By Zack Atkins and Tim Gustafson

The Washington State Department of Revenue ruled that an out-of-state baker whose only in-state “presence” was its use of in-state independent commissioned sales representatives to solicit orders had substantial nexus with Washington and therefore was subject to the state’s business and occupation (B&O) tax. The taxpayer contracted with the in-state representatives to solicit orders in a territory that included Washington. All orders were sent to the taxpayer outside of Washington for approval. Relying on the state statute and administrative rules in effect at the time and case law standing for the proposition that substantial nexus for B&O tax purposes can be established through the use of independent agents contracted to perform in-state activities, the Department concluded that the independent commissioned sales representatives provided significant services that enabled the taxpayer to establish and maintain a market in Washington. The Department also found that, even though shipment was made by common carrier and title passed to the customers outside of Washington, the taxpayer’s sales to Washington customers occurred in Washington because the baked goods were received there. Commercial law and UCC “delivery” terms, the Department said, are not dispositive for B&O tax purposes. Det. No. 16-0149, 35 WTD 613 (2016).

By Zack Atkins and Marc Simonetti

A federal district court denied a taxpayer’s motion to dismiss a lawsuit brought under the New York False Claims Act (FCA) for lack of subject matter jurisdiction and remanded the action to state court. The relator, an Indiana University professor, alleges that Citigroup violated the FCA by deducting net operating losses on its New York franchise tax returns while knowing that it was not entitled to such deductions under the New York Tax Law. The federal government acquired a substantial interest in Citigroup under its Troubled Asset Relief Program. While IRC § 382 generally limits net operating loss carryforwards that can be deducted after an “ownership change,” the IRS issued multiple notices indicating that it would not treat such acquisitions as ownership changes. The relator claims that Citigroup underpaid its tax liability because the IRS’s notices are invalid and therefore cannot be relied upon or, alternatively, that the notices were never incorporated into the New York Tax Law. The federal district court observed that while Citigroup’s arguments for dismissal—all of which were grounded in state law—were “potentially meritorious,” the lawsuit “does not truly present a federal question.” The lawsuit calls into question the validity of the IRS’s notices but the court held that the relator lacks standing to challenge the validity of the notices. Because it could conceivably resolve the relator’s FCA claim without deciding whether the IRS’s interpretation of IRC § 382 was arbitrary and capricious, the court concluded that the relator’s complaint did not necessarily raise a federal issue and therefore remanded the case to state court. State ex rel. Rasmusen v. Citigroup, Inc.

By Mike Kerman and Open Weaver Banks

The West Virginia Supreme Court held that a credit for taxes paid to other states on purchases of motor fuel is constitutional only if interpreted to include taxes paid to subdivisions of other states. The court determined that a credit that applies only to taxes paid to other states, and not localities, would violate both the fair apportionment and discrimination prongs of the U.S. Supreme Court’s Complete Auto test. If the court did not interpret the credit to include local taxes, a taxpayer who purchased motor fuel in a state without a local tax, or a taxpayer who purchased motor fuel in-state, would have a lower overall tax burden than a taxpayer who purchased motor fuel subject to a state and local tax. This would create a total tax burden on interstate commerce that is higher than an intrastate transaction, and therefore discriminate against interstate commerce. Although the statute’s terms apply only to allow a credit for taxes paid to other states, the court interpreted it to apply to local taxes as well, to avoid an unconstitutional application. No. 15-0935. 

By Chelsea Marmor and Madison Barnett

The California Court of Appeal upheld Comcast’s $2.8 million franchise tax refund. The court determined that: (1) Comcast and its subsidiary QVC were not unitary, such that QVC was properly excluded from Comcast’s combined group, and (2) a termination fee Comcast received from a failed merger constitutes apportionable business income. Comcast and QVC were not unitary because Mobil Oil’s three hallmarks of a unitary relationship—centralized management, functional integration and economies of scale—were not present.  The court concluded that because QVC’s day-to-day operations were conducted by QVC’s management independently from Comcast a non-unitary finding was justified. On the second issue, the court held that a merger termination fee satisfied California’s transactional test for business income. Sutherland represented the taxpayer in this matter. ComCon Prod. Serv. I Inc. v. Franchise Tax Bd., No. B259619 (Cal. Ct. App. 2016).

Tinkering with a state’s interest provisions can be a hidden way to increase revenue without expanding the base or increasing the tax rate—an important work-around for legislators who have pledged not to increase taxes. However, fundamental fairness requires states to follow specific tenets related to interest provisions. View this State Tax Notes article, which outlines four tenets that states should follow to ensure sound tax policy:

  • Interest provisions should be neutral and evenhanded;
  • Interest should compensate parties for the time value of money;
  • The legislature, not the tax department, should set the applicable interest rate; and
  • Interest provisions should be predictable and consistent.

Read the full State Tax Notes article by Sutherland SALT attorneys Jonathan Feldman and Samantha Trencs.

By Jessica Allen and Jeff Friedman

The Tennessee Department of Revenue (Department) released a letter ruling stating that a taxpayer’s charges for use of its web-based interface are subject to sales and use tax as the sale of ancillary services. The taxpayer’s proprietary software allows users to communicate through text and other messages on a single centralized web-based interface. The Department explained that the state imposes tax on the sale of telecommunications services and ancillary services. Telecommunication services are defined to include the transmission of data. Ancillary services include services associated with telecommunication services. Because the taxpayer’s web-based interface was “associated with, or incidental to, the provision of telecommunication services,” the interface qualifies as the sale of taxable ancillary services and therefore is subject to sales and use tax. Tenn. Letter Ruling 16-09, Tenn. Dep’t of Revenue (issued Nov. 10, 2016).

By Nick Kump and Amy Nogid

The Colorado Department of Revenue (Department) released a non-binding general information letter,  concluding that a marketplace provider’s payment of sales tax on transactions involving “jointly responsible” third-party retailers discharges the obligations of the third-party retailers to collect and remit sales tax. By statute, the Department has discretionary authority to treat an agent for a retailer as “jointly responsible” for the collection and remittance of sales tax, and can pursue the retailer’s agent when it is “necessary for the efficient administration” of the sales tax. Here, the marketplace provider, which operates a marketplace for third-party digital products such as games, apps, movies and books, and collects and remits sales tax on purchases of the third-party products, stated that it did so as a “jointly responsible” retailer. Relying on the principles of contract law, the Department determined that while both parties were liable for the full amount of sales tax, the marketplace provider’s payment of the correct amount of sales tax discharged the third-party retailers’ sales tax obligations. However, even though the third-party retailers were relieved of their immediate sales tax obligations, the Department could still collect the tax from either the marketplace provider or the third-party retailers, if a deficiency were to occur in the future. The Department added that if the marketplace provider exercises reasonable diligence when accepting an exemption certificate or sales tax license, then both of the jointly responsible retailers would be relieved of liability for collecting tax if the Department later determines that the exemption did not apply. Colo. Gen. Info. Letter No. GIL-16-020 (Colo. Dep’t Revenue Oct. 4, 2016, released Dec. 7, 2016). Colo. Gen. Info. Letter No. GIL-16-020 (Colo. Dep’t Revenue Oct. 4, 2016, released Dec. 7, 2016).

By Christopher Lutz and Jeff Friedman

On December 15, 2016, the Tennessee Joint Government Operations Committee held a hearing regarding the governor’s proposal to establish an economic nexus standard for the state sales tax. Under the proposal, remote sellers would be subject to collection obligations in the state if their Tennessee sales exceed $500,000. The rule would require out of state dealers to register with the DOR by 3/1/2017 and to begin collecting and remitting July 1, 2017. Testifying on behalf of the proposal were Larry Martin (Commissioner of Dept. of Finance and Administration), David Gerregano (Commissioner of Revenue); and Herbert Slatery (Attorney General). The proposed regulation was allowed to go forward with a vote of “no recommendation.” 

The principal skeptic of the proposed regulation was Rep. Mike Stewart (D-Nashville), who gave the rule a negative recommendation. During the hearing, Stewart noted that the State just passed legislation addressing physical presence with respect to franchise/excise and business taxes. Rep. Stewart observed that “it would seem if we chose to use statutes to get rid of physical presence for other taxes, isn’t what we’re doing here today most appropriately done through the legislation and not a regulation?” This question came up several times during the hearing, and the Department relied on Public Chapter 789 (1988), a 1988 bill, that it says establishes an economic nexus standard for sales tax (to this, Rep. John Ragan (R- Oak Ridge) replied, “We’ve also heard that a 1992 case is old, so I’d say that about the 1988 statute too”). Chairman Mike Bell (R- Riceville) also explicitly stated that the change should be “brought as a statute rather than a rule.” Others were explicit in their belief that this is something the US Congress, and not Tennessee, should do, such as Senator Mae Beavers (R- Mt. Juliet), who said, “I think this is something that federal congress should do.  I think this is completely out of our purview and we’ve wasted a lot of tax dollars here in something that is not our decision to make.” In summarizing his thoughts, Rep. Stewart said, “I want to point out that Colorado specifically suggested to the court in a brief that they use this DMA case as the vehicle to overturn Quill, and the fact that the Supreme Court didn’t suggest that, as with Streamlined Sales Tax, which never got off the ground, I’m just not sure that the landscape is really changing, and this regulation would put Tennessee at odds with most other states. We don’t do things to businesses that are unusual or strange, and I worry that this regulation would make us the odd man out. I recognize some states have deviated, but most states stick with physical presence.”

Another issue that came up in the meeting, a question raised by Rep. Ron Lollar (R-Bartlett), was whether the state would “consider giving relief to businesses in the state” upon adoption of the economic nexus standard.  Mr. Martin reiterated that this was something the Governor’s office is certainly open to.

From the community, 4 people spoke, 3 against the proposal, and one in favor.  Against the proposal was Steve Roth, general counsel of Jewelry Television; Carl Szabo, counsel at Net Choice; and George Gruhn, CEO of Gruhn Guitars Incorporated. In favor was Allen Dotty, co-owner of Cumberland Transit. Bill Fox, of University of Tennessee, also provided a presentation in favor of the proposal.  

Finally, Rep. Ragan ended by noting that if the governor would like to proceed with legislation rather than a regulation, the opportunity exists. The filing deadline is not until February. Ragan stated that he thinks “the administration would be well served by suggesting this to some of us willing to carry it. That way we avoid the concern that it is a regulation rather than legislation.” 

By Eric Coffill

New Oregon Gross Receipts Tax Proposal. On December 14, 2016, the group behind Measure 97 (which was defeated at the November 2016 general election), released a booklet setting forth its 2017 legislative proposals. The document includes the basic structure for a new “$100 Million Business Tax” “and is “calling on the Legislature to create this tax.” Highlights of this new gross receipts tax are (1) A 2% tax on Oregon gross receipts (M97 was 2.5%.): (2) All types of businesses would be subject to the tax. (M97 only applied to C corporations.); (3) Utility companies would be exempt; and (4) The threshold for applying the tax would be $100 million of Oregon gross receipts. (M97 had a $25 million threshold.) The booklet states this gross receipts tax would raise $4 billion per biennium (as opposed to the $6 billion that M97 was projected to raise). It is not entirely clear whether this proposal would operate like Measure 97, which modified Oregon’s corporate minimum tax, or if it would replace Oregon’s corporate income tax. However, the $4 billion revenue estimate suggests it would operate as would Measure 97, i.e., as a corporate minimum tax. To date, there is no Oregon legislative sponsor or author identified with this proposal (nor any draft bill language). “A Better Oregon Budget Report,” Dec. 14, 2016, http://www.abetteroregon.org/time-finally-invest/.

City of Portland Enacts Surtax on CEO Pay. On December 7, 2016, on a 3-1 vote (with one absence),the City Counsel of Portland approved a surtax (in addition to the 2.2% tax Business License Tax) on publicly traded companies operating there whose Chief Executive Officers earn at least 100 times as much as their median workers. Specifically, for tax years beginning on or after January 1, 2017, a 10% surtax is imposed if a company subject to the (2015 adopted) U.S. Securities and Exchange Commission pay ratio reporting requirement reports a pay ratio of at least 100:1, but less than 250:1, on SEC disclosures. If the reported pay ratio is 250:1 or greater, a 25% surtax is imposed. The Portland Revenue Division estimates there are approximately 550 public traded companies that are subject to and paying the City’s Business License Tax with collective liability of $17.9 million annually, and that the new surtax would increase revenue by $2.5 million to $3.5 million annually. Portland City Ordinance 7.02.500, as amended; see also Portland Revenue Division Impact Statement, December 2014 Version.

By Charles Capouet and Andrew Appleby

The Washington Supreme Court held that drop shipments and sales from out-of-state are subject to the Washington business and occupation (B&O) tax even when an in-state office was not involved in placing or completing the sales. A wholesaler of electronic components and computer technology worldwide sold products through its Arizona headquarters and its many regional sales offices, including one in Washington, but excluded its national and drop-shipped sales from its B&O tax liabilities. The taxpayer shipped goods into Washington from an out-of-state warehouse. The products were delivered to the customers at its Washington branch, but the goods were billed to the out-of-state office.

The taxpayer argued that the substantial nexus prong of the dormant Commerce Clause was not met because the Washington office was not involved with the sales. The court held that “merely showing that an in-state office was not involved in the placing or completion of a national or drop-shipped sale is insufficient to dissociate from the bundle of in-state activities that are essential to establishing and holding the market for its products.” The Washington employees provided the corporate office with market intelligence regarding Washington markets, met with the taxpayer’s sales teams and suppliers to strategize on how to create a greater demand for the products and services, and worked with customers to improve products and design new prototypes. The in-state activities created nexus and satisfied the dormant Commerce Clause for the taxpayer because they were “at least minimally associated with [the taxpayer’s] ability to establish and maintain a market in Washington for the sale of its products.”

The taxpayer also argued that a Washington regulation barred the imposition of the B&O tax on both categories of sales. The rule stated that “Washington does not assert B&O tax on sales of goods which originate outside this state unless the goods are received by the purchaser in this state and the seller has nexus.” The court held that the imposition of the B&O tax to the taxpayer’s sales was proper because the rule defined “received” as including the purchaser’s agent receiving the goods. Thus, the taxpayer’s buyer would qualify as either the purchaser or as the purchaser’s agent. Avnet, Inc. v. Washington Department of Revenue, No. 92080-0 (Wash. Nov. 23, 2016) (en banc).