Calling all trivia fans! Don’t miss out on a chance to show off your SALT knowledge!

We will award prizes for the smartest (and fastest) participants.

This week’s question: The Department of Treasury in which state recently updated its sales and use tax guidance on computer software and digital goods?

E-mail your response to SALTonline@eversheds-sutherland.com.

The prize for the first response to today’s question is a $25 UBER Eats gift card. This week’s answer will be posted on Saturday in our SALT Shaker Weekly Digest. Be sure to check back then!

The Texas Comptroller of Public Accounts held its annual briefing in Austin on September 26 and provided taxpayers with updates regarding the administration of research and development credits, pending litigation, rule updates and related topics. The meeting – which was the first all in-person briefing since the beginning of the pandemic – struck an optimistic tone regarding the strength of the Texas economy and the Comptroller’s efforts to recover from its recent staffing shortages.

A Texas-sized R&D Backlog

The Texas Comptroller has struggled to administer the R&D credit over the past few years, resulting in a significant backlog of R&D audits and appeals. Texas’ R&D credit was a topic of intense interest for this year’s annual meeting and was covered in many of this year’s presentations. 

Brett Hare, the director of the Comptroller’s Direct Tax Section, said that the agency is making progress on its large backlog of R&D cases. Tax Hearings Attorney Supervisor Sarah Berry similarly said that her team was starting to move forward with pending R&D-related hearings and would consider taxpayer settlement requests for R&D issues.

Audit Director Emma Fuentes said that the audit division has shifted its approach to reviewing R&D credits. R&D credits are no longer being sent solely to the Tax Policy Division, which had been overwhelmed by the volume of requests. Now, a team from the Comptroller’s headquarters assists auditors to review R&D credit documentation. Fuentes also said that the Comptroller’s office understands that taxpayers typically cannot provide perfect documentation to substantiate R&D claims. Therefore, the Comptroller expanded the types of documentation that it will consider such as contemporaneous emails from personnel demonstrating that testing activity occurred.

Nick Souza of the Comptroller’s Policy Division said that the agency continues to focus on the Four-Part Test to determine whether a project has conducted qualifying research activities. The Four-Part Test is the test described in IRC, §41(d) (“Qualified research defined”) that determines whether research activities are qualified research. The four parts of the test are the Section 174 Test, the Discovering Technological Information Test, the Business Component Test, and the Process of Experimentation Test.

Souza added that taxpayers should continue to submit information used to qualify for the federal R&D credit, but that such documentation is not always conclusive for Texas purposes because the IRS does not always analyze the Four-Part Test, and the Texas-specific R&D expenses may not be apparent.

Virtual Currency, Cloud Computing, Data Processing and other Indirect Tax Developments

The Comptroller’s Indirect Tax Division highlighted two recent memorandums concerning virtual currency and credit card reporting services:

  1. No. 202309029L, the Comptroller clarifies that it considers electronic video games and associated virtual currency, virtual goods, and other content to be taxable amusement services. Meanwhile, membership fees, subscription fees, or similar charges, by whatever name called, for access to an electronic game or associated content are charges for membership or access to special privileges.
  2. In Memo No. 202302004L, the Comptroller determined that services to assign credit ratings to legal entities are taxable as credit reporting services.

    Two legislative changes that the Indirect Tax team is helping administer are H.B. 1515, which modifies the residency requirement for qualified Enterprise Zone employees to permit remote work, and S.B. 1122, which deals with the taxability of designated doctor exams related to workers’ compensation claims.

    The Indirect Tax Analyst Melissa Schulz said that her team is working on updates to Comptroller Rule 3.330, to provide examples of data processing services. Schultz also added that the team is discussing topics such as resale exemptions for cloud computing, out-of-state software licenses, and what emerging technologies may constitute taxable data processing.

    Franchise Tax apportionment, reporting, and other Direct Tax Updates

    The Comptroller finalized amendments to its franchise tax apportionment rule, discarding the now-repudiated “receipt-producing, end-product act” test. The Comptroller proposed these amendments in response to the Texas supreme court’s unanimous decision in Sirius XM Radio, Inc. v. Hegar. Eversheds Sutherland’s SALT Team represented Sirius XM in this litigation.

    Comptroller’s rule replaces the term used by the Texas supreme court—“equipment”—with the more general term “property” in apparent recognition that the location of property that is not equipment may be relevant as well.

    The Direct Tax team discussed the implementation of S.B. 3, which increases the threshold before small businesses are required to pay and file franchise taxes. The Tax Policy division also issued a memo to the Audit division on the impact of Hegar v. Health Care Services Corp. to stop-loss insurance. Based on the decision in Health Care Services Corp., insurers can allocate premiums received for stop-loss policies purchased by employers to finance self-funded employee health care benefits when calculating gross premiums subject to premium and maintenance tax if the insurer follows a reasonable allocation methodology that is supported by sufficient evidence.

    Audit Sampling Gone Wrong

    The Comptroller’s audit team discussed an initiative to change how audit samples are developed. Audit Director Emma Fuentes said that her team has noticed instances where a taxpayer’s audit sample complies with the Comptroller’s standards, but is nevertheless so large that it becomes inefficient. The example provided was an audit sample of 6,000 items that took approximately 1,500 hours to review. Methods to reduce sample sizes include merging sample categories, eliminating immaterial sample categories, and increasing the variances between dollar stratums up to eight percent.

    Refund Claims for Nonpermitted Taxpayers

    Nonpermitted taxpayers are required to fill out a Form 00-985, “Assignment of Right to Refund” in order to file refund claims. The Audit Director Fuentes said that her staff has noticed a widespread issue of taxpayers losing their refund claims due to statute of limitations because the form is not being sufficiently completed, specifically the requirement to itemize the transactions that form the basis for the refund claim. Audit staff are now conducting more thorough reviews of the Assignment of Rights forms as they come in, but Fuentes implores service providers to be more thorough when submitting the forms.

    Ongoing Audit Staffing Problems

    The Comptroller’s audit division remains understaffed. Director Fuentes said that the audit division is averaging staffing levels around 460 auditors down from a pre-pandemic average of 570. Interest waivers may be available for taxpayers who experience audit-related delays.

    Tax Hearings Bypass Process

    Victor Simonds, Senior Counsel of Tax Compliance, highlighted the progress of the Comptroller’s relatively-new hearings bypass process. Simonds noted that although the process allows taxpayers to quickly access District Court, taxpayers should not ask auditors to summarily deny claims to expedite the process. Mr. Simonds said that it was important to develop a complete record for District Court and that the hearings bypass process has been successful at fully or partially resolving many claims.

    See you in court… This Year’s Texas Tax Litigation Update

    Bree Boyett from the Comptroller’s Tax Litigation Team provided an overview of recent significant tax cases, including:

    • Apple, Inc. v. Hegar: An Internet Tax Freedom Act challenge to the imposition of sales tax on iCloud and iTunes matching services as data processing services.
    • Hibernia Energy LLC v. Comptroller: A case concerning how flow-through status for federal tax purposes is converted to taxable entity status for the Texas franchise tax.
    • Anadarko Petroleum Corporation v. Hegar: A COGS case regarding whether a $4 billion payment related to the Deepwater Horizon oil spill could be deducted as a cost of goods sold under an “origin of the claim” theory. 
    • American Airlines v. Hegar: A franchise tax controversy in which an airline claims that Texas’ imposition of franchise tax on baggage and passenger fees is prohibited by the Anti-Head Tax Act.
    • Sidetracked Bar LLC v. Hegar: A case holding that an electronic sweepstakes using magnetic card strips was taxable as an amusement service.
    • Boaz Energy II Operating LLC. V. Hegar: A sales tax case concerning whether tangible personal property purchased in connection with the operation of secondary recovery injection wells is exempt as property specifically installed to reuse and recycle wastewater streams generated within the manufacturing, processing, fabrication, or repair operation. Similarly, XRI Holdings, LLC v. Hegar is a case about whether water used for fracking qualifies for a sales tax exemption for wastewater treatment.
    • Avalon Exploration and Production LLC v. Hegar: A case regarding whether oil soluble chemicals are exempt from sales tax because they become a component of property sold for resale.

    What’s Next for Texas

    The Texas economy continues to outpace expectations according to the Comptroller’s Chief Revenue Estimator, Brad Reynolds.

    Reynolds said that the forthcoming revised revenue estimate abandons predictions of a recession, and that there are no strong indications that Texas will experience a recession next year. Notable areas of increased Texas tax collections include hotel occupancy, insurance and franchise taxes. Reynolds also noted that state coffers received a boost for increased apportionment from service providers that relocated their corporate headquarters to the state.

    The presentations throughout this year’s briefing struck an equally optimistic tone for the agency’s continuous efforts to improve its staffing, resolve the backlog of R&D cases, and push to clarify existing guidance. Taxpayers will continue to navigate the Comptroller’s evolving rules and audit process, as well as litigate some highly interesting cases in court. Eversheds Sutherland’s tax team will keep monitoring Texas developments and provide insights on what Texas taxpayers can expect in the Lone Star State.

    Calling all trivia fans! Don’t miss out on a chance to show off your SALT knowledge!

    We will award prizes for the smartest (and fastest) participants.

    This week’s question: Which state’s Supreme Court recently held that the sales tax exemption for the sale of aircraft parts and maintenance did not apply to aircraft lease charges for repairs and maintenance?

    E-mail your response to SALTonline@eversheds-sutherland.com.

    The prize for the first response to today’s question is a $25 UBER Eats gift card. This week’s answer will be posted on Saturday in our SALT Shaker Weekly Digest. Be sure to check back then!

    So you think you know sales tax? Eversheds Sutherland SALT attorneys Liz Cha and Jeremy Gove will present on sales tax topics during the 2023 IPT Sales Tax Symposium, held in Chicago from October 1-4.

    Liz’s panel will identify notable local taxes and equip taxpayers with the skills to minimize risk, while Jeremy will explore trends in states’ manufacturing exemptions, with a focus on applicable cases and other hot topics.

    For more information and to register, click here.

    Calling all trivia fans! Don’t miss out on a chance to show off your SALT knowledge!

    We will award prizes for the smartest (and fastest) participants.

    This week’s question: Which state recently held that payroll, property and sales that generated deductible agricultural cooperative income must be included in the taxpayer’s corresponding payroll, property and sales apportionment factors?

    E-mail your response to SALTonline@eversheds-sutherland.com.

    The prize for the first response to today’s question is a $25 UBER Eats gift card. This week’s answer will be posted on Saturday in our SALT Shaker Weekly Digest. Be sure to check back then!

    On September 19, 2023, the D.C. Tax Revision Commission met for the second time to discuss proposals for changes to the D.C. tax scheme. Among the multiple topics reviewed, the Commission’s members discussed whether to create a business activity tax, which would primarily target entities that do not pay the District’s net income taxes on business entities – Corporation Franchise Tax or Unincorporated Business Franchise Tax. However, reception among the members on this proposal was mixed. The Commission also discussed a broad range of proposals, covering a range of tax types.

    Business Activity Tax

    For background, the District’s status as a federal enclave and not a state (while “functioning” as a state, county, and municipality for tax purposes) is unique among U.S. jurisdictions.  Pursuant to the Home Rule Act[1] and ultimate oversight by Congress, the District cannot impose tax on the personal income of non-residents. Because the District cannot tax the income of non-residents, it imposes the Unincorporated Business Franchise Tax to tax the entities of which they are owners, such as partnerships. However, the Unincorporated Business Franchise Tax does not apply to the income of professional partnerships.

    To address what it views as those inequities, the Commission now proposes creating a Business Activity Tax. The tax would apply at a 0.5% or 1.0% rate on the formula of Gross Receipts – [Cost of Goods Sold + Capital Purchases]. The Commission also considered the Business Activity Tax liability being a nonrefundable credit against the Corporation Franchise Tax or the Unincorporated Business Franchise Tax. In its proposal paper, the Commission specifically identifies law partnerships as being subject to new tax liabilities, along with, potentially, nonprofit entities. 

    The Commission’s members were not convinced by the business activity tax proposal. There were concerns about the tax applying to businesses that failed to make a profit and, also, providing a disincentive to start-ups considering locating in the District. The Commission’s members did not entirely rule out the tax, though, because of its potential as a revenue-raiser.

    Other Proposals

    The Commission brainstormed a number of other policy ideas affecting income taxes, taxation of partnerships, property taxes, and administrative issues, including:

    • Joyce to Finnigan. The District currently uses the Joyce method of combined reporting.  In other words, District combined reports may include only entities that separately have nexus with the District. The Commission’s members broadly supported switching to the Finnigan method of combined reporting, which would treat the entire combined group as includible in the combined return, unless otherwise excluded.
    • Pass-Through Entity Tax. Unlike many other states, the District does not currently have a SALT cap workaround option for individuals to bypass the federal cap on deductions for state taxes paid. The federal cap does not apply for taxes paid by businesses because they qualify instead as deductible business expenses. By allowing unincorporated pass-through entities that are not subject to the unincorporated business franchise tax (such as law and accounting partnerships) to pay entity-level tax and giving their owners an equivalent tax break at the individual level, the owners can reduce their federal income tax liabilities. This change would be optional for District taxpayers. The members of the Commission also supported this proposal.
    • Finally, the Commission’s members also discussed: (1) switching from I.R.C. rolling conformity to static conformity; (2) whether to increase the franchise tax filing thresholds and minimum tax amounts; (3) repealing, or increasing the threshold for, personal property tax; and (4) eliminating or limiting the District’s bar on issuing clean hands certificates for taxpayers with outstanding tax liabilities.

    Future meetings and next steps

    The Commission currently has scheduled four more proposal review sessions – September 26th, October 10th, October 20th, and October 24th. At the next meeting, the Commission expects to discuss whether to levy a per-employee service fee on employers and create an “extreme” wealth tax.

    [1] D.C. Code Ann. § 1-206.02(a)(5).

    On Wednesday, September 20, Eversheds Sutherland Partners Michele Borens, Jeff Friedman, Ted Friedman and Maria Todorova will provide various SALT updates to TEI’s Seattle Chapter.

    Sessions and speakers include:

    • Jeff Friedman – WA DOR update
    • Michele Borens, Maria Todorova – Sales Tax Is Cooler
    • Jeff Friedman, Ted Friedman – No, Income Tax Is Cooler
    • Michele Borens, Jeff Friedman, Ted Friedman, Maria Todorova – Why SALT isn’t Kosher?

    On September 13, 2023, the D.C. Tax Revision Commission met and evaluated over a dozen tax proposals. Most concerning, the Commission discussed the possibility of implementing a digital advertising tax or a data mining tax.

    D.C. Tax Revision Commission

    The Council of the District of Columbia established the Commission to comprehensively review the District’s tax code. The Commission’s mandate is to make tax policy recommendations on:

    1. Providing for fairness and equity in the apportionment of taxes and promoting progressivity;
    2. Broadening the tax base;
    3. Making the District’s tax policy more competitive with surrounding jurisdictions;
    4. Encouraging business growth and job creation; and
    5. Modernizing, simplifying, and increasing transparency in the District’s tax code.[1]

    By the end of 2023, the Commission is set to submit its slate of recommendations to the Council, along with specific steps for implementing the recommendations, such as draft legislation and regulations.

    The Commission previously released reports in 1998[2] and 2014.[3] Each Commission’s report made recommendations for changes to the District’s tax system. For example, in 1998, the Commission recommended a 1.5% business activities tax and “taxing sales of tangible products to District residents the same regardless of whether they are sold remotely or by District-based businesses.” In 2014, the Commission recommended reducing the District’s business franchise tax rate from 9.975% to 8.25%.

    D.C. Tax Revision Commission proposals

    Throughout 2023, the Commission has met with various tax and fiscal policy experts, as well as community and industry representatives. It has prepared a series of proposals to review and potentially suggest to the Council. On September 13, 2023, the Commission met for the first time to discuss these various proposals. In advance, the Commission released the list of proposals that they would review. 

    The first proposal on the list was “Strengthen and clarify taxation of digital ads and services.” The Commission released a proposal paper, elaborating on the topic. The proposal paper specifically listed as options: (1) a digital advertising tax act similar to Maryland’s enactment; and (2) a tax on “the extraction of consumer data by tech platforms in much the same way that states tax the extraction of valuable commodities like fossil fuels or precious metals.” The second option would be a “per-consumer excise tax that accounts for each user whose data is being mined.” 

    The sordid history of state digital advertising taxes

    Maryland became the first – and only – state in the United States to impose a tax on gross receipts from digital advertising services in 2022. The tax is imposed on gross revenues derived from digital advertising services in Maryland at graduated rates, from a minimum rate of 2.5% to a maximum rate of 10% of such revenues. The Maryland digital advertising generated immediate controversy, with taxpayers challenging the tax in state[4] and federal courts on federal statutory and constitutional grounds.[5] While those challenges have yet to result in a final nonappealable decision on the legality of the Maryland tax, we expect the Maryland Supreme Court to eventually reach the merits and, hopefully, find the tax to be unconstitutional. And while several other states have considered Maryland-style digital advertising tax legislation, those proposals ultimately have been rejected.

    With the history of Maryland’s digital advertising tax in mind, the Commission’s proposal paper acknowledged that any potential D.C. tax similar to Maryland’s tax would likely face similar legal challenges. But the paper noted that it may be able to “minimize challenges by, for example, imposing a tax on all advertising (as opposed to just digital advertising). There could then be less risk that the tax would violate the federal Internet Tax Freedom Act.” But imposing a broad advertising tax could prove difficult for the Council based on recent experience. In 2020, the Council considered expanding its sales tax base to include sales of advertising services and personal information, as part of its Fiscal Year 2021 Budget Support Act of 2020. Ultimately, the D.C. Council opted not to pursue expanding its sales tax base to these sales due to the adverse impact on local media and press, on top of the likely litigation that would follow if a targeted tax on digital advertising were adopted.[6]

    The Commission meeting on September 13th

    At the meeting, the Commission discussed the first batch of proposals but without formally voting on them, which will happen in a later meeting. Rather, the meeting was intended to advance discussion in preparation for later formal voting. 

    The Commission’s members were generally interested in pursuing a digital advertising tax or a data mining tax. The members saw these taxes as being worth consideration because of the potentially large amount of revenue they could generate. One member supported the taxes because he saw them as an expansion of the tax base to match changing technology, rather than a tax rate increase.

    However, there was hesitancy among the Commission’s members because of the ongoing Maryland litigation and potential tax implementation difficulties. The Commission’s members noted that the process to pass and implement these taxes could be long, especially as they were interested in whether the Maryland tax would survive legal scrutiny.

    The Commission also considered a variety of other proposals. For example, the Commission’s members reacted negatively to increasing the general sales tax rate from 6 percent to 7 percent due to regressivity concerns. However, they were supportive of eliminating the motor vehicle excise tax exemption for electric vehicles.

    Future meetings and next steps

    The Commission currently has scheduled five additional proposal review sessions—September 19th, September 26th, October 10th, October 20th, and October 24th. These sessions will shape which recommendations the Commission will make to the D.C. Council. Of particular interest for the September 19th meeting, the Commission likely will discuss a business activity tax proposal, which may resemble the Texas franchise (margin) tax and the Oregon corporate activity tax. Eversheds Sutherland will continue to follow these review sessions that will color the next decade of District taxation. 

    [1] D.C. Code Ann. § 47-462.

    [2] See Summary Report to the Mayor and Council of the District of Columbia, June 1998, D.C. Tax Revision Commission (June 1998), available at https://cfo.dc.gov/sites/default/files/dc/sites/ocfo/publication/attachments/ocfo_part_i_summary_report.pdf.

    [3] Final Report, D.C. Tax Revision Commission (May 2014), available at https://cfo.dc.gov/sites/default/files/dc/sites/ocfo/publication/attachments/DC%20Tax%20Revision%20050114.pdf.

    [4] The Maryland digital advertising tax was challenged in the Circuit Court of Anne Arundel County, with the plaintiffs seeking a declaratory judgment that the tax is unconstitutional and unlawful.  On October 17, 2022, the circuit court granted the plaintiffs’ motion for summary judgment and issued a final declaratory judgment, finding that the tax was unconstitutional and invalid because it violated the Internet Tax Freedom Act (which bars state and localities from imposing taxes that discriminate against electronic commerce), the Commerce Clause of the U.S. Constitution, and the First Amendment to the U.S. Constitution. Comcast of California/Maryland/Pennsylvania/Virginia/West Virginia, LLC, et al. v. Comptroller of the Treasury of Maryland, Case No. C-02-cv-21-000509 (Md. Cir. Ct. final declaratory judgment issued Nov. 17, 2022).While the Maryland Supreme Court later concluded that the circuit court lacked jurisdiction to enter the declaratory judgment, the supreme court did not address the tax’s legality. Comptroller of Maryland v. Comcast of California/Maryland/Pennsylvania/Virginia/West Virginia, LLC, et al., 484 Md. 222 (2023). As it stands, only one court has review the legality of Maryland’s digital advertising tax. That court found it to be unconstitutional under multiple theories.

    [5] The Chamber of Commerce of the United States is also pursuing a challenge to the Maryland digital advertising tax at federal court. However, the United States District Court for the District of Maryland concluded that the Tax Injunction Act precluded the Chamber’s substantive challenges to the tax. While the court initially allowed the lawsuit to proceed against the tax’s pass-through prohibition, the court later also dismissed that challenge as moot because of the Circuit Court of Anne Arundel’s declaration that the tax violated the U.S. Constitution. The Chamber is currently challenging these decisions before the United States Court of Appeals for the Fourth Circuit. Oral argument is set for September 20, 2023. Chamber of Commerce of the United States v. Lierman, No. 22-2275 (4th Cir. notice of appeal filed Dec. 13, 2022).

    [6] The sales tax on advertising services would have applied to “the planning, creating, placing, or display of advertising in newspapers, magazines, billboards, broadcasting, and other media, including, without limitation, the providing of concept, writing, graphic design, mechanical art, photography, and production supervision.” The tax would have encompassed both physical and digital advertising. The proposed sales tax on sales of personal information would have applied to “information or data that is derived from a person that identifies, relates to, describes, or is capable of being associated with, a particular person” and included a person’s browser habits and consumer preferences.

    This episode of the SALT Shaker Podcast welcomes a new voice into the mix, Eversheds Sutherland Associate Laurin McDonald. Laurin joins host and Associate Jeremy Gove to describe 80/20 rules used by states in the context of water’s-edge combined reporting, the subject of an article she co-authored in Tax Notes State.

    In addition to discussing the 80/20 rules, Jeremy and Laurin cover variations on the rules, compliance issues and recent cases that exemplify controversies that can arise from application of 80/20 rules.

    They wrap with an underrated/overrated question – how do you feel about concert encores?

    Questions or comments? Email SALTonline@eversheds-sutherland.com. You can also subscribe to receive our regular updates hosted on the SALT Shaker blog.

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    The back to school buzz has begun! Time to hit the books and open a new chapter with plenty of learning and growth.

    To commemorate the start of the 2023 school year, we’ve collected photos from members of our Eversheds Sutherland SALT team for your enjoyment! We wish all these bright minds a wonderful academic year!

    1: Partner Charlie Kearns’ daughter Ella (1st grade)

    2: Paralegal specialist Jaime Lane’s daughter Cassidy (6th grade) and son Cooper (8th grade)

    3: Legal secretary Janet Curry’s granddaughter Raegan (pre-K)

    4: Associate John Ormonde’s daughter Betsy (pre-K)

    5: Partner Jonathan Feldman’s daughter Anna (8th grade) and son Micah (5th grade)

    6: Partner Tim Gustafson’s son Luke (4th grade) and daughter Cate (8th grade)

    7, 8: Legal secretary Melissa Bragg’s daughters Madelyn (4th grade) and Emma (10th grade)

    9, 10: Partner Maria Todorova’s daughter Addison (7th grade) and son Nicholas (5th grade)