By Sahang-Hee Hahn and Pilar Mata

The Illinois Department of Revenue determined that a taxpayer’s cloud computing receipts should be sourced for sales factor purposes using a market-based approach because the receipts were derived from services. The taxpayer was an information technology hosting services provider engaged in a business that focused on the delivery and support of dedicated and public cloud computing for its customers. The Department relied upon the principles contained in IRC section 7701(e) to characterize the taxpayer’s cloud computing contracts as service contracts. In reaching this conclusion, the Department noted the following: (1) customers do not acquire an ownership interest in, or take physical possession of, the taxpayer’s hardware and software; (2) customers do not control the taxpayer’s hardware or software; (3) customers do not obtain a significant economic or possessory interest in the taxpayer’s hardware or software; (4) the taxpayer bears the risk of substantially diminished receipts or substantially increased expenditures if the taxpayer fails to perform under the contract; (5) the taxpayer uses the hardware and software to provide services concurrently to unrelated customers; and (6) the total contract price substantially exceeds the rental value of the hardware and software for the contract period (noting that the taxpayer provides its customers with remote customer support). Based on the foregoing, the Department determined that because the taxpayer’s cloud computing contracts are services contracts, the receipts should be sourced for sales factor purposes using market sourcing. In Illinois, this methodology first looks to the location where the customer receives the benefit. In this case, because the taxpayer was not able to determine where a customer was physically located when the customer accessed the taxpayer’s servers, the Department indicated that the services will be deemed received at the location of the office from which the customer ordered the services; if that location cannot be determined, the services will be deemed received at the customer’s billing address. The Department further determined that if the taxpayer is not taxable in the state in which services are deemed received, such receipts must be excluded from the numerator and denominator of the taxpayer’s sales factor. This ruling is effective for tax years ending on or after December 31, 2009. Ill. Priv. Ltr. Rul. No. IT 14-0003 (April 24, 2014).

By Kathryn Pittman and Andrew Appleby

In a post-audit challenge by a taxpayer, the Virginia Tax Commissioner addressed entity classification, nexus and royalty add-back issues. The Commissioner found that the taxpayer did not provide sufficient evidence that its single member LLC was a disregarded entity or that certain entities were financial institutions. Turning to nexus, the Commissioner determined that certain entities did not have positive apportionment factors or nexus in Virginia—and their exclusion did not distort income—so they could not be included in the Virginia consolidated group. Finally, the Commissioner determined the subject-to-tax exception to Virginia’s royalty add-back provision applied, but only to the extent that the income was subject to tax in other states. Va. P.D. No. 14-62 (May 6, 2014).

On June 25, the Arm’s Length Adjustment Services Advisory Group of the Multistate Tax Commission met via teleconference to continue the process of developing a multistate arm’s length pricing adjustment service. States participating in the meeting included Alabama, Florida, Georgia, Iowa, Kentucky, North Carolina, Pennsylvania and the District of Columbia. The primary focus of the meeting was to follow up from the June 2 meeting in St. Louis.

Read the full Legal Alert here.

On June 25, the Arm’s Length Adjustment Services Advisory Group (the Group) of the Multistate Tax Commission (MTC) met via teleconference to continue the process of developing a multistate arm’s length pricing adjustment service. States participating in the meeting included Alabama, Florida, Georgia, Iowa, Kentucky, North Carolina, Pennsylvania and the District of Columbia. The primary focus of the meeting was to follow up from the June 2 meeting in St. Louis.

Continue Reading MTC Speaks with Potential Transfer Pricing Vendors

By Stephen Burroughs and Andrew Appleby

The Florida Department of Revenue determined that the sale of remote storage and cloud computing services, along with related data transfer fees, are information services not subject to Florida sales tax or Communication Service Tax (CST). The taxpayer’s remote storage service grants customers access to servers for data storage. The taxpayer’s cloud computing service, which falls into the Infrastructure as a Service model, provides computing resources. The taxpayer also charges a data transfer fee when a customer requests data be transferred to a specific server location. The Department determined that neither the remote storage nor cloud computing services offered by the taxpayer involve a customer paying for the transmission or routing of information. Rather, each offers a customer the capability to store and retrieve data—hallmarks of a nontaxable information service. Further, the Department determined that the taxpayer does not provide licenses for software or tangible personal property with the remote storage or cloud computing services because a customer need not download software or have direct use of the taxpayer’s servers to utilize the services. And while data transfer utilizes a communication service to move customer data between servers, the charge is for making “the data or the computing power available [and] accessible” at a specific data center location, not “the ability to ‘transmit, convey, or route’ data.” Fla. Dep’t of Revenue, Tech. Asst. Advisement, TAA 14A19-001 (Mar. 13, 2014).

By Ted Friedman and Andrew Appleby

The South Dakota Supreme Court held that a corporation operating a hunting lodge did not owe use tax on its purchases of food, beverages and ammunition because the lodge purchased the goods for resale to the lodge’s customers in the regular course of business. The lodge offered hunting packages for a single “package price” that included unlimited food, beverages and ammunition. The court explained that use tax does not apply to goods purchased for “sale” to customers “in the regular course of business.” Determining there was a “sale” involving both transfer and consideration, the court reasoned that the lodge’s customers were given a right to an unlimited amount of the goods and that such goods were transferred for consideration because the lodge’s customers placed value on the unlimited goods as part of the purchase of an all‑inclusive package. The court also determined that the sale of the goods, although part of a larger transaction, was a steady and uniform occurrence in the lodge’s business and, therefore, constituted a sale “in the regular course of business.” Accordingly, the court held that the lodge did not owe use tax on its purchases of food, beverages and ammunition. Paul Nelson Farm v. Dep’t of Revenue, 2014 S.D. 31 (S.D. May 21, 2014).

On June 18, the Judiciary Committee of the U.S. House of Representatives voted in favor of H.R. 3086, the Permanent Internet Tax Freedom Act (PITFA) by a vote of 30-4. PITFA permanently extends the moratorium on state and local taxation of Internet access and “multiple” or “discriminatory” taxes on electronic commerce.

Read full Legal Alert here.

On June 18, the Judiciary Committee of the U.S. House of Representatives voted in favor of H.R. 3086, the Permanent Internet Tax Freedom Act (PITFA) by a vote of 30-4. PITFA permanently extends the moratorium on state and local taxation of Internet access and “multiple” or “discriminatory” taxes on electronic commerce.

Background: The Internet Tax Freedom Act’s Expiration

The Internet Tax Freedom Act (ITFA) is set to expire on November 1, 2014. In addition to permanently extending ITFA, PITFA will eliminate the “grandfather” provision that allows certain states to tax Internet access. Representative Bob Goodlatte (R-VA), the Committee Chair and co-sponsor of PITFA, addressed the grandfather provision, stating that “[f]or those that still haven’t [discontinued taxing Internet access], it has been sixteen years, time enough to change their tax codes.”

Opposition to Permanent Extension/Grandfather Repeal

In opposition to PITFA, Rep. John Conyers, Jr. (D-MI), the Ranking Member of the Judiciary Committee, put forth an amendment to PITFA, co-sponsored by Rep. Sheila Jackson Lee (D-TX), which would temporarily extend the moratorium for four years and preserve the grandfather provision. In support of his amendment, Rep. Conyers stated that allowing the grandfather provision to lapse would cost Texas approximately $350 million in tax revenues. Supporting the amendment to PITFA, Rep. Jerrold Nadler (NY) claimed that permanently extending ITFA sends the wrong message regarding states’ right to make fundamental decisions regarding taxation. The Conyers-Jackson Lee amendment was ultimately struck down by a vote of 12-21.

Attempts to Pass Other State Tax Federal Legislation

As expected, there were calls for the Committee to address other federal legislation that limit or expand state taxation:

  • Rep. Darrell Issa (R-CA) called for the Committee to pass PITFA and “pivot” to pass the “Marketplace Fairness Act” (MFA, S.743), which would allow states to compel remote retailers to collect sales tax. This push for the Committee to address the MFA was echoed by other Committee members.
  • Rep. Bobby Scott (D-VA) called for the Committee to address the “Business Activity Tax Simplification Act” (“BATSA” H.R. 5267). BATSA would require a bright-line physical presence nexus standard applicable to corporate income and other taxes.
  • Rep. Hank Johnson (D-GA) urged the Committee to address H.R. 1129, the “Mobile Workforce State Income Tax Simplification Act,” which would limit states’ ability to require employers to withhold personal income taxes if a traveling employee is present and performing employment duties for 30 days or less during the calendar year.
  • Rep. Zoe Lofgren (D-CA) and Rep. Steve Cohen (D. TN) put forth amendments to PITFA that would tack on H.R. 2309, the “Wireless Tax Fairness Act,” and H.R. 2543, the “End Discriminatory State Taxes for Automobile Renters Act,” respectively. Both amendments were withdrawn unanimously.

The next step for PITFA is a full vote by the House of Representatives. A similar bill, the “Internet Tax Freedom Forever Act,” S. 1431, is currently pending before the Senate.

If you have any questions about this Legal Alert, please feel free to contact any of the attorneys listed under ‘Related People/Contributors’ or the Sutherland attorney with whom you regularly work.

 

By Douglas Mo and Zachary Atkins

The California Court of Appeal held that the San Mateo County Assessor illegally assessed the intangible assets of the Ritz-Carlton Half Moon Bay Hotel. This is the first appellate decision to follow Elk Hills Power, LLC v. Board of Equalization, 57 Cal.4th 593, 304 P.3d 1052 (2013) (reported by Sutherland this legal alert). The court reaffirmed the exempt nature of intangibles and ruled that the assessor’s use of the “Rushmore Approach,” which simply calls for the deduction of the expenses associated with intangibles, failed to remove the value of the taxpayer’s intangibles when performing an income approach to value. In rejecting the assessor’s use of the Rushmore Approach, the court quoted with approval the California State Board of Equalization’s Assessors’ Handbook. The Assessors’ Handbook, the court noted, rejects the “Rushmore Approach” because it allows only a return of the investment in the intangibles and not a return on the intangibles. The court singled out intangibles such as work force, a leasehold interest and an operating agreement as assets that were not removed from the assessment of the taxable real property. Of note, the court rejected the taxpayer’s claim that the assessor illegally taxed goodwill, as the taxpayer employed a residual method to value goodwill. The court stated that the taxpayer did not refute the assessor’s evidence that the deduction of the management and franchise fee from the income stream fully accounted for the value of the taxpayer’s goodwill. SHC Half Moon Bay v. Cnty. of San Mateo, No. A137218, 2014 WL 2126637 (Cal. Ct. App. May 22, 2014).

The Court of Appeal’s decision is helpful for all California businesses that possess significant intangible assets, and it is a landmark decision for the hospitality industry in rejecting the use of the “Rushmore Approach”—an approach that has gained widespread acceptance in the assessment community.  That said, the decision is a cautionary tale for the exclusion of value for goodwill. Taxpayers would be best served to rely on more than a residual approach to support their claim to a goodwill value.

By David Pope and Timothy Gustafson 

The Michigan Court of Appeals held that Thomson Reuters’ sale of Checkpoint, an online tax and accounting research program, was the sale of a nontaxable information service and not tangible personal property for purposes of Michigan’s use tax. The Michigan Department of Treasury argued Checkpoint was tangible personal property because it constituted the sale of “prewritten computer software subject to tax when plaintiff’s Michigan customers used and controlled the computer code that resided on the web browser interface and on the server side.” Applying Michigan’s “incidental to service test,” however, the Court of Appeals found Checkpoint customers sought access to information, not the underlying computer code that constituted less than one percent of the transaction. Thus, any transfer of tangible personal property was incidental to the information service. This unpublished decision provides insight into the Department’s position regarding the taxability of prewritten computer software accessible via the internet, particularly where the Court of Appeals stated in a footnote that “such software may indeed be taxable” but for the application of the “incidental to service test” in this instance. Thomson Reuters Inc. v. Dep’t of Treasury, No. 313825, LC No. 11-000091-MT (Mich. Ct. of App. May 13, 2014) (unpublished opinion).