2018 Tax Executives Institute, Inc. Houston Texas May 11, 2018 ALL STATES UPDATE. Marilyn M. Wethekam (312)

Transcription

1 2018 Tax Executives Institute, Inc. Houston Texas May 11, 2018 ALL STATES UPDATE Marilyn M. Wethekam (312) Horwood Marcus & Berk Chartered 500 W. Madison Street, Suite 3700 Chicago, Illinois Tax Executives Institute, Inc.

2 Agenda What is the current state of nexus? Federal Tax Reform The Dividend Fallout Water s Edge and Other Combination Issues Addback Statutes Apportionment and Sourcing Issues 2

3 State of the State of the Saga of Nexus 3

4 South Dakota v. Wayfair, Inc. South Dakota SB 106 Eff. 5/1/ transactions or sales over $100k; it will not be applied retroactively. South Dakota Supreme Court held in favor of Wayfair, Inc. Argued April 17, 2018 at the U.S. Supreme Court, South Dakota, argued the Court should overturn and/or distinguish the 1992 decision of Quill Corp. v. North Dakota. Supreme Court s concerns: Retroactivity Cost of compliance Legislating from the bench concerns Will Congress act 4

5 Federal Tax Reform Dividends? 5

6 Dividends - What is discriminatory treatment? In the Matter of the Protest of General Electric Company & Subsidiaries, N.M. Admn. Hearings Office, D&0 No , April 6, The Hearing Officer denied General Electric's protest of corporate income tax assessment, finding that the denial of General Electric s deduction of dividends received from foreign subsidiaries did not violate the Foreign Commerce Clause. General Electric elected to be a consolidated group for New Mexico reporting purposes and had 419 foreign subsidiaries from which it received dividends. The Hearing Office found the taxation of the foreign dividends while excluding domestic dividends was not discriminatory because the consolidated group encompasses the total domestic income of the consolidated group including the income that was distributed in the form of dividends. Thus, the total domestic income is subject to tax just as the foreign dividend and Subpart F income is subject to tax. The penalties were abated. 6

7 Dividends What is discriminatory treatment? In the Matter of Costco Wholesale Corporation, Alaska Office of Admin. Hearings, No Tax, June 12, At issue was the deduction of dividends received from an affiliated domestic corporation that was not included in Costco s Alaska water s-edge combined return because it has 80% or more of its property and payroll outside the U.S. The statute provides for 100% deduction of dividends received from members of the unity group. The deduction is limited to 80% for dividends received from foreign affiliates excluded from the group.the statute does not address the treatment of dividends received from a domestic company that does not meet the 80% test. The ALJ concluded based on a review of legislative history that the 80% exclusion was to reflect the expense incurred by a domestic multinational parent to support the income producing activities of the foreign affiliate. In addition, there was no indication from the legislation that a domestic corporation that only had foreign income would be treated differently than a foreign corporation. Thus, there is equal treatment among domestic and foreign corporations not included in a combined return. 7

8 Water s-edge and Other Combination Issues 8

9 Water s-edge and other combination Issues Target Brand Inc. v. Department of Revenue (Denver Dist. Ct. No. 2015CVV33831, Jan. 27, 2017) The Colorado District Court recognized that a subsidiary of Target met the definition of an 80/20 company and thus, could not be included in the Target group but was liable for corporate income tax on a separate return basis. The taxation of the company was permissible because the company had substantial nexus through its instate-licensing activities despite the lack of an instate physical presence. The court rejected the alternative single sales factor apportionment method relied on the sales factor of its parent, Target concluding the Department s approach was neither reasonable nor equitable since it gave no consideration to Target Brand s activities that helped Target s sales in Colorado, and any alternative formula employed by the state must include Target Brand s payroll and property. 9

10 Water s-edge and other combination issues Oracle v. Dept. of Rev. (CO. Ct. of App. No. 16CA 1316, Nov. 30, 2017) The Appellate Court affirmed the District Court holding that Oracle was not required to include a domestic holding company that held the stock of a Japanese affiliate in its combined return as it qualified as an excluded 80/20 company and further could not tax the company on a separate basis. The Department s own regulation provides that a company that has no property or payroll cannot have more than 20% of its factors in the United States. Further, unlike the lower court the Appellate Court did not find the statute to the ambiguous. The court rejecting the Department s economic substance argument further concluded the Department did not have the authority to allocate the holding company s income among the members of the combined group. The company was formed pursuant to the terms of a note secured by Oracle from Nippon Steel and there is no evidence of abuse to support the transfer of income but rather the company was formed for a reasonable business purpose. 10

11 Water s-edge and other combination issues Agilent Technologies, Inc. v. Dept. of Rev. (CO App. Ct. No. 16CA0849, November 2, 2017) The Appellate Court held that a holding company that held the interest in 4 foreign entities which for federal tax purposes were characterized as flow through entities could not be included in the combined group. The court concluded the federal check the box rules cannot be used to validate the 80/20 rules because the federal rationale for the check the box rules is different than the rationale for the 80/20 rules. However, because the company had not property or payroll under the Colorado regulations it cannot have more than 20% of its factors assigned to the United States. 11

12 Addback Statutes 12

13 Addback Statutes Kohl s Department Stores, Inc. v. Virginia Department of Revenue (VA S.Ct No , March 22, 2018) In a 4-3 decision, the Virginia Supreme Court affirmed the Circuit Court s holding that only the portion of the royalties that are actually taxed by another state falls within the subject to tax exception. The Court acknowledged that the plain language of the statute is ambiguous looked to the legislative intent of the subject to tax exception. To prevent a conflict with the statute s purpose and intent, the Court held that the exception applies only to the extent the royalty payments were actually taxed by another state. 13

14 Addback Statutes The Court, upheld Kohl s alternative argument and held that the Department incorrectly calculated the amount of royalties that qualified for the subject to tax exception. The court rejected the Department s argument that the addback statute applies only to intangible expenses for the related member and one should look only to Kohl s Illinois s, and not Kohl s, tax returns. The court concluded the statute contained no such requirement. Thus, to the extent the royalties were actually taxed by separate return states or combined return states, they should qualify for the subject to tax exception. Note: Three justices dissented finding that the statute is not ambiguous and favored the taxpayer s application of the statute. The three justices resolved any ambiguity in the addback statute in favor of the taxpayer as they determined that the statute constituted an imposition statute. The dissenting justices found that a subsequent law change enacted by the Virginia legislature was evidence that the addback statute should be applied in a manner consistent with the taxpayer s proposed application 14

15 Addback Statutes Infosy s Limited of India Inc. v. Dir. Div. Of Taxation, NJ Tax Ct. Dkt. No , March 19, The New Jersey Tax Court held that Infosys net income for New Jersey purposes was equal to federal taxable income as shown on the federal return. The Tax Court rejected the Director s argument that even though line 29 of the Federal Form 1120 established the tax base there was authority to addback to taxable income any deduction or exemption allowed under foreign tax treaties. The basis for the argument was statutory language which allows the addback of specific exemption or credit allowed in any law of the United States. It was the Director s position that a treaty is the law of the United States and therefore the addback provision applies. The Tax Court found that a treaty is not a law of the United States but rather by definition an agreement between foreign governments. Treaties are governed by international law. The Tax Court held neither a treaty protection nor the Internal Revenue Code limitation on the scope of the taxation of foreign entities qualifies as a specific exemption or credit that is required to be added back to taxable income under New Jersey law. 15

16 Addback Statutes BMC Software, Inc. v. Dir., Div. of Taxation, 30 N.J.Tax 92 (N.J. Tax Court May 24, 2017) The New Jersey Tax Court found that a subsidiary s intangible expenses paid to its parent qualified for the state s unreasonable addback exception because the payments were substantively equivalent to an unrelated party transaction. The court held that: The unreasonable exception does not require showing that the relatedparty recipient paid Corporation Business Tax on the income. Showing that the related-party transaction was substantively equivalent to an unrelated third party transaction is sufficient evidence for the addback is unreasonable.

17 Apportionment and Sourcing Issues 17

18 Apportionment and Sourcing Issues The University of Phoenix v. IN Dept. of Revenue, IN Tax Ct. No. 49T TA November 30, 2017). The Tax Court addressed the issue of sourcing the University s online campus revenue. The question was should that revenue be sourced to Indiana based on the student s Indiana address or the location of its teachers. The Tax Court concluded the Department erroneously sourced the University s income based on the location of its market rather than using the cost of performance method set forth in the statute. In reaching its conclusion, the Tax Court applied the statutory cost of performance method and sourced the receipts to the location of the income producing activities. The court rejected the Department s argument that the only income producing activity was the opportunity to attend an online class which occurred in Indiana. Effectively, the court rejected the notion that income producing activity should be viewed from the student s prospective. 18

19 Apportionment and Sourcing Issues Honnigman Miller Schwartz & Cohn v. Detroit, MI Ct. Of App. No January 18, The Appellate Court held that for purposes of sourcing the income from legal services one must look to where the service is delivered not where the service is performed. In determining the firm s income sourced to Detroit a three factor formula consisting of property, payroll and sales is used. The sales factor is gross revenue derived from sales made and services rendered in Detroit. The issue relates to whether services rendered is where the clients receive the service or where the work is performed. The court analyzed the statutory language and concluded the term service rendered to mean where the service was received. If the services were received in Detroit the receipts were properly sourced to Detroit. In other words the sales factor adopts a destination approach for sourcing sales of services. 19

20 Apportionment and Sourcing Issues Rent-A-Center West Inc. v. S.C. Dep t of Revenue, No (S.C. Ct. App 2016) Question Presented: Does the statutory apportionment formula fairly represent the taxpayer s business activities in the state; and if not, was the state s alternative method reasonable? The South Carolina Court of Appeals held that the Department of Revenue did not meet its Carmax burden in proving the threshold issue of whether the statutory formula fairly represented the taxpayer s business activities in the state The court did not address (and did not have to address) whether the alternative method was reasonable or any constitutional violations by the Department s application of separate accounting to a unitary business 20

21 Apportionment and Sourcing Issues Corporate Executive Board v. Dep t of Taxation, No. CL (Va. Cir. Ct Sept. 1, 2017) The Virginia Circuit Court upheld the Department s use of the statutory COP method to apportion income from the sales of subscription-based services based on finding that COP method did not lead to inequitable results and was not unconstitutional. The court found that under the COP method, most of CEB s sales originated in Virginia and were attributable to the state. Taxpayer s request for alternative apportionment using market-based sourcing was characterized as arbitrary and CEB failed to show the statutory method lead to a grossly distorted result.

22 Questions? Thank you! m Marilyn M. Wethekam (312) mwethekam@saltlawyers.com Horwood Marcus & Berk Chartered 500 W. Madison Street, Suite 3700 Chicago, Illinois Tax Executives Institute, Inc.