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). 

 

In a decision sure to give Pennsylvania legislators and the Department of Revenue indigestion before their big Thanksgiving meals, the Commonwealth Court held that Pennsylvania’s net loss carryover deduction cap violated Pennsylvania’s Uniformity Clause because it resulted in disparate treatment of similarly situated taxpayers based on the size of the business. 

View the full Legal Alert.

By Zachary Atkins and Marc Simonetti

The U.S. Court of Appeals for the Second Circuit held that the attorney-client privilege and work-product doctrine protected legal memoranda prepared by an accounting firm that were disclosed to third parties. The Schaeffler Group sought to refinance its acquisition debt held by a consortium of banks and restructure its operations during the earliest stages of the economic downturn that subsequently threatened its solvency. Expecting the transactions to draw Internal Revenue Service (IRS) scrutiny, the Schaeffler Group and its eponymous owner (Taxpayers) sought advice from Ernst & Young (EY) on the federal tax consequences of the transactions. In connection with its eventual audit of the Taxpayers, the IRS sought all documents prepared by EY and disclosed to third parties. The Taxpayers withheld certain EY memoranda describing, among other things, the potential tax consequences of the transactions that they had shared with the banks and the banks’ counsel.

Rejecting the IRS’s waiver argument, the Second Circuit concluded that the attorney-client privilege (and necessarily the federal tax-practitioner privilege) applied to the EY memoranda because the bank consortium shared a “common legal interest” with the Taxpayers. The “common legal interest” rule, also known as the joint defense privilege exception, protects the confidentiality of communications from one party to the attorney for another party where the parties and their counsel have agreed on and undertaken a joint defense effort or strategy with respect to a legal matter. Although the refinancing and restructuring had both commercial and legal components, the court concluded that the rule applied because the transactions were tax-law driven, and both parties shared a common interest in ensuring exactly how the tax law applied. 

The court also held that the work-product doctrine applied to the EY memoranda. The work-product doctrine protects documents prepared in anticipation of litigation from disclosure, but it does not extend to documents prepared in the ordinary course of business when the form of the documents would not change even if litigation were expected. The court concluded that the EY memoranda directly addressed the legal issues arising from the refinancing and restructuring transactions and were prepared with an eye toward an anticipated IRS audit and litigation, both of which were highly probable. Schaeffler v. United States, No. 14-1965-cv (2d Cir. Nov. 10, 2015).

Happy Halloween from the Teenage Mutant Ninja Turtles’ Leonardo, Karai, Shredder and April (Counsel Maria Todorova).Thumbnail image for Halloween_Todorova.jpgThe family of Associate Robert Merten is just a couple shy of a full Justice League.Thumbnail image for Halloween_Merten.jpgNice to see Green Lantern (Robert Merten) rocking the Sutherland SALT jacket.Thumbnail image for Halloween_no name.jpg

Associate Zack Atkins’ little man Baird wasn’t too happy with his Superman costume, so they went with the bear hat. We think it was a good choice.Thumbnail image for Halloween_Atkins.jpgPartner Leah Robinson and family step back into pre-historic times for their Halloween.Thumbnail image for Halloween_Robinson.jpgSALT Secretary Candice Alba’s daughter in full character for her photo.  Thumbnail image for Halloween_Alba.jpgSALT Secretary Candice Alba’s son enjoying the fruits of his labor.Thumbnail image for Halloween_Alba2.jpgCounsel Tim Gustafson and family supporting the Badgers, Pack, Spartans and authority figures (of all species)!Thumbnail image for Halloween_Gustafson.jpg
Associate Chris Mehrmann and fiancée Tina Chen-Xu reenact deflategate.Thumbnail image for Halloween-Mehermann.jpgAssociate Stephen Burroughs thought his kids were Beauty and the Beast. His daughter quickly corrected him: “I am Cinderella, Dad. Belle only wears a yellow dress. Cinderella wears blue dresses.”Thumbnail image for Burroughs - Halloween 2015.jpgThis little monkey is the youngest grandson of Sutherland SALT Secretary Debbie Manders.Thumbnail image for Halloween_Maders.JPGSALT Secretary Melissa Bragg enjoyed Halloween with her witch (Emma) and little Monster (Madelyn).Thumbnail image for Halloween_Bragg1.jpg
Associate Madison Barnett’s daughters present an adorable bunny and an important literary figure.
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No Sutherland SALT Halloween would be complete without featuring a SALT pet. Associate Jessie Eisenmenger’s cat Lexie decked out in her devil costume.Thumbnail image for Halloween_Eisenmenger.jpgWe hope your weekend was as fun as ours. Share your Halloween photos with us in the comments or via Twitter @SutherlandSALT.

Read our October 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. 

Thumbnail image for Gracie with toys.jpegMeet Gracie, the two-year-old Rat Terrier who was recently adopted by Atlanta SALT secretary Rether White.

Thumbnail image for Thumbnail image for Gracie in the car.jpgRether adopted this sweet girl through an Atlanta-area rescue group about three months ago, and the two are so happy to have found each other.

Gracie has wasted no time making herself right at home. She loves to play fetch and goes crazy over any round object – balls, eggs, a round top to a jar – you name it. She will happily destroy a tennis ball in less than two minutes.

Like most terriers, Gracie is a digger. Unfortunately for Rether, Gracie’s digging sometimes leads to late night baths. Gracie will go outside after midnight, dig a hole and lay in it until Rether traipses through the wet grass to retrieve her. Once inside, it’s bath time – at 1 a.m. Gracie is happy as a clam to spend this quality time with mom during the wee hours of the morning; Rether not so much.

This silly pooch is grateful to be October’s Pet of the Month!

Louisiana will offer a tax amnesty from November 16, 2015 to December 15, 2015. Taxpayers that agree to pay delinquent taxes will receive a waiver of 33% of penalties and 17% of interest. The 2015 program applies to taxes due prior to January 1, 2015, for which the Louisiana Department of Revenue has issued an individual or business a proposed assessment, a notice of assessment, a bill, a notice, or a demand for payment no later than May 31, 2015. The 2015 program will be the last amnesty program until at least 2025 and taxpayers that do not participate in it may face increased penalties.

View the full Legal Alert.

By Nick Kump and Timothy Gustafson

The Wisconsin Tax Appeals Commission overturned a $2.4 million assessment against an intellectual property (IP) holding company, ruling that the company’s income-producing activities for Wisconsin sales factor purposes – IP licensing and related activities – occurred entirely outside of the state. The taxpayer, a wholly owned subsidiary of the California-based shoe company Skechers USA, Inc. (Skechers), owned all of Skechers’ domestic IP and licensed that IP to Skechers and to unaffiliated third parties across the United States in exchange for a royalty. The taxpayer also engaged in the design, development and marketing of “Skechers” brand footwear from outside of Wisconsin. Despite the taxpayer’s lack of employees, representatives, and real or tangible personal property in the state, the Department of Revenue issued an assessment against the taxpayer based on its parent company’s wholesale sales of shoes bearing and incorporating the “Skechers” IP in the state. The Commission did not address whether the taxpayer had taxable nexus in Wisconsin and rejected the Department’s market-based approach for sourcing the taxpayer’s royalty income, finding that the sale of shoes was Skechers’ income-producing activity, not the taxpayer’s. Given that the taxpayer’s licensing activities occurred entirely outside of the state, the Commission concluded that its Wisconsin sales factor was zero. As a consequence of the ruling, several other cases held in abeyance will now move forward to determine whether the Department properly denied Skechers’ deductions for the royalty payments made to its subsidiary. Skechers USA, Inc. II v. Wisconsin Department of Revenue, No. 10-I-173 WI (July 31, 2015). 

By Zack Atkins and Timothy Gustafson

The Oregon Tax Court held that the Multistate Tax Compact (Compact), which allows for an equally weighted, three-factor apportionment formula, was an illusory contract and its terms had been effectively disabled by the Oregon Legislature. The statute in question, ORS 314.606, provides that in case of conflict the provisions of ORS 314.605 to 314.675, which codified the Uniform Division of Income for Tax Purposes Act, trump the provisions of ORS 305.655, which codified the Compact. The taxpayer argued that ORS 314.606 violated, among other things, the Contract Clause of the Oregon Constitution and the Contract and Compact Clauses of the U.S. Constitution. The court concluded, as a threshold matter, that ORS 314.606 was intended to disable the Compact election rather than provide taxpayers with an alternative means of apportioning their income. The court also held that the state’s codification of the Compact did not create a statutory contract because, under Oregon law, any promises the state purportedly made when it adopted the Compact lacked consideration. The terms of the Compact gave member states the unconditional right to withdraw at any time without having to satisfy any conditions precedent, and it contained no reciprocal promises. The court also observed that member states had modified or disabled provisions of the Compact for years without any objection from other member states, which was evidence that the member states regarded the Compact as non-binding. Based on the foregoing, the court held that ORS 314.606 did not impair any contractual obligations in violation of the Oregon Contract Clause or the federal Contract Clause. The court noted that even if a statutory contract had been created, the federal Contract Clause would not have barred the state from disabling the Compact election (and thus modifying its financial obligations) because doing so was reasonable and necessary to serve two important public purposes: protecting the fisc and ensuring that all businesses are on equal footing. Health Net, Inc. v. Dep’t of Revenue, No. 5127, 2015 WL 5249431 (Or. Tax Ct. Sept. 9, 2015).