Tennessee

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By Liz Cha and Todd Lard

The Tennessee Department of Revenue issued a letter ruling finding that a taxpayer’s annual subscription charge for its cloud-based employee scheduling services is subject to Tennessee sales and use tax. 

In Tennessee, the use of computer software is subject to tax, even if it remains in the possession of the dealer or a third party. If a transaction involves taxable and non-taxable components, the entire transaction is subject to sales tax if the true object of the transaction is a crucial, essential, necessary, consequential or integral element of the transaction.

The taxpayer provides software and services that allows its customers to manage employee schedules remotely over the Internet through personal computers and handheld devices on a website or application. The taxpayer retains the scheduling software, and users in Tennessee access it remotely.

The Department determined that the true object of the transaction is the remotely accessed software, not the non-taxable services provided by the taxpayer, because without the software, the taxpayer’s services would be of no value to the subscribers. Thus, the cloud-based employee scheduling services are subject to Tennessee sales tax. Tenn. Dept. of Rev., Letter Ruling No. 17-15 (10/11/17).

By Alla Raykin and Charlie Kearns 

The US Court of Appeals for the Sixth Circuit held that the Tax Injunction Act (TIA) barred a religious nonprofit from bringing a federal suit over Tennessee’s denial of a retroactive property tax exemption. In Islamic Ctr. of Nashville v. Tennessee, the Islamic Center of Nashville sought a refund for property tax paid while its property was held by the bank under the terms of an ijara. Because Islamic doctrine prohibits interest, an ijara is a financial vehicle used to avoid interest. Here, the Islamic Center of Nashville transferred title of the property to the bank and paid the bank lease payments. Once title was transferred back to the Center, the Center sought a property tax refund for the years it paid tax while title was held by the bank. The Sixth Circuit upheld the District Court’s dismissal, because an action in a federal court seeking a refund of tax paid contravened TIA’s purpose of preventing the use of federal courts to avoid a state tax assessment. The Sixth Circuit distinguished the present case from US Supreme Court precedent in Hibbs v. Winn, 542 U.S. 88 (2004), where the plaintiffs sought to strike down a tax credit statute as unconstitutional, rather than to absolve the plaintiffs of tax. Here, the court reasoned, the Center sought a finding that the denial of the tax exemption was invalid. Therefore, the court concluded that the TIA prevented the federal court from interpreting state tax provisions when a sufficient state remedy existed. (– F. 3d –, 2017 WL 4159484 (6th Cir. Sep. 20, 2017).

By Liz Cha and Eric Coffill

The United States District Court for the Middle District of Tennessee held that Tennessee’s sales tax on railroad carriers for the purchase or use of diesel fuel was not discriminatory under the Railroad Revitalization and Regulatory Reform Act of 1976 (4-R Act) even though it did not similarly apply to motor carriers because motor carriers are subject to a comparable excise tax on motor carrier fuel. This case was on remand from the Sixth Circuit Court of Appeals following the U.S. Supreme Court’s decision in Alabama Dept. of Revenue v. CSX Transportation, Inc., 135 S.Ct. 1136, 1143 (2015), holding that a rail carrier can show discrimination under the 4-R Act by demonstrating that it is subject to differential tax treatment compared to its competitors; although, tax disparity may be nondiscriminatory if competitors are subject to an alternate, comparable tax. 

Railroad carriers are subject to a sales or use tax on their purchase, consumption or use of diesel fuel in Tennessee while competing motor carriers are exempt from such tax. However, in lieu of the sales tax, motor carriers pay a motor fuel tax. For the tax years at issue, the railroad carriers were subject to a 7% tax on diesel fuel and motor carriers paid a motor fuel tax of 18.4 cents per gallon. Despite the effect of varying fuel prices on the amount of taxes paid by railroad carriers and motor carriers in recent years, the court determined that the tax burden bore by motor carriers was historically higher than railroad carriers and that over the years the tax burden on both motor and railroad carriers was “roughly” equivalent. In addition, the court agreed with the Tennessee Department of Revenue that there was sufficient justification for a different tax imposed on railroad carriers because railroad carriers purposely choose to use dyed fuel instead of clear fuel, which is exempt from the sales and use tax. The railroad carriers could, like the motor carriers, use clear diesel fuel and be subject to the same tax scheme as motor carriers but choose not to do so to avoid a federal excise tax on the use of clear diesel fuel. Accordingly, the court determined that the Department provided sufficient justification for the sales tax on railroad carriers for their purchase or use of diesel fuel and that there was no violation of the 4-Act. Illinois Central Railroad Co. v. Tennessee Dep’t of Revenue, No. 3:10-cv-00197 (M.D. Tenn. April 12, 2017).

By Eric Tresh and Liz Cha

On April 10, 2017, a Tennessee Chancery Court ordered that the Tennessee Department of Revenue is temporarily prohibited from enforcing a regulation that requires out-of-state retailers making annual sales in excess of $500,000 to collect and remit sales tax. The Order arises out of a dispute between the Plaintiffs and the Department of Revenue regarding the Constitutionality of the regulation. The regulation, which became effective January 1, required out-of-state retailers to register with the Department of Revenue by March 1 and to begin collecting state sales taxes after July 1. The Department of Revenue and Plaintiffs, American Catalog Mailers Association and NetChoice jointly requested the court’s order to limit uncertainty in the marketplace while the case is pending. The Court’s order also provides that retailers who may be subject to the regulation may voluntarily comply with the regulation during the pendency of the litigation. Am. Catalog Mailers Ass’n v. Tenn. Dep’t of Revenue, Tenn. Ch. Ct., No. 17-307-IV (complaint filed Mar. 30, 2017).

By Jessica Allen and Jeff Friedman

The Tennessee Department of Revenue (Department) released a letter ruling stating that a taxpayer’s charges for use of its web-based interface are subject to sales and use tax as the sale of ancillary services. The taxpayer’s proprietary software allows users to communicate through text and other messages on a single centralized web-based interface. The Department explained that the state imposes tax on the sale of telecommunications services and ancillary services. Telecommunication services are defined to include the transmission of data. Ancillary services include services associated with telecommunication services. Because the taxpayer’s web-based interface was “associated with, or incidental to, the provision of telecommunication services,” the interface qualifies as the sale of taxable ancillary services and therefore is subject to sales and use tax. Tenn. Letter Ruling 16-09, Tenn. Dep’t of Revenue (issued Nov. 10, 2016).

By Christopher Lutz and Jeff Friedman

On December 15, 2016, the Tennessee Joint Government Operations Committee held a hearing regarding the governor’s proposal to establish an economic nexus standard for the state sales tax. Under the proposal, remote sellers would be subject to collection obligations in the state if their Tennessee sales exceed $500,000. The rule would require out of state dealers to register with the DOR by 3/1/2017 and to begin collecting and remitting July 1, 2017. Testifying on behalf of the proposal were Larry Martin (Commissioner of Dept. of Finance and Administration), David Gerregano (Commissioner of Revenue); and Herbert Slatery (Attorney General). The proposed regulation was allowed to go forward with a vote of “no recommendation.” 

The principal skeptic of the proposed regulation was Rep. Mike Stewart (D-Nashville), who gave the rule a negative recommendation. During the hearing, Stewart noted that the State just passed legislation addressing physical presence with respect to franchise/excise and business taxes. Rep. Stewart observed that “it would seem if we chose to use statutes to get rid of physical presence for other taxes, isn’t what we’re doing here today most appropriately done through the legislation and not a regulation?” This question came up several times during the hearing, and the Department relied on Public Chapter 789 (1988), a 1988 bill, that it says establishes an economic nexus standard for sales tax (to this, Rep. John Ragan (R- Oak Ridge) replied, “We’ve also heard that a 1992 case is old, so I’d say that about the 1988 statute too”). Chairman Mike Bell (R- Riceville) also explicitly stated that the change should be “brought as a statute rather than a rule.” Others were explicit in their belief that this is something the US Congress, and not Tennessee, should do, such as Senator Mae Beavers (R- Mt. Juliet), who said, “I think this is something that federal congress should do.  I think this is completely out of our purview and we’ve wasted a lot of tax dollars here in something that is not our decision to make.” In summarizing his thoughts, Rep. Stewart said, “I want to point out that Colorado specifically suggested to the court in a brief that they use this DMA case as the vehicle to overturn Quill, and the fact that the Supreme Court didn’t suggest that, as with Streamlined Sales Tax, which never got off the ground, I’m just not sure that the landscape is really changing, and this regulation would put Tennessee at odds with most other states. We don’t do things to businesses that are unusual or strange, and I worry that this regulation would make us the odd man out. I recognize some states have deviated, but most states stick with physical presence.”

Another issue that came up in the meeting, a question raised by Rep. Ron Lollar (R-Bartlett), was whether the state would “consider giving relief to businesses in the state” upon adoption of the economic nexus standard.  Mr. Martin reiterated that this was something the Governor’s office is certainly open to.

From the community, 4 people spoke, 3 against the proposal, and one in favor.  Against the proposal was Steve Roth, general counsel of Jewelry Television; Carl Szabo, counsel at Net Choice; and George Gruhn, CEO of Gruhn Guitars Incorporated. In favor was Allen Dotty, co-owner of Cumberland Transit. Bill Fox, of University of Tennessee, also provided a presentation in favor of the proposal.  

Finally, Rep. Ragan ended by noting that if the governor would like to proceed with legislation rather than a regulation, the opportunity exists. The filing deadline is not until February. Ragan stated that he thinks “the administration would be well served by suggesting this to some of us willing to carry it. That way we avoid the concern that it is a regulation rather than legislation.” 

 By Liz Cha and Todd Lard

Applying the “true object” test to the taxpayer’s web-based services, the Tennessee Department of Revenue ruled that charges for granting access to the taxpayer’s website for purposes of obtaining information would not be subject to sales tax. While the access to web-based services is tax-exempt as a sale of services, a subscription to the taxpayer’s web-based technology solution system that allows a customer to manage its own information is taxable as a sale of remotely accessed software. However, the taxpayer’s purchase of the technology solution system from a third party qualifies for a sale for resale exemption if it provides the third party with a properly completed resale certificate. Tennessee Letter Ruling No. 16-01, 01/26/2016.

By Chris Mehrmann and Charlie Kearns

The Tennessee Department of Revenue has issued guidance explaining that the retail sale of, use of, or subscription to a computer software maintenance contract is subject to sales and use tax when: (1) the maintenance contract is sold as part of a taxable sale of computer software; (2) the underlying software is installed on a computer located in Tennessee; or (3) the location of the underlying software is unknown by the seller, but the purchaser’s residential or primary business address is located in Tennessee. The Department noted that additional tax is not imposed on any repairs or maintenance performed as part of the computer software maintenance contract. However, if any repairs or maintenance are not covered by the contract, then those transactions are subject to sales and use tax. Finally, the Department stated that separate sales of support services (e.g., help desk and customer service support) are not subject to sales and use tax, provided that: (1) the purchaser is not required to purchase the support services in connection with the computer software maintenance contract; and (2) the support services do not include the installation, transfer, repair or maintenance of the computer software. Tenn. Dep’t of Revenue, Notice No. 15-25 (Dec. 1, 2015).

By Mike Kerman and Andrew Appleby

The Tennessee Supreme Court held that the Tennessee Department of Commerce and Insurance (Department) improperly imposed retaliatory taxes on Pennsylvania-domiciled insurance companies doing business in Tennessee, because Pennsylvania workers’ compensation assessments were not imposed on Tennessee insurance companies, but rather on the insurance companies’ policyholders. Tennessee Code § 56-4-218 authorizes the state to impose a retaliatory tax when another state imposes taxes or obligations on Tennessee insurance companies doing business in that state that exceed the taxes or obligations Tennessee imposes on that state’s insurance companies doing business in Tennessee. Here, Pennsylvania imposed assessments to support three workers’ compensation funds. The statutes authorizing these assessments state that they are imposed on insurers. However, a more recent statute states that the assessments “shall no longer be imposed on insurers,” and instead requires insurers to merely collect the assessments from policyholders. The court determined that this later statute implicitly repealed the original statutes and that the assessments are therefore not imposed on insurance companies directly. Because the assessments are imposed on policyholders rather than insurance companies, Tennessee is not authorized to impose a retaliatory tax on Pennsylvania insurance companies. The court also rejected the Department’s argument that a related regulation, which provides that insurance companies remain responsible for collecting and remitting the total assessment amounts even if policyholders fail to pay, imposes a direct burden on insurance companies. The regulation imposes only a responsibility to “collect and timely remit” payments and does not impose any penalties or fines on insurance companies when policyholders fail to pay, the court concluded. Several New York-domiciled insurance companies filed similar tax refund claims, which the Tennessee Court of Appeals also denied. The Tennessee Supreme Court denied review of the New York cases, stating that the New York statutes differed significantly from the Pennsylvania statutes. Chartis Cas. Co. et al. v. State, No. M2013-00885-SC-R11-CV (Tenn. Oct. 2, 2015). 

By Andrew Appleby

Illinois enacted a direct placement tax on non-admitted insurance in 2014. However, there is a strong movement in Illinois to repeal or narrow the tax. Tennessee has now legislatively expanded its direct placement tax on non-admitted insurance, falling in line with many other states, including Illinois. Previously, Tennessee imposed a direct placement tax only on limited lines of insurance (such as marine insurance). Many states are now focusing on direct placement taxes after the Nonadmitted and Reinsurance Reform Act (NRRA) altered the tax landscape. The NRRA, part of the Dodd-Frank legislation, mandates that only an insured’s home state may impose tax on premiums paid for non-admitted insurance. Tenn. SB 82, amending Tenn. Code Ann. § 56-2-411.