The Tennessee Department of Revenue ruled recently that an information technology company’s platform product was subject to Tennessee sales and use tax. The platform was used to support a decision-making process.

The platform was hosted on Taxpayer or third-party servers, and users accessed the platform from their employer’s electronic software system. The platform was highly integrated into employers’ systems. After integration, a separate tab for users to click for access to the platform would appear, or certain triggers in an employer’s software system would produce a pop-up directing the user to use the platform. In some cases, the platform’s use was mandatory.

Although some user input was required, both the platform and customer’s computer systems exchanged information with each other, presumably automating the information transfer process. After the platform received the necessary information, it produced a decision tree that users would follow as additional information is entered. Ultimately, the platform suggests an outcome based on the information users provide.

The taxpayer charged customers three different fees in connection with the product: Platform Fees, Implementation Fees, and Content Fees. All three fees are part of a single contract, itemized within the same, and separately stated on invoices.

The Platform Fee was paid to license the platform’s technology and required configuration, content integration, and hosting, customer support, and connectivity maintenance. The Implementation Fee was paid for resources necessary to assure seamless implementation, employee onboarding, on-site user training, and the strategies to drive customer success.  Onboarding was necessary for the platform’s function, and generally involved configuring the platform so that information with a customer’s computer system could be exchanged. The Content Fee was charged for access to the platform’s proprietary content and was based on the amount and type of content made available to the customer. Only the Implementation Fee and Content Fee were at issue.

The Department concluded that both were taxable. The Department explained that retail sales of tangible personal property and computer software are subject to sales tax, including the “use of computer software,” which includes the access and use of computer software in Tennessee.

The Department observed that whether the Fees were taxable turned on the outcome of the “true object” test, since the transaction involved the sale of a combination of items or services.

The Department then determined that the true object of the transaction was for access to the platform. The Department did not explain its basis for concluding, and the taxpayer did not dispute, that the Platform Fees were subject to sales tax as charges for access and use of computer software. Finding the Implementation Fee and Content Fee were necessary to complete the sale or essential and integral to the sale, they too were taxable. The Department reasoned that the platform would not operate properly without onboarding (for which Implementation Fees were charged). And, because the taxpayer’s proprietary content could not be purchased without the platform, the Department had no difficulty concluding they were also taxable.  The Content Fees were charges for tools and information essential and integral to the platform’s operation.

Concluding, the Department wrote, “The sale and access to and use of the Platform (computer software) is subject to Tennessee sales and use tax. The Taxpayer’s Implementation Fees and the Content Fees are in turn subject to the Tennessee sales and use tax because the services covered by the fees are necessary to complete the sale and/or an essential and integral part of the taxable sale of the [p]latform.”

Tennessee Dep’t. of Revenue, Letter Ruling 21-10 (Oct. 21, 2021)

The California Office of Tax Appeals (OTA) recently sustained the Franchise Tax Board’s (FTB) income tax treatment of an IRC 338(h)(10) election. In return for all the outstanding stock in the target S-Corporation taxpayer, third-party buyers paid an initial (fixed) purchase price and agreed to make deferred contingent earnout payments totaling up to $50 million if the taxpayer’s earnings exceeded certain thresholds during the three years immediately following the transaction. The earnout payments ultimately totaled more than $33 million.

The OTA made three determinations regarding the transaction:

  1. The unreported installment gain should be accelerated for inclusion in the taxpayer’s taxable income for the final short tax year. While a taxpayer generally recognizes gain in the year received under the installment method, California law provides an exception which includes such installment income in the measure of tax for the last year the taxpayer is subject to California tax. Acceleration was warranted even though the taxpayer continued California business operations as a C corporation. This is because when an IRC 338(h)(10) election is made, the corporation is treated as if it sold its assets, liquidated, and ceased to exist, and thus the subsequent C-Corporation was a different entity.
  2. The income from the deemed asset sale relating to intangibles such as goodwill and going concern value constitutes business income because these assets were integral to the taxpayer’s regular trade or business operations and thus satisfied the “functional” test for business income.
  3. Gross receipts from the deemed asset sale should be excluded from the taxpayer’s sales factor pursuant to Regulation section 25137(c)(1)(A) as receipts arising from a substantial and occasional sale. As a result, the taxpayer was required to exclude the fixed portion of the sale amount from the sales factor numerator and denominator. This increased the taxpayer’s California sales factor apportionment percentage and California taxable income, resulting in a tax liability.

Finally, the OTA determined that the taxpayer was not entitled to alternative apportionment. The taxpayer argued that excluding the gross receipts from the sales factor while including the corresponding net gain in its apportionable tax base was distortive and did not fairly reflect the extent of the taxpayer’s California business activity during the period that the value of the intangible assets were generated. The OTA evaluated the distortion arguments under both the qualitative and quantitative approaches, as well as for reasonableness.  The OTA held that it was not necessary to include the gross receipts from the sale of goodwill in the apportionment factor for the year at issue to represent the gradual effects of the buildup of the goodwill’s value over several years as such value was already represented within the regular sale of inventory. The OTA also held that the deemed sale of assets was substantial and occasional and it would be distortive to treat the proceeds from this transaction the same as proceeds from the taxpayer’s regular business operations.

In the Matter of Amarr Company, Case No. 20046125 & 20046127, (Cal. Office of Tax Appeals Dec. 9, 2021, published Feb. 7, 2022) (pending precedential).

In this episode of the SALT Shaker Podcast focused on policy issues, host and Eversheds Sutherland Partner Nikki Dobay welcomes back fellow SALT Partner Charlie Kearns for a conversation with Luke Morris, Deputy Secretary of the Louisiana Department of Revenue. Together, they discuss Louisiana’s local tax administration situation, including the 2021 efforts at the ballot and recently pre-filed 2022 legislation that seek to address some of these challenges.

Nikki’s surprise non-tax question focuses on burritos – are they classified as a sandwich?

The Eversheds Sutherland SALT team has been engaged in state tax policy work for years, tracking tax legislation, helping clients gauge the impact of various proposals, drafting talking points and rewriting legislation. Partner Nikki Dobay, who has an extensive background in tax policy, hosts this series, which is focused on state and local tax policy issues.

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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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: What was the second state to pass legislation that would decrease corporate and individual income tax rates this year?

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. Answers will be posted on Saturdays in our SALT Shaker Weekly Digest. Be sure to check back then!

 

 

The New York Tax Appeals Tribunal upheld the New York Division of Tax Appeals’ determination that an information technology security company provides a taxable protective service. The taxpayer provides monitoring and firewall management services, by configuring its customers’ software and devices to prevent malicious activity. The Department of Taxation and Finance asserted that the taxpayer’s services were taxable protective services, which include protection against any malfunction or damage to property. In upholding the assessment, the Tax Appeals Tribunal found that the taxpayer’s services prevented outside threats to customers’ networks, which falls within the statutory definition of taxable protective services. The Tribunal rejected the taxpayer’s argument that the services did not actively or directly guard or protect property, because the purpose of the taxpayer’s software and devices is to protect or guard customers’ networks from malicious activity.

On March 7, Eversheds Sutherland Partner Jeff Friedman will participate in a panel from Thomson Reuters ONESOURCE and Tax Executives Institute (TEI), covering important SALT trends and issues to watch in the coming year. For more information and to register, click here.

In addition, on March 9, join Eversheds Sutherland attorneys Tim Gustafson and Eric Coffill for a California tax update, as they will explore recent key California tax developments and how they will impact the state’s tax landscape in 2022. To register, click here.

Finally, on March 10, Eversheds Sutherland Partners Nikki Dobay and Charlie Kearns will present during the during the 2022 COST Sales Tax Conference in Las Vegas, NV.

Presentation topics include:

  • Issues with Local Taxes – Focus on Lodging Taxes and Home Rule Jurisdictions – Nikki Dobay
  • Does the Permanent Internet Tax Freedom Act Have any Teeth? – Charlie Kearns

For more information and to register, click here.

On March 4, 2022, the United States District Court for the District of Maryland partially dismissed a challenge to the Maryland Digital Advertising Gross Revenues Tax.

  • The plaintiffs asserted that the Tax violates the Internet Tax Freedom Act and the Commerce and Due Process Clauses of the United States Constitution.
  • The federal court held that the Tax Injunction Act applied and, therefore, the court did not have jurisdiction to hear a challenge to the Tax.
  • However, the court agreed to hear the First Amendment and Commerce Clause challenges to the Tax’s “anti-pass-through” provision.
    • The Tax contains a provision that prohibits the taxpayer from “directly pass[ing] on the cost of the [Tax] to a customer who purchases the digital advertising services by means of a separate fee, surcharge, or line-item.” Code Ann., Tax-Gen. § 7.5-102(c).
    • But the Tax does not contain any express penalties for violating the anti-pass-through provision.
    • The court determined that a challenge to this provision does not fall within the Tax Injunction Act because it does not involve a challenge to the assessment, levy, or collection of the Tax.

Chamber of Commerce of the United States of America, et. al., v. Franchot, No. 21-cv-00410-LKG (D. Md. Mar. 4, 2022).

The Texas Court of Appeals ruled that a law firm’s purchases of loan packages for lending institution clients was the taxable purchase of data processing services. The law firm purchased loan packages consisting of promissory notes, deeds of trust, tax disclosures and other pertinent legal documents from vendors. The law firm argued that the “essence of the transaction” was the conveyance of the loan package, which included services of paralegals and mortgage experts and not data processing. The court disagreed, finding that the contracts provided that the firm’s vendors collect and manipulate data, while the firm is responsible for the legal content in the packages. Thus, the “essence of the transaction” was the purchase of taxable data processing services.

Missouri Senate Joint Resolution 33 provides that voters will decide whether to amend the state constitution to tax digital products. Missouri’s constitution prohibits expanding the sales and use tax to any services that were not taxable as of January 1, 2015. Joint Resolution 33 proposes to allow taxation of “subscriptions, licenses for digital products, and online purchases of tangible personal property.” The Joint Resolution still needs approval from the full House.

In this episode of the SALT Shaker Podcast, host and Eversheds Sutherland Associate Jeremy Gove is joined by Associate Annie Rothschild to discuss some noteworthy developments in the proposed amendments to California’s market-sourcing regulations. They highlight changes to the regulations that Annie discusses at length in a recent Tax Notes State article.

They conclude their discussion with Jeremy’s favorite question – overrated/underrated? Cold means citrus season, so this time they discuss the sumo citrus orange.

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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