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).

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).