaction.  The Thomson Reuters decision reversed a 2013 Court of Claims opinion that granted summary disposition in favor of Treasury’s ability to tax the cloud-based service as “prewritten computer software.”

Analysis

While all three Michigan decisions issued this year reach the same conclusion, the most recent decision makes an explicit effort to affirmatively block any potential avenue Treasury may use to impose the use tax on cloud-based transactions.  For what it’s worth, the Rehmann Robson opinion was written by the same judge who wrote the Auto-Owners opinion released in March 2014, and contained an identical analysis.  Unlike the Thomson Reuters decision that found use of prewritten computer software in the state, but simply found it to be incidental to the nontaxable information services provided under Catalina Marketing, Auto-Owners (and now Rehmann Robson) both undercut the Treasury’s argument before it begins.

First, the court held that there was no tangible personal property transferred because the definition of “prewritten computer software” was not satisfied.  Like many other states, Michigan defines this term as software “delivered by any means.”  The court reasoned that because the accounting firm simply accessed information via the web that was processed via BNA and Thomson Reuter’s own software, hardware and infrastructure, there was no “delivery” under a conventional understanding of the word.  Absent delivery, there was no prewritten computer software for Treasury to impose tax upon.

Second, the Court of Claims went on to note that even if prewritten computer software was delivered, the accounting firm did not sufficiently “use” the software to impose the tax.  Because the accounting firm did not exercise a right or power over the software incident to ownership (other than the ability to control research outcomes by inputting research terms), there was no use.  The court explicitly turned down Treasury’s argument that mere “access” to Checkpoint’s computer servers equates to use.

Finally, the court noted that even if prewritten computer software was delivered and used within the meaning of the use tax statute, the use of the software was merely incidental to the services rendered under the Catalina Marketing test.  The court objectively considered the six Catalina factors and determined that as a whole, any prewritten computer software was an incidental component of the principal transaction (the provision of information services).

The Rehmann Robson opinion, when paired with Auto Owners and Thomson Reuters, provides three cases that set strong precedents that Treasury has to overcome before subjecting cloud-based services to use tax in Michigan.  It remains to be seen whether Treasury will ignore the Michigan judiciary and continue to litigate cloud-based cases.  With three strikes against them, Michigan taxpayers can only hope that Treasury will take a seat on the bench when it comes to litigating alleged use tax obligations for cloud-based transactions.

Legislative Fix?   

Last Wednesday’s opinion should spark discussion in Michigan over a pair of bills (SB 0142 and SB 0143) introduced in 2013 and carried over into 2014 that would amend the definition of prewritten computer software to explicitly exclude granting the right to use prewritten software installed on another person’s server for sales and use tax purposes.  While these bills will not be carried over into 2015, they certainly appear to be prime candidates to be reintroduced if Treasury continues to assess and litigate the issue.  While no pre-filing of bills is allowed in Michigan, the 2015 session is set to begin January 14, 2015.

Practice Note:  The Rehmann Robson opinion would appear to settle any debate that cloud-based transactions are subject to use tax in Michigan.  At the same time, Michigan has been plagued by a long history of economic difficulties that have put serious pressure on Treasury to raise revenue.  Any party interested in legislatively fixing this ongoing dilemma in Michigan is encouraged to contact the authors as soon as possible to discuss.

The saga over local sourcing of Illinois retailers’ occupation taxes is well known. The Illinois Department of Revenue has a dedicated webpage for the issue, and Inside SALT covered some of the litigation aspects last month (see Illinois Regional Transportation Authority Suffers A Setback In Its Sales Tax Sourcing Litigation).  A new chapter is unfolding now, with revised proposed local sourcing rules that would apply a multifactor sourcing analysis to both intrastate and interstate sales. The regulations may be made final as soon as next month, and retailers with complex retailing processes should consider how the rules could apply to their operations.

Background: The Illinois Department of Revenue Issued Emergency and Proposed Local Tax Sourcing Regulations after the Supreme Court of Illinois Invalidated Its Old Rules in Hartney

Illinois has perhaps the most complex sales and use tax system in the country. One driver of this complexity is the fact that the Retailers’ Occupation functions as a sales tax but is really an occupation tax measured by gross receipts – the tax imposed is on the privilege of engaging in the occupation of being a retailer. Illinois lets some local jurisdictions impose additional Retailers’ Occupation Taxes, and so the effective local rate can climb higher than the 6.25 percent statewide base rate, e.g., the 9.25 percent rate applicable in Chicago. As the tax is imposed on the business occupation rather than the sale itself, origin-based sourcing principles apply. And for out-of-state sales shipped into Illinois and not subject to Retailers’ Occupation Tax, retailers have only a use tax collection obligation at the 6.25 percent state rate.

For decades, the Department of Revenue’s regulations applied a bright-line test based on order acceptance to determine where the taxable retailing activity had occurred for local Retailers’ Occupation Tax sourcing purposes. Some taxpayers structured their operations in reliance on this approach. But the Supreme Court of Illinois struck down the bright-line order acceptance test in Hartney Fuel Oil Co. v. Hamer, 2013 IL 115130 (Nov. 21, 2013), holding that an evaluation of all the retailing activities was necessary to determine where the retailing occupation occurred and consequently to which local Retailers’ Occupation Taxes a transaction was subject. The old local tax sourcing regulations were invalidated.

After Hartney, the Department promulgated new emergency local tax sourcing rules, effective January 22, 2014 (see the Department of Revenue press release, letter to Joint Committee on Administrative Rules, sample rule text). The emergency rules also served as a framework for the initial proposed final rules. These emergency and initial proposed final rules applied to intrastate tax sourcing and did not affect the Department’s longstanding rule governing whether a transaction was subject to in-state Retailers’ Occupation Tax or merely an out-of-state use tax collection obligation, 86 Ill. Admin. Code 130.610.

The Newly Revised Proposed Regulations Generally Consider Five Primary Factors in Determining the Location of the Taxable Retailing Activity

After consulting stakeholders and receiving numerous comments, the Department substantially revised the proposed rules. This revised proposal was announced on May 29, and the Joint Committee on Administrative Rules approved this revised version at its June 17, 2014 meeting. These rules could be promulgated in final form as soon as mid-July. They are an evolution of the multifactor analysis in the original proposal and emergency rules.

The core of the revised proposed local tax sourcing regulations considers five “primary” factors:”

  1. The location of sales personnel who can both solicit and make sales;
  2. The location where the seller takes action that binds it to the sale;
  3. The location where payment is tendered and received, or from which invoices are issued;
  4. The location of inventory if tangible personal property that is sold is in the retailer’s inventory at the time of its sale or delivery; and
  5. The location of the retailer’s headquarters or principal place of its business of selling.

If one jurisdiction can claim at least three of the five factors, then the sale is considered to occur at that location. The relative certainty of this bright-line primary factor test is a significant addition that was not in the original proposed rules. If no jurisdiction can claim such a majority of primary factors, then additional secondary factors are considered:

  1. The location where marketing and solicitation occur;
  2. The location of the seller’s own product procurement activities;
  3. The location where the retailer sets its prices;
  4. The location where purchase orders are received;
  5. The location where title passes; and
  6. The showroom or other display location.

There are also special rules for various industries and situations.

The New Proposed Regulations Would Apply to both Interstate and Intrastate Transactions

A highly significant change from the emergency and original proposed regulations is that the rule would also apply to interstate transactions. Hartney involved intrastate fuel sales, and so the Supreme Court of Illinois did not consider the validity of 86 Ill. Admin. Code 130.610. Rule 130.610 tends to treat transactions as subject to Retailers’ Occupation Tax if some aspect of the transaction beyond solicitation occurs in Illinois. For example, one or two of the new primary factors would often be enough to trigger Retailers’ Occupation Tax under Rule 130.610.

The Department of Revenue has now announced the planned repeal of this regulation, which is consistent with language in the revised proposed local tax sourcing regulations that clearly states that the same rules apply to sourcing both interstate and intrastate transactions. This change would tend to shift transactions from the in-state Retailers’ Occupation Tax to the out-of-state Use Tax collection obligation, because it effectively results in a higher in-state activity threshold for imposition of Retailers’ Occupation Tax.

The Regional Transportation Authority (RTA) Has Promised to Challenge the New Sourcing Regulations

The RTA has been a very active litigant in disputing local tax sourcing arrangements. It has announced an intent to file suit challenging these revised proposed regulations.   Thus, while ordinarily one would expect the Department’s revised proposed regulations to be made final as early as mid-July, a RTA challenge – if it is able to craft a viable claim – may complicate the implementation of the proposed revised local tax sourcing regulations.