Industry Specific Nexus Issues

Transcription

1 Jeffrey A. Friedman Maria M. Todorova STARTUP Spring 2014 Conference May 15, 2014 Industry Specific Nexus Issues

2 Agenda Jurisdiction to Tax Recent Nexus Developments Industry-Specific Issues Characterization Considerations Flash Title & Inventory Book-Outs Trading Affiliates and Commodity Traders Telecommuting & Nexus Local Tax Nexus Impact of State Registration 2

3 Jurisdiction to Tax 3

4 Constitutional Limitations Due Process Clause Requires a definite link and minimum connection between a State and the person, property or transaction it seeks to tax. Income taxes must be rationally related to values connected with the taxing State. Commerce Clause Substantial nexus required to meet Commerce Clause nexus standard. 4

5 Federal Legislation Limitation P.L protects an out-of-state company from state income taxes if the company s only contact with a state is the mere solicitation of orders for sales of tangible personal property, which are approved and filled from a stock of goods located outside the state. Additional Considerations: Is the item sold tangible personal property? Are the in-state activities limited to mere solicitation? Are the in-state activities ancillary to solicitation? Are the in-state activities de minimis? Is the tax at issue an income tax? 5

6 Recent Nexus Developments 6

7 Income Tax Nexus Gore Enterprise Holdings, Inc. v. Comptroller of the Treasury, No. 36 (Md. Ct. App 2014). The Maryland Court of Appeals (state s highest court) held that out-of-state holding companies of an in-state parent were subject to corporate income tax in Maryland because the subsidiaries had no real economic substance as business entities separate from their parent. Rejected unitary nexus. Third-party transactions were window dressing. Application of in-state parent s apportionment formula and the denial of statute of limitations protection. 7

8 Economic Nexus L.L. Bean, Inc. v. Levin, No (Ohio Bd. Tax App. Mar. 7, 2014) The Ohio Board of Tax Appeals sustained the Department of Taxation s assessment of L.L. Bean for the commercial activity tax based on the statutory bright-line presence test (taxable gross receipts of at least five hundred thousand dollars), even though L.L. bean had no physical presence in Ohio. 8

9 Affiliate Nexus Harley-Davidson, Inc. v. Franchise Tax Bd., Dkt. No CU-MC-CTL (Cal. Super. Ct. May 1, 2013). The San Diego County Superior Court held that two bankruptcy remote special purpose entities (SPEs) created for the purpose of bundling and selling securitized loans had substantial nexus with California. 9

10 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) 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) 10

11 Characterization Considerations 11

12 Characterization Considerations What is electricity: service, intangible or tangible personal property? A handful of states have addressed the issue, but the majority are silent. Sales of electricity are entitled to P.L protection only if electricity is treated as tangible personal property. If options and other derivatives on power are treated as a service, then P.L does not apply. Sourcing If tangible personal property, then sourced on destination basis If other than tangible personal property, then sourced on COP or market basis. 12

13 Characterization Considerations (cont d) Some states treat electricity as tangible personal property Illinois: Exelon Corp. v. Dep t of Revenue, 917 N.E.2d 899 (Ill. 2009), cert. denied, 130 S. Ct (2010). Supreme Court of Illinois held that electricity constitutes tangible personal property. However, the Illinois legislature subsequently enacted legislation characterizing electricity as other than tangible personal property, thereby effectively overturning the Exelon court s decision. S.B. 256, 96th Gen. Assem. (Ill. 2009). 13

14 Characterization Considerations (cont d) Other states treat electricity as service or intangible California: In re PacificCorp, 2002 Cal. Tax LEXIS 469 (SBE Sept. 12, 2002) (Sale of electricity constitutes the sale of services). Massachusetts: EUA Ocean State Corp. v. Comm r of Revenue, Mass. App. Tax Bd., No. C (April 24, 2006) (Electricity is not tangible personal property and thus sales of electricity are sourced based on COP). North Carolina: Request for Private Letter Ruling, North Carolina Dep t of Revenue (Feb. 9, 2007) (Sales of electricity constitute sales of services). Oregon: Powerex v. Dep t of Revenue, TC 4800 (Or. Tax Ct., Sept. 17, 2012) (Sales of electricity are sales of other than tangible personal property for Oregon apportionment purposes). 14

15 Characterization Considerations (cont d) MTC takes the position that electricity should be treated as an intangible for purposes of the sales factor. FTA has taken the position that electricity is not tangible personal property. 15

16 P.L Considerations If electricity is treated as tangible personal property, sales of electricity qualify for P.L protection but only if: Out-of-state purchases: thus, if electricity is purchased and sold in the same state, P.L does not apply. The state tax applies to, or is measured by, net income: thus, states like Michigan, Texas, Washington and Ohio that impose a franchise tax on capital do not afford P.L protection. 16

17 Flash Title & Inventory Storage 17

18 Flash Title Flash Title transaction involves: An out-of-state seller holds legal title to a commodity within the stream of interstate commerce; The commodity is in the control of (typically) a third-party common carrier; and In the course of shipment, title is transferred, often by terms of a contract) to another party (typically an out-of-state buyer) in a state where neither the seller not the buyer has business operations (nexus). 18

19 Flash Title (cont d) Does Flash Title create physical nexus? Likely not under traditional nexus standards, because the putative seller and the end user of the commodity are both outside the state of title transfer. Does Flash Title create economic nexus? Arguably not because the putative taxpayer is likely not deemed to actively make a market in the state in which the title is deemed to have transferred 19

20 Flash Title (cont d) Koch Fuels, Inc. v. Oklahoma Tax Comm n, 862 P.2d 471 (Okla. 1993) (sales tax) The Oklahoma Supreme Court ruled that the imposition of sales tax on the sale of fuel oil that entered a pipeline in Oklahoma but was extracted from the pipeline in Nebraska was unconstitutional because it discriminated against interstate commerce. Koch Fuels, Inc. v. Clark, 676 A.2d 330 (R.I. 1996), cert. denied, 519 U.S. 930 (1996) (gross receipts tax) The Rhode Island Supreme Court found that an out-of-state fuel marketer that used common carrier to deliver fuel to Rhode Island customers had substantial nexus in the state for gross receipts tax purposes because title to the fuel did not pass until it reached the purchaser s flange inside the state, and the seller maintained possession of, and control over, the fuel until the delivery point. 20

21 Flash Title (cont d) Williams Cos., Inc. v. Dep t of Revenue, No. CT (Mont. State Tax App. Bd. Dec. 31, 1998) (corporation income tax). An out-of-state natural gas pipeline company had nexus with Montana for purposes of the corporation license (income) tax when it purchased gas from a Canadian company and immediately sold the gas at the international border, because the pipeline was deemed to have possession of the gas, whether that is for a nanosecond or some other period of time. Rev. Rul. No. URT (Ind. Dep t of Rev. Oct. 17, 2005) (gross utilities tax). A flash title of natural gas within Indiana created substantial nexus and thus subjected the taxpayer to the gross utilities tax. Although holding flash title to the natural gas was the taxpayer's only activity within the state, the Department reasoned that it constituted the "ownership of inventory" in the state, thereby establishing substantial nexus. 21

22 Flash Title (cont d) In re Wascana Energy Mktg. (U.S.), Inc., DTA No (N.Y. Div. of Tax App., A.L.J. Unit Aug. 8, 2002) (utility gross receipts tax). An out-of-state natural gas company did not have nexus with New York for purposes of the former utility gross receipts tax when it purchased and sold natural gas imported from Canada and title to the gas passed immediately after custody of the gas transferred from the Canadian Company into the U.S. 22 Letter Ruling 3885 (Mo. Dep t of Rev. May 17, 2007) (corporate income and franchise tax) An out-of-state retailer sold items to customers via a website, the only connection with the state being the momentary ownership of tangible personal property." The Department held that such a brief ownership of property within the state was not enough to truly establish property ownership for purposes of the corporate income and franchise tax because it would have violated the Commerce Clause, which requires substantial nexus, not a mere de minimis contact with the taxing state.

23 Inventory Storage In re Missouri Gas Energy, 234 P.3d 938 (Okla. 2008), cert. denied, 130 S.Ct (2010) (personal property tax). Oklahoma Supreme Court applied Complete Auto test and held that there is substantial nexus to tax natural gas in pipeline storage. Taxpayer had no office or other presence in Oklahoma other than this portion of natural gas allocated among all shippers on the pipeline. 23

24 Inventory Storage (cont d) Peoples Gas, Light, & Coke Co. v. Harrison Cent. Appraisal Dist., 270 S.W.3d 208 (Tex. Ct. App. 2008), cert. denied, 131 S.Ct (2011). Midland Cent. Appraisal Dist. v. BP Am. Prod. Co., 282 S.W.3d 215 (Tex. Ct. App. 2009), cert. denied, 131 S.Ct (2011). Texas Courts determined the natural gas was in transit in interstate commerce since FERC rules provide that pipeline storage is considered part of the transportation in interstate commerce. The Texas Courts also applied Complete Auto and held that there is not substantial nexus to tax natural gas in pipeline storage because the pipeline, rather than the taxpayer, controlled the location of the gas and therefore the connection to the taxpayer was too tenuous. 24

25 Book-Outs 25

26 Book-Outs Most commodities forward contracts are settled by virtue of book-outs, with the parties settling their respective obligations financially, as a matter of administrative convenience, without actual delivery of the underlying commodity. The parties book-out their delivery obligations with the party owing the greater purchase price liability making a cash payment to the other party. Does a book-out transaction constitute the sale of tangible personal property or an intangible transaction? 26

27 Book-Outs (cont d) Neste Oy Ltd. v. Dep t of Revenue & Taxation, La. BTA No (Feb. 22, 2006). The Louisiana Board of Tax Appeals ruled that taxpayer s forward contract transactions that the taxpayer closed by reselling its right to receive delivery of natural gas to another counterparty prior to the delivery date constitute intangible trading transactions. The company did not take possession or delivery of the natural gas within the pipeline, and it only bought and sold intangible contract rights. The Board of Tax Appeals found that these forward contracts had the same economic and tax consequences as financially settled transactions, which would be taxable only in the state where the company s trading employees executed such transactions. 27

28 Book-Outs (cont d) Texas Comptroller of Public Accounts, TR 1349 (STAR System T) (June 11, 1996); Texas Comptroller of Public Accounts Administrative Dec. No P (Feb. 14, 2003). Swap transactions and book-outs of transactions involving commodities are treated as financial transactions and as such are sales of intangibles for purposes of the former Texas corporation franchise tax. Thus, net gains from sales of investments and capital assets are sourced to the state where the payor is incorporated or organized Tax saving opportunity for power traders because it appears they can apportion income from forward contracts with non-texas parties outside of Texas, even if the forward contract specified a delivery point in Texas. 28

29 Trading Affiliates & Commodity Traders 29

30 Trading Affiliates In creating a special purpose energy trading affiliate, a utility should be careful to provide the necessary personnel and equipment to the subsidiary or affiliate and to observe corporate law formalities to defend against the state s assertion of attributional nexus over the energy trading affiliate. States will assert nexus over out-of-state businesses if an affiliated company present in the state is conducting activity on behalf of the out-of-state business or is not a separate legal entity for tax purposes. The mere presence of affiliated utility companies in the state should not establish nexus for power or gas trading companies as long as affiliated companies do not conduct activities on behalf of the trading company. 30

31 Commodity Traders Financial institutions or insurance companies entering the commodities trading business Does commodities trading create nexus? 31 Is the taxpayer treated as a public utility subject to public utilities taxes or bank/insurance company subject to taxes applicable to those entities? E.g., Electricity futures contracts that do not involve actual physical delivery constitute financial transactions taxable under the other services classification; Washington s exemption for sales of electricity for resale does not encompass trading in electricity futures contracts. Washington Tax Determination , 23 WTD 285 (1/16/2004).

32 Nexus & Telecommuting 32

33 Nexus & Telecommuting Telebright Corp. Inc. v. Director, Division of Taxation, Docket No. A T2 (N.J. Super. Ct. App. Div., March 2, 2012) An out-of state company had nexus with New Jersey for Corporation Business Tax purposes because it had one employee who worked out of her home in New Jersey The employee wrote computer software code that was incorporated into web-based products that the taxpayer sold on its website The New Jersey appellate court affirmed the trial court s decision 33

34 Local Tax Nexus 34

35 Local Tax Nexus Van Horn v. Alabama Dep t of Revenue, No. S (Alabama Dep t of Revenue, Admin. L. Div. Jan. 3, 2013). One sales transaction by one individual in the course of a year was not enough to establish local nexus. Local nexus regulation was amended effective January 1, 2014 to expand the local nexus standard. 35

36 Impact of State Registration Connecticut Kelly-Springfield Tire Company (1993) Qualification to do business in Connecticut did not remove P.L protection. Annual visits by credit managers were de minimis non-solicitation activities. Illinois Regulation A business that registers or otherwise formally qualifies to do business within Illinois does not lose its protection under P.L Massachusetts Regulations 830 CMR (4)(a) P.L immunity will be lost if taxpayer qualifies to do business in state. 36

37 Questions? Jeffrey A. Friedman Sutherland Asbill & Brennan Maria M. Todorova Sutherland Asbill & Brennan

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