In another taxpayer victory, the New Jersey Superior Court, Appellate Division held that an intangible holding company was not required to throw out any of its so-called “nowhere receipts” from an affiliated tobacco company in computing the denominator of its receipts factor. In Lorillard Licensing Company LLC v Dir., Div. of Taxation, the court held that New Jersey’s economic nexus standard must be applied to determine whether a corporation is “subject to tax” in other jurisdictions for purposes of New Jersey’s Throw-Out Rule. Further, the court held that it is irrelevant whether the corporation actually filed returns in or paid tax to those other jurisdictions. The Appellate Division agreed with the Tax Court that “New Jersey has no legitimate interest in considering the tax policy and practices of other States when determining whether to apply the Throw-Out Rule.” 

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By Suzanne Palms and Charlie Kearns

The Commonwealth Court of Pennsylvania held that network infrastructure services (including local dial networks, telephone numbers and modems, i.e., Internet “backbone”) sold to Internet service providers (ISPs) to provide Internet access to end users were not subject to Pennsylvania sales and use tax. The commonwealth court found that the taxpayer, a facilities-based provider of backbone services, was not subject to Pennsylvania sales and use tax on its sales because such transactions were charges for access to the Internet excluded from the definition of taxable “telecommunications service.” Under Pennsylvania sales tax law, “[c]harges for access to the Internet” includes access to the Internet but does not include “telecommunication services purchased by an [ISP] to deliver access to the Internet to its customers.” 72 P.S. § 7201(rr)(3)(B).

On audit, the Pennsylvania Department of Revenue (Department) assessed sales tax for the tax periods January 1, 2000, through April 30, 2003, on the grounds that the taxpayer’s sales of Internet backbone services were taxable sales of telecommunications service. Specifically, at issue was the taxpayer’s sale of services to America Online, Inc. (AOL), a retail ISP. The commonwealth court distinguished the America Online, Inc. v. Commonwealth, 932 A.2d 332 (Pa. Cmwlth. 2007), case in which it previously held that port management services offered by a third-party service provider were taxable telecommunications services. Here, the commonwealth court found that there were fundamental technological differences between the taxpayer’s service and the service at issue in the AOL case. In AOL, among other relevant facts, the third-party service provider controlled and managed the analog calls that traveled along its network to the taxpayer’s modems. In this case, however, the analog calls traveled from end users through the taxpayer’s modems and over the taxpayer’s network, which then converted the analog calls to digital signals via Internet protocol. The commonwealth court next found that because the taxpayer’s facility was an access point that established an end user’s connection with the Internet (a “Point of Presence” or “PoP”), the taxpayer’s Internet backbone service constituted “Internet access service” per se. Thus, unlike the service at issue in AOL, which in the court’s view was telecommunications service purchased by ISPs to provide Internet access service, the taxpayer’s service in this case provided end users with a connection to the Internet at the taxpayer’s PoP facility. Accordingly, the commonwealth court determined that the taxpayer’s backbone services fell squarely within the Pennsylvania statutory exclusion for “[c]harges for access to the Internet.”

Of note, the taxpayer in Level 3 also argued that the Department’s assessment of sales tax on its Internet backbone services violated the Internet Tax Freedom Act, 46 U.S.C. § 151 (ITFA). However, because the commonwealth court resolved the case under Pennsylvania sales tax law, it did not address the taxpayer’s ITFA preemption argument. Level 3 Communications, LLC v. Commonwealth of Pennsylvania, 166 F.R. 2007 (Commw. Ct. Oct. 15, 2015).

By Nick Kump and Charlie Kearns

On October 27, the Michigan Court of Appeals affirmed the trial court’s decision in favor of the taxpayer and held that several contracts for data processing services, access to computer programs and databases, and other online services did not include the use of taxable prewritten computer software. After considering the definitions of key statutory terms such as “prewritten computer software,” “computer software,” “delivery” and “use,” the court developed a test to determine when online transactions involving access to computer programs and associated services can be considered taxable prewritten computer software: “if plaintiff exercised control over a set of coded instructions that was conveyed or handed over by any means and was not designed and developed by the author or other creator to the specifications of a specific purchaser.” Applying this test to each of the transactions at issue, the court generally found that accessing and using computer programs via a web browser, or submitting data for analysis to third-party computer programs, did not constitute delivery of prewritten computer software because the plaintiff did not control the software’s code. In those contracts where the vendor provided written materials or the plaintiff had to download computer software onto its computers, the court applied the six-factor “incidental to service” test from Catalina Mktg Sales Corp v. Dep’t of Treasury, 470 Mich. 13 (2004) and found that in each case the tangible personal property was incidental to the service that the plaintiff contracted for. Specifically, the court reasoned, “[t]here is no indication that plaintiff could purchase the software or other tangible personal property independent of the services, and the services gave value to the software and other tangible personal property.” Auto-Owners Ins. Co. v. Dep’t of Treasury, No. 321505 (Mich. Ct. App. Oct. 27, 2015).

Read our November 2015 posts on stateandlocaltax.com or read each article by clicking on the title. For the latest coverage and commentary on state and local tax developments delivered directly to your phone, download the latest version of the Sutherland SALT Shaker mobile app. 

 
 
 

By Nick Kump and Charlie Kearns

The Iowa Department of Revenue issued a policy letter declaring that the delivery of a digital software key on a tangible card is exempt from sales tax, as long as the software itself is delivered digitally and there is not a separate charge for the key. Iowa Code section 423.3(67) exempts from sales tax the “sale price of a sale at retail if the substance of the transaction is delivered to the purchaser digitally [or] electronically . . . .” However, under Iowa Admin. Code r. 701-231.14, even if a product is ordered digitally or electronically, the sale of the product is not excluded from sales tax if the product is delivered by conventional, physical means such as common carrier. The Department compared the conventionally delivered digital software key to the electronically delivered software, and concluded that even though the customer could not access the software without the digital key, the software was the “substance of the transaction.”  Therefore, the entire transaction was exempt from sales tax. Sales of Software in Iowa, Iowa Dept. Rev. Policy Letter, Document No. 15300041 (Sept. 30, 2015) (released Nov. 2, 2015).       

By Nick Kump and Charlie Kearns

The Ohio Board of Tax Appeals held that medical transcription services are taxable automatic data processing services, rather than tax-exempt personal or professional services, because of the minimal level of personal skill involved in transcription services. Under Ohio law, personal or professional services are not subject to Ohio sales and use tax. To qualify as a personal or professional service, the service provider must apply specialized cognitive skills to “study, alter, analyze, interpret, or adjust” data provided by the customer. In its decision, the Board looked to both the expectations of the customer, here a medical practice, and the transcriptionists’ duties to determine whether medical transcription should be an exempt personal or professional service. While transcriptionists must decipher different physicians’ speech patterns and properly transcribe medical terminology, the transcriptionist merely reduces the physicians’ spoken word to written form verbatim without altering the substantive content. Additionally, the Board considered that there was no specialized training required of transcriptionists to perform their jobs, no licensing or certification process that must be completed in order to work as a transcriptionist, and no regulatory authority that oversaw the profession. As a result, the medical transcription services were subject to Ohio use tax. Dayton Physicians, LLC v. Testa, Ohio BTA, Case No. 2014-3986, 09/28/2015; Columbus Oncology Assoc., Ohio BTA, Case No. 2014-3984, 09/28/2015.

By Stephen Burroughs and Charlie Kearns

The Indiana Department of Revenue (Department) concluded that a company’s employment screening and background checking services are not subject to sales tax. The company in this matter receives requests from customers seeking to verify the background, employment history or education of a potential employee or tenant. The company then compiles information from various government databases, courthouse records and educational institutions to create a customized report for the customer. The customer may only view the custom report by accessing the company’s secure website. 

Indiana does not tax electronically delivered items unless the item constitutes a taxable digital product, prewritten software or a telecommunications service. The Department determined that the company’s custom reports are not similar to digital songs, movies/TV shows or books and therefore are not taxable as a digital product. It further concluded that the customized nature of the background checks excluded them from the definitions of telecommunications service and prewritten software. The Department’s conclusions are consistent with the provisions of the Streamlined Sales and Use Tax Agreement (see Sections 333 and 332) that require its Member States (including Indiana) to exclude electronically transferred products from their respective definitions of tangible personal property unless the item is separately delineated as taxable. Ind. Dep’t of Revenue, Rev. Rul. No. 2013-07ST (Oct. 1, 2015).  

 

jaxmolly.jpgThis month’s Pet of the Month column begins as a tribute to two cherished Labrador Retrievers belonging to Angie Moore, Tax Director at Liberty Media. Sweet Molly and Jax passed away suddenly within three weeks of each other this past summer. They were siblings to Bogey, a seven-and-a-half-year-old Shih Tzu who Angie has had since he was just a pup.

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Sometimes called “Boge” for short, he learned to swim alongside Molly. He even shared a bed with the two Labs and would spoon Molly as they fell asleep. 

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After losing both members of his pack, Bogey had trouble adjusting to life as an only child. Enter Cooper, a Chocolate Lab, who is now a little over seven months old and all puppy. Bogey adores his new rambunctious brother.

Cooper and Bogey enjoy playing with their favorite toy – a multi-leg squeaker-filled frog. (Sometimes Angie’s granddaughter likes to hold onto a leg and get in on the tug-of-war action with them!) The two also share an affinity for dog chews especially each other’s bone. Angie says she could lay out 10 bones in front of them, and the most desirable one would still be the one in the other’s mouth.

These handsome boys are so very thankful to be the November Pets of the Month.

By Liz Cha and Timothy Gustafson

In its first decision on combined unitary reporting since Vermont adopted combined reporting in 2006, the Vermont Supreme Court held that the AIG insurance group was not unitary with its wholly owned ski resort subsidiary, Stowe Mountain Resort. Applying the U.S. Supreme Court’s test for unity articulated in Mobil Oil Corp. v. Comm’r of Taxes, 445 U.S. 425 (1980), the Vermont Supreme Court determined that Stowe was a distinct business operation from AIG, and there was not enough evidence to support a “linkage of economic realities” between Stowe’s operations in Vermont and AIG’s operations outside the state. First, the court determined there were no economies of scale between AIG’s insurance and financial services business and Stowe’s dissimilar ski resort business. Second, despite AIG being Stowe’s sole shareholder with the power to appoint AIG board members to Stowe’s board, the court held there was no centralization of management because Stowe did not have common purchasing, advertising or marketing with AIG. The evidence also failed to show that AIG’s control over appointments to Stowe’s board resulted in actual control over Stowe’s operations, because Stowe made its own operating decisions. Third, the court determined that AIG and Stowe were not functionally integrated because AIG and Stowe operated in different lines of business, were not part of a vertically integrated enterprise, and did not engage in joint purchasing or other common activities. The court also concluded that the financing Stowe received from AIG—Stowe’s sole lender—served an investment function rather than an operational function for AIG and noted that such intercompany financing alone, absent other indicia of unity, was not sufficient to warrant combination. While acknowledging AIG filed on a combined basis in 15 other jurisdictions, the court nevertheless found that such representations to other states “cannot create a unitary operation where it does not otherwise exist.” AIG Ins. Mgt. Serv. Inc. v. Department of Taxes, No. 2014-312 (Vt., November 20, 2015).

By Samantha Trencs and Open Weaver Banks

The Texas Comptroller of Public Accounts and the New York Courts have treated a former in-house attorney turned whistleblower very differently—Texas made a substantial payment to the individual, and New York kicked him to the proverbial curb.

The Texas Comptroller of Public Accounts paid $117,000 to David Danon, a former in-house tax attorney at Vanguard Group Inc. for his role as a confidential informant in a tax audit of the company. 

Pursuant to federal and state False Claims Acts, whistleblowers may be entitled to a share of any damages sustained as a result of a defendant’s false claims to the government. Danon’s allegations were first made public in a New York State False Claims Act suit in which he claimed Vanguard operated as an illegal tax shelter and evaded billions in taxes by avoiding payroll withholding obligations and charging artificially low prices to its related funds for investment management and administrative services. According to Danon’s attorney, Stephen Sorensen, more payments could be coming Danon’s way because whistleblower investigations are underway in California, at the Internal Revenue Service, and at the Securities and Exchange Commission.

In sharp contrast to the result in Texas, the New York courts frowned upon Danon’s actions, given that his access to confidential information was granted while he had ethical obligations to keep the information confidential. In a recent decision of the New York Supreme Court (a trial level court in New York), Danon’s qui tam action against Vanguard was dismissed due to Danon’s violations of attorney ethics rules. The trial court did not reach the merits of the case, but relying on analogous federal law found that Danon, as a former in-house attorney, “may not proceed with, nor profit from, any disclosures of confidential information . . . in violation of New York State attorney ethics rules.” The court rejected Danon’s argument that the disclosures of confidential client information were permitted in order to avoid a crime. State of New York ex rel David Danon v. Vanguard Group, Inc., Index No. 100711/13 (N.Y. Sup. Ct., Nov. 13, 2015).