Thumbnail image for Thumbnail image for Thumbnail image for OpenandCat.jpgMeet Finnick, a very lucky kitty belonging to Sutherland SALT Counsel Open Weaver Banks.

Named after Finnick Odair from The Hunger Games trilogy, Finnick is a former stray that Open had found sleeping under a bush while she was gardening last fall. Shortly before Finnick took up residence in the Banks’ backyard, the family had been having trouble with some pesky chipmunks on their property. Open’s father had suggested she go to an animal shelter and adopt a cat that would live outside. She passed along the idea to her husband, who wondered if Open would get too attached to the adopted cat and end up bringing it inside. About a week later, before the family got to the shelter, Finnick turned up in their garden and Alvin, Simon, and Theodore haven’t been seen since!

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Even though he spends most of his time outdoors, Finnick is an excellent lap cat who loves to be held. But watch out when lap time is over! Finnick will try to stop people from putting him down or leaving him by biting and scratching.

This feisty feline is proud to be April’s Pet of the Month!

By Zachary Atkins and Douglas Mo

A California Court of Appeal held that the sale of real property to a lessee having an original lease term of more than 35 years did not result in a change in ownership triggering reassessment for property tax purposes. Proposition 13 established a 2% per-year ceiling on increases in the assessed value of real property. One of the notable exceptions to this limitation is the occurrence of a change in ownership, after which assessors are authorized to reassess real property at its current market value. A change in ownership has three elements: (1) a transfer of a present interest in real property (“present interest”); (2) including the beneficial use of the real property (“beneficial ownership”); and (3) the value of which real property is substantially equal to the value of the fee interest (“value equivalence”). The person who has a present interest, beneficial ownership, and value equivalence is regarded as the primary owner of the property.

A change in ownership can occur by the creation of a leasehold interest in real property for a term of 35 years or more because the lessee is regarded as the primary owner of the property—the lessee obtains a present interest in and the beneficial use of the property, and the value of the property is substantially equal to the value of the fee interest. The expiration of a leasehold interest in real property with an original term of 35 years or more results in a change in ownership too. In contrast, the creation and termination of a leasehold interest with an original term less than 35 years will not result in a change in ownership because, although the lessee obtains a present interest in and beneficial ownership of the real property, the value of the property is not substantially equal to the value of the fee interest. In other words, the lessor is regarded as the primary owner in a short-term lease of real property.

In 1977, the owner of the subject property entered into a 60-year lease with a general partnership that subsequently constructed and operated a shopping center on the property. In 2006, with approximately 30 years left on the lease, the owner and lessee amended the lease and extended the term another 15 years. The owner sold the property several weeks later to a consortium comprising, among others, a partner in the general partnership that was leasing the property and an outside investor. The question before the Court of Appeal was whether the transactions resulted in a change in ownership.

Drawing on guidance issued by the California Board of Equalization, the court referred to the first transaction as an “over/under/over” scenario—when there is less than 35 years remaining on a lease with an original term of 35 years or more, the parties extend the lease so that the term is, once again, 35 years or more. The court agreed with the Board’s conclusion that the extension of a lease in an over/under/over scenario does not result in a change in ownership. A change in ownership occurred when the leasehold interest for a term of 35 years or more was initially created. The value equivalence shifts to the lessor when, through the passage of time, the remaining term drops below 35 years; however, the extension of the lease causes the value equivalence to shift back to the lessee. No change in ownership occurs because the lessee at all times retained a present interest in and beneficial ownership of the subject property.

The court found that the second transaction—the sale of property encumbered by a lease with an original term of 35 years or longer to the lessee—did not result in a change in ownership. Under California law, a change in ownership does not occur upon the transfer of a lessor’s interest in real property encumbered by a lease with a remaining term of 35 years or more. A rule adopted by the Board follows this statutory exclusion but also provides that a change in ownership does not occur even when the subject property is transferred to the lessee. The court agreed with the rule’s conclusion, noting that all three elements for a change in ownership are present upon the creation of the lease agreement. The transfer of the underlying fee interest, whether to the lessee or a third party, does not create a change in ownership because the lessee retains primary ownership under both circumstances.

A second Board rule says that a change in ownership occurs when the lessor transfers its interest in real property encumbered by a lease with a remaining term of less than 35 years. The court disagreed with this second rule and held that the mere passage of time cannot transfer primary ownership of the property to the lessor. The lessee became the primary owner of the property upon the initial creation of the long-term lease and remained the primary owner upon the transfer of the underlying fee interest.

The court next turned to the issue of whether the lease extension and sale of the underlying fee interest, together, constituted a sham intended to avoid a change in ownership and reassessment of the subject property. The county assessor, wary of the fact that the general partnership was effectively acting as both lessee and buyer, applied the step transaction doctrine and concluded that a change in ownership had occurred. The court held that the step transaction did not apply. The court found no evidence that the outside investor participated in or encouraged the lease extension, which necessarily meant that the parties could not have shared the same goal of avoiding reassessment from the outset. The court also determined that the 15-year lease extension had economic substance independent of the subsequent sale of property. Dyanlyn Two v. Cnty. of Orange (2015) 23 Cal.App.4th 800.

By Stephen Burroughs and Open Weaver Banks

The South Carolina Department of Revenue requested public comment on a draft Revenue Ruling and a draft Revenue Procedure that detail how it will prospectively apply alternative apportionment to multistate taxpayers. This represents the Department’s second attempt at drafting alternative apportionment guidance (previous coverage). The Ruling describes when and how the Department will use alternative apportionment while the Procedure provides specific steps a taxpayer must follow to apply for alternative apportionment. Noteworthy points from the draft guidance include:

  • The Ruling quotes Carmax Auto Superstores for the requirement that the party invoking alternative apportionment must prove by a preponderance of the evidence that: “(1) the statutory formula does not fairly represent the taxpayer’s business activity in South Carolina and (2) its alternative accounting method is reasonable.” 
  • The Procedure requires a taxpayer petitioning for alternative apportionment to explain “why the alternative apportionment method will more fairly represent the taxpayer’s business activity in the State.” This language appears to be a holdover from the draft guidance that the Department abandoned in 2014, which was based on the portion of the Court of Appeals’ Carmax decision that was overturned by the Supreme Court in December 2014 (above).  
  • The Department will not limit its use of alternative apportionment to unique or nonrecurring factual situations. 
  • The Ruling provides a list of factors the Department will consider when determining whether the statutory formula fairly represents the business activity of a taxpayer that is part of a unitary group. Several of these factors relate to whether the taxpayer’s intercompany transactions are at arm’s length. The Ruling specifies that a taxpayer’s transfer pricing study will not be determinative of whether the statutory formula fairly represents its business activity in South Carolina.
  • The Ruling also details the Department’s general unitary combined reporting methodology. The Department will apply the unitary business principle to its constitutional limits and generally employ a water’s edge reporting method. The Department will use the Finnigan method for calculating the group’s sales factor, and will treat a unitary group as a single taxpayer for purposes of sharing tax attributes within the group.
  • If the Department’s alternative apportionment method results in a substantial understatement of tax, the Department will not: (1) extend the statute of limitations to six years; or (2) impose South Carolina’s 25% understatement penalty. 

The Department will accept public comment on both the draft Ruling and the draft Procedure through May 14, 2015. While the Department’s draft guidance represents a good start in clarifying South Carolina’s future use of alternative apportionment, it also raises significant questions regarding its specific application and the Department’s authority for requiring it. S.C. Rev. Proc. #15-X (Draft – 4/21/2015); S.C. Rev. Rul. #15-X (Draft – 4/21/2015).

By Evan Hamme and Timothy Gustafson

The Maryland Tax Court held that the Comptroller can subject an out-of-state subsidiary holding company to tax because the subsidiary did not have real economic substance separate from its parent, which conducted business in the state. The Comptroller assessed ConAgra Brands, Inc. (Brands) for the 1996-2003 tax years, arguing that the company was a mere conduit used to shift its affiliates’ income out of Maryland. A Nebraska-based company, Brands had no employees or property in Maryland and did not otherwise conduct business in the state. Brands, however, held and managed the intellectual property of a number of affiliated companies, all of which were owned by ConAgra Foods, Inc. (ConAgra) and many of which did business in Maryland. Brands licensed the trademarks to the ConAgra subsidiaries from which they had been acquired in exchange for annual royalty payments. These annual royalties were the primary source of Brands’ income and were ultimately paid to ConAgra through various types of intercompany payments. The court focused its inquiry on “whether the taxpayer had real economic substance as a business separate from ConAgra.” The court observed that nearly all of Brands’ revenue was derived from payments from ConAgra and its subsidiaries, the flow of funds from Brands back to ConAgra was “entirely circular,” and “Brands could not have functioned” without the centralized “support services” provided by ConAgra. In addition, the court noted that Brands and ConAgra had interlocking directorates and that ConAgra was partly motivated to create Brands due to possible tax savings. As a result, the court concluded Brands lacked any economic substance separate from its parent. Citing the Maryland Court of Appeals’ decision in Gore Enterprise Holdings, Inv. v. Comptroller of the Treasury (prior coverage here), the court held that the parent’s business thus established taxable nexus for Brands. Because Brands had no property, payroll or sales in the state, the court upheld the Comptroller’s use of a “blended apportionment factor,” which included the apportionment factors of five related entities that filed returns in Maryland. The court waived interest and penalties, however, holding that the Comptroller’s assessment of both for the period following Brands’ appeal was inappropriate, because the state of the law at the time of the assessment was unclear, and Brands acted in good faith in contesting the Comptroller’s assessments. ConAgra Brands, Inc. v. Comptroller of the Treasury, No. 09-IN-OO-0150 (M.D. Tax Ct. Feb. 24, 2015).

 

The Louisiana Court of Appeal reversed and remanded Bridges v. Polychim USA, Inc., No. 581,759, a case in which the trial court held that an out-of-state corporation was subject to the franchise tax by virtue of its indirect ownership interest in a general partnership doing business in Louisiana. Bridges v. Polychim USA, Inc., No. 2014 CA 0307. The court of appeal’s decision is important because it rejected the Louisiana Department of Revenue’s taxability theories, including a unitary business-type standard and a tax avoidance argument, and likely impacts numerous taxpayers with pending refund or assessment cases.

View the full Legal Alert.

On April 13, 2015, Governor Andrew Cuomo signed New York’s 2015-2016 budget legislation, which, among other changes, conforms the New York City general corporation tax to the most significant changes from last year’s New York State corporation franchise tax reform.

View the full Legal Alert.

In the ongoing saga over Colorado’s use tax reporting laws in Direct Marketing Association v. Brohl, the U.S. Court of Appeals for the Tenth Circuit ordered a full briefing on the Comity Doctrine and the Commerce Clause on April 13. The outcome of this case could have broad implications for states and taxpayers seeking to apply constitutional nexus limitations to state taxation.

View the full Legal Alert.

The Multistate Tax Commission’s Arm’s-Length Adjustment Services Advisory Group met via teleconference to continue the design of a program to analyze intercompany transfer pricing. Since they last met on March 4, the Group sent invitations to 48 states to join the program. Of the responding 21 states, 4 states indicated an interest in joining the program: Alabama, Iowa, New Jersey, and North Carolina. The states that declined generally did so because of budgetary constraints and perhaps uncertainty of the ultimate costs of the program. The Group’s goal is to present a final program design to the MTC Executive Committee when they meet in Washington, D.C., on May 7.

View the full Legal Alert.

By Charles Capouet and Madison Barnett

The Florida Department of Revenue determined that a Florida data center’s power fees are not subject to gross receipts tax but may be subject to sales tax. The taxpayer operates a colocation data center and purchases electricity to power the data center from a utility. The taxpayer’s customers have the option of paying for the electricity through a fixed monthly recurring “Breakered Power Fee.” The fee is charged regardless of actual usage, although the customer cannot use more than 80% of the allotted power circuit’s breakered capacity limit. If additional power is needed, the customer may pay for additional power circuits. Florida imposes a tax on certain “gross receipts received by a distribution company for its sale of utility services.” The Department determined that the data center power fees are not subject to gross receipts tax because the taxpayer is “not a distribution company, it charges a set rate based on circuits (and not usage), and it does not manipulate or purify” the electricity it buys. The Department instead characterized the power fees as “consideration for the license to use real property ([that are] taxed accordingly for sales and use tax).” Fla. Dep’t of Revenue, Tech. Assist. Adv. No. 15A-003 (Feb. 24, 2015).

By Suzanne Palms and Open Weaver Banks

The Louisiana Court of Appeal held that GameStop, a video game retailer, correctly applied trade-in credits to reduce the sales price of new items in determining local sales tax due. GameStop accepted used games from its customers in exchange for a trade-in amount on a stored value card (an “Edge Card”) for use by the customer at GameStop at a later date. In computing the tax due on purchases paid for using an Edge Card, GameStop charged sales tax on the sales price of the new purchase, less the trade-in amount taken from the Edge Card. 

Relying on a regulation, the Department argued that the trade-in amount on the Edge Card could not offset the taxable sales price unless the trade-in occurred simultaneously with the sale. The court found that the statute, which excludes the market value of any article traded in from the determination of sales price, does not define “trade-in” and does not set forth any time frame within which a trade-in must occur. Construing the term “trade-in” liberally in favor of GameStop, the court held that Edge Card transactions came within the generally prevailing meaning of “trade-in.” Furthermore, the court determined that the Department’s regulation, requiring a simultaneous trade-in and sale, impermissibly expanded the taxing jurisdiction of the statute. GameStop, Inc., v. St. Mary Parish Sales and Use Tax Dep’t, No. 2014 CA 0878 (La. Ct. App. Mar. 19, 2015).