By Madison Barnett and Jonathan Feldman

A Texas trial court denied a taxpayer’s claim that it was entitled to use the Multistate Tax Compact’s three-factor formula election for the Texas Margin Tax. The court’s order did not specifically address either the availability of the election or whether the tax meets the MTC’s definition of an “income tax.” The ruling is the first judicial decision in Texas on the issue and adds to the growing body of conflicting case law on the MTC election. The taxpayer’s remaining claims—an as-applied constitutional challenge to the single factor sales apportionment formula and tax rate structure and a challenge to the imposition of penalties and interest—remain pending. Graphic Packaging Corp. v. Combs, No. D-1-GN-12-003038 (353rd Jud. Distr. Ct., Travis Cnty., Tex., Jan. 15, 2014) (Byrne, J.).

By Madison Barnett and Timothy Gustafson

In the first appellate decision arising from a Texas Margin Tax audit, the Texas Court of Appeals ruled in favor of the taxpayer, holding that a combined group’s eligibility for the cost of goods sold (COGS) deduction is determined on a group-wide rather than a separate-entity basis. The Comptroller denied the portion of the combined group’s COGS deduction attributable to a subsidiary that injected and removed “drilling mud” as part of the combined group’s oil and gas well drilling services. In the Comptroller’s view, the subsidiary was a service provider and thus was ineligible for the COGS deduction. The court rejected this view and held that “each member’s [COGS] deduction must be determined by considering the member’s expenses in the context of the combined group’s overall business.” The court further held that the subsidiary’s waste disposal labor costs were properly included in the COGS deduction because they constituted labor furnished to a project for the construction or improvement of real property, i.e., to the drilling of oil and gas wells. Combs v. Newpark Resources, Inc., No. 03-12-00515-CV (Tex. App. Dec. 31, 2013).

By Zachary Atkins and Andrew Appleby

The Pennsylvania Supreme Court held that treating a merger between two in-state banks differently than a merger between an in-state bank and an out-of-state bank did not violate the Uniformity Clause of the Pennsylvania Constitution. If two in-state banks merged, Pennsylvania law formerly required the combination of the banks’ book values and deductions for purposes of calculating a six-year moving average used to determine the tax base for Bank Shares Tax purposes. For calendar years prior to January 1, 2014, this “combination” provision applied only to mergers between in-state banks. First Union Nat’l Bank v. Commonwealth, 867 A.2d 711, 716 (Pa. Commw. Ct.), exceptions dismissed, 885 A.2d 112 (Pa. Commw. Ct. 2005), aff’d, 901 A.2d 981 (Pa. 2006). The taxpayer, an in-state bank that merged with another in-state bank, claimed that the combination provision violated the Uniformity Clause by favoring mergers with out-of-state banks over mergers with in-state banks. Since the combination provision did not apply to mergers with out-of-state banks, the pre-merger book values and deductions of an out-of-state bank would not be combined with pre-merger book values and deductions of the surviving in-state bank. Thus, all else being equal, the six-year average share value of an in-state bank that merged with an out-of-state bank was lower than the six-year average share value of an in-state bank that merged with another in-state bank. The Pennsylvania Supreme Court held that this differential tax treatment did not violate the Uniformity Clause. The court reasoned that a merger between an in-state bank and an out-of-state bank brings previously untaxed assets into the Commonwealth’s taxing jurisdiction for the first time and “enriches the public coffers,” whereas a merger between two in-state banks does not. This distinction was sufficient for the court to conclude that the two scenarios were materially different and that the differential tax treatment did not violate the Pennsylvania Constitution. A law change effective January 1, 2014, made significant changes to the Bank Shares Tax, including adopting a reporting and payment standard based on whether a bank is “doing business” in the state and replacing the six-year moving average calculation with a one-year valuation formula. Lebanon Valley Farmers Bank v. Commonwealth, No. 78 MAP 2011, 2013 WL 6823061 (Pa. Dec. 27, 2013).

By Derek Takehara and Andrew Appleby

The Oklahoma Tax Commission issued three Letter Rulings addressing the digital economy. First, the Commission ruled that receipts from sales of digital photos, videos and designs delivered via the Internet are not subject to sales tax when no tangible item is conveyed. The Commission also ruled that charges for Internet web designs are nontaxable. These determinations reiterate Oklahoma’s existing regulation on the taxability of internet-related services and transactions. Ok. LR-13-013 (July 11, 2013). Second, the Commission determined that receipts derived from the renewal of annual software maintenance contracts are not subject to sales tax when no physical media is supplied and software updates are available for download via the Internet. By statute, Oklahoma law exempts from sales tax prewritten software delivered to a customer electronically. Oklahoma’s regulations provide that this exemption includes optional software maintenance contracts under which prewritten upgrades are delivered to customers by means other than tangible storage media. Ok. LR-13-034 (Sept. 23, 2013). Third, the Commission ruled that receipts from sales of video game console points cards, video game console online membership cards and online points cards are not subject to sales tax. The Commission resolved the issue under Oklahoma’s gift certificate regulation, which exempts sales of gift certificates from sales tax. However, the Commission clarified that sales tax must be collected to the extent that the certificates are later redeemed for tangible personal property. Ok. LR-13-033 (Sept. 16, 2013).

Click here to read our December 2013 posts on stateandlocaltax.com or read each article by clicking on the title. A printable PDF is also available here. To read our commentary on the latest state and local tax developments as they are published, be sure to download the Sutherland SALT Shaker mobile app.

There is still time to enter the SALT Pet of the Year contest! 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. From the Sutherland SALT Shaker mobile app, click on the menu button to navigate to the Pet of the Month section, and Submit a Pet for a chance to win. For more details, see our previous post. Hurry! The contest ends on December 31.

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).