Litigation and Controversy Update

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Jeff Friedman, Partner Michele Borens, Partner TEI San Diego State and Local Tax Seminar September 29, 2016 Litigation and Controversy Update All Rights Reserved.

1 Jeff Friedman, Partner Michele Borens, Partner TEI San Diego State and Local Tax Seminar September 29, 2016 Litigation and Controversy Update All Rights Reserved. This communication is for general informational purposes only and is not intended to constitute legal advice or a recommended course of action in any given situation. This communication is not intended to be, and should not be, relied upon by the recipient in making decisions of a legal nature with respect to the issues discussed herein. The recipient is encouraged to consult independent counsel before making any decisions or taking any action concerning the matters in this communication. This communication does not create an attorney-client relationship between Sutherland and the recipient.

2 Road Map 1. Nexus 2. Apportionment 3. Qui tam/false claims act 4. Other fun developments 2

3 NEXUS 3

4 More Attempts to Overturn Quill Quill established (or reaffirmed) a physical presence nexus standard in Alabama Regulation requires remote sellers with significant Alabama sales (>$250,000 annually) to collect and remit Newegg filed suit in the Alabama Tax Tribunal in June South Dakota Law requires remote sellers with more than $100,000 in South Dakota sales or that conduct 200 or more transactions in the state to collect and remit State and taxpayer filed separate lawsuits in state court in April 4

CAT is not governed by Quill because it is not a sales and use tax; also says

5 More Attempts to Overturn Quill Crutchfield et al. (Ohio) Adopted factor nexus provision for CAT purposes The Department claims the CAT is not governed by Quill because it is not a sales and use tax; also says physical presence met because of cookies placed on customers computers The Ohio Supreme Court heard oral arguments in May 5

More Attempts to Overturn Quill DMA (Colorado) Law requires remote sellers to report Colorado sales and notify customers of their use tax obligations In February, after remand from U.S.

6 More Attempts to Overturn Quill DMA (Colorado) Law requires remote sellers to report Colorado sales and notify customers of their use tax obligations In February, after remand from U.S. Supreme Court, Tenth Circuit upheld the law against Commerce Clause challenge In August, the taxpayer filed a cert petition with the U.S. Supreme Court asking it to overrule the Tenth Circuit s decision Significance of the Tenth Circuit s similarly situated analysis, and its comment that laws should be understood in their broader context rather than in isolation 6

7 APPORTIONMENT 7

8 Cost of Performance Dish DBS (South Carolina) Administrative Law Court said that South Carolina is not a COP state but an income-producing activity state; the statute provides a flexible standard based upon the income-producing activity for a given industry Court agreed with Department that Dish had one IPA: the delivery of the signal to the customer premises Advertising as an IPA 8

9 Alternative Apportionment Vodafone (Tennessee) Pursuant to its alternative apportionment authority, the Department required Vodafone to apportion sales using market-based (PPU) sourcing rather than statutory COP sourcing method Tennessee Supreme Court found no abuse of discretion: COP did not fairly reflect extent of Vodafone s in-state business The importance of optics in COP-based refund cases 9

10 Apportionment Quest Diagnostics (Louisiana) The Louisiana Court of Appeals ruled in favor of the taxpayer and granted the taxpayer s refund claims Louisiana law prior to 2016 (now market-based sourcing as of January 1, 2016) lacked express instructions for determining how to apportion income derived from general services The Louisiana Department Revenue asserted that a destination test applied (i.e., market-based sourcing) and receipts from medical lab testing should be sourced in Louisiana where the tests were ordered from Louisiana, but conducted in Texas The Court of Appeals held that sourcing of service income for apportionment purposes was legislatively defined as the location-ofperformance as opposed to a market-based sourcing rule 10

11 Apportionment Skechers USA (Wisconsin) The Wisconsin Tax Appeals Commission concluded that the state did not have the statutory authority to impose its income or franchise tax on an out-of-state company licensing intangible property to its in-state affiliate because none of its income would be apportioned to Wisconsin under the sales factor. No income would be sourced to Wisconsin because the company s costs of performing such licensing were outside Wisconsin The Commission did not reach the issue regarding whether the out-of-state company had nexus with Wisconsin due to its licensing of intangible property to its in-state affiliate 11

12 Treasury Receipts Duke Energy (South Carolina) Statute provides that sales factor numerator/denominator includes total sales ; South Carolina Supreme Court held that principal recovered from sales of short-term securities cannot be included Court relied on decisions from other states, threat of distortion, and possibility of absurd results ; but what happened to the actual statutory language? What was the effect of subsequent legislation defining the term sales to exclude recovery of principal? 12

Throw-Out Lorillard (New Jersey) Intangible holding company was not required to throw out nowhere receipts from an affiliated tobacco company in computing receipts factor denominator Appellate

13 Throw-Out Lorillard (New Jersey) Intangible holding company was not required to throw out nowhere receipts from an affiliated tobacco company in computing receipts factor denominator Appellate Division said that New Jersey s economic nexus standard must be applied to determine whether a corporation is subject to tax in other jurisdictions It was irrelevant whether company actually filed returns in or paid tax to those other jurisdictions 13

14 MTC Election Update Gillette (California) - Cert. petition filed in U.S. Supreme Court Gillette (Michigan) - Retroactive repeal upheld. November 21 st deadline to file cert. petition for Sonoco, one of the businesses in the consolidated cases. Kimberly-Clark (Minnesota) - Denied use of the Compact s three-factor apportionment formula. October 20 th deadline to file cert. petition. Health Net (Oregon) - Appeal pending at Oregon Supreme Court Graphic Packaging (Texas) - Petition for review filed to Texas Supreme Court 14

15 QUI TAM/ FALSE CLAIMS ACT 15

16 16

17 Qui Tam/False Claims Act Lush (Illinois) Plaintiff alleged Lush affiliate underpaid sales and use taxes on online sales, arguing that the affiliate had nexus with the state Circuit court held plaintiff failed to prove by preponderance of the evidence that Lush affiliate (1) had nexus with Illinois, and (2) knowingly failed to collect taxes Is qui tam/fca liability appropriate where there are disputed legal questions or unclear areas of the law (like nexus)? 17

18 Qui Tam/False Claims Act Sprint Nextel (New York) Court of Appeals upheld denial of motion to dismiss because AG s complaint sufficiently pleaded cause of action under state False Claims Act that Sprint knowingly filed false tax records Court said that an objectively reasonable interpretation of tax statute will not preclude action; reasonableness of position is for trier of fact U.S. Supreme Court denied cert. on question of whether MTSA preempted state law with respect to taxation of bundled services 18

19 Qui Tam/False Claims Act 911 Fee Litigation Lawsuits filed in numerous jurisdictions on grounds that providers of voice services under-collected 911 fees If a state s FCA contains a tax bar, does it preclude lawsuits related to the collection of 911 fees? Are 911 fees taxes? Other types of fees to which tax bar may not apply 19

20 Qui Tam/False Claims Act Vanguard (Texas / New York / Pennsylvania) Former in-house tax counsel sued Vanguard on grounds that company operated as illegal tax shelter, evaded billions in taxes by avoiding payroll withholding obligations and charging below arm s length prices to related entities Texas Comptroller paid whistleblower for his role, but New York trial court dismissed his qui tam action because he violated state attorney ethics rules Pennsylvania federal court dismissed the suit because the case had already been dismissed by the New York trial court and was precluded from hearing the matter Takeaways from New York opinion 20

21 OTHER FUN DEVELOPMENTS 21

22 Bona Fide Debt National Grid Holdings (Massachusetts) Deferred subscription arrangements among related entities to sell and repurchase shares of stock; designed to look like debt for U.S. purposes and equity for British purposes Massachusetts Appeals Court agreed that the DSAs did not constitute debt because company failed to prove that there was an unqualified obligation to repurchase shares (and thus repay the funds) d Ambiguity and rules of contract interpretation 22

23 Manufacturing Exemptions Southwest Royalties (Texas) Gas and oil exploration company claimed equipment used in or during hydrocarbon extraction process qualified for sales and use tax exemption for property used in manufacturing $4.4 billion in refunds and a $500 million annual hit to tax revenue were on the line While hydrocarbons undergo physical changes during extraction process, Texas Supreme Court agreed with lower court that those changes are not directly caused by the company s equipment 23

24 Dormant Commerce Clause First Marblehead (Massachusetts) For financial institutions, law includes loans in property factor numerator of jurisdiction where preponderance of SINAA factors occur Massachusetts Supreme Judicial Court held that in absence of SINAA factors, all loans purchased and securitized by taxpayer were sourced to its commercial domicile (Massachusetts) Invoking Wynne, taxpayer claimed that court s internal consistency analysis was flawed; U.S. Supreme Court vacated SJC s decision and remanded On remand, the SJC held that the apportionment did not violate the internal consistency test 24

Transfer Pricing Transfer pricing studies pay off in Indiana Tax Court Rent-A-Center East Department attempted to force combination on grounds that intercompany transactions resulted in distortion

25 Transfer Pricing Transfer pricing studies pay off in Indiana Tax Court Rent-A-Center East Department attempted to force combination on grounds that intercompany transactions resulted in distortion Court rejected the Department s position that transfer pricing studies are not relevant to whether a separate return fairly reflects Indiana source income Columbia Sportswear Court held that standard sourcing rules clearly reflected Columbia s Indiana source income because transfer pricing studies supported Columbia s intercompany transactions as being consistent with Indiana s conformity to I.R.C

26 Dormant Commerce Clause American Business USA (Florida) In-state florist challenged constitutionality of statute imposing sales tax on retail sales regardless of where or by whom items are delivered Intermediate appellate court struck down the statute, but the Florida Supreme Court reversed finding no substantial nexus or fair apportionment issues Where did sales to out-of-state customers occur? Does it matter? 26

27 Due Process Clause Corrigan (Ohio) Ohio law imposed income tax on capital gain realized by nonresident investor in a pass-through entity if the investor held 20% or greater interest in the entity, with the gain apportioned based on entity s factors Ohio Supreme Court held law violated Due Process Clause as applied to the nonresident owner because selling an ownership interest did not involve purposeful availment of the state s protections and benefits, even where the sold entity conducted business in Ohio 27

28 Royalty Addback Exception Kohl s (Virginia) Royalties paid to related members must be added back to a taxpayer s federal taxable income unless such payments are subject to a tax based on or measured by net income or capital Virginia trial court said that even where royalties are reported by related members to other states, royalty payments do not qualify for the addback exception unless those other states actually tax them 28

29 Questions? Jeffrey A. Friedman Sutherland Asbill & Brennan LLP Michele Borens Sutherland Asbill & Brennan LLP

30 Connect with us! Download the Sutherland SALT Shaker app today: Apple App Store Google Play Windows Phone Store Amazon Sutherland SALT Group This communication cannot be used for the purpose of avoiding any penalties that may be imposed under federal, state or local tax law. 30

State Income Tax Litigation You Need to Know About

Michele Borens, Partner Amy Nogid, Counsel TEI New York State and Local Tax Seminar November 9, 2016 State Income Tax Litigation You Need to Know About All Rights Reserved. This communication is for general