The Washington Department of Revenue Appeals Division ruled that for B&O apportionment purposes under the “services and other activities” tax classification, an out-of-state automated teller machine (ATM) card transaction processor’s receipts are properly sourced to the location of its financial institution customers’ ATM transaction activities. The Appeals Division found that location to be the location of an ATM machine where an individual cardholder “swiped” his/her ATM card and the ATM transaction was completed, and not the customer’s billing address. The Appeals Division concluded that the Department of Revenue’s method of attributing the benefit of the taxpayer’s service to the location of the taxpayer’s customers’ activities did not violate the Commerce Clause and Due Process Clause of the US Constitution and was a reasonable method under Washington law. Finally, the Appeals Division ruled that the card service fees were not royalties because they were not related to an intangible right such as a license, a trademark or a similar item, but rather were charged for access to a payment system that was vital to the business activities of the taxpayer’s customers. (Det. No. 16-0026, 37 WTD 201 (2018)).
This is the eleventh edition of the Eversheds Sutherland SALT Scoreboard, and the third edition of 2018. Each quarter, we tally the results of what we deem to be significant taxpayer wins and losses and analyze those results. This edition of the SALT Scoreboard includes a discussion of California combined reporting, insights regarding the Washington bad debt deduction, and a spotlight on apportionment cases.
View our Eversheds Sutherland SALT Scoreboard results from the third quarter of 2018!
The Washington Court of Appeals upheld the denial of sales tax and B&O tax refund claims filed by Lowe’s Home Centers, LLC based on the bad debt deduction. Lowe’s, a home improvement retail store with locations in Washington, entered into private label credit card (“PLCC”) agreements with two issuing banks. Among the typical terms of the PLCC agreements, Lowe’s and the banks shared in profits and losses of the PLCC accounts. Under those profit-sharing provisions, defaulted accounts reduced Lowe’s share of profits from the PLCC agreements and, therefore, were deductible under IRC § 166 for federal income tax purposes. Due to the deductibility under IRC § 166, Lowe’s argued that it also qualified for the Washington bad debt deduction for sales and B&O tax purposes under R.C.W. § 82.08.37. The appeals court, however, found deductibility under federal tax law alone is not sufficient to qualify under the Washington bad debt statute. Explaining that, per R.C.W. § 82.08.37, the bad debt must also be “on sales taxes previously paid” that are “written off as uncollectible” by the seller to qualify for a deduction under that provision. Lowe’s relationship to the bad debts at issue in this case failed both of these requirements: (1) the bad debts were not “directly attributable” to a retail sale on which sales tax was paid, but instead were attributable to Lowe’s separate, contractual profit sharing reductions with the banks; and (2) Lowe’s books and records did not reflect any written-off accounts that resulted in bad debt. Accordingly, the appeals court concluded that Lowe’s was not entitled to a refund of sales or B&O taxes based on the bad debt deduction under R.C.W. § 82.08.37.
The Superior Court of Washington for King County held that Seattle’s new income tax on “high income residents” violates a provision of Washington state law which prohibits a city from levying a tax on net income.
On July 14, 2017, Seattle Mayor Ed Murray signed Seattle Ordinance No. 125339, which would impose an income tax on “high-income residents.” This tax would impose an additional tax of 2.25% on the amount of total income in excess of $250,000 for individuals and the amount of total income in excess of $500,000 for married taxpayers filing jointly.
Plaintiffs raised multiple arguments against the tax regarding Seattle’s authority to levy the tax such as whether the tax was an income tax or an excise tax, whether state law prohibited cities from enacting income taxes, and whether the tax violates the Washington Constitution. The court considered each argument but ultimately decided the case on the issue of whether the tax violated state law prohibiting cities from levying a tax on net income.
Wash. Rev. Code Sec. 36.65.030 provides that a “county, city, or city-county shall not levy a tax on net income.” The court rejected the city’s challenge that Wash. Rev. Code Sec. 36.65.030 was invalid because it violated the Single Title Rule and Subject in Title Rule provisions of the Washington State Constitution. Instead, to determine whether this statute applied to the tax, the court analyzed the meaning of the term “net income.” Notwithstanding the dictionary definitions cited by the city, the court determined that there could only be one conclusion—that the city’s income tax is tax on net income. Thus, the court concluded that the city did not have the authority to impose the new income tax because it applied to the net income of high income residents. Kunath v. City of Seattle, No. 17-2-18848-4 (Wa. Sup. Ct. Nov. 22, 2017).
The Washington Administrative Review and Hearings Division of the Department of Revenue found that an out-of-state diamond and gold wholesaler was subject to the business and occupation (B&O) tax based on in-state consigned property. The wholesaler consigned jewels to Washington jewelry retailers for five days at a time, during which time the retailers had the option to purchase. The audit began when the Department identified the wholesaler as a creditor in financing statements within Washington UCC filings. Upon petition of an assessment for the wholesaling B&O tax, the Hearing Division concluded that the consigned jewels constituted substantial nexus as the person who consigns property retains ownership of that property. Further, the B&O tax applied because the jewels were located in Washington at the time they were sold to the retailer and thus the purchaser received the goods in Washington. Det. No. 17-0057, 36 WTD 529 (2017).
The Washington Court of Appeals recently held that Seattle could not impose a utility tax on revenue derived from international roaming charges (charges for mobile telephone communications that originate in a foreign country). City of Seattle v. T-Mobile West Corp., No. 75423-8-1 (Wash. Ct. App. May 22, 2017). Washington law grants cities the authority to tax revenue derived from “intrastate toll telephone services” (services that incur a fee and that originate and terminate within the same state). See RCW 35.21.714(1). The Court of Appeals found that because roaming charges involve communications originating in a foreign country, they are not derived from intrastate telephone services, and are therefore exempt from the City’s utility tax. The appellate court further held that the City’s reliance on the federal Mobile Telecommunications Sourcing Act (MTSA) conflated the sourcing of roaming revenue—which is governed under the MTSA—with the taxability of that revenue in the first place—which is governed under state law.
A new landmark sales tax statute has been adopted in Minnesota, which expands sales tax collection requirements to those retailers that sell their goods on certain “marketplaces.” Generally, only a retailer that is physically present in a state is required to collect and remit the state’s sales tax. The US Constitution’s dormant Commerce Clause requires that a person or transaction have “substantial nexus” with a state before the state may impose its sales tax on that person or transaction. Complete Auto Transit v. Brady, 430 U.S. 274 (1977).
In 1992, the US Supreme Court clarified in Quill Corp. v. North Dakota, 504 U.S. 298 (1992), that “substantial nexus” only exists when there is a non-trivial physical presence for sales tax purposes. Given the changes in technology and consumer sophistication since Quill was decided, states have been enacting broader sales tax nexus laws in an effort to increase revenues, especially from ecommerce. There also have been various attempts to expand the definition of substantial nexus or what constitutes a physical presence.
In the most recent attempt, Minnesota statutorily expanded its sales tax collection obligation to “marketplace providers” that provide their platforms to retailers to sell their goods. On May 30, 2017, H.F. 1 was passed, which effectively creates a sales tax collection requirement for any retailer that makes sales through a “marketplace provider,” even if the retailer is not actually physically present in Minnesota. The legislation also requires a “marketplace provider” to collect and remit sales tax for the retailer’s sales it facilitates. A “marketplace provider” is defined as “any person who facilitates a retail sale by a retailer” by: (1) listing or advertising sales by the retailer; and (2) collecting payments from the retailer’s customers and transmitting those payments to the retailer.
A marketplace provider is obligated to collect and remit Minnesota sales tax regardless of whether it facilitates payment collection and transmission or whether the marketplace provider is compensated for its services. The marketplace provider is relieved of its collection obligation if the retailer is already registered to collect Minnesota sales tax. There is also a de minimis threshold—if a retailer makes less than $10,000 in taxable sales in the previous year, then there is no collection obligation. The law goes into effect on July 1, 2019, or sooner if the US Supreme Court overturns Quill. Minnesota became the first state to enact this type of law. Other states are quickly joining Minnesota, including Washington, which also extended sales tax collection obligations to marketplace operators on July 7, 2017 (H.B. 2163).
The Administrative Review and Hearings Division at the Washington Department of Revenue (the Division) determined that administrative activities qualify as business activities for purposes of applying Washington’s throw-out rule under the Washington business and occupation (B&O) tax. The taxpayer, a single member LLC, performed airplane certifications on aircraft worldwide. While the certifications were performed outside of Washington, the taxpayer’s member took calls, arranged scheduling, and managed travel and billing from his home office in Washington. Washington’s throw-out rule excludes gross income from the denominator of the receipts factor if at least some of the activity that generated the gross income was performed in Washington. The taxpayer argued that the activities that generated the gross income were the certifications performed outside of Washington and not the administrative activities performed at the member’s home office. The Division disagreed, determining that the taxpayer performed activities in Washington in support of the taxpayer’s business contracts and, therefore, the throw-out rule exclusion applied to such gross income. Det. No. 16-0226, 36 WTD 344.
The Washington State Department of Revenue ruled that an out-of-state baker whose only in-state “presence” was its use of in-state independent commissioned sales representatives to solicit orders had substantial nexus with Washington and therefore was subject to the state’s business and occupation (B&O) tax. The taxpayer contracted with the in-state representatives to solicit orders in a territory that included Washington. All orders were sent to the taxpayer outside of Washington for approval. Relying on the state statute and administrative rules in effect at the time and case law standing for the proposition that substantial nexus for B&O tax purposes can be established through the use of independent agents contracted to perform in-state activities, the Department concluded that the independent commissioned sales representatives provided significant services that enabled the taxpayer to establish and maintain a market in Washington. The Department also found that, even though shipment was made by common carrier and title passed to the customers outside of Washington, the taxpayer’s sales to Washington customers occurred in Washington because the baked goods were received there. Commercial law and UCC “delivery” terms, the Department said, are not dispositive for B&O tax purposes. Det. No. 16-0149, 35 WTD 613 (2016).
The Washington Supreme Court held that drop shipments and sales from out-of-state are subject to the Washington business and occupation (B&O) tax even when an in-state office was not involved in placing or completing the sales. A wholesaler of electronic components and computer technology worldwide sold products through its Arizona headquarters and its many regional sales offices, including one in Washington, but excluded its national and drop-shipped sales from its B&O tax liabilities. The taxpayer shipped goods into Washington from an out-of-state warehouse. The products were delivered to the customers at its Washington branch, but the goods were billed to the out-of-state office.
The taxpayer argued that the substantial nexus prong of the dormant Commerce Clause was not met because the Washington office was not involved with the sales. The court held that “merely showing that an in-state office was not involved in the placing or completion of a national or drop-shipped sale is insufficient to dissociate from the bundle of in-state activities that are essential to establishing and holding the market for its products.” The Washington employees provided the corporate office with market intelligence regarding Washington markets, met with the taxpayer’s sales teams and suppliers to strategize on how to create a greater demand for the products and services, and worked with customers to improve products and design new prototypes. The in-state activities created nexus and satisfied the dormant Commerce Clause for the taxpayer because they were “at least minimally associated with [the taxpayer’s] ability to establish and maintain a market in Washington for the sale of its products.”
The taxpayer also argued that a Washington regulation barred the imposition of the B&O tax on both categories of sales. The rule stated that “Washington does not assert B&O tax on sales of goods which originate outside this state unless the goods are received by the purchaser in this state and the seller has nexus.” The court held that the imposition of the B&O tax to the taxpayer’s sales was proper because the rule defined “received” as including the purchaser’s agent receiving the goods. Thus, the taxpayer’s buyer would qualify as either the purchaser or as the purchaser’s agent. Avnet, Inc. v. Washington Department of Revenue, No. 92080-0 (Wash. Nov. 23, 2016) (en banc).