The Latest and Greatest in State Tax Litigation

Transcription

1 Marc Simonetti Andrew Appleby TEI Upstate New York Tax Conference May 6, 2014 The Latest and Greatest in State Tax Litigation

2 Agenda Group Composition / Unitary Disputes Apportionment Nexus MTC Election Controversy

3 Group Composition / Unitary Disputes

4 Group Composition: New York Matter of the Petition of IT USA Inc., Nos and (N.Y. Div. of Tax App. Dec. 20, 2012) Parent company created to reduce subsidiaries overhead costs by centralizing management Parent controlled centralized cash management system; paid subsidiary expenses; all employees transferred from subsidiaries to parent; no formal agreement created ALJ found that taxpayers: (1) met capital stock ownership requirement;(2) were engaged in unitary business; and (3) separate filing would distort true nature of income and tax liability Department appealed to Tax Appeals Tribunal 4

5 Group Composition: New York Matter of the Petition of IT USA Inc., Nos and (N.Y. Tax App. Trib. Apr. 16, 2014) Tax Appeals Tribunal upheld ALJ decision Even though intercompany services were reimbursed, the lack of arm s-length pricing created distortion Department was not permitted to decombine the taxpayer 5

6 Group Composition: New York Matter of the Petitions of Knowledge Learning Corp. and Kindercare Learning Centers, Inc., Nos & (N.Y. Div. of Tax. App. June 27, 2013) The Administrative Law Judge found that taxpayers failed to establish substantial intercorporate transactions existed between affiliates to permit a combined filing First post-2007 law change decombination case The taxpayers attempted to establish that substantial intercorporate transactions existed because: 1) all of Kindercare s employees were paid and employed by KLC; and 2) all of Kindercare s expenses were paid by KLC In rejecting those arguments, the ALJ noted that there was no written agreement documenting the employee transfers between the affiliates and that KLC s payments of Kindercare s expenses were on behalf of Kindercare, using Kindercare s own cash 6 Appealed to Tax Appeals Tribunal, awaiting decision

7 Group Composition: New York Matter of the Petition of SunGard Capital Corp., DTA No (N.Y. Div. of Tax App. Apr. 3, 2014) ALJ determined that taxpayers did not operate a unitary business The ALJ found that the centralized operations and services provided by the parent corporation were stewardship-activities not resulting from the parent s operational expertise The decision rejects many of the traditional indicia of functional integration, centralization of management, and economies of scale Likely to see more unitary disputes now that New York shifted to unitary combined reporting effective for tax years beginning Jan. 1,

8 Group Composition: New York New York Tax Reform (Jan. 1, 2015) Budget Bill implemented vast corporate tax reform Water s-edge unitary combined reporting Taxpayers shall file a combined report with entities it (a) owns or controls directly or indirectly, and (b) with which it is engaged in a unitary business Includes a combined election, regardless of whether the members establish a unitary relationship Includes Combinable captive insurance companies; Alien corporations with effectively connected income; and Captive real estate investment trusts (REITs) and regulated investment companies (RICs) 8

9 Unitary Dispute: California ComCon Production Services I, Inc. v. California Franchise Tax Bd., Case No. BC (Los Angeles Super. Ct. Mar. 6, 2014) The court held that Comcast was not unitary with its subsidiary, QVC The court held that none of the unitary tests were satisfied The court held, however, that Comcast s receipt of a $1.5 billion termination fee constituted business income 9

10 Unitary Dispute: Alaska Tesoro Corp. et. al. v. Alaska, 312 P.3d 830 (Alaska Oct. 25, 2013) The Alaska Supreme Court held that a taxpayer s entities constituted a unitary business and thus all their worldwide income was subject to Alaska s three-factor apportionment formula The taxpayer argued that Alaska s tax scheme violated the Due Process Clause and the Commerce Clause, and thus only its Alaska-based subsidiaries should be subject to Alaska income tax Taxpayer filed a certiorari petition with U.S. Supreme Court 10

11 Group Composition Florida: The Florida Department of Revenue determined that a taxpayer s substantial growth was sufficient reasonable cause to allow the taxpayer to discontinue consolidated filing The approval of discontinuation is rare Tech. Assistance Advisement No. 13C1-008 (Oct. 25, 2013, released Feb. 18, 2014) Indiana: The Indiana Department of Revenue determined in letter of findings that a 12-year old transfer pricing study was insufficient to show that the Department s forced combination was improper The Department relied on the state s equitable apportionment, and the state s forced combined reporting provisions Ind. Dep t of Revenue, Ltr. of Findings No (Feb. 26, 2014) 11

12 Apportionment

13 Alternative Apportionment CarMax Auto Superstores West Coast, Inc. v. South Carolina Dep t of Revenue, 397, S.C. 604, 25 S.E.2d 711 (S.C. App., 2012) Taxpayer (a retailer) used standard three-factor apportionment to compute its income for a five-year period. Department determined this method did not fairly reflect taxpayer s income and used an alternate method: income from royalty and financing receipts in South Carolina vs. everywhere Court of Appeals: Department had to prove by a preponderance of the evidence: Statutory apportionment method did not fairly represent taxpayer s business activities in state; and Department s proposed alternative apportionment method was more reasonable than any competing method 13

14 Alternative Apportionment S.C. Supreme Court On August 29, 2013, S.C. Supreme Court granted Department s leave for appeal Taxpayer asked Court to determine whether Court of Appeals erred in: (1) determining taxpayer was a unitary business; (2) holding receipts at issue should be sourced to South Carolina; and (3) failing to find a violation of taxpayer s constitutional rights Department requested Court determine whether Court of Appeals erred in determining Department has the burden of proof to show its alternative apportionment formula is more appropriate than any competing methods Oral arguments heard March 19, 2014, decision pending 14

15 Alternative Apportionment Subsequent Developments Following the S.C. Supreme Court s grant, the Department of Revenue issued a draft revenue ruling citing to the case. South Carolina Dep t of Revenue, Rev. Rul. 14-STAFF DRAFT (Feb. 28, 2014) The revenue ruling clarifies that the party asserting alternative apportionment bears the burden of proving that the standard apportionment formula does not fairly represent the taxpayer s in-state business activity The ruling does not mention the additional burden of showing that the alternative apportionment method is reasonable and more fairly representative of taxpayer s in-state business activity 15

16 Alternative Apportionment Equifax, Inc. v. Mississippi Dep t of Revenue, 2012, WL (Miss. Ct. App.) Taxpayer applied cost-of-performance method for sourcing its service provider revenue Department applied an alternative apportionment method utilizing marketbased sourcing Trial Court Upheld Department s alternative apportionment, holding taxpayer failed to meet its burden and Department s interpretation was not arbitrary or unreasonable Court of Appeals Reversed trial court for improperly imposing burden on taxpayer and remanded case for determination on merits Held state bears burden to prove two things: The statutory formula does not fairly represent the taxpayer s business activity in the state; and The state s proffered alternative method is reasonable 16

17 Alternative Apportionment Equifax, Inc. v. Mississippi Dep t of Revenue, 125 So.3d 36 (Miss. 2013) Mississippi Supreme Court reversed Court of Appeals Held taxpayer bears burden to prove that an alternative apportionment method imposed by state is arbitrary and unreasonable Court relied on Mississippi APA to determine that Chancery Court must give deference to holdings of Mississippi State Tax Commission 17 Taxpayer failed to prove that, by applying alternative apportionment, Department promulgated a new rule in violation of the Mississippi APA Under APA, burden of proof is on taxpayers seeking refunds in Chancery Court

18 Alternative Apportionment Motion for Rehearing Equifax filed a motion for rehearing on July 22, 2013 Equifax argued that although parties had a full evidentiary hearing at trial, court proceeded under assumption parties had a full evidentiary hearing at administrative agency level, but parties had only a limited stipulation of facts at agency level Mississippi Supreme Court denied Equifax s motion for rehearing on November 21, U.S. Supreme Court Petition Equifax filed a petition for writ of certiorari on February 21, 2014 with the U.S. Supreme Court Argues that the Mississippi Department of Revenue violated due process by rejecting the company s use of a the statutory apportionment formula and assessing interest and penalties under an alternative formula

19 Alternative Apportionment Legislative Response to Equifax Mississippi passed legislation in response to Equifax decision Requires Department to present preponderance of evidence to invoke alternative apportionment, e.g., deviate from COP, or forcibly combine entities from requiring a combined return that includes one or more corporations not subject to state income tax until regulations have been promulgated Good-faith challenge to constitutionality or legality of a law would preclude Department from assessing penalties arising from forced combinations Mississippi Governor approved on April 10, 2014 (effective Jan. 1, 2015) 19

20 Apportionment: NJ Throwout Lorillard Licensing Co., LLC v. Dir., Div. of Taxation, No. A T1 (N.J. Tax Ct. order issued Jan. 14, 2014) The New Jersey Tax Court held that only one standard the economic nexus standard upheld in Lanco applies in determining whether receipts must be thrown out of the sales factor Recall, under New Jersey s now-repealed throwout rule, receipts attributable to a state or foreign country in which the taxpayer is not subject to a tax on or measured by profits or income, or business presence or business activity are excluded from the sales factor Applying the Lanco standard, licensors of intangibles should be deemed taxable in any state where they have receipts As such, should not have to throw out any receipts New questions: Can this apply beyond throwout? Should you file refund claims? 20

21 Apportionment: NJ Throwout Whirlpool Properties Inc. v. Div. of Tax n; Docket No Whirlpool still in Tax Court October 22, 2013: Tax Court denied 3 summary judgment motions: 1. Whirlpool: Define the application of New Jersey Supreme Court s throwout decision Lorillard-type argument 2. New Jersey: Whirlpool had economic nexus and was required to remit CBT returns before the Tax Court could determine the application of the Throwout Rule Standing/nexus argument 3. Whirlpool: Did not have nexus in New Jersey and does not owe CBT Nexus argument 21

22 Apportionment: New York New York Tax Reform (Jan. 1, 2015) Market (customer) based sourcing for all receipts Creates several new categories of receipts, including digital goods Specific sourcing provisions for financial transactions and an election for taxpayers to source a flat 8% of their receipts from qualified financial instruments (QFIs) to New York 22

23 Nexus

24 Sales and Use Tax Nexus Amazon.com et. al. v. New York State Dep t of Tax. & Fin., 20 N.Y.3d 586, 987 N.E.2d 621 (N.Y. 2013), cert. denied, 134 S.Ct. 682 (2013) New York Court of Appeals upheld the constitutionality of New York s Amazon law Rejected taxpayers facial Commerce Clause challenge, finding that utilizing an affiliate program with an in-state seller creates sufficient nexus/physical presence Physical presence need not be substantial Active, in-state solicitation that produces a significant amount of revenue qualifies as demonstrably more than a slightest presence.... Law s presumption of business solicitation did not violate the Due Process Clause because it is a rational presumption the in-state affiliate will solicit customers and seek referrals for compensation 24

25 Sales and Use Tax Nexus Performance Marketing Ass n v. Hamer, No CH (Ill. Cir. Ct. May 7, 2012) In 2011, Illinois passed an Amazon law that imposed sales and use tax registration and collection obligations on: [A] retailer having a contract with a person located in this State under which the person, for a commission or other consideration based upon the sale of tangible personal property by the retailer, directly or indirectly refers potential customers to the retailer by a link on the person's Internet website Cook County Circuit Court held Illinois Amazon law violated the Commerce Clause and the Internet Tax Freedom Act (ITFA) Two findings: Judge held that the law violated the Commerce Clause because it required retailers with no substantial nexus with the state to register and collect the state s sales and use taxes Judge held that the law violated the ITFA as a discriminatory tax on e-commerce 25

26 Sales and Use Tax Nexus Performance Marketing Ass n, Inc. v. Hamer, 2013 IL , 998 N.E.2d 54 (Ill. 2013) Illinois Supreme Court affirmed the Illinois Circuit Court s holding that the ITFA preempted Illinois s click-through nexus law The court held that the Illinois click-through nexus regime was a discriminatory tax under the ITFA because it imposed sales and use tax collection obligations on retailers engaged in an Internetbased activity without imposing similar obligations on retailers that advertised through traditional media such as magazines, newspapers, and television Although Illinois tax law provided that retailers advertising through traditional media must collect tax, the collection requirement applied to activities directed toward in-state consumers Click-through nexus provision did not limit its applicability and effectively applied to interstate or international activities The court declined to reach the Commerce Clause challenge 26

27 Income and Franchise Tax Nexus Comptroller of the Treas. v. Gore Enter. Holdings, Inc., 209 Md. App. 524, 60 A.3d 107 (Md. Ct. Spec. App. 2013) Maryland Court of Special Appeals held that two out-of-state intangible holding companies were a unitary business and had nexus with Maryland for corporate income tax purposes Sufficient nexus exists if the economic reality is that the parent company in Maryland produced the subsidiary s income Hallmarks of a unitary business present functional integration, centralized management, and economies of scale Subsidiaries dependent upon parent and controlled by parent Parent s expenses in Maryland is the subsidiaries income Recovery by Comptroller not barred by statute of limitations Apportionment properly based on three-factor apportionment formula, rather than single-sales factor Gore Enterprise Holdings, Inc. v. Comptroller of the Treas., 2014 WL (Md. 2014) Maryland high court affirmed the Court of Special Appeals decision Distinguishes its ruling by stating that the out-of-state intangible holding companies did not have economic substance 27

28 Use Tax Reporting Direct Marketing Assoc. v. Colorado Dep t of Rev., Case No. 13CV34855 (Denver Dist. Ct. Feb. 18, 2014) A Colorado state district court issued a preliminary injunction preventing the Colorado Department of Revenue from enforcing Colorado s out-of-state seller use tax reporting statutes and related regulations Previously, the Tenth Circuit Court of Appeals dismissed a federal district court s grant of a permanent injunction against the Colorado Department of Revenue that prevented the Department from enforcing Colorado s use tax notice and reporting requirements Direct Mktg. Ass'n v. Brohl, 2013 U.S. App. LEXIS (10th Cir. Aug. 20, 2013) 28 Oklahoma customer notice of use tax when ordering South Carolina (limited) South Dakota customer notice of use tax when ordering Tennessee (limited) Vermont (repealed once click-through enacted)

29 MTC Election Controversy

30 Apportionment Under the MTC Election Background of issue Article IV of The Uniform Division of Income for Tax Purposes Act (UDITPA) within the Multistate Tax Compact (adopted by 23 states), provides an election for taxpayers to apportion multistate income pursuant to: State law; or The standard evenly-weighted three-factor formula provided within UDITPA As states strayed away from the standard formula by enacting more heavily sales-factor-weighted apportionment, taxpayers began to utilize this election 30

31 Apportionment Under the MTC Election Gillette Company v. Franchise Tax Board, 209 Cal. App.4 th 938, 147 Cal. Rptr.3d 603 (2012) 31 Court invalidated the 1993 amendments (imposing 2X sales) attempt to repeal the MTC equally-weighted three-factor formula ( notwithstanding CRTC ). Three holdings: MTC is a valid compact: supersedes conflicting state law MTC is an enforceable contract: U.S. and CA Constitutions prohibit CA from passing laws impairing the obligations of contracts 1993 amendments did not validly repeal MTC three-factor election: violation of reenactment clause of CA Constitution The notwithstanding language in the 1993 amendments was not effective to repeal the MTC alternative California Supreme Court granted cert. Awaiting argument

32 Apportionment Under the MTC Election California s reaction: On June 27, 2012, CA withdrew from the Compact (SB 1015) Bill also contains Doctrine of Election language aimed at possibly limiting elections on amended returns Two-thirds vote? Issues as to whether SB 1015 violates Prop. 26 FTB Notice provides procedural guidance on filing claims for refund Enacted mandatory single sales factor apportionment (for most taxpayers) beginning in

33 Apportionment Under the MTC Election IBM v. Dep t of Treasury, No (Mich. Ct. App. Nov. 20, 2012) 33 Michigan Court of Appeals held that adoption of MBT repealed the Compact election MCL (1) and (2) state that single sales factor applies to MBT, unless otherwise provided by a provision of the MBT Act MCL was amended by 2011 PA 40, explicitly stating that the Compact election was unavailable to the MBT after Jan. 1, 2011 Court viewed this as mere clarification of prior law rather than change in law to be applied prospectively But see Anheuser-Busch, Inc. v. Dep t Treasury, No MT (Mich. Ct. Cl. June 6, 2013) (holding that MTC is binding) Cert. application granted by Michigan Supreme Court on July 3, 2013 Arguments heard on Jan, 15, 2014, awaiting decision (expected by July 2014)

34 Apportionment Under the MTC Election TX: Graphic Packaging Corp. v. Combs, No. D-1-GN (Travis Count. Dist. Ct., order issued Jan. 15, 2014) Taxpayer filed suit claiming right to elect MTC s equally-weighted three-factor formula rather than single sales factor required by Franchise Tax statutes Comptroller and Administrative Law Judge have previously rejected the use of the MTC s three-factor apportionment formula for apportioning franchise tax, e.g., Texas Comptroller s Decision No. 106,508 (July 13, 2012) Judge granted the state s partial summary judgment motion, thus denying the right to apportion income using the MTC three-factor apportionment formula 34

35 Apportionment Under the MTC Election OR: Health Net, Inc. v. Dep t of Revenue, No. TC (Ore. Tax Ct., amend. complaint filed Jan. 17, 2013) Taxpayer filed suit claiming right to elect MTC s equallyweighted three-factor formula rather than single sales factor required by Oregon statute Department protective refund claim guidance issued on Sept. 24, 2012 Both the Oregon Attorney General and taxpayer filed motions for summary judgment (Feb. 11, 2014) Oral Arguments set for July 22,

36 Questions? Marc Simonetti, Partner Andrew Appleby, Associate

37 Connect with us! The Sutherland SALT Shaker mobile app is now available in the itunes App store and on Google Play for Android! Visit us at Sutherland SALT Group