Clydesdales 3.jpgMeet Isabella and Zelda, the latest additions to the family of Carley Roberts, partner in Sutherland’s Sacramento office, and her husband, Jeremy (you may recall some of Carley’s other pets, featured here and here). These Clydesdales (technically Shires, a type of “draft” or working horse) joined the Roberts’ ranch in September to be companions for their other Clydesdale, 007. Seven lost his half-brother suddenly in 2008 and was never the same, often spotted with his head down in the pasture. For years Carley and Jeremy tried to mix isabella_the_horse.jpgSeven with other non-draft horses, but he remained an outcast. Isabella and Zelda came to the ranch as babies, five and six months old, from Indiana and were led to Seven’s pasture. He immediately began calling out to them in anticipation, while all of the other horses ran the other way. Could it be that he recognized his own kind? Yes! The three have been inseparable ever since. Seven does not let the two out of his sight, and likewise the two fillies look to Seven for protection from the other horses on the ranch. People may say animals do not have the same emotions as humans, but Seven, Isabella and Zelda certainly have us believing otherwise, and we are thrilled to feature these two beauties as Pets of the Month!

By Stephen Burroughs and Andrew Appleby

A Vermont Superior Court held that the Commissioner of Taxes unconstitutionally applied the unitary business principle to AIG and its subsidiary, Stowe Mountain Resort. Stowe operates a ski resort, lodging and conference business in Vermont. None of AIG’s other 700 subsidiaries resemble a ski resort, and the Commissioner acknowledged that AIG was not actively involved in Stowe’s ski business. The Commissioner’s argument for unitary combination was based on AIG’s purported active management of Stowe’s financial operations, including the following administrative level findings: loans by AIG not made at arm’s length, management of expansion efforts at the resort by AIG, AIG’s assistance with financial and asset management expertise and various centralized corporate services, and AIG’s provision of marketing support through resort discounts offered to AIG employees. The Commissioner ultimately argued that Stowe was dependent upon AIG loans for its financial viability, and a separate accounting would not capture the true financial picture of AIG’s involvement with Stowe’s operations. But the Commissioner’s findings lacked one critical ingredient—adequate support from the record. The court held that the Commissioner’s findings “far outrun the evidence, which unambiguously shows that Stowe was a discrete business that did not send taxable value out of state in any appreciable way.” AIG offered uncontradicted testimony from several key AIG executives and independent Stowe consultants, whose testimony combined to describe a discrete business enterprise. Accordingly, the court held the Commissioner’s finding of unity at the administrative level was outside the constitutional boundaries of the unitary business principal. This decision represents an important taxpayer victory, as it is one of the first court decisions to apply the unitary business principle to Vermont’s combined reporting statutes. AIG Insurance Mgmt. Services, Inc. v. Vermont Dept. of Taxes, No. 589-9-13 (Vt. Sup. Ct., July 30, 2014).

By Sahang-Hee Hahn and Pilar Mata

The New Jersey Tax Court ruled for Toyota Motor Credit Corp. on three issues for New Jersey Corporate Business Tax purposes. Specifically, the court upheld the taxpayer’s gain calculation method using an upwardly adjusted federal tax basis; upheld the taxpayer’s departure from federal bonus depreciation rules; and set aside the Division’s application of the throwout rule to the taxpayer’s receipts for tax years 2003-2006. The taxpayer operated a vehicle leasing business whereby it leased vehicles to consumers and sold the used vehicles after the lease period ended. On the gain calculation issue, the court analogized the taxpayer’s case to a prior decision, Moroney v. Director, Div. of Taxation, 376 N.J. Super. 1 (App. Div. 2005), and ruled the gain from the sale of used vehicles could be calculated using a tax basis upwardly adjusted for depreciation deductions taken for federal tax purposes. On the decoupling issue, the court held that the Division’s regulation constituted an unreasonable exercise of authority because it limited the State’s decoupling provision to property acquired after January 1, 2002 for a fiscal year beginning on or after January 1, 2002, whereas the governing statute states that New Jersey’s decoupling provisions apply to property acquired after September 10, 2001 and before September 11, 2004. On the throwout issue, the court determined that the Division could not “throw out” receipts sourced to Nevada, South Dakota and Wyoming from the taxpayer’s receipts factor denominator because it had sufficient contacts with each state to merit the inclusion of such receipts. The court noted the taxpayer had paid tax to Nevada on its lease receipts and that such fact was irrelevant to whether the tax was on the taxpayer’s business activity or a sales tax. The court also ruled the taxpayer had a sufficient in-state presence in South Dakota and Wyoming through its in-state property or payroll. This case provides helpful guidance for taxpayers seeking either to compute gains using a non-federal tax basis or to defend against the Division’s throwout adjustments for prior tax years. Toyota Motor Credit Corp. v. Dir., Div. of Taxation, Dkt. No. 002021-2010 (Aug. 1, 2014).

By Ted Friedman and Andrew Appleby

The Indiana Department of Revenue determined that an Indiana taxpayer owed use tax on its rental of equipment from a related entity. After concluding the taxpayer was involved in a retail transaction when it rented equipment from a related entity, the Department imposed use tax on the taxpayer’s storage, use or consumption of the equipment in Indiana. The taxpayer asserted an equitable argument, contending that because its related entity paid tax at the time of the related entity’s purchase of the equipment, and the related entity did not request a refund of such tax from the Department, the taxpayer should receive credit for the amounts paid by the related entity against the use tax on the rental transactions. The Department concluded that the taxpayer and its related entity were two separate taxpayers, and whether the related entity was responsible for the tax on its original purchase of equipment or could have filed a refund claim due to an exemption was “irrelevant to and beyond the scope” of the taxpayer’s protest for the rental transactions at issue. Ind. Dep’t of Revenue, Letter of Findings No. 04-20130697 (July 30, 2014).

By Stephen Burroughs and Prentiss Willson

Indiana’s Department Revenue determined that the sale of prepaid phone cards and prepaid cell phones are “telecommunication services” subject to Indiana’s Utility Receipts Tax (URT). The URT is an income tax imposed upon the receipts a taxpayer receives from the sale of utility services. Included within utility services are telecommunications services, defined in part as “the transmission of messages or information.” Without analysis, the Department concluded that because the taxpayer is in the business of selling prepaid phone cards and prepaid wireless phones, the taxpayer is in the business of selling telecommunications services consisting of the transmission of messages or information. The Department did not address whether prepaid texting and internet access are telecommunication services subject to the URT because the taxpayer did not separately state such charges in its records or returns. Indiana will tax otherwise nontaxable receipts unless a taxpayer segregates the two in its books and records. As a result, the Department did not distinguish between the prepaid ordinary phone service and the perhaps nontaxable texting and internet access components in applying the URT to the taxpayer’s gross receipts from the bundled transactions. Ind. Dep’t of Revenue, Letter of Findings No. 40-20140076 (July 30, 2014).

By Kathryn Pittman and Andrew Appleby

The Virginia Tax Commissioner determined that an ink manufacturer’s purchase of cleaning chemicals did not qualify for the industrial manufacturing exemption from sales and use tax. To avoid color contamination, the taxpayer had to regularly clean the equipment used to produce the ink with special cleaning chemicals. The taxpayer claimed such cleaning chemicals were exempt from sales and use tax pursuant to the industrial manufacturing exemption because the cleaning chemicals were an integral and necessary part of the manufacturing and quality control process. Virginia law provides an exemption from sales and use tax for certain materials that are “used directly” in and are an “immediate part of” a manufacturing process. After reviewing relevant Virginia authorities, the Tax Commissioner found that the chemicals were not an “immediate part of” the ink production process but rather were used before and after production. The Tax Commissioner specifically noted that production had to stop before any cleaning activity could begin. Therefore, the chemicals were not actively and continuously used in the taxpayer’s manufacturing process and as such failed to meet the “used directly” requirement in the industrial manufacturing exemption. Va. Pub. Doc. No. 14-114 (Jul. 18, 2014).

By Stephanie Do and Timothy Gustafson

The Texas Comptroller has filed a reply supporting its petition for review to the Texas Supreme Court in Titan Transp., LP v. Combs, 433 S.W.3d 625 (Tex. App. 3rd 2014). The taxpayer in Titan was in the business of hauling, delivering and depositing aggregate at construction sites, providing its services primarily through subcontractor drivers. For Texas franchise tax purposes, the taxpayer excluded certain flow-through payments to its subcontractors mandated by contract from its total revenue, claiming a substantial revenue exclusion. Alternatively, the taxpayer claimed it was entitled to deduct these flow-through payments as a cost of goods sold. The Court of Appeals determined the taxpayer was entitled to a tax refund based on the substantial revenue exclusion and thus did not address the taxpayer’s alternative claim. The Comptroller subsequently filed a petition for review to the Texas Supreme Court. In response, the taxpayer argued Titan did not merit review because the Court of Appeals properly applied the statutory exclusion. Moreover, although the Court of Appeals did not address the merits of the taxpayer’s cost-of-goods-sold deduction claim, the taxpayer contended its alternative claim provided a basis to affirm the Court of Appeals’ decision. Urging the Texas Supreme Court otherwise, the Comptroller subsequently argued that permitting the taxpayer to exclude such payments to subcontractors would allow businesses to exclude similar receipts by merely changing contract terms. In addition, with regard to the taxpayer’s cost-of-goods-sold deduction claim, the Comptroller argued that the case should be remanded to the Court of Appeals for consideration as it is a matter of first impression and is of great importance to the State. Reply Supporting Petition for Review, Combs v. Titan Transp., LP, No. 14-0307 (Tex. Aug. 13, 2014); Response to Petition for Review, Combs v. Titan Transp., LP, No. 14-0307 (Tex. Aug. 11, 2014).

By Todd Betor and Timothy Gustafson

A California Franchise Tax Board (FTB) Chief Counsel Ruling concluded that a taxpayer’s sales of assets pursuant to a plan of reorganization under Chapter 11 of the U.S. Bankruptcy Code were not “occasional sales” within the meaning of 18 Cal. Code Regs. § 25137(c)(1)(A)2. Instead, the sales of assets were deemed to be part of the taxpayer’s normal course of business and occurred frequently. As a result, the taxpayer’s gross receipts from the asset sales were includable in its sales factor for apportionment purposes. Under 18 Cal. Code Regs. § 25137(c)(1)(A), receipts are excluded from the sales factor when a substantial amount of gross receipts arise from an occasional sale of assets used in that taxpayer’s trade or business. A sale is an “occasional sale” if the transaction is outside of a taxpayer’s normal course of business and occurs infrequently. The taxpayer at issue filed for Chapter 11 bankruptcy, which lead to a number of creditors cashing out to investors for amounts less than face value of the debt. In order to monetize their investments, and as part of the taxpayer’s plan of reorganization, the new owners directed the taxpayer’s management to sell the taxpayer’s assets, resulting in a series of asset sales over a two-year period. The FTB concluded that “[t]o accomplish the goal of the Plan of Reorganization, negotiation and implementation of asset sale transactions became part of [the] Taxpayer’s normal course of business.” Consequently, the asset sales were found not to be “occasional sales.” California FTB Chief Counsel Ruling No. 2014-2 (June 3, 2014).

By Ted Friedman and Timothy Gustafson

The New York State Department of Taxation and Finance issued a Tax Bulletin addressing the application of sales tax to sales of computer software and related services. The Department explained that the sale of prewritten software is taxable, while the sale of custom software is not subject to tax. Accordingly, the sale of an upgrade of prewritten software is subject to tax unless the upgrade is designed and developed to the specifications of a particular purchaser. Further, a sale of software includes any transfer of title or possession, including a license to use, and the sale to a purchaser in New York of a license to remotely access software is subject to tax because, by accessing the software, the purchaser gains “constructive possession of” and “the right to use or control” the software. The situs of the sale is “the location from which the purchaser uses or directs the use of the software, not the location of the code embodying the software.” Separately stated and reasonable charges for maintaining, servicing or repairing software are exempt from sales tax. However, if a software maintenance agreement provides for the sale of taxable and nontaxable elements, the charge for the entire maintenance agreement is subject to tax unless the charges for the nontaxable elements are: (1) reasonable and separately stated in the maintenance agreement; and (2) billed separately on the invoice or other document of sale given to the purchaser. In addition, custom software is exempt from tax when resold or transferred directly or indirectly by the purchaser of the software to either: (1) a corporation that is a member of an affiliated group of corporations that includes the original purchaser of the custom software; or (2) a partnership in which the original purchaser of the custom software and other members of the affiliated group have at least a 50% interest in capital or profits. Finally, services related to computer software, such as training, consulting, troubleshooting, installing, programming and servicing, are exempt from tax, except when provided in conjunction with the sale of prewritten software; then such services are exempt only when related charges are reasonable and separately stated on the invoice or billing statement given to the customer. N.Y. Tax Bulletin, TB-ST-128 (Aug. 5, 2014).

By Stephen Burroughs and Pilar Mata

The California Franchise Tax Board (FTB) issued a legal ruling determining that it will attribute the business activities of a multiple-member limited liability company classified as a partnership for tax purposes (LLC) to its members when determining whether such members are “doing business” in California. As a result, out-of-state business entities that own a membership interest in an LLC doing business in California will be subject to tax themselves. In reaching this determination, the FTB acknowledged that LLCs share characteristics with both partnerships and corporations but determined that LLCs that do not “check the box” for federal tax purposes are considered partnerships under California tax law. Because “the activities of [a] partnership are attributed to each partner,” the FTB concluded that “if an LLC…is ‘doing business’ in California [then] the members of the LLC are themselves ‘doing business’ in California.” The FTB declined to extend the exception provided to limited partnerships in Amman & Schmid Finanz AG, et al., 96-SBE-008, April 11, 1996, to LLCs on the ground that, unlike limited partners, LLC members have the statutory right to manage or control the decision-making process of the entity. The legal ruling includes six examples. The first two examples find that an LLC merely registering to do business or organizing in California is not actively engaging in a transaction for the purpose of financial gain or profit attributable to its members, and therefore will not create a filing requirement for its members. The other examples demonstrate that the FTB will consider a member of an LLC to be doing business in California if the LLC is commercially domiciled in California or has activities or factor presence in California sufficient to constitute “doing business” within the meaning of Cal. Rev. & Tax. Code § 23101. The ruling has come under criticism from practitioners not only disagreeing with the ruling’s substantive conclusions but also its timing, as the FTB is actively litigating related issues in the California courts. California FTB Legal Ruling 2014-01 (July 22, 2014).