By Kathryn Pittman and Andrew Appleby

A Washington Superior Court held that using leased specialized railroad cars to transport products in Washington did not rise to the level of “substantial nexus.” The taxpayer, a California company, sold food products into the state by transferring its products into specially leased railroad cars that traveled to Washington. The Washington Board of Tax Appeals overturned the Department of Revenue’s business and occupation (B&O) tax assessment against the taxpayer, determining that the taxpayer lacked the substantial nexus with the state required to impose tax. On appeal, the Superior Court recognized that a taxpayer must take action to establish and maintain a market in the state in order to create nexus. The court held that the use of the leased railroad cars in the state was not sufficient to create nexus, particularly in this case where there was no evidence that the taxpayer was attempting to maintain a business in Washington. Dep’t of Revenue v. Sage V Foods, LLC, Dkt. No. 12-2-01893-3 (Wash. Super. Ct. 2013), nonprecedential order.

Skip and Zack 1.pngMeet Skip, the five-month-old Welsh Terrier of Sutherland State and Local Tax Associate Zack Atkins and his fiancé, Emily. Skip hails from a small country town in western Tennessee, but he is quickly becoming an Atlantan. Don’t let his small size fool you; Skip thinks he is the king of the Piedmont Dog Park. He likes to run with the big dogs, but most of theSkip 2.JPG time the big dogs chase him!

Between the hours of 6:00 a.m. and 8:00 p.m., Skip likes to get into mischief. Whether it is biting holes in clothing (especially socks), discovering new areas of the house, or barking at the dishwasher and dryer, Skip keeps his owners busy. After 8:00 p.m., however, Skip is a completely different puppy. He likes to lay on the couch (preferably between the cushions) and either watch television with Zack and Emily or sleep.

By Mary Alexander and Andrew Appleby

The Indiana Department of Revenue disallowed a taxpayer’s deduction for interest expenses accrued to a subsidiary because the Department considered the loan a sham. Unless eligible for an exemption under Ind. Code § 6-3-2-20(c), a taxpayer that is subject to Indiana’s adjusted gross income tax is required to add back its federal deductions relating to interest expenses paid or accrued to a member of the same affiliated group. The Department determined that the taxpayer did not meet any of the add-back exceptions and that the loan fell within the definition of a “sham transaction” because it lacked “economic substance.” While the form of the transaction was a loan, the Department determined that the substance “could be treated as a capital contribution or some relevant account of money, but the form of the loan is a ‘sham.’”  The subsidiary did not have any employees, and its only activity was to hold a master note for a line of credit between the taxpayer and the subsidiary. The Department also noted that although the taxpayer made substantial profits from its operations in Indiana, the income apportioned to Indiana was “severely distorted” by the interest deduction. The Department concluded that the loan was “motivated by nothing other than” the taxpayer’s “desire to secure the attached tax benefit.” The Department also addressed the characterization of the taxpayer’s income from the sale of a specialized industry subsidiary and determined the income was appropriately re-characterized as business income under Indiana’s functional test. Letter of Findings No. 02-20120140, Ind. Dep’t of Revenue (Aug. 28, 2013).

By Madison Barnett and Timothy Gustafson

In a case involving the exclusion of captive insurance companies from combined reporting groups, the Indiana Tax Court held that a captive must be physically present in Indiana to be “subject to” the insurance premiums tax and therefore exempt from the corporate income tax. The Tax Court initially had ruled that two foreign captive reinsurers were “subject to” the premiums tax, although they did not actually pay the tax, based on the plain meaning of the phrase “subject to.” After the Indiana Supreme Court reversed this ruling, the Tax Court on remand had to determine whether the foreign reinsurers were doing business in Indiana so as to be “subject to” premiums tax. The Tax Court ruled that while the captives received premiums on insurance policies covering risks within Indiana, a physical presence rather than economic presence standard applies to the premiums tax and thus the captives were not doing business in Indiana. The Tax Court also rejected a Commerce Clause challenge to the outcome—taxing domestic reinsurers under the premiums tax but foreign reinsurers under the corporate income tax—finding that state taxes on insurance are “immune from Commerce Clause challenges” under the federal McCarran-Ferguson Act. United Parcel Service, Inc. v. Ind. Dep’t of Revenue, Case No. 49T10-0704-TA-24 (Ind. Tax Ct. Sept. 16, 2013), on remand from Ind. Dep’t of Revenue v. United Parcel Service, Inc., 969 N.E.2d 596 (Ind. 2012), rev’g United Parcel Service, Inc. v. Ind. Dep’t of Revenue, 940 N.E.2d 870 (Ind. Tax Ct. 2010).

By Saabir Kapoor and Andrew Appleby

The Illinois Department of Revenue determined that the redemption of rewards points by a hotel patron was generally not subject to the state’s Hotel Operators’ Occupation Tax (HOOT) because the rewards program was operated by the hotel, and the HOOT was remitted upon a patron’s initial stays at the hotels. Illinois imposes the HOOT on persons engaged in the business of renting, leasing or letting rooms in a hotel. The taxpayer, a global hotel company that owned, operated and franchised hotels throughout the world, operated a loyalty program through a wholly owned subsidiary whereby patrons earned rewards points that could be exchanged for complimentary lodging by staying at the taxpayer’s hotels. Upon a patron’s initial paid stay, a percentage of the proceeds was placed in the subsidiary’s fund for reimbursement of gross charges by persons utilizing the rewards points program. The taxpayer argued that the redemption of points was akin to a promotion that offers a fourth night free when a patron pays for a three-night stay; in such a situation, as argued by the taxpayer, the HOOT operates by effectively reducing the per-night price because the cost of the fourth night has been borne by the price paid for the three nights. Similarly, when a patron redeems its accumulated rewards points for complimentary lodging, the consideration for the free night has been paid by the guest at the time the points were earned. The Department agreed with the taxpayer, but caveated that the redemption would be subject to the HOOT “should a third party pay any reimbursement of the gross charges to the franchised hotels or if the operator upon the initial stay or stays did not remit [HOOT].” Ill. Dept. of Rev. Gen. Info. Ltr. ST 13-0043-GIL (Aug. 23, 2013).

The Sutherland SALT team invites you to join us November 7-9 in San Jose for the California Tax Policy Conference (CTPC), California’s premier state tax event. We are pleased to be a Diamond Sponsor of the conference, which provides a unique venue for state tax professionals to pursue continuing education while enjoying significant opportunities to network with government officials. The CTPC features more than 20 speakers from the California Franchise Tax Board and Board of Equalization, in addition to speakers from leading industry organizations and the public and private sectors.

We are honored that our partner Carley Roberts serves as chair emeritus of the CTPC, and the following members of our team are presenting:

  • Todd Lard will moderate a panel on “2013 SALT Cases that Promise to Shake up the Landscape”
  • Marc Simonetti will share his take on “To Conform or Not To Conform: What’s All the Fuss About?”
  • Carley Roberts will present “Intangibles: You Can’t Touch, But They May Tax”
  • Prentiss Willson will be part of the “California Chief Counsel Roundtable”

We also hope you will join us Friday evening, November 8, as we host “Late Night with Sutherland – Vegas Style,” a casino-themed party immediately following the conference dinner.

For more information about the conference and to register, please visit the CTPC website or view the conference brochure. Please let us know if you have any questions about the conference. We look forward to seeing you there!

By David Pope and Timothy Gustafson

The Virginia Tax Commissioner determined that an out-of-state manufacturer was subject to use tax on “local marketing group” fees charged to its customers because the true object of the transaction was the sale of tangible personal property. The taxpayer manufactured heating, ventilating and air conditioning (HVAC) systems for sale to independent contractors who, in turn, installed the systems as capital improvements to real property. The taxpayer charged a mandatory 2% fee on the sales price of the products for training and advertising costs, separately contracting for the fee with each customer, separately stating the fee on each customer’s invoice, and limiting the fee to a maximum of $10,000 per customer per year. Despite the foregoing, the Commissioner determined that the fees were “inextricably linked” to the products because the fees were mandatory and computed as a percentage of sales; the taxpayer permitted a discount on the sale of the product if the fees were paid timely; the fees were collected for training and advertising expenses that contributed to and benefited the sale of the taxpayer’s products; and the fees were similar to overhead expenses. With minimal analysis of Virginia’s “true object” rules, the Commissioner concluded the true object of the transaction was the sale of the HVAC products, and therefore the entire sales price, including the separately stated fees, was subject to use tax. Virginia Rulings of the Tax Commissioner, Document No. 13-167 (Aug. 27, 2013).

Click here to read our August 2013 posts on stateandlocaltax.com or read each article by clicking on the title. If you prefer, you may also read a printable PDF version.

Feature Your Pet as Pet of the Month! Submit a photo of you with your pet and any fun details you would like to share toSALTTeam@sutherland.com for consideration for future editions of the SALT Pet of the Month.

 

Mark and Annie.JPGMeet Annie, the lovable, six-year-old Sheltie of Sutherland’s Managing Partner, Mark Wasserman and his wife, Rebekah. After years of begging, Mark and Rebekah finally gave in and got Annie for their sons, who promised to always feed and take care of her. And while that may not have turned out to be true, the Wassermans love their sweet Annie, who greets them every day as if she has not seen them in years.

The Wassermans think Annie is the most wonderful dog, except for one slight character flaw—she is one of the most easily startled dogs you will ever meet. She is extremely playful and affectionate, but be sure not to make any loud noises, or Annie will run for cover. In fact, her least favorite day of the week is Monday, when the garbage collector makes its Annie 1.JPGrounds and scares Annie into hiding all morning.

Although she is timid, Annie is anything but shy about her love for playing fetch and eating. In fact, she is known to bring her toy to Mark, ready to play, and nudge him until he obliges. She also is sure to remind Rebekah when it is time to be fed, particularly if she realizes Rebekah might be leaving the house soon; Annie will stand guard at the door, barking and blocking Rebekah’s path to make sure she receives dinner.

Annie is excited to be the SALT Pet of the Month but asks that you congratulate her very, very quietly!

By Saabir Kapoor and Timothy Gustafson

The California Court of Appeal, in affirming summary judgment in favor of the City of Los Angeles, concluded that the taxpayer, j2 Global Communications, Inc., did not produce evidence to demonstrate that its purchase of telecommunications services was exempt from the City’s communication users tax (CUT) under the Internet Tax Freedom Act (ITFA). The ITFA imposes a moratorium on the collection of taxes by state and local governments on “Internet access,” which is defined, in part, to include the purchase, use or sale of telecommunications by a provider of a service that enables users to connect to the Internet to the extent such telecommunications are purchased, used, or sold to provide such service or to otherwise enable users to access content, information, or other services offered over the Internet. 47 U.S.C.A. § 151, note, § 1105, subd. (5). At issue was whether the CUT imposed on j2’s purchase of telecommunications services used in conjunction with its core service offering, eFax, was exempt “Internet access” under the ITFA. In order to provide the eFax service, which enables users to receive faxes in their email inboxes and to send faxes via the Internet, j2 purchased telephone numbers known as “direct inward dials” (DIDs) from third-party telecommunications providers and then assigned a number to a customer. j2 filed a refund claim with the City for the CUT imposed on its purchase of the DIDs, asserting that the ITFA precludes the City from imposing such taxes because the DIDs were used to provide Internet access. The City demonstrated that, although the eFax service requires j2’s customers to connect to the Internet in order to access the eFax content and services, it requires them to do so through a third party; thus, j2 itself does not enable customers to connect to the Internet as required under the ITFA. The court agreed with the City and declined to interpret the ITFA’s definition of Internet access so broad as to render it “essentially meaningless.” j2 Global Communications, Inc. v. City of Los Angeles, Los Angeles County Super. Ct. No. BC423661 (Cal. App. 2nd July 26, 2013).