By Todd Betor and Pilar Mata

On July 3, 2013, the Michigan Supreme Court granted International Business Machines Corporation’s (IBM) motion for leave to appeal the Court of Appeals’ November 20, 2012, judgment in favor of Michigan in International Business Machines v. Department of Treasury, Michigan Supreme Ct., Case No. 146440. Consequently, the highest courts in Michigan and California are now both poised to decide whether taxpayers in those states have the right to elect to apportion their business income using the Multistate Tax Compact’s (Compact) apportionment formula. The California Supreme Court is reviewing the California Court of Appeal’s decision in Gillette Co. v. Franchise Tax Board, Cal. Supreme Ct., Case No. S206587, with briefing already under way.

The Michigan Supreme Court’s order granting IBM’s appeal provided that the parties shall brief whether:

  1. IBM could elect to use the Compact’s apportionment formula in calculating its 2008 tax liability to Michigan, or whether IBM was required to use the Michigan Business Tax (MBT) Act’s single-sales factor apportionment formula;
  2. The MBT repealed, by implication, the Compact’s apportionment formula;
  3. The Compact is a contract that cannot be unilaterally altered or amended by a member state; and
  4. The MBT’s modified gross receipts tax component constitutes an income tax under the Compact, thus subjecting it to the Compact’s election and apportionment provisions.

By Kathryn Pittman and Andrew Appleby

The Arizona Department of Revenue determined that a taxpayer providing online backup and restoration services was subject to Arizona’s transaction privilege tax (TPT) after concluding that the receipts from such services were taxable as rentals of prewritten software. The taxpayer provided services that automatically backed up and restored files. As a conduit for the backup service, the taxpayer provided a software “agent” that customers installed on their computers to facilitate backups. The service agreement included a software license for the “agent.” Based on the foregoing facts, the Department determined that the taxpayer’s services included receipts for software. Software is considered tangible personal property for purposes of the TPT, and thus receipts therefrom are subject to the TPT. The Department further determined that the transactions fell within the personal property rental classification, as opposed to the retail classification, because customers had limited duration of access to the software. The Department did not undertake a “true object” analysis to examine whether or not the software conduit was de minimis compared to the overall backup service. Ariz. Priv. Ltr. Rul. No. LR 13-002 (Mar. 25, 2013).

By Mary Alexander and Prentiss Willson

The Arizona Department of Revenue determined in a private letter ruling that gross receipts from “renting” prewritten software available online are subject to Arizona’s transaction privilege tax (TPT). The definition of tangible personal property for purposes of the TPT includes the electronic delivery of software. Thus, according to the Department, a business is subject to the TPT if the customer has “the defined and exclusive right of use of the software for a specified period….” The Department concluded that the requesting company’s customers had “the requisite amount of use and possession” to constitute a rental, because they could use the company’s employment application software to “add, delete, and modify job descriptions” and had the “ability to search and sort information in the reports produced by [the company].” Further, the Department noted that a customer’s access to the company’s software terminated when its contract expired. Thus, the Department determined the company’s gross receipts from customers using the software at locations in Arizona were subject to the TPT under the personal property rental classification. Ariz. Private Taxpayer Ruling LR13-005 (Apr. 29, 2013).

By Suzanne Palms and Andrew Appleby

The Arizona Department of Revenue determined that shipping and handling fees were subject to Arizona’s transaction privilege tax (TPT). The company sold tangible personal property via the Internet. The company’s affiliates fulfilled the orders, which included activities such as labeling, packaging and shipping the items via common carrier. The company billed its customers a separately stated shipping and handling fee (S&H fee), which included: (1) selecting, packaging and fulfilling the order, and (2) shipping the order to the customer via common carrier. The Department explained that delivery charges are typically deductible for purposes of the TPT as a “[s]ervice rendered in addition to selling tangible personal property at retail.” The term “delivery” is not defined by statute, but the Department interpreted it to mean a retailer’s actual costs to ship or deliver merchandise to a customer. The Department reasoned that since the S&H fee included a handling component for selecting, packaging and fulfilling a customer’s order, a portion of the S&H fee was attributable to activities that occurred before the merchandise was shipped. Because the S&H fee included both components, the Department concluded that the entire S&H fee was subject to the TPT. Ariz. Priv. Ltr. Rul. LR13-003 (May 13, 2013).

By Saabir Kapoor and Timothy Gustafson

Texas has clarified the Comptroller’s authority to disregard certain retail business locations in determining the situs of a sale for local sales tax purposes. Current law requires retailers to collect and remit local sales tax based on the ship-from location on all delivery sales of taxable items that are shipped from a “place of business” in Texas when the order is not placed in person by the purchaser or lessee. Texas Senate Bill (S.B.) 1533, which becomes effective on September 1, 2013, allows the Comptroller to disregard a business location only if the location functions or exists to “avoid the tax legally due” or “exists solely to rebate a portion of the tax imposed.” S.B. 1533 also provides that an outlet, office, facility or location will not be disregarded if such location “provides significant business services, beyond processing invoices, to the contracting business, including logistics management, purchasing, inventory control, or other vital business services.” The legislation specifies that the changes do not affect tax liability accruing before September 1, 2013, and that any accrued liability continues in effect as if S.B. 1533 had not been enacted. Tex. S.B. 1533; Tex. Tax Code § 321.002(a)(3), eff. Sept. 1, 2013.

By David Pope and Prentiss Willson

The New Jersey Division of Taxation concluded in a technical bulletin that sales of cloud computing services are not subject to sales and use tax in New Jersey. Although this is not a change to the Division’s position, the bulletin specifically identifies software as a service (SaaS), platform as a service (PaaS), and infrastructure as a service (IaaS) as non-taxable cloud computing services. The Division explained that SaaS retailers provide customers with access to software through remote means; PaaS retailers provide customers with computing platforms through remote means; and IaaS retailers provide customers with equipment and services necessary to support and manage the customer’s content and dataflow through remote means. While New Jersey generally defines taxable tangible personal property to include prewritten software delivered electronically, the Division stated that SaaS, PaaS, and IaaS do not fit within New Jersey’s definition of tangible personal property because the retailer does not transfer any software to its customers. The Division further stated that New Jersey does not enumerate SaaS, PaaS, or IaaS as taxable services. New Jersey Division of Taxation Technical Bulletin TB-72 (July 3, 2013).

By Sahang-Hee Hahn and Andrew Appleby

Effective September 1, 2013, Texas will refund state sales and use taxes paid by providers of cable television, Internet access or telecommunications services on tangible personal property used in their businesses. On June 14, 2013, Governor Rick Perry signed H.B. 1133 into law, authorizing such refunds. Under the new legislation, a provider is entitled to a refund of sales and use taxes paid on the sale, lease, rental, storage or use of tangible personal property if it meets two requirements. First, the provider or one of its subsidiaries must sell, lease, rent, store, consume or otherwise use the tangible personal property on which taxes were paid. Second, the provider or one of its subsidiaries must directly use or consume such property in the provision of cable television, Internet access or telecommunications services. Purchases made for data processing or information services do not qualify for a refund. The legislation includes a $50 million limitation on the amount of the refund. If the total tax paid by all providers and subsidiaries eligible for a refund is not more than $50 million for a calendar year, then the refund amount will be the amount paid by the provider or the subsidiary. If this $50 million threshold is exceeded, then the refund amount will be a pro rata share of $50 million. Tex. Tax Code Ann. § 151.3186 (2013).

During the Multistate Tax Commission’s Annual Conference and Committee Meetings in San Diego on July 22, 2013, the Income and Franchise Tax Uniformity Subcommittee discussed its effort to redesign the financial institution apportionment rules. In addition, the Sales and Use Tax Uniformity Subcommittee will move forward in drafting a model nexus statute. 

View our full Legal Alert for more details.

By Nicole Boutros and Andrew Appleby

In a case of first impression interpreting when substantial intercorporate transactions are present for purposes of New York’s mandatory combined reporting provisions, a New York State Division of Tax Appeals Administrative Law Judge (ALJ) concluded that the taxpayers could not file on a combined basis. In 2007, New York State amended Tax Law section 211[4] to provide that a combined report is required for corporations engaged in a unitary business if substantial corporate transactions exist between the corporations. Knowledge Learning Corporation (KLC) acquired KinderCare and moved all of KinderCare’s employees to KLC. KLC and KinderCare, along with certain other affiliates, filed on a combined reporting basis for their 2007 tax year. Despite all employees being KLC employees and KLC paying all of KinderCare’s expenses, the ALJ failed to find “substantial intercorporate transactions.” The ALJ weighed “heavily” against the taxpayers because of the absence of written intercompany agreements memorializing the claimed intercorporate transactions and disregarded witness testimony specifically supporting the existence of such intercorporate transactions. The ALJ inexplicably declined to analyze the taxpayers’ alternative argument that there was actual distortion even if there were not substantial intercorporate transactions, permitting “forced combination.” Although the “forced combination” provision remains in New York Tax Law, the ALJ summarily concluded in a footnote that the 2007 amendment eliminated the need to entertain a distortion analysis. Matter of Knowledge Learning Corp., DTA Nos. 823962 and 823963 (June 27, 2013).

By Stephen Burroughs and Timothy Gustafson

The Texas Comptroller determined that receipts received for the delivery of satellite programming to Texas subscribers should be sourced to the site of the subscriber’s set-top box for apportionment purposes. The taxpayer provides direct broadcast satellite television programming to subscribers in Texas and across the United States. For the years in dispute, the taxpayer did not include programming receipts in its Texas receipts factor numerator because the equipment used to receive, amplify and transmit programming signals was located outside of Texas, and therefore the taxpayer concluded the service was being performed outside of Texas. However, the Comptroller determined that “the act that produces the receipts at issue…is the act performed by the [set top box]” in Texas. The set-top box descrambled incoming satellite signals into viewable television programming and therefore, according to the Comptroller, provided the “end-product acts for which the customer contracts and pays to receive.” Texas’s place-of-performance sourcing statute resembles a market-based sourcing mechanism for satellite television providers. Tex. Comp. Dec. 104,224 (May 17, 2013).