By Scott Booth and Timothy Gustafson

The Massachusetts Appellate Tax Board ruled that an out-of-state corporation’s subsidiary qualified as a financial institution by virtue of the lending activities undertaken by the trusts in which it held beneficial ownership and from which the subsidiary derived more than 50% of its gross income. Under Massachusetts’ statutory “catchall” provision (Mass. G.L. c. 63, § 1(e)), a corporation “in substantial competition with financial institutions. . .[that] derives more than 50 per cent of its gross income. . .from lending activities” qualifies as a financial institution. To support the subsidiary’s claim that it was properly characterized as a financial institution, it established to the Board’s satisfaction that the trusts owned student loan portfolios that had been securitized by its parent and affiliates, and the trusts also engaged in a number of “lending activities” regularly performed by other banks securitizing student loans, within the meaning of the catchall. Further, because the trusts were correctly characterized as partnerships for federal and state purposes, the trusts’ activities were properly attributed to the subsidiary. Therefore, the Board ruled that the subsidiary should be separately taxed as a financial institution because it derived substantially all of its income from the trusts’ lending activities, which were in substantial competition with financial institutions and were attributable to the subsidiary. Based on its ruling, the Board also concluded that the subsidiary was entitled to apportion its income as a financial institution but that all of its property (i.e., the loans) was to be assigned to the subsidiary’s commercial domicile in Massachusetts in the absence of a regular place of business outside of the state. Marblehead Corp. v. Comm’r of Revenue, Dkt. No. C293487 (Mass. App. Tax Bd. Apr. 17, 2013).

By Kathryn Pittman and Jack Trachtenberg

On April 17, 2013, Select Medical Corporation (Select Medical) filed suit in federal district court seeking to enjoin Delaware from enforcing an unclaimed property assessment issued for years that had been resolved already through the state’s voluntary disclosure program. In 2006, Select Medical entered into Delaware’s voluntary disclosure program for the years 1997-2001. As part of the voluntary disclosure process, Select Medical escheated approximately $17,000 to Delaware and paid approximately $300,000 in unclaimed property to states other than Delaware. On the same day that Delaware cashed Select Medical’s escheatment check, it notified the company that it was being placed under audit. Using a third-party auditor, Delaware demanded payment of $297,436 for the period 1997-2001 based on an estimate that looked to the amount of property owed to other states from 2002-2008. Unable to resolve the matter with the state, Select Medical commenced a lawsuit and sought injunctive relief against the demand for payment, alleging that Delaware exceeded its authority under state law by estimating an unclaimed property liability through extrapolation of amounts paid to other states for a different period, even though Select Medical had actual records from which any liability could be determined and the owners of any unclaimed property identified. Select Medical also alleged a variety of federal common law and constitutional violations. Given Delaware’s position as one of the most aggressive states in enforcing unclaimed property law, the trajectory of this litigation will be important, especially given the recent trend toward more aggressive unclaimed property enforcement in all states. Taxpayers who have previously entered into voluntary disclosure agreements or who are contemplating doing so should pay close attention to this case as it may frame new powers for the states with respect to escheatment. Select Medical Corp. v. Del. Sec’y of Finance, Del. Dir. Of Rev., & Del. State Escheator, Case No. 1:13-cv-00694-UNA (D. Del. Apr. 17, 2013).

By Todd Betor and Pilar Mata

In a Letter of Findings, the Indiana Department of Revenue disallowed a corporate partner’s attempt to deduct flow-through income from a limited liability company as “foreign source dividends and other adjustments” on its Indiana corporate income tax return. Indiana requires corporate partners to report their share of partnership income, whether distributed or undistributed, on their income tax returns, with certain adjustments for intercompany and related party transactions. If a corporate partner is unitary with a partnership, only nonbusiness income can be removed from a corporate partner’s apportionable base. The taxpayer, an Indiana corporation, held a majority interest in an Indiana limited liability company (LLC) that elected to be treated as a partnership for U.S. federal income tax purposes, and which owned an Indiana LLC that was a disregarded entity for U.S. federal income tax purposes and conducted a gaming business in Indiana. The taxpayer argued that it was not domiciled in Indiana and thus, under Riverboat Development, Inc. v. Department of State Revenue, 881 N.E.2d 107 (Ind. Tax Ct. 2008), the taxpayer did not have to report or pay tax on the flow-through income. The Department disagreed, not only finding the taxpayer to be incorporated in and operating in Indiana, but also that Riverboat Development was distinguishable because that case involved a non-resident shareholder’s receipts of “intangibles,” and no “intangibles” were at issue in this case. Finally, the Department found that the taxpayer and the LLCs were unitary because the taxpayer earned its income solely from business in Indiana as the majority member of the LLCs and from managing the gaming LLC’s daily business operations. Consequently, the Department determined that the taxpayer’s flow-through income from the LLCs was nondeductible business income that was attributable to Indiana and subject to Indiana corporate income tax. Ind. Dep’t of State Rev., Ltr. Of Findings No. 02-20100152 (Mar. 1, 2013).

By Christopher Chang and Jack Trachtenberg

The New York State Division of Tax Appeals (DTA) ruled that the dividend income received by a taxpayer holding company from its minority ownership in a publicly traded corporation constituted “investment income” for purposes of New York’s Article 9-A franchise tax on business corporations. The holding company held stock in American International Group, Inc. (AIG), which functioned as an equity compensation plan by using the return on the stock to compensate its shareholders, all of whom were AIG senior executives. The State argued that the AIG dividends were not investment income because the holding company’s intent in acquiring the AIG stock was to benefit the AIG executives, not to “invest in” the stock “for its own account.” Using a common dictionary definition of the term “investment,” the DTA held that the dividends were investment income derived from investment capital because the holding company acquired the AIG stock in exchange for its own capital, held the stock for some 35 years, and during its period of ownership stood to gain or lose on the acquisition based upon the performance of the issuer of the stock. The DTA rejected the State’s attempt to read a “motive” requirement into the statutory and regulatory provisions, stating that “[n]either the motive for making an acquisition of a given type of item otherwise qualifying as investment capital, nor the investor’s subsequent use of the returns gained from that acquired item (i.e., dividends and capital appreciation over time) serve to negate that fact that such acquisition was an investment.” Matter of C.V. Starr & Co., Inc., Division of Tax Appeals, DTA No. 824121 (April 18, 2013).

Jack Pet of the Month 1.jpgMeet Maximus (Max, pictured below) and Elphaba (Elphie, pictured here with Jack), the lovable cats of Sutherland SALT’s Jack Trachtenberg.

Max likes to think that his size makes him tough, as he walks around like the tough cat in the house, but as soon as visitors come to the door, he scrambles for cover under the bed. Never one to miss a meal, Max is now on a strict wet-food-only diet to help him shed his kitty curves. He is certain to remind Jack when it is time for breakfast, which, according to Max, is as soon as the sun rises.

Elphie, named for Elphaba from the musical Wicked, joined Jack after persistently coming to the back door of his house, Jack Pet of the Month 2.jpgbegging for food. After deciding to nurse the sweet cat back to health while trying to locate her owner, Jack finally decided to keep her after no one claimed her. Despite Max’s tough-guy image, it’s Elphie who is secretly the bully of the house. Sweet and innocent at first meeting, Elphie loves to hide and wait for the perfect opportunity to startle Max with a sneak-attack pounce, which only makes his skittish nature worse. Her second-favorite pastime is bird hunting through the window, determined that someday she may catch one.

Max and Elphie say thanks for choosing them as the March Pet(s) of the Month!

By Mary Alexander and Andrew Appleby

The New York State Department of Taxation and Finance determined that a women’s apparel company’s “inspirational shopping” trips were not sufficient to be considered “doing business” in the state for corporate franchise tax purposes. Petitioner was a traditional remote seller headquartered outside of New York. Petitioner’s employees occasionally traveled to New York for two to three days to meet with potential merchandise vendors and to go on “inspirational shopping” trips, but Petitioner did not have any sales representatives promoting or soliciting sales in the state. As of May 31, 2008, Petitioner had also terminated its online web affiliate linking program with New York-based web affiliates. Although a “close question,” the Department concluded that, pursuant to Section 1-3.2 of the Business Corporation Franchise Tax Regulations, Petitioner’s occasional trips did not rise to the level of “doing business” in the state. However, the Department noted that if Petitioner was engaged in solicitation activity protected by Public Law 86-272, as well as the occasional trips, then Petitioner would be considered to be “doing business” in New York. N.Y. Adv. Op. TSB-A-13(6)C (Apr. 11, 2013).

By Zachary Atkins and Timothy Gustafson

The Iowa Supreme Court passed on an opportunity to breathe life into equal protection jurisprudence and, instead, rejected Qwest Corporation’s challenge under the Iowa Constitution to a property tax regime that taxes the personal property of incumbent local exchange carriers (ILECs) but not competitive long distance telephone companies (CLDTCs) or wireless service providers. In 1973, the Iowa legislature enacted a phase-out of the state’s personal property tax generally, but telephone companies continued to be taxed on their real and personal property. In 1995, the legislature created an exemption for the personal property of CLDTCs in an effort to foster competition in the “facilities-based” telephone market in Iowa. Wireless service providers, like CLDTCs, are and have been subject to tax only on their real property. Rejecting Qwest’s challenge to the constitutionality of this regime, the court held that a rational basis existed for relieving new market entrants like CLDTCs of certain barriers to entry, such as a tax on personal property, to promote competition in a market long-dominated by ILECs, which continued to benefit from their previously held monopolies. The court also held that a rational basis existed for treating wireless service providers differently than ILECs because the two could be viewed as operating in distinct markets, and the legislature could have concluded that competition in the wireless market was sufficiently robust. Qwest Corp. v. Iowa State Bd. of Review, Case No. 11-1543 (Iowa 2013).

The Multistate Tax Commission’s Financial Institutions Working Group held its monthly meeting on April 23, 2013 to discuss a proposed apportionment formula for financial institutions. For additional details about the meeting, read our legal alert, “Hate the Sin, Love the Sinner: MTC’s Financial Institution Apportionment Effort.”

By Shane Lord and Andrew Appleby

The Indiana Department of State Revenue issued a Letter of Findings concluding that a taxpayer’s sales of tangible personal property from Indiana to foreign countries were attributable to Indiana for income tax purposes because the taxpayer did not show that its activities in the foreign countries exceeded the protections of Public Law 86-272 (P.L. 86-272). For income tax purposes, Indiana requires the throwback of sales under its apportionment provisions when the sales involve tangible personal property shipped from Indiana to a purchaser in a state where the taxpayer is protected from income taxation under P.L. 86-272. The taxpayer asserted that its activities exceeded the protections of P.L. 86-272, so the throwback rule would not apply. The Department conceded, without analysis, that the taxpayer’s activities in three countries for one tax period exceeded the protections of P.L. 86-272. However, the Department concluded that the taxpayer’s activities for the remaining tax years and foreign countries did not exceed the mere solicitation of sales, and thus fell within the protections of P.L. 86-272 and were subject to Indiana’s throwback rule. Ind. Dep’t of State Rev., Ltr. of Findings No. 02-20120352 (Mar. 24, 2013).

In this edition of A Pinch of SALT, Jeff Friedman, Pilar Mata and Mary Alexander examine the requirements and ramifications of states’ attempts to apply prospective-only remedies to unconstitutional taxes and explore why Maryland State Comptroller of the Treasury v. Wynne is not an appropriate case for prospective-only relief.

 

Read “Wynne-ing Isn’t Everything: Remedies for Unconstitutional Taxes,” reprinted with permission from the April 1, 2013 issue of State Tax Notes.