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).

Sutherland’s state and local tax team will host the Sutherland SALT Roundtable Silicon Valley on Tuesday, June 17 at the Sofitel San Francisco Bay in Redwood City, California. The roundtable will take an in-depth look at significant state and local tax issues and developments impacting the technology sector, including:

  • Digital Unrest – Legislation, Litigation and Other Policy Changes Impacting the Tech Sector
  • The Source Code – Unraveling States’ Sourcing Methodologies for Cloud Services, Software and Other Developing Technology
  • Combined Reporting – New York Becomes California’s Little Brother

Click here for more information and to register. Our program is complimentary, and seating is limited. The program is intended for in-house attorneys and tax professionals.

Yesterday the Louisiana 24th Judicial District Court held that a cable service provider’s video-on-demand and pay-per-view video programming are not tangible personal property subject to sales tax. Jefferson Parish had alleged that the programming could be seen and heard and thus fell within the definition of tangible personal property.

Read the full Legal Alert here.

Yesterday the Louisiana 24th Judicial District Court held that a cable service provider’s video-on-demand and pay-per-view video programming are not tangible personal property subject to sales tax. Jefferson Parish had alleged that the programming could be seen and heard and thus fell within the definition of tangible personal property. Following a trial, the court found for the taxpayer and held that the programming is a nontaxable service rather than tangible personal property. Sutherland represented the taxpayer in the matter. Newell Normand, Sheriff and Ex-Officio Tax Collector of Jefferson Parish, Louisiana v. Cox Communications Louisiana, L.L.C., Jefferson Parish 24th Judicial District Court, Case No. 706-766 (Pitre, J.).

In their article for State Tax Notes, “Heads They Win, Tails You Lose: New York Decombination and Discretionary Adjustments,” Sutherland attorneys Marc A. Simonetti, Andrew D. Appleby and Sahang-Hee Hahn assert that the New York State Department of Taxation and Finance applies its combined reporting and discretionary authority provisions arbitrarily to maximize its tax assessments.

Read “Heads They Wing, Tails You Lose: New York Decombination and Discretionary Adjustments,” reprinted with permission from the May 19, 2014 edition of State Tax Notes. 

On June 2, the Arm’s Length Advisory Group (the Group) of the Multistate Tax Commission (MTC) met in St. Louis, Missouri, to begin the process of developing a multistate arm’s length pricing adjustment service. States participating in the meeting included Alabama, Florida, Georgia, Iowa, Kentucky, New Jersey, North Carolina and the District of Columbia. Joe Garrett (Alabama) was elected to chair the Group. The Group is primarily concerned with addressing the inability to effectively conduct transfer pricing audits at the state level. It seeks to create a viable project design sufficiently developed for an operational model by July 2015.
The need for the Group—according to the representatives from the participating states—derives from an inability to successfully rectify corporate income tax returns that states assert are distorted. While most states participating in the Group have applied expense disallowance rules for the better part of a decade, the states still believe that many intercompany transactions not covered by expense disallowance are distortive.
One issue contributing to this problem from the state’s perspective is the lack of substantial resources to successfully enter into a dispute with a taxpayer asserting that a transfer pricing agreement accurately represents the value of an intangible asset. For example, while the taxpayer consults with economists to accurately determine the true market value of an intangible asset, states lament their inability to obtain such a costly, detailed and thorough report. Moreover, states lack the human capital necessary to conduct an extensive transfer pricing audit, thus increasing the demand for the MTC to participate in such audits. New Jersey, the District of Columbia, Alabama and Kentucky have all previously contracted with third-party consultants to assist in transfer pricing assessments or audits.
Two substantive recommendations were offered for discussion by Dan Bucks, the project facilitator. First, to compensate for the lack of state resources, the MTC could develop institutional knowledge and experts with statistical and economic expertise. This expertise would be utilized by participating states to determine the true market value of intangible assets transferred by intercompany agreements. How the economist or other expert would develop the report for the state was still to be determined. With limited public taxpayer financial information, an economist would inherently fail to make a precise calculation without all relevant financial information. Simply put, the economic expertise is useless without the economic figures needed to develop a legitimate transfer pricing report. Ultimately, the viability of an expert to assist the MTC was left unresolved.
Second, the Group discussed the possibility of creating a joint audit function to assist with corporate taxpayer compliance and expedite the development of state institutional audit knowledge. The Group cited the ability of joint audits to “accelerate the training and acquisition of expertise by the staff of individual agencies.” However, it is unclear where—if at all—joint audits in the context of transfer pricing fit in with the current joint audits under the MTC. Moreover, it is unclear how many states would be interested in the joint audit program. For example, Florida indicated that it had no desire to be a part of the joint audit program, but indicated its interest in the development of economic expertise. Surprisingly, several states participating in the Group were intrigued by the apparent success of the District of Columbia’s transfer pricing audit program. The District of Columbia program has been widely criticized for resulting in taxpayer assessments where taxpayers were never actually audited.
The next meeting will take place via teleconference on June 25. The Group will meet in person and via teleconference at the 2014 Annual MTC Conference and Committee Meetings on July 28. Members of the public are invited to join both meetings.

On June 2, the Arm’s Length Advisory Group (the Group) of the Multistate Tax Commission (MTC) met in St. Louis, Missouri, to begin the process of developing a multistate arm’s length pricing adjustment service. States participating in the meeting included Alabama, Florida, Georgia, Iowa, Kentucky, New Jersey, North Carolina and the District of Columbia. Joe Garrett (Alabama) was elected to chair the Group. The Group is primarily concerned with addressing the inability to effectively conduct transfer pricing audits at the state level. It seeks to create a viable project design sufficiently developed for an operational model by July 2015.

The need for the Group—according to the representatives from the participating states—derives from an inability to successfully rectify corporate income tax returns that states assert are distorted. While most states participating in the Group have applied expense disallowance rules for the better part of a decade, the states still believe that many intercompany transactions not covered by expense disallowance are distortive.

One issue contributing to this problem from the state’s perspective is the lack of substantial resources to successfully enter into a dispute with a taxpayer asserting that a transfer pricing agreement accurately represents the value of an intangible asset. For example, while the taxpayer consults with economists to accurately determine the true market value of an intangible asset, states lament their inability to obtain such a costly, detailed and thorough report. Moreover, states lack the human capital necessary to conduct an extensive transfer pricing audit, thus increasing the demand for the MTC to participate in such audits. New Jersey, the District of Columbia, Alabama and Kentucky have all previously contracted with third-party consultants to assist in transfer pricing assessments or audits.

Two substantive recommendations were offered for discussion by Dan Bucks, the project facilitator. First, to compensate for the lack of state resources, the MTC could develop institutional knowledge and experts with statistical and economic expertise. This expertise would be utilized by participating states to determine the true market value of intangible assets transferred by intercompany agreements. How the economist or other expert would develop the report for the state was still to be determined. With limited public taxpayer financial information, an economist would inherently fail to make a precise calculation without all relevant financial information. Simply put, the economic expertise is useless without the economic figures needed to develop a legitimate transfer pricing report. Ultimately, the viability of an expert to assist the MTC was left unresolved.

Second, the Group discussed the possibility of creating a joint audit function to assist with corporate taxpayer compliance and expedite the development of state institutional audit knowledge. The Group cited the ability of joint audits to “accelerate the training and acquisition of expertise by the staff of individual agencies.” However, it is unclear where—if at all—joint audits in the context of transfer pricing fit in with the current joint audits under the MTC. Moreover, it is unclear how many states would be interested in the joint audit program. For example, Florida indicated that it had no desire to be a part of the joint audit program, but indicated its interest in the development of economic expertise. Surprisingly, several states participating in the Group were intrigued by the apparent success of the District of Columbia’s transfer pricing audit program. The District of Columbia program has been widely criticized for resulting in taxpayer assessments where taxpayers were never actually audited.

The next meeting will take place via teleconference on June 25. The Group will meet in person and via teleconference at the 2014 Annual MTC Conference and Committee Meetings on July 28. Members of the public are invited to join both meetings.