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

Sutherland SALT created a spreadsheet describing state tax filing extensions related to Hurricane Irene. This spreadsheet is general in nature and does not address states that have not issued guidance regarding Hurricane Irene. Further, some states may conform to federal tax extensions associated with Hurricane Irene. Additionally, taxpayers should be aware that, while some states allow for filing extensions, they may not provide for payment extensions.

View the Fifty-State Survey of Hurricane Irene Tax Extensions. Please note: this spreadsheet is for general informational purposes only and is not intended to constitute legal advice or a recommended course of action.

Businesses that sell video games and related content online and by remote access have been pondering an essential sales and use taxability question: What is the proper characterization of the goods and services being sold? Although downloaded video games have long been thought to be a form of prewritten computer software, businesses that sell related subscription services, virtual goods, and virtual currencies have enjoyed much less tax certainty.

Two states have weighed in on this issue in recent months. Kansas and Missouri issued letter rulings addressing the tax issues that arise in the gaming environment. Although the states’ guidance is not entirely consistent, gaming companies may welcome any move toward improved tax clarity in the virtual gaming business.

Continue Reading Virtual Chaos: Two States Log In to the Online Gaming Arena

The Arizona Department of Revenue (the Department) issued an Individual Income Tax Ruling describing the treatment of Real Estate Mortgage Investment Conduits (REMICs). Ariz. ITR 11-6 (Aug. 8, 2011). The ruling affirms the Department’s longstanding positions regarding the sourcing of income received from REMICs and whether simply holding an interest in an Arizona REMIC creates nexus. Ariz. ITR 91-2 (Apr. 2, 1991). 

For federal tax purposes, the IRS treats REMICs as flow-through entities and does not tax the entity itself on its income. Rather, the REMIC’s interest holders are taxed on the REMIC’s income. Generally, REMICs will have two types of holders: regular interest holders and residual interest holders. Regular interest holders are taxed as if their interests were debt instruments, whereas residual interest holders report the REMIC’s taxable income or loss in proportion to their percentage ownership, similar to partners in a partnership.

Continue Reading REMIC – the Remix – Arizona Style

The New York State Department of Taxation and Finance (the Department) recently released an advisory opinion analyzing the proper characterization and sourcing of various revenue streams derived from the facilitation of online trading activities. Petition No. C080222A, TSB-A-11(8)C (July 12, 2011).  Relying on our old friends, Deloitte & Touche, LLP, TSB-A-02(3)C (Apr. 18, 2002); Ins. Servs. Offices, Inc., TSB-A-99(16)C (Apr. 7, 1999); and New York Merchantile Exch., TSB-A-00(15)C (Apr. 18, 2002), the opinion represents the Department’s growing trend to expand the category of “other business receipts,” to source receipts on a market rather than on a cost-of-performance basis.

In the opinion, the Parent is a Delaware corporation headquartered in New York. It owns and operates an Internet-based platform (Exchange) that serves as a marketplace for over-the-counter (OTC) global futures markets. Although the Parent is not a registered broker-dealer, the Exchange serves as a marketplace for buyers and sellers of certain commodities contracts, financial contracts, and other derivatives contracts in futures and OTCs to meet and execute trades on a real-time basis. All of the Parent’s property and equipment associated with the Exchange is located outside of New York, and all of the clearing administration for the OTC is performed outside of New York. In addition to the Parent’s activities, its affiliates generate receipts from various transactions, including open outcry trading, digital auction, flat monthly subscriptions, and trades executed with the assistance of interdealer brokers.

Continue Reading The Big Apple Goes to the Market for Online Trading Revenue