Fees masquerading as taxes have become increasingly common. And, as illustrated by the Iowa Supreme Court’s recent decision in Kragnes v. City of Des Moines, Docket No. 09-1473 (Mar. 2, 2012), in some cases all or part of a fee may constitute an illegal exaction to the extent it is deemed to be a tax. In Kragnes, the Iowa Supreme Court affirmed the district court’s holding that municipal franchise fees imposed on gas and electric services for almost 10 years exceeded the city’s reasonable costs of regulating the gas and electric franchises and, thus, the difference between the tax collected by the city and the city’s reasonable costs constituted an illegal tax.

Continue Reading City of Des Moines and Residents in ROW over Franchise Fees

False claims act (FCA) statutes allow private persons to bring civil actions against alleged wrongdoers on behalf of the government. FCAs and qui tam actions vary, but generally impose significant penalties for “knowingly” failing to comply with a state law. In this edition of A Pinch of SALT, Sutherland SALT’s Jack Trachtenberg, Jeff Friedman and Eric Tresh explore the disturbing trend of the use of FCAs as a basis for challenging state taxpayers.

Read “Applying False Claims Acts in State Taxation,” reprinted with permission from the May 7, 2012 issue of State Tax Notes.

The controversial methodology relied upon by several states to assess corporate taxpayers for transfer pricing violations has been ruled invalid by a D.C. Administrative Law Judge. Several revenue authorities, including New Jersey, Alabama, Louisiana, Kentucky and the District of Columbia, have relied on this now invalidated transfer pricing audit methodology to assess corporate franchise and income tax.

Read Sutherland SALT’s Legal Alert, “Transfer Pricing Assessment Invalidated by DC ALJ” for more details.

 

The Michigan Court of Appeals recently affirmed a Court of Claims summary judgment finding that sales to a related party are sourced to the location of the related party’s customers. Uniloy Milacron USA, Inc. v. Dep’t of Treasury, No. 300749 (Mich. Ct. App. Jan. 26, 2012).

Uniloy Milacron USA, Inc. (Uniloy), a manufacturer of molds used in blow-molding machines, entered into a distributor agreement with an affiliated corporation to purchase for resale and market Uniloy’s products. The affiliate did not obtain physical possession of the products. Instead, Uniloy packaged, loaded, and shipped the products directly to the affiliate’s customers.

The Michigan Department of Treasury (Department) argued that all of Uniloy’s sales should be sourced to Michigan for purposes of the Single Business Tax (SBT) sales apportionment factor because Uniloy’s products were “delivered” to the affiliate in Michigan before ultimately being sold/shipped to the affiliate’s customers.

Continue Reading Michigan Court of Appeals Finds Drop-Shipped Sales Are Sourced for SBT Purposes Based on Delivery Location

Iowa and Kansas recently issued rulings regarding the taxability of cloud-based software applications and online training services. While the conclusions reached by both states—that the services are not taxable—are generally the same, the reasoning relied upon by each department of revenue illustrates the ongoing uncertainty of applying state sales and use tax laws to cloud computing services.

The Iowa Department of Revenue (IDOR) looked to the state’s statutory authority and acknowledged that the taxability of “cloud computing has not been expressly addressed by the Iowa Code.” Nonetheless, the IDOR determined that the sale of hosted software is not taxable because the Iowa Code provides that a “taxable ‘sale’ of tangible personal property does not occur if the substance of the transaction is delivered to the purchaser digitally, electronically, or by utilizing cable, radio waves, microwaves, satellites, or fiber optics.” I.C. § 423.3(67). Likewise, the IDOR considered web-based training to be nontaxable because “software training” is not an enumerated service under the Iowa Code.

Continue Reading Iowa and Kansas: Remote Access to Software is Not Taxable . . . Or Is It?

The Massachusetts Department of Revenue ruled that a California lubricant and cleaning products manufacturer was a manufacturing corporation, even though 70% of its production activities were outsourced to third parties. As a result, the Department permitted the company to use a single sales factor to apportion its taxable net income to Massachusetts. Mass. Ltr. Rul. 11-8: Qualification as a Manufacturing Corporation under G.L. c. 63, s. 38(I) (Dec. 16, 2011).

Under Massachusetts Law, a “manufacturing corporation” that has income from business activity that is taxable both in Massachusetts and outside the state is required to apportion its net income to Massachusetts using a single sales factor. There are two requirements to be a “manufacturing corporation.” First, the corporation must be engaged in manufacturing during the year, and second, the manufacturing activity must be substantial. A corporation’s manufacturing activities are substantial if the corporation meets one of the five statutorily enumerated tests. The first test is that the corporation derives 25% or more of its receipts for the taxable year from the sale of manufactured goods that it manufactures.

Continue Reading Massachusetts Greases the Skids for Lubricant Manufacturer to Use Single Sales Factor

Almost a year after vetoing similar legislation, Arizona Governor Jan Brewer signed SB 1046 on February 21, 2012, which allows “multistate service providers” to elect to use a market sourcing methodology for purposes of computing the sales factor numerator.  The election is limited to taxpayers that derive more than 85% of sales from services provided to customers outside of Arizona.

Last year, Governor Brewer vetoed similar market sourcing legislation because it was viewed as conflicting with the temporary voter-approved increase to Arizona’s sales tax rate.  This time around, legislators cured the conflict between tax hikes and cuts by delaying the effective date of the marketing sourcing election until 2014, after the sales tax increase expires, and by adopting a unique phase-in that will delay full market sourcing for qualified taxpayers until 2017. 

The first year of the phase-in will allow multistate service providers to include 85% of market sourced sales along with 15% of costs-of-performance sourced sales in the numerator.  Similar to when states phase-in a single sales factor formula by still accounting for the property and payroll factors at a reduced weight, this phase-in requires taxpayers to source sales using both sourcing methods and to include the respective percentage of those sales in the numerator of the sales factor during the phase-in period.

Under the new market sourcing rules, receipts are included in the numerator of a taxpayer’s sales factor based on where a purchaser receives the benefit of the service.  However, there is no elaboration on how to determine where the benefit of a service is received.  This lack of clarity may present difficulties for taxpayers in trying to implement the new sourcing rules.  However, because of the delayed effective date, the Arizona Department of Revenue will have an opportunity to issue regulations or guidance to help taxpayers interpret the provisions.