The Virginia Department of Taxation refused to consider whether a taxpayer was entitled to claim an exception from the state’s addback statute because the taxpayer failed to follow the statutory procedure. P.D. 11-174 (Oct. 12, 2011).

Virginia law requires the addback of intangible expenses and costs, which includes losses related to, or incurred in connection with, factoring transactions. The taxpayer paid factoring fees to a related company and deducted them on its federal income tax return. The taxpayer claimed an exception from Virginia’s addback requirement on its original Virginia return based upon the exception that it had a valid business purpose other than the avoidance of tax. Upon audit, the Department disallowed the exception from the addback rules because the sales lacked a valid business purpose.

The Department disallowed the taxpayer’s claimed exception because the taxpayer did not petition the Department to consider whether there was clear and convincing evidence that the related party transactions had a valid business purpose other than the avoidance or reduction of tax. Because the taxpayer had claimed the business purpose exception on its original return—rather than applying the addback, paying the tax, and petitioning for relief—the Department upheld the assessment. 

The ruling went on to recognize that facilitating the securitization of receivables and complying with lending requirements of unrelated third-party lenders may be a valid business purpose. The Department invited the taxpayer to follow the proper procedures within the applicable statute of limitations to claim the valid business purpose exception.

While the attorneys and admins on the Sutherland SALT Team may have been a bit camera-shy this Halloween, their kids (and even a pet) were happy to show off their costumes for us. We hope you enjoy these photos of Sutherland SALT’s Halloween 2011.

Continue Reading Trick or Treat: Sutherland SALT Families Celebrate Halloween

The Massachusetts Appellate Tax Board recently upheld the Commissioner of Revenue’s denial of deductions for interest expense on intercompany loans. Sysco Corp. v. Comm’r of Revenue, Docket Nos. C282656 & C283182 (Mass. App. Tax Bd., Oct. 20, 2011).

In Sysco, the taxpayer employed a common cash management arrangement in which cash was swept on a nightly basis from its subsidiary entities to a common “cash manager” for investment purposes. If Sysco received more money from an operating company than it disbursed to it, the subsidiary earned interest (prime rate less 1%) on the balance, and if Sysco disbursed more money than it received, Sysco earned interest (prime rate) from the subsidiary.

The Board determined that the loans were not true indebtedness. The Board found that the purported loans were not memorialized in writing (whether in the form of promissory notes or formal agreements) and there were no repayment schedules or fixed maturity dates. Also, the Board determined that the upstream payments were intended to remain with Sysco for use in its corporate activities, including paying dividends. The Board found that Sysco had no intention of repaying the funds transferred by the operating companies and that the operating companies never once requested repayment from Sysco. The Board placed great reliance on the fact that the aggregate amount Sysco owed to its operating companies increased dramatically from approximately $700 million in 1996, to more than $1.8 billion in 2001. Further, the Board gave no weight to Sysco’s experts because they “failed to demonstrate the existence of ‘an unconditional and legally enforceable obligation for the payment of money’ in the context of Sysco’s cash-management system.”

The Board’s decision is troubling because it interferes with a common intercompany arrangement for large multi-entity businesses that is meant to reflect the compensation for the use of each legal entity’s capital in an efficient manner. Some states have even imputed a charge on intercompany transactions when a taxpayer has not charged a related company for such an arrangement. See, e.g., United Parcel Serv. Gen. Servs. Co. v. Director, Div. of Taxation, 25 N.J. Tax 1 (2009). Finally, it is worth noting that the sting of the Board’s decision is lessened by Massachusetts’ shift to combined reporting.

Recently, there has been significant activity in Congress related to sales tax nexus.

  • In July, Sen. Richard Durbin (D-Ill.) introduced the Main Street Fairness Act (the “Durbin Bill”), the first of three bills introduced this year that would allow states to collect sales taxes from remote sellers.
  • On October 13, 2011, Rep. Steve Womack (R-Ark.) and Rep. Jackie Speier (D-Cal.) introduced the Marketplace Equity Act of 2011 (the “Womack Bill”) that would allow states to impose a sales or use tax collection requirement on remote sellers with no physical presence in a state.
  • Yet another bill, the Marketplace Fairness Act, was introduced by Sen. Michael Enzi (R-Wyo.) on November 9 (the “Enzi Bill”). This bill appears to have bipartisan support, as senators on both sides of the aisle are co-sponsors: Sens. Durbin, Lamar Alexander (R-Tenn.) Tim Johnson (D-S.D.), John Boozman (R-Ark.), Jack Reed (D-R.I.), Roy Blunt (R-Miss.), Sheldon Whitehouse (D-R.I.), Bob Corker (R-Tenn.), and Mark Pryor (D-Ark.).
  • In contrast to these bills, Sens. Ron Wyden (D-Ore.) and Kelly Ayotte (R-N.H.) introduced a resolution opposing the enactment of “new burdensome or unfair” tax collection requirements on small Internet sellers. Sen. Res. 309 (Introduced Nov. 2, 2011).

Despite the resolution, Congress will seriously consider the three proposed acts. The three acts attempt to address the same issue through slightly different approaches. All three would allow states to collect tax from remote sellers if certain uniformity requirements are met. The uniformity requirements are similar, for the most part, but with some slight differences as discussed below.

Continue Reading Nexus? Who Said Anything about Nexus?: A Summary of the Federal Nexus Bills

Most multistate taxpayers are audited, assessed, or challenged on their tax positions and are faced with a decision whether to challenge or settle. In this edition of A Pinch of SALT, Sutherland SALT’s Michele Borens and David Pope discuss techniques and considerations for deciding whether to settle; determining the scope of a settlement; developing a settlement strategy; and finalizing and memorializing a settlement.

Read “The Major League of Settlements: How to Pitch a Perfect Settlement,” reprinted with permission from the November 7, 2011 issue of State Tax Notes.

The Franchise Tax Board (FTB) recently issued guidance on California’s updated “doing business” provision for California corporate income tax purposes. FTB Notice 2011-06 (Oct. 12, 2011).  This guidance clarifies recent amendments that specify when the Chief Counsel may issue a ruling regarding whether a taxpayer is doing business in the state. 

Effective January 1, 2011, Senate Bill 858 amended Cal. Rev. & Tax Code § 23101 to add a “factor-presence” nexus provision.  Specifically, California law now provides that a taxpayer is doing business in the state if the taxpayer meets any of the following conditions:

  1. The taxpayer has more than $500,000 of sales in the state or the taxpayer’s sales in the state exceed 25% of the taxpayer’s total sales;
  2. The taxpayer has more than $50,000 of property in the state or the taxpayer’s property in the state exceeds 25% of the taxpayer’s total property; or
  3. The taxpayer has more than $50,000 in compensation in the state or the taxpayer’s compensation in the state exceeds 25% of the taxpayer’s total compensation. 

However, Cal. Rev. & Tax Code § 23101(a) continues to provide that doing business in the state means “actively engaging in any transaction for the purpose of financial or pecuniary gain or profit.”

FTB Notice 2011-06 makes clear that even if a taxpayer does not meet any of the factor-presence threshold tests, it may still impose income tax if a company is “actively engaging in any transaction for the purpose of financial or pecuniary gain or profit.”  Fortunately, the FTB will continue to provide Chief Counsel Rulings regarding whether a taxpayer is actively engaging in transactions for financial or pecuniary gain or profit, but it will not provide rulings on whether a taxpayer’s specific facts trigger the factor-presence nexus threshold because the answers would depend principally on factual issues and would not require legal interpretation. 

The Louisiana Court of Appeal recently ruled that a corporation’s passive ownership interest in a limited partnership doing business in Louisiana is not sufficient to create Louisiana corporate franchise tax nexus. Utelcom, Inc. v. Bridges, Dkt. No. 535,407 (Division “D”, Ct. App., First Dist., Sept. 12, 2011). The court held that because capital contributed to a limited partnership is no longer owned or used by the contributing partner, an ownership interest in the partnership does not create franchise tax nexus.

The Louisiana Department of Revenue issued a corporate franchise tax assessment against two out-of-state corporate limited partners. The limited partnership was engaged in the business of long-distance telecommunications in Louisiana. The Department asserted that the corporations were subject to tax because they acted in unison with the general partner to conduct business through the limited partners’ capital contributions. The trial court upheld the assessment based on a Louisiana regulation, which provided that mere ownership of property in Louisiana through a partnership creates franchise tax nexus over an out-of-state corporation.

The Court of Appeal reversed the trial court decision and held that the regulation was an impermissible expansion of the portion of the franchise tax statute that imposes tax on foreign corporations that own or use a part of its capital in the state. The court emphasized that the franchise tax is not a tax on interstate business conducted in the state, but a tax on “doing business in Louisiana in a corporate form.” The court reasoned that once the capital was contributed by the foreign corporations to the limited partnership, the capital was no longer owned or used by the foreign corporations.

The New York State Department of Taxation and Finance (Department) provided another example of its longstanding eagerness to force taxpayer combination—at least in cases where it results in increased tax revenue. In the Matter of Kellwood Co., No. 820915 (N.Y. Tax App. Trib. Sept. 22, 2011).

The Department (or taxpayer) must prove three elements to require a combined report: 

  1. Sufficient ownership 
  2. Existence of a unitary business 
  3. Distortion

Continue Reading New York Attempts to Take Taxpayer Out Behind the (Kell)Woodshed

In shocking similarity to the once-popular Amy Winehouse song “Rehab,” the U.S. Supreme Court denied certiorari in two nexus cases: KFC Corp. v. Iowa, 792 N.W.2d 308 (Iowa Dec. 30, 2010) and Lamtec Corp. v. Wash. Dep’t of Revenue, Docket No. 83579-9, en banc (Wash. Jan. 20, 2011) but left open the possibility to hear DIRECTV, Inc. v. Levin, 128 Ohio St.3d 68 (Ohio Dec. 27, 2010).

KFC is an economic nexus case involving the license of intangibles. KFC did not have any employees or property within Iowa; KFC licensed the use of trademarks and other intangibles to independent franchisees in the state in exchange for royalties. The Iowa Supreme Court held that KFC’s license of the intangibles was the “functional equivalent” of physical presence under Quill and that, in the alternative, physical presence was not required to find substantial nexus for corporate income tax purposes.

The Court also denied certiorari in Lamtec, where the taxpayer’s sole presence in the state was irregular employee visits to customers. The Washington Supreme Court determined that Lamtec had nexus with Washington for Business and Occupation (B&O) tax purposes and raised additional questions regarding how Washington views the physical presence test relating to the B&O tax, stating: “We conclude that to the extent there is a physical presence requirement, it can be satisfied by the presence of activities within the state.” (emphasis added).

Continue Reading These Cases Tried to Go to the U.S. Supreme Court, But the Court said “No…No…Oh?”

The Virginia Department of Revenue (i) applied its narrow interpretation of the State’s related member add-back provision to disallow a taxpayer’s factoring company discount losses, and (ii) prohibited the taxpayer and its affiliated factoring company from filing a combined return because the factoring company did not have nexus with the State. Va. Public Document No. 11-162 (Sept. 26, 2011).

The taxpayer sold, or “factored,” its account receivables to a bankruptcy remote affiliate at a discounted price and claimed deductions for its losses on the discounted sales. The taxpayer did not add back its factoring discount losses paid to a related party because the add-back statute provides a “subject to tax” exception from the add-back requirement if the related party was subject to tax in any other state. In this case, the factoring company was subject to tax in one state. Notwithstanding the literal language of the exception, the Department interprets the subject to tax exception narrowly to allow an exception only for the amount actually apportioned to and taxed by other states and, on audit, reduced the taxpayer’s losses accordingly. The Commissioner upheld the auditor’s narrow interpretation of the subject to tax exception, limiting it to post-apportionment amounts, consistent with prior rulings (See Va. Pub. Doc. Nos. 09-49, 09-115).

Continue Reading Who Lost the Remote?: Virginia Disallowed Losses and Combined Reporting