By Zachary Atkins and Prentiss Willson

The Oregon Supreme Court held that the state’s sales factor exclusion for gross receipts from intangible assets not derived from a taxpayer’s primary business activity applies to all types of intangible assets. The taxpayer, Tektronix, sold its printer division to Xerox for approximately $925 million, of which almost $600 million represented gross receipts from intangible assets.  The fact that the income in question constituted business income was undisputed; however, the parties disagreed as to whether the gross receipts from the intangible assets should have been excluded from Tektronix’s sales factor for apportionment purposes. The exclusion at issue, ORS 314.665(6)(a), applies to “gross receipts arising from the sale, exchange, redemption or holding of intangible assets, including but not limited to securities, unless th[e] receipts are derived from the taxpayer’s primary business activity.” The Oregon Supreme Court disagreed with the Oregon Tax Court’s conclusion that the reference to “intangible assets” in ORS 314.665(6)(a) means “liquid assets,” although it conceded that it was clear from the legislative history that the provision was intended to exclude treasury function receipts from the sales factor. The court noted that the statute used the broader term “intangible assets” rather than “liquid assets”—evidence that the legislature intended to give broader effect to the exclusion. The court held that the gross receipts from the intangible assets did not derive from Tektronix’s primary business, which was the manufacture and distribution of electronic products, and therefore the gross receipts should have been excluded from Tektronix’s sales factor. Tektronix, Inc. & Subs. v. Dep’t of Revenue, ___ P.3d ____, 2013 WL 6508861 (Or. Dec. 12, 2013) (en banc).

By Christopher Chang and Andrew Appleby

The Arizona Court of Appeals upheld a broad definition of business income, adopting both the transactional and functional tests. The Court of Appeals stated that business income includes both income arising from transactions in a taxpayer’s regular course of business (the “transactional test”) and income from the acquisition, management, or disposition of tangible and intangible property used in a taxpayer’s regular course of business (the “functional test”). The Court of Appeals determined that the functional test was necessary because taxpayers would not include gain upon sale even though they could deduct business expenses related to the property before the taxpayer sold it. The Court of Appeals also rejected the liquidation exception stating that any such exception is inconsistent with the functional test. Harris Corp. v. Ariz. Dept. of Rev., Dkt. No. 1 CA-TX 11-0006 (Nov. 26, 2013).

By Kathryn Pittman and Andrew Appleby

The Colorado Department of Revenue determined that sales of digital images, whether delivered electronically or via tangible medium, are sales of tangible personal property for income tax apportionment purposes. The taxpayer was engaged in the business of providing digital images to commercial and government customers and provided such images electronically and via tangible medium depending on the preferences of the customer and other factors. The Department determined that sales of the images constituted sales of tangible personal property for income tax purposes regardless of the manner of delivery. The Department analogized the electronic transfers of the images to sales of digital goods, which the Department had previously determined to be sales of tangible personal property for sales tax purposes. Therefore, the Department determined that sales of images in this case were also sales of tangible personal property for income tax purposes regardless of the delivery method and should be sourced according to the Colorado rules relating to tangible personal property (i.e., sourced based on destination). Thus, according to the Department’s determination, such sales of images to Colorado customers or sales of images ultimately delivered to a recipient in Colorado must be sourced to Colorado for corporate income tax purposes. Co. Priv. Ltr. Rul. PLR-13-008 (Oct. 2, 2013).

By Maria Todorova and Timothy Gustafson

The Mississippi Supreme Court denied the taxpayer’s motion for rehearing in Equifax, Inc. v. Mississippi Dep’t of Revenue, a case on which we previously reported. The denial leaves undisturbed its June holding, reversing the Mississippi Court of Appeals’ decision, which held the taxpayer bears the burden of proving that an alternative apportionment method proposed by the State is arbitrary and unreasonable. The decision, in effect, appears to grant the Mississippi Department of Revenue unlimited power to impose alternative apportionment methods and to obligate taxpayers to defend against the impropriety of such methods. The court made two minor revisions to its original decisions. Those changes, however, have no significant impact on the court’s burden of proof holding. Nor do the changes impact the court’s holding that, essentially, Mississippi taxpayers no longer are afforded a de novo judicial review of tax assessments, even though a Mississippi statute, as interpreted by a prior Mississippi Supreme Court decision (W.C. Fore v. Dep’t of Revenue, 90 So. 3d 572 (Miss. 2012)), appeared to afford taxpayers exactly that—a right to a trial de novo and a full evidentiary judicial hearing on the substantive issues underlying a tax assessment. Equifax v. Dep’t of Revenue, No. 2010-CT-01857-SCT, reh’g den., op’n mod., 2013 Miss. LEXIS 604 (Miss. Nov. 21, 2013).

By Scott Booth and Timothy Gustafson

The Arizona Department of Revenue concluded in a Taxpayer Information Ruling that court-ordered proceeds from a patent infringement lawsuit were properly characterized as business income. The taxpayer held more than 200 patents that it developed or acquired for use in its own manufacturing process or patent licensing activities, one of which had been infringed by a competing manufacturer. The taxpayer filed a patent infringement lawsuit, which it successfully prosecuted, and was awarded a judgment intended to compensate the taxpayer for lost profits and reasonable royalties, plus punitive damages, attorney’s fees and interest. The taxpayer requested a ruling addressing Arizona’s corporate income tax characterization of the expected judgment proceeds. The Department determined the taxpayer’s ability to generate revenue was contingent upon effectively managing its patents. Accordingly, because the award was “the result of loss of business or royalties resulting from the patent infringement of a particular patent that was acquired by [the taxpayer] for use in its regular trade or business,” the Department concluded that the award was properly characterized as business income. The Department also determined that the income derived from the 931 total patents in the affiliated group’s manufacturing operations was at the “core of the group’s income producing capabilities,” and as such the income from the patent infringement lawsuit was properly treated as business income when viewed on the whole. Ariz. TIR LR13-004 (Released Nov. 2013).

StephanieThumbnail.jpgMeet Henry P. Wienerman, the four-month-old Boston Terrier of Sutherland SALT legal secretary Stephanie Fulps and her husband, Jason. Henry is the latest addition to Stephanie and Jason’s family; his older “sisters,” Abby and Olive, were featured previously as Pets of the Month.

Henry came to live with Stephanie and Jason two months ago and loves being a little brother to Abby and Olive. He is 100% puppy and full of mischief. When not chasing his sisters or stealing their toys, Henry enjoys chewing bull stick treats and lounging in the sun. He is an excellent cuddler and makes a great napping companion, but do not expect to sleep peacefully if Henry starts snoring!HenryThumbnail.jpg

Henry can be startled and confused by his reflection. He will often run up to the full-length mirror and scratch at it, trying to play with the handsome puppy looking back at him. Once the sun goes down, if he sees his reflection in the glass doors that lead to the backyard, he goes into protective mode and barks and howls to scare away the backyard intruder while Abby and Olive relax on the couch.

By Mary Alexander and Timothy Gustafson

The Arizona Court of Appeals held that a liquidation exception to the functional test for business income does not exist in Arizona and that a taxpayer’s sale of its wholly owned subsidiary was business income. The parties to the sale made an I.R.C. § 338(h)(10) election, which required the taxpayer to treat the sale of the subsidiary’s stock as an asset sale. Arizona statutes and regulations adopt a functional test for business income whereby gain from property qualifies as business income if the property was used in the taxpayer’s trade or business. The court held that a liquidation exception was inconsistent with the functional test because it focused on the “nature of the transaction” instead of on the “relationship between the property and the taxpayer’s business.” The frequency of a transaction was considered irrelevant in determining the relationship of the property to the business. As the taxpayer had previously treated the income that resulted from the subsidiary’s assets as “arising in the regular course of business,” the sale of the subsidiary’s stock constituted business income as well. First Data Corp. v. Ariz. Dep’t of Rev., Dkt. No. 1 CA-TX 11-0008 (Ariz. Ct. App. Nov. 26, 2013).

By Suzanne Palms and Andrew Appleby

The Arizona Court of Appeals held that Home Depot U.S.A., Inc. (Home Depot) was required to include in its combined Arizona income tax return the income of an out-of-state subsidiary that licensed the retailer’s trademarks. Relying on R.R. Donnelley & Sons Co. v. Arizona Dep’t of Rev., 229 P.3d 266 (Ariz. Ct. App. 2010), the court concluded the trademark subsidiary was a part of Home Depot’s unitary business because the operations of the two entities were substantially interdependent. The court found the subsidiary’s sole business was the management of Home Depot’s trademarks, and that without Home Depot’s continuing efforts to promote its brand, the trademarks that constituted the subsidiary’s only assets would have been worthless. The court also found that although the subsidiary had substantial income during the tax years in question, it had only four employees, which was indicative, in the court’s opinion, that the subsidiary’s income was generated solely by Home Depot’s marketing efforts. Home Depot U.S.A., Inc. v. Arizona Dep’t of Rev., No. 1 CA-TX 12-0005 (Ariz. Ct. App. Dec. 5, 2013).

Can’t get enough of the SALT Pet of the Month?! Think your best friend has what it takes to win? Download the new Sutherland SALT Shaker mobile app today, and enter your pet in our Pet of the Year Contest for a chance to win a $100 Amazon.com gift card! Awards will be given to the top dog, cat and other exotic pet. Runners-up will receive Sutherland SALT gear specially designed for our furry friends. Here’s how to enter:

1. Download the Sutherland SALT Shaker mobile app on your smartphone.

Available in iTunes App Store.png          Amazon Appstore Logo.jpg          GooglePlay Logo.jpg         

2. Navigate to the Pet of the Month page using the menu button in the top left corner.

3. Click “Submit a Pet” to upload a photo and enter details about your pet.

Don’t delay. The deadline to enter is December 31.

Good luck!

The Sutherland SALT Team

By Derek Takehara and Andrew Appleby

The Virginia Tax Commissioner determined that the Department of Taxation was permitted to make net operating loss deduction (NOLD) adjustments for taxable years outside the statute of limitations because the adjustments were necessary to determine the correct federal taxable income for the taxable years at issue. The taxpayer, an affiliated group, originally filed its Virginia corporate income tax returns on a consolidated basis. In later years, including the years at issue, the group filed returns on a combined basis—instead of on a consolidated basis—without obtaining permission from the Department. The auditor adjusted the taxpayer’s returns to a consolidated basis and correspondingly recomputed the taxpayer’s NOLDs for net operating losses incurred prior to the years at issue. The taxpayer objected and argued that the auditor’s adjustments to the NOLDs were made beyond the state’s three-year statute of limitations for assessments. Virginia uses federal taxable income as the starting point for computing Virginia taxable income, and the Tax Commissioner explained that the adjustments were necessary to accurately reflect the taxpayer’s federal taxable income for the taxable years at issue. As such, the Tax Commissioner determined that the adjustments did not constitute assessments prohibited by the statute of limitations and permitted the auditor’s recomputations. Va. Pub. Doc. Rul. No. 13-213 (Nov. 18, 2013).