By Stephen Burroughs and Andrew Appleby

The Mississippi Supreme Court held that the taxpayer bears the burden to prove that an alternative apportionment method imposed by the State is arbitrary and unreasonable. Rejecting the taxpayer’s original cost-of-performance filing position, the Department of Revenue applied an alternative apportionment method utilizing market-based sourcing. On appeal, the Chancery Court found the Department’s “application of equitable apportionment and the market-based sourcing method to be somewhat troubling,” but upheld the alternative apportionment method because it did not “rise to the level of arbitrary or unreasonable.” The Court of Appeals reversed and held that the party invoking alternative apportionment bears the burden of showing that: (1) the standard apportionment method does not fairly represent the extent of the taxpayer’s business activity in the state; and (2) the alternative method is reasonable. See Microsoft Corp. v. Franchise Tax Bd., 39 Cal.4th 750 (Cal. 2006). Unfortunately, the Mississippi Supreme Court reversed the well-reasoned Court of Appeals decision, ignoring substantial case law interpreting the burden related to an alternative apportionment adjustment. It instead relied on Mississippi’s Administrative Procedures Act, which places the burden of proof on taxpayers seeking refunds in Chancery Court. Therefore, Mississippi taxpayers now shoulder the burden to prove that the Department’s alternative apportionment method is improper. Equifax, Inc. v. Mississippi Dep’t of Revenue, — So.3d — (Miss. June 20, 2013).

By David Pope and Pilar Mata

The Texas Comptroller of Public Accounts determined that a taxpayer was not permitted to elect the Multistate Tax Compact’s (Compact) three-factor apportionment formula. This treatment is consistent with prior Texas Comptroller decisions holding that Texas law requires a single-factor apportionment methodology (see Sutherland SALT’s previous articles on this topic here and here). However, unlike those prior decisions, the taxpayer in this matter argued that California’s Gillette decision (permitting California taxpayers to make a Compact election for three-factor apportionment) supported the Texas taxpayer’s position. The Comptroller determined that no weight should be afforded to the Gillette decision because the decision was depublished pending the California Supreme Court’s grant of review, and therefore has no precedential value. The Comptroller further stated that it would be “premature” to consider the Gillette decision on its merits, thus abdicating any responsibility to analyze the implications of the Compact on Texas law. Texas Comptroller’s Accession No. 201305712H (May 2, 2013).

By Jessica Kerner and Jack Trachtenberg

The Missouri Department of Revenue determined that a company’s telecommunications services provided to customers on its cloud computer network are subject to sales tax. The company’s cloud network is hosted on servers located outside of the state, and customers access the network through public telecommunications lines and through the customers’ internal network. Customers separately purchase the necessary hardware and internet connection. The services provided to customers through the cloud network include voice, video, messaging and conferencing. The Department determined that the company is providing taxable “telecommunication services” because it transmits information through its services that direct and control its customers’ hardware and because it stores messages on its server, which are taxable events in Missouri. The Department also noted that customers would not be able to use their equipment without the company’s software and hosting unless the customer was willing to engage another telecommunications company or built its own in-house system. This ruling suggests the Department believes that the provision of software that provides switching or routing functions constitutes the provision of telecommunications for sales tax purposes. Taxability of Telecommunications Services, L.R. 7248, Mo. Dept. of Rev. (May 24, 2013).

By Kathryn Pittman and Timothy Gustafson

The Massachusetts Commissioner of Revenue concluded in a letter ruling that a taxpayer’s sales of subscriptions to use its virtual event platform and planning software were subject to sales tax where the use of the software was the object of the transactions. For a flat fee based on length of access or a defined event period, the taxpayer provided its customers a virtual event platform and licensed software that allowed its customers to create and customize virtual events via the Internet. Customers also could elect custom design or professional services for an added fee. In ruling that the taxpayer’s provision of the service was subject to sales tax, the Commissioner first noted that sales of prewritten computer software, including software hosted by a third party, are taxable regardless of the method of delivery. The Commissioner further noted, however, that where there is no separate charge for the use of software, and the true object of the transaction is acquiring a good or service other than the use of software, such software is generally not taxable. Under this framework, the Commissioner determined that the taxpayer’s sales were subject to tax because the use of the software to create customized virtual events by the customers was the true object of the transactions. Finally, the ruling stated that any personal or professional services (e.g., design services) offered in conjunction with the event planning software would be subject to sales tax if sold in a bundled transaction for one subscription price, but may be exempt from tax if the charges for such services were separately stated. Mass. Ltr. Rul. No. 13-5 (Jun. 4, 2013).

By Saabir Kapoor and Prentiss Willson

Virginia’s Tax Commissioner denied a taxpayer’s request for alternative apportionment because the taxpayer did not demonstrate by clear and cogent evidence that the statutory apportionment methodology led to an unconstitutional and inequitable result. The taxpayer, a limited partnership headquartered outside Virginia, sold real estate located in its home state and sought to allocate income to Virginia based on a separate accounting methodology. Virginia will only grant permission to use an alternative method of apportionment if the taxpayer can show: (1) the statutory method produces an unconstitutional result under the particular facts and circumstances; and (2) the statutory method is inequitable because it results in double taxation, and the inequity is attributable to Virginia’s, rather than another state’s, method of apportionment. The Commissioner relied on the long-standing principle established by the U.S. Supreme Court in Moorman Manufacturing Company v. G.D. Bair, etc., 437 U.S. 267 (1978), that states have wide latitude in the selection of apportionment formulas that will only be disturbed when the taxpayer can demonstrate by clear and cogent evidence that income attributed to the state is out of all appropriate proportion to business transacted in the state or has led to a grossly distorted result. The Commissioner ruled that the taxpayer did not meet its burden of proof because the only evidence offered was the fact that Virginia’s statutory apportionment methodology would “substantially increase” the amount of income subject to tax by Virginia. Rulings of the Tax Commissioner, No. 13-86 (June 10, 2013).

By Madison Barnett and Timothy Gustafson

The Tennessee Department of Revenue announced that the existing opportunity to compromise prior year liabilities related to the disallowance of certain intangible expense deductions will be closing on September 30, 2013. For several years, Tennessee has been issuing wide-scale assessments—using the Department’s discretionary authority—to taxpayers that deducted intangible expenses paid to related parties. The mass compromise program was first announced in November 2011. See Tenn. Important Notice No. 11-17. While not set forth in the notices, the terms of the compromise typically consist of a 25% disallowance of the intangible expense deduction with interest due on any additional tax that may result from the disallowance. A waiver of penalties associated with a failure to disclose the deduction must generally be requested separately. According to the most recent notice, “the Department will not continue to recommend compromises on the same terms if contacted by the taxpayer after September 30, 2013.” Taxpayers with existing assessments or potential exposure related to this issue should consider whether to request participation in the compromise program in advance of the September 30 deadline. Tenn. Important Notice No. 13-06 (June 2013).

The add-back statute has been amended, effective for tax periods ending on or after July 1, 2012, to require pre-approval from the Commissioner before a taxpayer may deduct specified intangible expenses, subject to certain safe harbors that do not require pre-approval. See Tenn. Code Ann. § 67-4-2006(b)(2)(N).

As part of its implementation of mandatory combined reporting, the District of Columbia’s Office of Tax and Revenue issued a taxpayer-friendly proposed regulation that would provide an automatic seven-month extension for calendar and fiscal year taxpayers.


For more details, read our legal alert, “D.C. Proposes to Extend Deadline for Combined Reports“

By Mary Alexander and Prentiss Willson

The Oklahoma Court of Appeals held that retroactive relief applied to a facially unconstitutional capital gains deduction. The court previously held that the capital gains deduction set forth in 68 O.S. §238(d) discriminated on its face against interstate commerce because the holding period for out-of-state companies was longer than the required holding period for Oklahoma companies. On rehearing, the Oklahoma Tax Commission (OTC) argued that the court’s decision should only apply prospectively. However, pursuant to long-standing Oklahoma precedent, the court recognized that “retroactivity is generally applied to constitutional opinions.” Holding that retroactivity applied to the taxpayer, the court also stated that a constitutional pronouncement must be “given full retroactive effect” and went on to apply the “pipeline rule.” Under the “pipeline rule,” a decision applies to all cases still open on direct review and to all events that are not time-barred. The purpose of the rule is to secure equality for all pending claims, or those capable of being litigated, when a new rule is announced. The OTC will likely appeal the decision to the Oklahoma Supreme Court. CDR Sys. Corp. v. Oklahoma Tax Comm’n, Okla. Ct. of App., Case No. 109,886 (filed June 12, 2013).

By Zachary Atkins and Andrew Appleby

The Arizona Court of Appeals held that Cable One, Inc. was subject to central assessment as a telecommunications company because of its Voice over Internet Protocol (VoIP) service offering. The court found that Cable One, which provided cable television, Internet access and VoIP services, met the statutory definition of a “telecommunications company” because it owned communications transmission facilities and provided “telecommunications exchange and inter-exchange access.” The latter finding marked a significant departure from the lower court’s decision, which held that Cable One did not provide “telecommunications exchange and inter-exchange access” because it did not connect its VoIP subscribers to an exchange. The appellate court, in contrast, reviewed the legislative history and determined that “telecommunications exchange and inter-exchange access” mean local telephone service and long-distance telephone service, respectively. Since Cable One’s VoIP service permits subscribers to make and receive local and long-distance telephone calls, the appellate court concluded that Cable One provided “telecommunications exchange and inter-exchange access.” Cable One, Inc. v. Ariz. Dep’t of Revenue, Cause No. 1 CA-TX 12-0006 (Ariz. Ct. App. June 11, 2013).

On June 6, 2013, the Michigan Court of Claims became the second court in the country to hold that the Multistate Tax Compact (the Compact) is a binding multistate compact that cannot be repealed by a separate, subsequent statute. The taxpayer was thus entitled to apportion its income under the former Business Income Tax component of the Michigan Business Tax using the Compact’s equally-weighted three factor formula rather than the statutory single sales factor formula. 

For more details, read our legal alert, “Michigan Court Allows Multistate Tax Compact Election.”