On January 14, 2020, legislation (L.B. 989) was introduced in the Nebraska Legislature that would expand the sales tax base to include sales of “digital advertisements.” “Digital advertisement” means “an advertising message delivered over the Internet that markets or promotes a particular good, service, or political candidate or message.” Nebraska is now the second state (after Maryland) to consider taxing digital advertising services. While the Nebraska and Maryland proposals take different approaches to taxing those services, both proposals likely violate the Internet Tax Freedom Act as discriminatory against e-commerce. If L.B. 989 passes, the tax on digital advertisements would take effect on October 1, 2020.
Maryland State Senators Miller and Ferguson have introduced legislation (Senate Bill 2) that would impose a new Digital Advertising Gross Revenues Tax for all taxable years beginning after December 31, 2020. If signed into law, Maryland would become the first state to impose a tax that targets digital advertising. Senate Bill 2 was read for the first time in the Budget and Taxation Committee on January 8, 2020.
Please see the full Legal Alert here.
New York Administrative Court (Again) Holds Royalties Received from Foreign Related Parties Cannot be Excluded from Taxable Income
On December 19, 2019, the New York Division of Tax Appeals (DTA) held that a corporate taxpayer must include royalties received from foreign affiliates in the computation of its entire net income for its 2007 through 2012 tax years. Matter of IBM Corp., DTA Nos. 827825, 827997, and 827998 (N.Y. Div. Tax App. Dec. 19, 2019).
Under prior law enacted in 2003, New York put in place a royalty add-back regime requiring a taxpayer that paid royalties to a related party to add back the payments to the extent they were deductible in calculating federal taxable income. At the same time, New York also enacted a “royalty income exclusion” that allowed royalty payees (the parties that received, rather than paid, the royalties) to exclude from income the royalty payments received from a related entity to the extent the payments were included in the payee’s federal taxable income, “unless such royalty payments would not be required to be added back” by the related payor entity under the royalty add-back provisions. The use of the word “would” in the “royalty income exclusion” indicated that there was no explicit requirement that the related payor of the royalty actually be a New York taxpayer that added back a royalty payment.
In the case, the corporation/payee that received related party royalties was a New York taxpayer, but the related foreign affiliate payors of the royalties were not. The corporation argued that the royalty payments received from its foreign affiliates qualified for the “royalty income exclusion” because the foreign affiliates would be required to add back such payments if they were New York taxpayers. However, the DTA concluded that the “royalty income exclusion” required that the payees be New York taxpayers to qualify for the exclusion and, therefore, that the royalty payments at issue could not be excluded from the corporation’s entire net income.
The DTA’s decision is nearly word-for-word identical to a DTA decision that was authored by the same Administrative Law Judge and issued on May 30, 2019, in Matter of Walt Disney Company and Consolidated Subsidiaries. The Disney decision has been appealed to the New York Tax Appeals Tribunal.
The California Office of Tax Appeals held that pursuant to market-based sourcing rules, a nonresident individual did not derive California sourced income and was not required to file a California return or pay personal income tax. The taxpayer resided in Texas and worked as an independent contractor for Christopher Konrad Consulting, LLC (Konrad), a company with its principal place of business in California. Pursuant to an agreement with Konrad, the taxpayer agreed to design the user experience of products and services for Konrad’s customer, BMC. The taxpayer performed his work solely in Texas and received a 1099-MISC from Konrad. The FTB argued that based on its market-based sales factor sourcing provisions, Konrad received the benefit of the taxpayer’s services in California, and thus, the taxpayer was subject to tax in California. The OTA found that while the billing address of the taxpayer’s direct customer, Konrad, was in California, the location where Konrad’s customer, BMC, received the benefit of taxpayer’s services was in Vancouver, Canada. Thus, the taxpayer did not derive California sourced income and was not required to file a nonresident return or pay California personal income tax.
The New Jersey Tax Court held that distributions made to a corporation’s two shareholders constituted dividends, and rejected the corporation’s argument that the distributions should be treated as compensation for managerial services that could be deducted for New Jersey Corporation Business Tax purposes. The Court explained that New Jersey has adopted the federal test to determine whether a distribution constitutes compensation for services rendered, which provides that: (1) the amount of the compensation must be reasonable, and (2) the payments must, in fact, be purely for services. The Court explained that proof of the second prong can be difficult to establish, so courts generally concentrate on the first prong. To determine whether compensation is reasonable under the first prong, courts consider: (1) the employee’s role in the corporation; (2) a comparison of the compensation payment with those paid by similar companies for similar services; (3) the size and complexity of the company’s business; (4) the existence of a relationship between the company and its employee which would permit disguising of nondeductible dividends as salary, and (5) whether internal consistency exists in the corporation’s treatment of payments to employees. Having analyzed the factors, the Court determined that there was no evidence in the record establishing that it would be reasonable for the shareholders to receive the distributed amounts as compensation for services, and concluded that a reasonable independent shareholder would view the distributions as dividend payments.
The Maryland Court of Special Appeals upheld the Comptroller’s determination that an out-of-state pet food seller did not qualify for Public Law 86-272 protection because the seller’s collection of competitive information in Maryland by its employees was not ancillary to solicitation of sales and not de minimis. The out-of-state pet food seller maintained a limited number of employees in Maryland, including several dozen “Pet Detectives” and one Account Manager, who were responsible for encouraging customers and retailers to buy the out-of-state pet food seller’s products. These employees also engaged in various forms of quality control and provided information regarding market opportunities and competitor activities in regular reports to regional managers. The Comptroller argued, and the appellate court agreed, that such activities in Maryland exceeded the solicitation protection of P.L. 86-272, as the activities were not ancillary to the solicitation of sales. The appellate court concluded the seller’s quality control efforts were de minimis, though, with only two instances in the record of a Pet Detective either restocking or pulling bad product from retailer shelves. In contrast, the court held the gathering of competitive intelligence constituted “a nontrivial additional business activity conducted in the State of Maryland,” despite the fact that less than five percent of the employees’ reports discussed competitors and their activities. Because the “collection of competitive information was carried out on a regular basis as a continuing matter of company policy,” the court held such activity was sufficient to forfeit P.L. 86-272 immunity. Blue Buffalo Company, Ltd. v. Comptroller of the Treasury, — A.3d — (Dec. 20, 2019).
Meet Ruby, a Cavalier King Charles Spaniel mix, who eight years ago became a pupil of Richard Pomp, the Alva P. Loiselle Professor of Law at UConn School of Law. While Ruby is very much the teacher’s pet, enjoying anything that gives her extra class time with Professor Pomp, she’s always looking for extra credit for that time when on cue, she unplugged the Professor’s connection to a video deposition with her furry tail.
When the Professor is not teaching or giving a deposition, he and Ruby bond over a few of their favorite things, including sushi dinners and hot tubbing. Ruby loves sushi that has festered on the counter for three days driving the cat crazy. Ruby always demands the hot tub be cooled down to a chilly 80 degrees before she gets in, though. Ruby also loves holidays, and her favorite holiday is Halloween. She enjoys wearing costumes in the hopes of getting treats from her neighbors, but she only wants the good stuff. So if you see her around, don’t even think of trying to give her a dog biscuit – she’s looking for the full-size candy bars!
We are thrilled to feature Ruby as our December Pet of the Month!
For our final Marketplace Monday of 2019, we look back at what happened this year, what people are talking about and what to expect in 2020. Prior to 2019, only seven states had marketplace collection laws or guidance requiring marketplace collection in effect. However, in 2019 a record number of states passed state tax marketplace collection laws. We expect marketplace collection to be a hot topic in 2020 as the states continue to pass and tinker with these laws.
- In 2019, thirty-two states, including the District of Columbia (DC), enacted marketplace collection legislation and/or had marketplace collection laws go into effect on or after January 1, 2019.
- As of December 23rd, thirty-nine states have enacted marketplace collection laws.
- As of December 23rd, only seven states have not enacted marketplace collection laws – Florida, Georgia, Kansas, Louisiana, Mississippi, Missouri and Tennessee.
- Four states amended their existing marketplace collection laws or guidance:
- Minnesota passed a more common marketplace collection law to capture marketplace facilitators that do not have a physical presence in the state;
- Oklahoma amended its marketplace collection law to modify, among other things, which marketplace facilitators are required to collect and remit sales tax or comply with notice and reporting requirements;
- South Carolina passed S.B. 214 officially adopting marketplace collection after the South Carolina Department of Revenue issued Revenue Ruling 18-14 (9/19/2018) requiring marketplace collection, and
- Washington State replaced its original marketplace collection law to, among other things, require marketplace facilitators (effective 1/1/2020) to expand its marketplace law to other Washington taxes imposed on a buyer and that the seller is required to collect and pay over to the Department of Revenue.
- The Multistate Tax Commission (MTC) Wayfair Implementation and Marketplace Facilitator Work Group (the Marketplace Group) released a final white paper on 12/13/2019 addressing issues arising from the states’ marketplace facilitator laws. The white paper notes the Marketplace Group’s thirteen priority issues:
- Definition of marketplace facilitator/provider.
- Who is the retailer?
- Remote seller and marketplace seller vs. marketplace facilitator/provider recordkeeping, audit exposure and liability protection.
- Marketplace seller-marketplace facilitator/provider information requirements.
- Collection responsibility/determination.
- Marketplace seller economic nexus threshold calculation.
- Remote seller sales/use tax economic nexus threshold issues.
- Certification requirements.
- Information sharing.
- Taxability determination.
- Return simplification.
- Foreign sellers.
- Local sales/use taxes.
What Marketplaces are Talking About
- A majority of the marketplace collection discussions are reflected in the Marketplace Group’s thirteen priority issues, with significant outstanding questions on the application of state marketplace collection laws to:
- Local sales/use taxes;
- Foreign sellers, and
- Marketplace facilitator certification requirements.
- What, if any, are the income tax implications from marketplace facilitator’s sales and use tax registrations?
- Do/will marketplace collection laws require marketplaces to collect additional taxes and fees?
- States and industry groups have been in discussions for explicit carve-outs from marketplace collection requirements for, among others, payment processors and online travel companies (OTCs).
- Litigation in Louisiana and South Carolina challenging marketplace collection assertions by states/localities without marketplace collection laws.
What to Expect in 2020
- It is anticipated that the remaining states (Florida, Georgia, Kansas, Louisiana, Mississippi, Missouri and Tennessee) will enact marketplace collection.
- Those states with marketplace collection laws will further refine their collection laws to address concerns regarding the breadth of the current marketplace collection laws in some states.
- A decision from the Louisiana Supreme Court in Normand v. Wal-Mart.com USA LLC, No. 2019-C-263, addressing whether there is a requirement for marketplaces to collect local sales and use taxes (Jefferson Parish) in the absence of a marketplace collection law.
- Alaska localities implementation of a single-level statewide administration of marketplace collection pursuant to the Alaska Municipal League’s Alaska Intergovernmental Remote Sales Tax Agreement.
 Connecticut, Minnesota, New Jersey, Oklahoma, Pennsylvania, South Carolina and Washington.
The Massachusetts Appellate Tax Board determined that three licensors of software properly sought refunds (or “abatements”) to apportion sales tax based upon proof of their purchasers’ intent to use the software in multiple locations, including outside of Massachusetts. In doing so, the Board rejected the Commissioner of Revenue’s argument that the taxpayers could apportion sales tax, but only on their original reports.
The Board concluded that the Commissioner’s regulation did not prohibit taxpayers from seeking apportionment through the abatement process, contrasting the apportionment regulation with several other regulations that required certain actions – such as elections – to be made on original reports. The Board also pointed to the regulation’s retroactive application – it took effect in October 2006, but applied to transactions in April 2006 – as proof that there is no original-report requirement. If there were, retroactive application would be impossible.
On October 22, 2019, the Ohio Board of Tax Appeals (BTA) held that an insurance company was entitled to a refund of sales tax paid on its purchase of CAT-5 and CAT-6 communication cabling for internet and Voice over Internet Protocol (“VoIP”) installed in its headquarters office building. The company purchased the cabling as part of a construction contract for the renovation of its headquarters and paid sales tax to the contractor at the time of the purchase. The company then filed a refund claim, asserting that since the cabling was incorporated into the real property, the charges for the cabling and its installation constituted a construction contract under Ohio Rev. Code Ann. § 5739.01(B)(5) and not a retail sale subject to sales tax. The Ohio Tax Commissioner argued that the construction contract rule did not apply because the cabling constituted a “business fixture” under Ohio Rev. Code Ann. § 5701.03(B). In support of its position, the Commissioner cited a 1998 decision where the BTA held that communications cabling was a business fixture because it benefitted the business occupant and was not a communication line common to buildings. Newcome Corp. v. Tracy, Case No. 97-M-320 (Oh. Bd. Tax App. Dec. 11, 1998).
The BTA ruled in favor of the company, finding that the communications lines were not a business fixture, because they were not designed to meet the specific needs of the company’s business, but could be installed in any office building for VoIP and internet communications, “and are as common to commercial property as telephone lines and coaxial cables were in the past.” The BTA also held that Ohio Department of Taxation Information Release ST 1999-01 (Mar. 1999), which applies the Newcome decision and provides that the sale and installation of all computer cabling constitutes a taxable sale of a “business fixture,” is incorrect “given the ubiquitous presence of industry-standard cabling in commercial buildings.” Nationwide Mutual Insurance Co. v. McClain, Case Nos. 2018-313, 2018-315, 2108-316, 2018-317, and 2018-318 (Oh. Bd. Tax App. Oct. 22, 2019).