On June 13, 2018, an Arkansas Administrative Law Judge concluded that a taxpayer’s proceeds from dispositions of tax credits were apportionable business income. In Arkansas, business income arises from either: (1) transactions and activity in the regular course of the taxpayer’s business (the transactional test); or (2) income from the acquisition, management and disposition of property that constitutes integral parts of the taxpayer’s regular business (the functional test). The ALJ followed the Commissioner’s interpretation of the term “integral” and concluded that the taxpayer’s sales of credits “contributed to and were identifiable with (i.e. ‘integral parts of’) the Taxpayer’s trade or business operations.” The taxpayer routinely sold tax credits and had previously lost an appeal on the same issue because its tax credit depositions generated the majority of its federal taxable income. The taxpayer argued that the years at issue in this appeal were different because tax credits no longer constituted the majority of the taxpayer’s federal taxable income. The ALJ rejected this argument, concluding that the proceeds from the dispositions of the credits were integral and business income under the functional test. Dkt. Nos. 18-232, 18-405, Ark. Dep’t of Fin. & Admin., Office of Hearings & Appeals (Jun. 13, 2018).
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.
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.
Wayfair Case Background
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
- Politico, A taxing case on the Supreme Court’s docket“.” Bernie Becker. (April, 17, 2018)
- Tax Notes, “South Dakota Slams Physical Presence Rule as ‘Unworkable and Indefensible.” Jad Chamseddine. (April 10, 2018) (Subscription.)
- Bloomberg, “South Dakota Rebuffs E-retailer Concerns in Last High Court Brief.” Ryan Prete. (April 9, 2018)
- Reuters, “U.S. Supreme Court takes up state online sales tax dispute.” Lawrence Hurley. (Jan. 12, 2018)
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 “Entire 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).
On May 24, 2018, the Circuit Court of Cook County upheld the City of Chicago’s imposition of its amusement tax on streaming services.
- On June 9, 2015, the Chicago Department of Finance issued a ruling indicating that electronically delivered amusements are subject to the amusement tax.
- The circuit court upheld the tax against arguments that the tax violated the federal Internet Tax Freedom Act, the Commerce Clause of the United States Constitution and the Uniformity Clause of the Illinois Constitution, and that the tax exceeds Chicago’s home rule authority.
- Now that Chicago has received a court ruling that the tax does not violate state and federal law, taxpayers should expect that Chicago will aggressively step up their enforcement of the tax.
Maryland Tax Court holds that Maryland’s limitation of interest on refunds resulting from the US Supreme Court’s decision in Comptroller of the Treasury of Maryland v. Wynne violates the US Constitution.
- In 2014, the Maryland legislature passed a law to retroactively limit the statutory interest rate on refunds related to the Comptroller of the Treasury of Maryland v. Wynne decision.
- The Tax Court held that the same rationale used by the Supreme Court in finding the law at issue in Wynne was in violation of the dormant commerce clause also applies to the limited interest rate on Wynne refunds.
- The limited interest on Wynne refunds is also the subject of a separate class action lawsuit filed in the Circuit Court of Baltimore City, which had previously been dismissed due to Plaintiff’s failure to exhaust administrative remedies.
The Oregon Tax Court held that the state was not constitutionally prohibited from imposing its statewide 911 tax on an out-of-state VOIP service provider with no physical presence in the state. The court held that the 911 tax was not a sales or use tax because it was not measured by sales price (rather it was a fixed fee) or imposed on the purchase or sale of telecommunication services (rather on those who have access to the 911 system through such services). Accordingly, the 911 tax was not a tax controlled by the Quill physical presence standard for Commerce Clause purposes. Instead, the court found that the taxpayer’s regular sales of telecommunication devices and services directly to Oregon residents constituted sufficient purposeful availment (Due Process) and substantial nexus with the state (Commerce Clause) to satisfy both constitutional standards. In finding that the tax did not create an undue burden on interstate commerce, the court found that the taxpayer did not show that the tax created a “welter of complicated obligations” similar to the sales and use taxes in Bellas Hess and Quill. Ooma Inc. v. Dep’t of Revenue, No. TC-MD 160375G (Or. Tax Ct. Apr. 13, 2018).
In another of the so-called “Compact” cases, the Oregon Supreme Court affirmed the decision of the Oregon Tax Court and held that: (1) the 1967 Oregon Legislature, in enacting Oregon Statute Section 305.655, did not clearly and unmistakably intend for Oregon to enter into a binding contract that would bind the states under the Oregon and federal contract clauses, and (2) the 1993 Legislature’s repeal of part of Oregon Statute Section 305.655 did not violate the Oregon Constitution by not setting out the text of that statute. In reaching the first part of its holding, the court considered the text, context and legislative history of Section 305.655. The court found that functionally, the terms of the statute did not resemble a contract, because the Multistate Tax Commission did not permit member states to do anything collectively that each state could not do unilaterally. The context of the statute was consistent with the adoption of a uniform law instead of an interstate compact. While the legislative history supports the position that the Oregon legislature understood that it was entering into an interstate compact, the history also supports that the compact would require congressional approval before the compact could go into operation. In reaching its second holding, and relying on one of its prior decisions, the court found that the amendment of Section 305.655 by the 1993 Legislature reflected a complete and perfect legislative choice to replace one set of apportionment formulas with another. In a concurring opinion, three judges reached a different conclusion, finding that the 1967 Oregon Legislature, in enacting Section 305.655, intended to enter into a binding contract, although it ultimately agreed with the majority that the taxpayer did not have a contractual right to enforce Section 305.655. Health Net, Inc. v. Department of Revenue, 362 Or. 700 (2018).
The New Mexico Administrative Hearings Office affirmed the Taxation and Revenue Department’s assessment based on General Electric’s exclusion of foreign dividend and Subpart F income from its base income in its New Mexico consolidated return. In this case of first impression, the Hearings Office held that New Mexico’s inclusion of dividends and Subpart F income received from foreign affiliates, while excluding dividends received from domestic affiliates, did not unconstitutionally discriminate against foreign commerce, did not result in multiple taxation of foreign commerce, and did not result in unfair apportionment of foreign commerce. The Hearings Office engaged in a detailed analysis of US Supreme Court case law regarding state taxation of foreign commerce, as well as the New Mexico Supreme Court’s decision in Conoco, Inc. v. Taxation & Revenue Dep’t, 931 P.2d 730 (N.M. 1996), in which the court prohibited the state from including foreign dividend income in the base for separate method filers because domestic dividends were provided favorable treatment over foreign dividends.
With respect to facial discrimination, the Hearings Office determined that there was no facial discrimination under the consolidated reporting method elected by General Electric, because unlike the separate reporting situation considered in Conoco, the inclusion of the domestic subsidiaries’ income in General Electric’s consolidated group created a “taxing symmetry.” According to the Hearings Office, the consolidated reporting method ensured that the income generation activity of the entire group, including the income ultimately distributed through domestic dividends, is still included. The Hearings Office further found that there was no inevitable multiple taxation of foreign income because the apportionment factor included factor representation of the foreign activity and the New Mexico tax was not imposed on the foreign corporation itself, but was an apportioned tax on the entire domestic consolidated group’s income. Regarding General Electric’s third argument, the Hearings Office held that General Electric had not met its burden of showing that the apportionment method resulted in unfair apportionment of income to New Mexico. The Hearings Office cited the US Supreme Court’s decision in Container Corp. v. Franchise Tax Bd., 463 U.S. 159 (1983), for the proposition that standard three-factor apportionment formulas generally avoid unfair distortion and observed the difficulty of finding that General Electric’s 0.1895% New Mexico apportionment factor was “out of all appropriate proportion” to its New Mexico business activities.
In addition to the rulings based on the Commerce Clause arguments, the Hearings Office held that General Electric had a good faith legal basis for excluding foreign dividends and subpart F income from its New Mexico income, given that this was a case of first impression in New Mexico. As a result, the civil negligence penalty under N.M. Stat. Ann. § 7-1-69 was abated. Finally, the Hearings Office denied General Electric’s request for an award of costs and fees related to the protest. New Mexico law provides for the award of reasonable costs and attorney’s fees when a taxpayer is the prevailing party in an administrative proceeding under N.M. Stat. Ann. § 7-1-29.1. The Hearings Office held that General Electric did not prevail on the major issue of the hearing and therefore was not entitled to costs and fees. In the Matter of the Protest of General Electric Company & Subsidiaries, N.M. Admin. Hearings Office, Decision and Order No. 18-12 (Apr. 6, 2018).
The Commonwealth Court of Pennsylvania affirmed a decision by the Board of Finance and Revenue that found American Electric Power Service Corporation (“Taxpayer”) was subject to Pennsylvania’s gross receipts tax as a wholesale seller of electricity. The Taxpayer presented two substantive arguments, both of which the Court found unconvincing. Taxpayer asserted that it was not subject to the gross receipts tax because it was not a “public utility.” Alternatively, Taxpayer asserted that its sales of electricity were exempt sales for resale because Taxpayer did not provide electricity to end-user customers. The Court found that the Taxpayer was subject to the gross receipts tax because the tax applied to all sales of electric energy, regardless of whether the Taxpayer was subject to the jurisdiction of the Pennsylvania Public Utility Commission. Additionally, the Court found that Taxpayer’s sales did not qualify as sales for resale because the customer to which Taxpayer sold electricity did not fall into one of the statute’s listed entities eligible for the resale exemption. See American Electric Power Service Corporation v. Commonwealth of Penn., Pa. Commw. Ct., Dkt. No. 861 F.R. 2013, (Mar. 15, 2018).