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).

Following in the footsteps of Ohio more than 20 years ago, more than 20 states have enacted addback statutes, which generally limit taxpayers from reducing their state income tax liability by deducting interest and intangible expenses paid to out-of-state related parties. In this edition of A Pinch of SALT, Sutherland SALT’s Michele Borens and Jessica Kerner outline the three basic components shared by all addback statutes, analyze litigation involving those components and explore the lack of litigation on addback statutes.

Read “20 Years of Ambiguity in Addback Statutes,” reprinted with permission from State Tax Notes.

Click here to read our November 2013 posts on stateandlocaltax.com or read each article by clicking on the title. You may also view a printable PDF here.

By Sahang-Hee Hahn and Timothy Gustafson

The New York Supreme Court, Appellate Division, held that interest income derived from Xerox Corporation’s equipment financing agreements with governmental customers failed to qualify as “investment income” for New York Corporation Franchise Tax purposes. Xerox’s financing agreements consisted of two types: fixed purchase option leases and installment sales. Xerox argued that the interest income from these agreements was properly characterized as “investment income” because the underlying financing agreements qualified as “investment capital,” which New York law defines to include investments in “stocks, bonds and other securities.” N.Y. Tax Law § 208(5)&(6). Xerox took the position that the financing agreements constituted “debt instruments” issued by governmental entities, thereby satisfying the Department of Taxation and Finance’s own regulatory definition of “other securities.” 20 NYCRR 3-3.2(c)(2). The Appellate Court rejected this argument. Noting the absence of a statutory definition for “stocks, bonds [or] other securities,” the court applied two securities law tests to determine whether Xerox’s financing agreements, which the court described as “basic sale or lease contracts,” were of a similar nature to stocks or bonds or otherwise qualified as securities and concluded that they did not. The court also found no evidence that the financing agreements were intended to be considered debt instruments and that such agreements qualified as debts “issued by” a governmental entity under the Department’s regulation, or that such agreements should be considered debts of governmental customers in light of state restrictions on government assumption of debt. The court held that the financing agreements were business capital whether the purchaser was a governmental or private entity. Xerox Corporation v. N.Y. Tax App. Trib., 2013 WL 5745853 (N.Y.A.D. 3 Dept., Oct. 24, 2013).

 

By Maria Todorova

The Indiana Department of Revenue determined that a taxpayer and its two affiliated entities were not required to report their income using a “separate accounting” method because the Department’s audit staff failed to prove the standard apportionment formula did not fairly reflect the taxpayer’s business activities in Indiana. The taxpayer, a manufacturer of automotive parts, filed a separate Indiana income tax return until 2005, when it began filing a consolidated income tax return with two affiliated entities. On audit, the Department’s audit staff concluded that the standard method of apportionment did not fairly represent the taxpayer’s income from Indiana sources because the taxpayer and one of its affiliated entities had substantial disparities in both the amount of their Indiana activities and their respective amounts of income and loss. As a result, audit staff required separate accounting for the companies. On appeal, the taxpayer presented evidence that the affiliated entity in question maintained resident and non-resident employees in Indiana who regularly conducted business activities within the state that exceeded the protections under P.L. 86-272 and that such entity had taxable income in years prior to the audit years. The Department reasoned that while sufficient differences in the method of doing business may be justification for separate classification and differential tax treatment, the Department has the burden of establishing that the standard apportionment method does not fairly reflect the taxpayer’s Indiana sourced income. Consequently, the Department concluded that the taxpayer established that the affiliated entity in question had substantial contacts with the state and that the Department audit staff failed to demonstrate that a departure from the standard apportionment formula was necessary. On a separate issue involving the disallowance of royalty expenses, the Department ruled in favor of the taxpayer, concluding that its audit staff failed to establish such royalty payments distorted the taxpayer’s Indiana source income. Letter of Findings 02-20130215 (Ind. Dep’t of Rev. Oct. 30, 2013).

By Todd Betor

A nonresident corporation requested a ruling from the Virginia Tax Commissioner as to whether the corporation was required to withhold Virginia state income tax and pay Virginia unemployment insurance for an employee who worked and resided in Virginia. The employee’s in-state activities consisted solely of performing legal services on behalf of the corporation from her Virginia home. The Commissioner briskly concluded the corporation was required to withhold Virginia income tax from the employee’s wages and deferred to the Virginia Employment Commission on any liability for unemployment insurance tax. While not requested by the corporation, the Commissioner then examined whether nexus existed for Virginia corporate income tax purposes. The Commissioner concluded that legal services, even if related to the sale of tangible products, are generally considered to be the type of activity that exceeds the protections of P.L. 86-272, unless they are found to be de minimis. Consequently, the Commissioner determined that the employee’s activities appeared to create nexus for Virginia corporate income tax purposes. Va. Pub. Doc. Rul. No. 13-203 (Nov. 1, 2013). This is the third ruling to discuss the nexus effects of a single employee in the state that the Commissioner has issued in the last two years. See Va. Pub. Doc. Rul. No. 12-37 (Mar. 30, 2012) and Va. Pub. Doc. Rul. No. 13-172 (Sept. 19, 2013).

By David Pope and Andrew Appleby

The New Jersey Tax Court denied three summary judgment motions in the ongoing Whirlpool litigation relating to nexus and the “Throwout Rule.” In 2011, the New Jersey Supreme Court held that New Jersey’s Throwout Rule was facially constitutional but narrowed the application of the rule to untaxed receipts from states that lacked jurisdiction to tax the corporation. The taxpayer, an intangibles holding company, subsequently filed a motion for summary judgment in the Tax Court seeking to define the application of the Throwout Rule under the Supreme Court’s decision. The New Jersey Division of Taxation filed a cross-motion for summary judgment asserting that the taxpayer had nexus in New Jersey and was required to remit tax returns before the court could determine the application of the Throwout Rule. In response, the taxpayer filed its own cross-motion for summary judgment arguing a lack of nexus in New Jersey. The court denied all three motions. Both parties’ nexus-related motions were denied because the court found issues of material fact in dispute. In particular, the court stated that whether the taxpayer (1) earned income properly attributable to the state and (2) had a physical presence in the state or exercised control over its parent company’s activities in the state were material facts that remained in dispute relative to the issue of nexus. The court also denied the taxpayer’s original motion seeking to define the application of the Throwout Rule because the issue was premature. The court determined that the nexus issue must be determined as a threshold matter before reaching the Throwout Rule issue. For those watching the Whirlpool litigation, stay tuned, as there should be some interesting developments relating to economic nexus (the Division’s primary nexus argument) and the application of the Throwout Rule as this litigation progresses. Whirlpool Props., Inc. v. Director, Div. of Taxation, Docket No. 000066-2007 (Oct. 22, 2013).

By Kathryn Pittman and Andrew Appleby

The Virginia Tax Commissioner found that a corporation with a single employee in Virginia who conducted work-related activities from a home office had nexus for corporate income tax purposes. The taxpayer, headquartered outside of Virginia, had one employee who conducted training at various facilities outside Virginia, but also developed test methods relating to such training from her home office in Virginia. The Commissioner determined that the employee’s activities from her home office exceeded the protection of P.L. 86-272 because they were related to the taxpayer’s sales of training and consulting services to its customers and were not related to sales of tangible products. The Commissioner noted that the activities would not create nexus if they were de minimis, but the taxpayer did not provide sufficient information to make such a determination. Thus, the Commissioner concluded that the taxpayer had nexus with Virginia for corporate income tax purposes. This is the second ruling discussing the nexus effects of a single employee in the state that the Commissioner has issued in the last two years. See Va. Pub. Doc. Rul. No. 12-37 (Mar. 30, 2012). Other states have also issued their own P.L. 86-272 decisions relating to the presence of a single employee in the state. See, e.g., Colo. Gen. Inf. Ltr. No GIL-13-021 (Aug. 20, 2013) (noting that a wholesaler that had an employee in Colorado would have nexus in Colorado if the employee’s activities were not closely related to the solicitation of sales). Taxpayers should be aware of these developments, particularly in states in which they have employees engaged in telework or other flexible employment arrangements. Va. Pub. Doc. Rul. No. 13-172 (Sept. 19, 2013).