Yesterday, the New Jersey Supreme Court heard oral arguments in the Whirlpool case. Whirlpool Properties, Inc. v. Div. of Taxation, Docket A-25-10 (N.J. Supreme Court argued May 4, 2011). Whirlpool argued that the New Jersey “Throwout Rule” is facially unconstitutional because it is designed to tax extraterritorial income. The New Jersey Throwout Rule required taxpayers to exclude (or “throwout”) receipts from the denominator of their sales factor if the sales were assigned to a state where the taxpayer was not “subject to tax.” Interestingly, New Jersey asserted that the Throwout Rule is not a tax and does not increase New Jersey tax because the rule impacts only the denominator and not the numerator. In its questioning, the court appeared to scrutinize the Throwout Rule from both an internal and external consistency perspective. While the argument related to the facial constitutional challenge, the court posed several questions relating to an as-applied constitutional challenge, which many taxpayers are in line to bring if the court holds that the Throwout Rule is not facially unconstitutional.

Sutherland filed an amicus brief on behalf of the Council on State Taxation (COST) supporting Whirlpool’s argument that the Throwout Rule is facially unconstitutional.

You can find prior Sutherland SALT coverage of the Whirlpool case here.

Digitally provided content and services raise numerous questions when it comes to reporting, collecting and enforcing taxes because tax laws have yet to catch up with the digital world. In this month’s A Pinch of SALT (a column published by the Sutherland SALT Team in State Tax Notes), attorneys Steve Kranz, Beth Freeman and Mark Yopp highlight some of the notable virtual business models and explore the complex tax challenges raised by each.

 

Read “Taxing the Virtual World… And Beyond,” reprinted with permission from the May 2, 2011 issue of State Tax Notes.

The Washington Supreme Court recently adopted the “primary purpose of the purchaser” test to determine whether a transaction should be broken down into its component parts or considered as a whole. In Qualcomm, Inc. v. Department of Revenue, the court overturned the state court of appeals and held that a taxpayer’s vehicle tracking service was subject to buiness and occupation (B&O) tax as an information service, and not as a network telephone service. The court reasoned that the purchaser was buying an integrated management tool that happened to include data transmission, not a telephone service coupled with tracking hardware and software.

Continue Reading Keep on Truckin’: Washington Supreme Court Analyzes the Primary Purpose of Vehicle Tracking Service

A significant decision by the Texas Court of Appeals clarified the size and scope of the Texas sales tax resale exemption. In Combs v. Health Care Services. Corp., the taxpayer purchased tangible personal property and services for use in administering employee benefit programs for the federal government. After paying sales tax on the purchases, Health Care filed refund claims on the theory that the purchases qualified for the sale-for-resale exemption.

Health Care claimed that its purchases made pursuant to its federal government contract qualified for the resale exemption. While title to the purchased property automatically passed to the government, Health Care retained possession of the property. In finding that the purchases qualified for the resale exemption, the court reached the following important conclusions:

  • A reseller of property is not precluded from qualifying for the exemption merely because it also provides a nontaxable service, even if the property being resold is used in the provision of the nontaxable services, and even if the contract does not require the seller to purchase the property;
  • Failing to provide an exemption certificate does not disqualify the reseller from claiming the exemption;
  • A sale-for-resale may qualify for the exemption even where the resale is nontaxable;
  • A taxable service may qualify for the exemption despite the fact that there is no subsequent transfer of title to the services; and
  • There is no impermissible “double recovery” of sales tax where the reseller’s cost reimbursed by the purchaser includes sales tax but the reseller does not separately state or explicitly pass through the sales tax.

Taxpayers making sales to Texas exempt entities should consider the implications of this case as it relates to their operations and consider filing refund claims as appropriate.

On March 2, 2011, the IRS released Appeals Settlement Guidelines (ASG) addressing the federal income tax treatment of state and local economic development tax credits and incentives, other than refundable or transferrable credits or incentives.

Many taxpayers have long taken the position that state and local tax credits and incentives (e.g., tax rate reductions, tax credits for job creation or investment, and tax abatements or exemptions) should be treated as a payment to the taxpayer by the state or local government equal to the amount of the credit or incentive, followed by a payment of the tax by the taxpayer in the same amount. Under this approach, the payment to the taxpayer is included in gross income under Section 61 and deductible as a payment of tax under Section 164, but then excluded from income as a non-shareholder contribution to capital under Section 118. As a result, taxpayers claim an expense for the amount of the credit or incentive in exchange for a reduction in the basis of property under Section 362(c). The net effect is a deduction in the current tax year which is not recaptured until the taxpayer disposes of the reduced-basis property or depreciates the property. Often the property subject to basis reduction is non-depreciable real property, which effectively allows a near-permanent deferral of income.

The IRS identified this position as a Tier 1 issue and previously addressed it in Coordinated Issue Paper (CIP) LMSB-04-0408-023 (May 23, 2008). The ASG continues the guidance provided in the CIP and details the IRS position that non-refundable state and local credits and incentives are most appropriately characterized as reductions in liability that do not constitute income under Section 61 and do not give rise to additional deductions under Section 164. The IRS also takes the position that even if the incentives were income, they are not excludable non-shareholder contributions to capital under Section 118.

The Texas Comptroller of Public Accounts (Comptroller) took a “members only” approach to determine how revenue derived from website access fees should be sourced to Texas for Texas Franchise Tax apportionment purposes. In Letter No. 201102989L (Feb. 2, 2011), the Comptroller considered the sourcing of revenues derived from a company’s social networking website. The social networking website allowed registered users to pay a flat fee to access the website’s database, publish information, communicate with other users, and utilize and interact with the website’s programs. The Comptroller concluded that such fees were akin to membership fees because customers were charged a flat rate for certain benefits and thus should be sourced to the location of the payor.

Continue Reading Texas “Tweets” Guidance on Sourcing Social Networking Website Revenue

The Multistate Tax Commission (MTC) is proposing to significantly change how the sales factor is calculated for apportioning corporate income. Currently, most states define “sales” includable in the sales factor as “all gross receipts of the taxpayer” (except those receipts related to nonbusiness income). MTC members are considering a proposal to limit the definition of “sales” to include only those gross receipts from activity that meets the “transactional test” of the definition of “business income.” Under this proposal, all other receipts—including receipts from sales that satisfy the “functional test”—would be excluded from the sales factor (even though the related income would remain subject to apportionment). 

Thus, under this MTC proposal, the sales factor would include only those receipts arising from sales of inventory or services.  Examples of receipts that would be excluded are receipts from treasury or hedging transactions and the proceeds from the sale of a unitary subsidiary.

 

The Business Activity Tax Simplification Act of 2011 (BATSA) (H.R. 1439) was introduced on April 8, 2011, and is the latest attempt to enact federal legislation governing state tax nexus.  A hearing on the bill was held on April 13 before the Subcommittee on Commercial and Administrative Law of the House Judiciary Committee.

Read Sutherland SALT’s Legal Alert, “BATSA Up: Congress Once Again Considers Nexus Legislation,” for a description of H.R. 1439 and the hearing.

Sutherland’s SALT Poll, “The Impact of State Budget Deficits,” revealed that the majority of those surveyed believe that state budget deficits have led to a difficult state tax audit environment. The poll results are consistent with Sutherland’s recent experience with state tax auditors—an overwhelming 80% of respondents believe that state auditors generally are less flexible in negotiating difficult issues. Further, 60% of the respondents experienced state tax auditors creating more substantial assessments during this time of state budget shortfalls.

Continue Reading Weekly SALT Poll Results: The Impact of State Budget Deficits

On April 1 (fittingly), the District of Columbia’s new Mayor, Vincent G. Gray, unveiled his proposed budget, B19-0203 “Fiscal Year 2012 Budget Support Act of 2011” (Budget Bill), which includes the long-awaited/feared combined reporting provisions. If the Budget Bill passes as-is, the District will formally adopt a combined reporting regime effective retroactively to tax years beginning after December 31, 2010. In the latest Legal Alert by Sutherland SALT, “Shades of Gray: District of Columbia Combined Reporting Unveiled,” we discuss the issues raised by the proposed combined reporting regime, including questions raised by the unique tax aspects of the District, such as its net income tax on unincorporated businesses.

Click to read “Shades of Gray: District of Columbia Combined Reporting Unveiled”