Understanding states’ various approaches to accountant-client privileges can make the difference in protecting communications from disclosure in litigation. In this edition of A Pinch of SALT, Sutherland SALT’s Pilar Mata and Melissa Smith examine the scope and breadth of accountant-client privileges that have been adopted by some states.
Read “Demystifying Accountant-Client Privileges in State Tax Litigation,” reprinted with permission from the April 2, 2012 issue of State Tax Notes.
All seems right in the world, or at least in Michigan, where the Michigan Court of Appeals recently held that the Department of Treasury (Department) improperly disallowed Pfizer’s deductions of “royalties” for Michigan Single Business Tax (SBT) purposes. Pfizer, Inc. v. Dep’t of Treas., Docket No. 301632 (Mich. Ct. App. Feb. 14, 2012).
To calculate the SBT tax base (now two tax regimes ago), “royalties” were subtracted from federal taxable income. Pfizer calculated its royalty income based on the “profit split methodology” under Internal Revenue Code § 482 regulations, which treat 50% of a subsidiary’s profits as “intangible property income” to the parent. Pfizer subtracted these “royalty” amounts to compute its SBT tax base.
The Department disallowed the royalty deduction, claiming that “intangible property income” was not synonymous with the term “royalties” as defined by the Michigan Supreme Court in Mobil Oil Corp. v. Dep’t of Treas., 373 N.W.2d 730, 736 (1985): “payment received by the transferor in patent . . . transactions[.]” The Department claimed that the definition of “royalties” in Mobil is narrower than the term “intangible property income,” as used in IRC § 936(h)(3)(B), and thus items that may be included in “intangible property income” may not necessarily be considered “royalties” for SBT purposes.
However, the court dismissed the Department’s theoretical arguments because Pfizer met its burden of proof through uncontroverted affidavits that all of the relevant income related to the subsidiary’s use of Pfizer’s patents. The court placed great weight on the Department’s failure to produce any evidence that Pfizer’s royalty payments were for anything other than the use of its patents.
A recently released California Chief Counsel Ruling authorized a corporate taxpayer to use its customers’ billing addresses as a proxy for the customers’ “commercial domicile” in calculating the taxpayer’s sales factor numerator. Chief Counsel Ruling 2011-01 (Aug. 23, 2011, rel. Dec. 28, 2011).
For sales factor purposes, California sources the sales of intangibles and services using costs of performance (COP) apportionment. The sales of intangibles and services are attributable to California if a greater proportion of the income-producing activity is performed in California than in any other state, based on COP. Before 2008, taxpayers could not include payments to agents and independent contractors as part of the taxpayer’s COP analysis. But beginning in 2008, California began to require taxpayers to take into account payments made to agents and independent contractors in calculating COP. As part of the analysis, the taxpayer must determine the location of the income-producing activity, and the regulations provide a comprehensive list of cascading rules to determine the appropriate location of the income-producing activity. See Cal. Code Regs. tit. 18, § 25136.
Continue Reading We Know Where You Live: California’s Billing Address Sourcing
Have you read our special edition April Fool’s 2012 SALT Shaker newsletter? You can read the full newsletter here. If you would like to subscribe to receive Sutherland SALT’s publications and legal alerts, sign up at www.sutherland.com.
On March 30, 2012, the U.S. District Court for the District of Colorado permanently enjoined the enforcement of Colorado’s sales and use tax notice and reporting requirements. Read our full legal alert, “Colorado’s Use Tax Reporting Regime Declared Unconstitutional,” for more details.
Meet Dolce, the three-year-old female doxie mix of Sutherland SALT partner Carley Roberts. Dolce is one of her mom’s favorites in a large family of five dogs, five cats, five horses and two goats (for full coverage of Carley and husband Jeremy’s clan, check out our April Fool’s 2012 SALT Shaker newsletter). Carley and Jeremy fostered Dolce at only four weeks old. At the time, Dolce had scabies and an upper respiratory infection with little hope of surviving, and she accompanied Carley everywhere for the next six weeks.
Carley and Dolce’s special bond has endured. Now healthy and happy, Dolce continues to come to the office when Carley is not traveling. (Yes, “dog friendly” was a key factor in Sutherland SALT’s search for Sacramento office space!) When not working on SALT matters, Dolce assists Jeremy in his profession—she is a trained and registered service dog and helps Jeremy, a speech and language service provider, in his work with autistic children.
But more important than Dolce’s impressive work ethic is her sweet and gentle nature. Marking the start of their tradition of naming their dogs after alcohol-related beverages, Carley and Jeremy named Dolce after Far Niente’s “Dolce” dessert wine. The winemakers call the wine “liquid gold,” which reminded Carley of Dolce’s coloring. The fact that “dolce” also means “sweet” in Italian made Dolce the perfect name for this very sweet Pet of the Month.
The California Franchise Tax Board recently released Legal Division Guidance 2012-03-02, concluding that taxpayers may not simultaneously report tax under a single sales factor election and the standard three-factor formula to avoid application of the Large Corporate Understatement Penalty. For full details, read our legal alert, “Single Sales Factor Election May Create Exposure to Large Corporate Understatement Penalty in California.”
A decision by Maryland’s highest court illustrates the complexities taxpayers face in reporting federal income tax audit changes for state income tax purposes. The Maryland Court of Appeals held that an individual must claim a state income tax refund resulting from a “final” federal audit change within one year of the Internal Revenue Service’s issuance of Form 4549A, Income Tax Examination Changes, rather than the date when the taxpayer could no longer appeal the Service’s determination. King v. Comptr. of Treas., 2012 WL 592788 (Md. Feb. 24, 2012), aff’g Md. App. (unreported), rev’g 2009 WL 6767497 (Calvert Cnty Cir. Ct. Nov. 12, 2009), rev’g Md. Tax Ct. (Aug. 28, 2008), aff’g Md. Comptr. Off. Hrg. and App. Section.
The taxpayer, who is the ex-wife of author Tom Clancy, owned a limited partnership interest in the Baltimore Orioles baseball team. A federal income tax audit of the partnership resulted in the IRS adjusting certain partnership items using Form 870-PT, Agreement for Partnership Items and Partnership Level Determinations. The partnership adjustments flowed through to the taxpayer’s personal income tax return and permitted her to utilize additional losses, thereby reducing her federal taxable income. The IRS reported the impact of the partnership’s flow through adjustments to the taxpayer on Form 4549A, after which the taxpayer had a minimum of six months to challenge the IRS’ adjustments.
Continue Reading A Swing and a Miss: No Refund for Baseball Team Owner Following Federal Audit
The Washington Department of Revenue (Department) determined that an out-of-state mail order retailer (Taxpayer) had substantial nexus with the state based on the activities of an in-state affiliate (Affiliate), and therefore, upheld an assessment of business and occupation tax (B&O Tax) and sales tax. Determination No. 10-0057 (released Dec. 20, 2011). The Taxpayer sold tangible personal property via catalog and shipped the goods to Washington customers from out-of-state via a common carrier. Although the Taxpayer did not have a place of business in Washington, the Taxpayer’s Affiliate operated two retail stores in Washington that engaged in activities on the Taxpayer’s behalf.
The Department found that the Affiliate engaged in three activities on the Taxpayer’s behalf that established or maintained a market for the Taxpayer: (1) the Affiliate sold gift cards at its two Washington stores that customers could redeem on the Taxpayer’s website; (2) the Affiliate handed out the Taxpayer’s catalogs free to its customers at its two Washington stores; and (3) the Affiliate assisted the Taxpayer’s customers seeking to return catalog purchases by calling or emailing customer service to request a free shipping label to be sent to the customer. Therefore, the Department attributed the in-state physical presence of the Affiliates to the Taxpayer, causing the Taxpayer to be subject to the B&O Tax and the sales tax.
Recently, the Washington Legislature amended state law to provide that an economic presence created sufficient contact or nexus with the state to require Taxpayers to be subject to the B&O Tax. The economic nexus rule, enacted in 2010, requires those taxpayers organized or commercially domiciled outside of Washington to register for and remit the B&O Tax if they have: (1) more than $50,000 of property in the state; (2) more than $50,000 of payroll in the state; (3) more than $250,000 of receipts from the state; or (4) at least 25% of their total property, total payroll, or total receipts in the state. Wash. Rev. Code Ann. § 82.04.067(1)(c). While Washington modified the nexus standard for the B&O Tax, the physical presence standard remains unmodified for sales tax purposes. Finally, the new nexus law may be inconsistent with the U.S. Supreme Court’s analysis of B&O Tax nexus in Tyler Pipe Indus., Inc. v. Washington Dep’t of Revenue, 438 U.S. 232 (1987).
Sutherland SALT’s Marc Simonetti and Tyco International’s Paul Buchman pose for a ceremonial In-N-Out Burger photo after enjoying a few Animal Style Double-Double burgers during a recent trip to Sacramento, California.
