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The Minnesota Supreme Court held that the state’s standard apportionment method did not fairly reflect the taxpayer’s net income allocable to the state, reversing the Tax Court’s ruling. The taxpayer, a national financial institution, transferred its loan portfolios to two newly formed partnerships. For apportionment purposes, Minnesota requires financial institutions to include loan interest in their sales factor numerators, but does not require other entities to do so. Unlike the taxpayer, the partnerships were not financial institutions. The partnerships thus excluded loan interest and reported their receipts factors as zero. The taxpayer’s distributive share of the partnerships’ apportioned income, in turn, contributed no receipts to its own receipts factor.

The Commissioner argued that the partnerships’ application of the statutory apportionment method failed to account for the taxpayer’s Minnesota business activities and thus, distorted the taxpayer’s state income by excluding interest income paid by Minnesota borrowers. The Commissioner proposed an alternative apportionment method requiring the partnerships to follow the rules for financial institutions and include interest income in their receipts factors. The court agreed with the Commissioner, concluding that the statutory apportionment formula failed to recognize any of the taxpayer’s income from its Minnesota business activities. The court noted that the taxpayer’s transfer of  its loan portfolios to the partnerships did not change the management of the loans, and Minnesota borrowers continued to make their loan payments directly to the taxpayer as a collection agent for the partnerships. The statutory method therefore distorted the taxpayer’s in-state income. No. A7-0923.

On Tuesday, June 24, the Judiciary Committee of the US House of Representatives held a hearing on “Examining the Wayfair decision and its Ramifications for Consumers and Small Businesses.” The hearing was scheduled at the direction of Rep. Robert Goodlatte (R-VA), Chairman of the Judiciary Committee and did not address any specific pending or former legislation, but instead was informational and used to assist the committee in determining whether and how Congress should intervene.

View the full legal alert.

This is the tenth edition of the Eversheds Sutherland SALT Scoreboard, and the second edition of 2018. Each quarter, we tally the results of what we deem to be significant taxpayer wins and losses and analyze those results. This edition of the SALT Scoreboard includes a discussion of the United States Supreme Court’s decision in South Dakota v. Wayfair, Inc., insights regarding Chicago’s taxation of streaming video, and a spotlight on New York cases.

View our Eversheds Sutherland SALT Scoreboard results from the second quarter of 2018!

 

The North Carolina Supreme Court recently held that the presence in the state of a trust’s beneficiary is not sufficient to establish income tax nexus for the trust. In the Kimberly Rice Kaestner 1992 Family Trust case, the trust’s beneficiaries were residents of North Carolina. There were no other connections between the state and the trust. The court held that the trust did not have sufficient minimum connections with the state of North Carolina to satisfy the due process requirements of the US Constitution and the equivalent due process requirements of the Constitution of North Carolina. The court emphasized that a trust is a separate and distinct entity from its beneficiaries, and a trust’s connections with the state are what matters for determining whether the tax violates due process. The court reasoned that the beneficiaries’ residency in North Carolina cannot be viewed as the trust conducting purposeful activities in the state because the trust and its beneficiaries are separate legal entities. Kimberley Rice Kaestner 1992 Family Trust v. N.C. Dep’t of Revenue, No. 307PA15-2 (N.C., June 8, 2018).

For more information on the lower court decisions in this case, please see our previous posts regarding the North Carolina Court of Appeals decision and the Wake County Superior Court decision.

In the midst of a budget showdown between New Jersey’s Legislature and Governor Murphy, on June 25, 2018, the Legislature passed a replacement bill that seeks to raise revenue with a temporary Corporation Business Tax “surtax” on corporations meeting certain income thresholds and by limiting New Jersey’s dividend exclusion. The Legislature also responded to the Tax Cuts and Jobs Act (TCJA) passed by the United States Congress late last year by decoupling from the IRC § 199A qualified business income deduction. However, the current version of the bill fails to address other TCJA provisions, such as the tax on global intangible low-taxed income and the foreign-derived intangible income deduction. With the Governor threatening to veto the bill, the Legislature and the Governor are expected to continue negotiations over the next few days as the end of June deadline for the budget approaches.

View the full legal alert.

In a 5-4 decision, the US Supreme Court today overruled its landmark decisions in Quill Corp. v. North Dakota and National Bellas Hess, Inc. v. Department of Revenue of Illinois, disposing of the “physical presence” rule that has served as the bright-line standard for whether remote sellers are required to collect state sales taxes. Although the Court made clear its criticisms of the physical presence standard—referring to it as “arbitrary,” “artificial,” and a “judicially created tax shelter”—it was less clear in describing a new standard to replace it.

View the full legal alert.

On June 21, 2018, the US Supreme Court struck down the “physical presence rule” of Quill and National Bellas Hess which barred states from imposing sales tax collection requirements on certain out-of-state sellers. This decision is expected to have a significant impact on online sales across the country.

The case, South Dakota v. Wayfair, is the first sales tax jurisdiction case heard by the US Supreme Court in 25 years.

The physical presence rule challenged in this case has long been criticized as giving out-of-state sellers an advantage. In its opinion, the Supreme Court held that over time, the physical presence rule became further removed from economic reality and resulted in significant revenue losses to the States. Additionally, the court held that the physical presence rule, both as first formulated and as applied today, is an incorrect interpretation of the Commerce Clause.

Read the Wayfair Opinion

Read the full opinion in South Dakota v. Wayfair here. Additional insight and analysis will be added to this post throughout the week.

About the Case

  • Title:   South Dakota v. Wayfair, Inc., et al.
  • Supreme Court Decision: No. 17–494.
  • Decision Below: State v. Wayfair Inc., 901 N.W.2d 754 (2018) (PDF)
  • Listen: Oral Argument Audio.

The Wayfair case re-examines the Supreme Court’s 1992 holding of Quill v. North Dakota, in which the court ruled that states could not require mail order retailers that lack a physical presence in the state to collect sales tax from their customers. The Quill decision protects Internet retailers that lack physical presence from being forced to collect tax on online sales.

Post-Wayfair Oral Argument Webcast

On April 18, 2018, the Tax Executives Institute (TEI) and Thomson Reuters hosted a two-hour webcast entitled “South Dakota v. Wayfair – Insights on the Oral Argument.”  Eversheds Sutherland Partner Jeff Friedman was among the panelists who addressed the issues raised by Wayfair and provided commentary on the oral arguments.

View Details and listen to the webcast replay now.

Wayfair Case Background

Prior Cases

In 1967, the US Supreme Court held that the Commerce Clause prohibits a state from requiring catalog retailers to collect sales taxes on sales unless the retailer has a physical presence there. Nat’l Bellas Hess v. Dep’t of Rev. of Ill., 386 U.S. 753 (1967).

In 1992, the US Supreme Court declined to overrule the physical presence requirement of Bellas Hess in a state sales tax case involving a  mail-order catalog seller. Quill Corp. v. North Dakota, 504 U.S. 298 (1992). In Wayfair, South Dakota has brought a similar case against three online sellers – Wayfair Inc., Overstock.com, Inc., and Newegg Inc.

More: See the Supreme Court docket for complete case filings.

Photos from Oral Arguments

Eversheds Sutherland partners in the Supreme Court Bar line ahead of the Wayfair oral arguments.
Eversheds Sutherland partners in the Supreme Court Bar line ahead of the Wayfair oral arguments.
Eversheds Sutherland partner Todd Lard and others in the Supreme Court Bar line.
Eversheds Sutherland partner Todd Lard and others in the Supreme Court Bar line.
The Supreme Court Bar line inside ahead of the Wayfair oral arguments.
The Supreme Court Bar line inside ahead of the Wayfair oral arguments.
Eversheds Sutherland partners Jeffrey A. Friedman and Michele Borens in the Supreme Court Bar line ahead of the Wayfair oral arguments.
Eversheds Sutherland partners Michele Borens and Jeffrey A. Friedman in the Supreme Court Bar line ahead of the Wayfair oral arguments.
The public line in front of the Supreme Court around 6 a.m.
The public line in front of the Supreme Court around 6 a.m.
The public line in front of the Supreme Court around 6 a.m.
The public line in front of the Supreme Court around 4:30 a.m.
The public line in front of the Supreme Court around 7 a.m.
The public line in front of the Supreme Court around 7 a.m.
This reporter did two newscasts from the Supreme Court before the South Dakota v. Wayfair oral argument.
This reporter did two newscasts from the Supreme Court before the South Dakota v. Wayfair oral argument.
The public line in front of the Supreme Court around 7 a.m.
The public line in front of the Supreme Court around 7 a.m.
Spectrum News NY1 reporter Samantha-Jo Roth reporting live from the line in front of the Supreme Court.
Spectrum News NY1 reporter Samantha-Jo Roth reporting live from the line in front of the Supreme Court.
The public line in front of the Supreme Court waiting to get into the Wayfair oral arguments.
The public line in front of the Supreme Court waiting to get into the Wayfair oral arguments.
The Supreme Court Bar line walking inside for the South Dakota v. Wayfair oral arguments.
The Supreme Court Bar line walking inside for the South Dakota v. Wayfair oral arguments.
The Supreme Court Bar line walking inside for the South Dakota v. Wayfair oral arguments.
The Supreme Court Bar line walking inside for the South Dakota v. Wayfair oral arguments.
The Supreme Court Bar line waiting for the South Dakota v. Wayfair oral arguments.
The Supreme Court Bar line waiting for the South Dakota v. Wayfair oral arguments.
Long lines around 10:30 a.m. in front of the Supreme Court.
Long lines around 10:30 a.m. in front of the Supreme Court.

Media Coverage:

About Eversheds Sutherland SALT:

As state and local jurisdictions in the US evolve their tax systems and engage in increasingly sophisticated enforcement and litigation strategies, businesses need sound state and local tax (SALT) advice more than ever before. Eversheds Sutherland’s SALT practice is committed to delivering innovative solutions that meet the needs of your business. Read more.

In Kraft Foods Global, Inc. v. Director, Division of Taxation, 2018 WL 2247356 (May 17, 2018), the New Jersey Superior Court, Appellate Division, recently upheld a New Jersey Tax Court decision denying a taxpayer an exception to the state’s interest add-back requirement in determining the taxpayer’s corporate net income subject to New Jersey’s corporation business tax (CBT). This case highlights the unintended tax consequences that may result from financing arrangements between related entities.

Like many states, New Jersey uses federal taxable income as a starting point for the CBT and then has several modifications to federal taxable income to arrive at New Jersey taxable income. One of these modifications is the related party interest add-back provision, which provides that “[e]ntire net income shall be determined without the exclusion, deduction or credit of … [i]nterest paid, accrued or incurred for the privilege period to a related member….”  N.J.S.A. 54:10A–4(k)(2)(I).

There are five statutory exceptions to the interest add-back requirement. In Kraft Foods, the only exception relied upon by the taxpayer was the “Unreasonable Exception,” which requires the taxpayer to establish “by clear and convincing evidence, as determined by the director, that the disallowance of a deduction is unreasonable.” In support of its argument, the taxpayer argued that its parent company simply “pushed down” loans from bondholders because the parent company could secure a better interest rate on the open market than the taxpayer.

The appellate court upheld the determination of the Tax Court that the taxpayer did not qualify for the Unreasonable Exception. While acknowledging that legislative history supported the taxpayer’s contention that the Unreasonable Exception may apply to a “pushed down” loan, even in the absence of a guarantee of the third-party debt, the appellate court found that the taxpayer did not meet its evidentiary burden. According to the court, the taxpayer produced no document suggesting that it was ultimately responsible for the third-party debt. The taxpayer’s promise to pay its parent company did not contain a guarantee to the third-party bondholders, nor did the promissory notes the taxpayer signed on behalf of its parent contain payment terms or a schedule for principal payments. Thus, according to the appellate court, it was reasonable for the Director to determine that the parent’s debt to the bondholders “was not, legally or effectively, ‘pushed down’” to the taxpayer. Kraft Foods Global, Inc. v. Director, Division of Taxation, 2018 WL 2247356 (May 17, 2018).