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.

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