By Todd Betor and Andrew Appleby

The Indiana Department of Revenue issued a Letter of Findings denying a taxpayer’s deductions for certain intercompany payments to a subsidiary management company. The taxpayer and its subsidiary management company (Management Co.) entered into an intercompany agreement based on a federal income tax transfer pricing study, which endorsed the “residual profit method.” Under the residual profit method, in addition to general payment for expenses and operating costs, the taxpayer paid Management Co. a “residual profit” beyond the “routine profit” that is customary in that business line. The taxpayer deducted the intercompany payments, including residual profits, for Indiana tax purposes. The Department denied the taxpayer’s deduction for the residual profits paid to Management Co, arguing that Indiana Code § 6-3-2-2(m) is synonymous with I.R.C. § 482, so Indiana must permit the deduction that was allowed for federal purposes. The Department focused on the potential windfall for the taxpayer based on circular cash flow. Although there was no actual circular cash flow, the Department posited hypothetical scenarios that could potentially create circular cash flow.  Therefore, the Department determined that the taxpayer’s residual profits deduction did not reflect the taxpayer’s economic realities and denied the deduction. Ind. Dep’t of State Rev., Ltr. of Findings No. 02-20120310 (July 1, 2013).

By Nicole Boutros and Pilar Mata

The U.S. Court of Appeals for the Second Circuit determined that dial-up internet services were taxable local telephone services when analyzing an Internal Revenue Service bankruptcy claim for federal excise taxes (FET). The taxpayer, WorldCom, Inc., purchased central-office-based remote access (COBRA) services from local telephone companies to provide internet access services to its customers. The COBRA services transferred telephone signals to a local company’s switch network and over primary rate interface lines, converting the signals into an internet-ready format used for the taxpayer’s services. The court determined such services were local telephone services subject to the FET because the services provided access to a local telephone system and had the technical capacity to transmit voice communications, even though the taxpayer and its customers were unable to make calls using the services. By categorizing the services as telecommunications, the Second Circuit potentially opened the floodgates to taxing other internet-based services as telecommunications under the FET. Internal Revenue Service v. WorldCom, Inc., Docket No. 12-803 (2d Cir. July 22, 2013).

In its unanimous decision in Elk Hills Power, LLC v. Board of Equalization, the California Supreme Court held that the California State Board of Equalization may not assess the value of intangible Emission Reduction Credits when valuing taxable power plant property. The decision makes clear that property taxation of virtually all intangible assets is prohibited under California law.

For more details, read our Legal Alert, “California Supreme Court Confirms That Intangible Assets Are (Still) Not Subject to Property Taxation.”

By Zachary Atkins and Andrew Appleby

An Arizona Department of Revenue hearing officer determined that the gross receipts from a taxpayer’s deemed asset sale pursuant to I.R.C. § 338(h)(10), including gross receipts attributable to goodwill, could not be included in the taxpayer’s sales factor for corporate income tax apportionment purposes. The taxpayer asserted that goodwill is an intangible asset, and gross receipts attributable to goodwill should be sourced based on costs of performance, which were outside Arizona. The hearing officer noted that Ariz. Admin. Code R15-2D-903 excludes from the sales factor substantial amounts of gross receipts arising from an incidental or occasional sale of a fixed asset used in the regular course of the taxpayer’s trade or business. Goodwill is an intangible asset, not a fixed asset, but the hearing officer concluded that the gross receipts attributable to goodwill could not be included in the sales factor because they do not fairly reflect the taxpayer’s day-to-day business activity in Arizona. Relying on a legal ruling issued by the California Franchise Tax Board, the hearing officer found “no logical basis for distinguishing between fixed assets and intangibles.” In the Matter of [Redacted], Case No. 201200235-C (Ariz. Dep’t of Revenue, May 31, 2013).

By Shane Lord and Prentiss Willson

The Missouri Administrative Hearing Commission held that a telephone company’s interest income received from its parent company was passive, non-Missouri source income and thus excludible from apportionable income as nonbusiness income. The interest income at issue was related to a note between the taxpayer and its parent company pursuant to which the taxpayer loaned its parent company excess cash after payment of the taxpayer’s expenses. The Missouri Director of Revenue conceded that the interest income was passive but took the position that such income was Missouri source income. The Director argued that even passive, non-Missouri source income was apportionable income for the taxpayer because the apportionment statute for telephone companies does not include a specific provision allowing for the allocation of passive, non-Missouri source income. The Commission disagreed on both points. First, the Commission held the passive interest income was non-Missouri source income because decisions regarding the use of the loaned funds were made outside Missouri, and the loaned funds were held, used and controlled outside Missouri. The Commission then stated that under the general apportionment statute and Missouri Supreme Court precedent reviewing the statute, income is allocable as nonbusiness income if it is both passive and non-Missouri source income, even though the general statute does not include a specific allocation provision for such income. Consequently, the Commission held that a specific allocation provision is also not necessary to allocate income under the apportionment statute for telephone companies, and thus the taxpayer properly allocated its passive, non-Missouri source income as nonbusiness income. AT&T Communications of the Southwest Inc. v. Director of Revenue, No. 11-1375 RI (Mo. Admin. Hearing Comm’n).

By Sahang-Hee Hahn and Timothy Gustafson 

On July 24, 2013, the Massachusetts Legislature passed the Transportation Finance Bill (H.B. 3535) over Governor Patrick’s veto, implementing three key changes to Massachusetts’ state tax system. To begin, the new legislation requires the use of a market-based sourcing method for sales of intangibles in computing the sales factor of a taxpayer’s apportionment formula for corporate excise tax purposes. The new law also expands Massachusetts’ sales and use tax base to include “computer system design services,” defined as “the planning, consulting, or designing of computer systems that integrate computer hardware, software, or communication technologies and are provided by a vendor or a third party.”  Finally, the legislation amends the statutory definition of taxable “services” to include “the modification, integration, enhancement, installation or configuration of standardized software” and to exclude “data access, data processing or information management services.” The legislative changes are effective July 31, 2013. Mass. St. 2013 c. 46; Mass. G.L. c. 63 § 38(f), c. 64H § 1. On July 25, 2013, the Massachusetts Department of Revenue issued a Technical Information Release to provide initial guidance on the application of the sales and use tax to computer system design and software modification services, including applicable sourcing rules and transition rules for existing service contracts. Mass. TIR 13-10, Sales and Use Tax on Computer and Software Services Law Changes Effective July 31, 2013 (July 25, 2013).

Click here to read our July 2013 articles here on our website, 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 to SALTTeam@sutherland.com for consideration for future editions of the SALT Pet of the Month.

By Shane Lord and Prentiss Willson

Under the Delaware Infrastructure Emergency Response Act, emergency work related to a declared state of emergency does not constitute legal presence, residency, or doing business in Delaware for purposes of state and local taxes, licensing, and regulatory requirements. This exclusion applies to out-of-state businesses and employees that conduct emergency work relating to “infrastructure” during a defined period of five days prior to and 60 days after a declared state of emergency (unless a longer period is authorized). The term “infrastructure” for the purposes of the exclusion is defined to include property and equipment owned or used directly in connection with the provision of services to multiple customers or citizens, and does not include office buildings or billing or administrative offices. Out-of-state businesses and employees that remain in the state after the emergency period are subject to the normal standards for establishing presence, residency, or doing business in the state. The Multistate Tax Commission has recommended that other states consider enacting comparable legislation. Delaware 147th Gen. Assemb., H.B. 145 (Approved July 16, 2013).

Chase JC.JPGMeet Juan Carlos and Felipe, the furry royalty of Sutherland Tax Partner Robb Chase and his wife, Allie. Juan and Felipe are Abyssinians, which the breeder described as a “regal” breed, so the brothers were named after the king and prince of Spain.   

Juan is not a people person and lets his dislike be known if anyone other than Robb comes too close for comfort. Despite his tough demeanor, one of Juan’s favorite pastimes is eating flowers, particularly when he wants to alert Robb that it is time to be fed. Chase F.JPGAlthough he is not allowed, Juan prefers to drink water from the faucet, and if a glass of water is left unattended, he will quickly claim it.

Unlike Juan, Felipe is prone to dropping on his side and rolling over so that you can scratch his belly. But, do not let these signs of affection fool you. Between Juan and Felipe, Felipe rules the roost and has been known to attack his (larger) brother without warning, to the point that Juan has a healthy respect for Felipe and typically keeps his distance. 

Juan Carlos and Felipe say thank you for featuring them as Pets of the Month!

By Zachary Atkins and Douglas Mo

A California appellate court held that an ice cream maker’s property tax appeal involving an alleged failure to make an external obsolescence adjustment was subject to the “substantial evidence” standard of review. The taxpayer asserted that certain production equipment used in its novelty product lines was underutilized as a result of low market demand for those novelty products. The primary issue before the court was whether the failure to include an adjustment for external obsolescence was an error in the valuation method and thus a question of law to be reviewed de novo, or whether it was simply a matter of appraisal judgment and thus an issue of fact subject to the substantial evidence standard. The court concluded that the substantial evidence standard applied because the question was whether the assessment appeals board could conclude, based on the evidence presented, that the taxpayer failed to meet its burden of proving its entitlement to an external obsolescence adjustment based on underutilization. In affirming the judgment of the superior court upholding the assessment, the appellate court found that the taxpayer did not establish that it met the requirements for an underutilization adjustment because it did not show that the claimed underutilization was beyond the control of a prudent operator that was recognized in the market. Dreyer’s Grand Ice Cream, Inc. v. Cnty. of Kern, Case No. F064154 (Cal. Ct. App. July 22, 2013) (unpublished).