State and Local Tax Update. Tuesday, November 28, 2017 Wichita Country Club Tim Hartley - Director

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1 State and Local Tax Update Tuesday, November 28, 2017 Wichita Country Club Tim Hartley - Director

2 Presenters Tim Hartley Director Tax Grant Thornton LLP. All rights reserved. 2

3 Learning Objectives Determine the state of the states by examining significant legislation and important court decisions on state tax issues impacting the business landscape Identify and discuss the recent trends, important court decisions and legislation in state and local tax Grant Thornton LLP. All rights reserved. 3

4 Agenda 1 Nexus 2 Unitary filings 3 Business / nonbusiness income 4 Apportionment 5 Other Developments Grant Thornton LLP. All rights reserved. 4

5 Nexus

6 California Swart Enterprises In Swart Enterprises, Inc. v. Franchise Tax Board, CA Court of Appeal held that an outof-state corporation was not "doing business" in the state if the corporation merely owns a passive interest in an LLC If a corporation's only connection to CA is a 0.2% ownership in a manager-managed CA LLC, the corporation is not subject to the $800 minimum franchise tax Corporation's interest in the LLC closely resembled a limited partnership interest because it had no ability to participate in the management and control of the LLC Because a partnership's business activities cannot be attributed to a limited partner, corporation could not be deemed to be doing business in CA solely by virtue of its ownership interest in the LLC FTB announced that it would not appeal case and it issued administrative guidance (FTB Notice ) Grant Thornton LLP. All rights reserved. 6

7 New Mexico Aventis Pharmaceuticals In Aventis Pharmaceuticals, Inc., NM Taxation and Revenue Department held that subsidiaries of a large multinational pharmaceutical company had nexus with NM because they had activities in the state beyond solicitation of sales and those activities increased their market and market potential in the state Along with the solicitation of sales, doctors were provided with ongoing education, clinical trials, textbooks, funding for training materials, and classes at the doctors' offices Grant Thornton LLP. All rights reserved. 7

8 Oregon Capital One Auto Finance In Capital One Auto Finance v. Department of Revenue, OR Tax Court held two out-ofstate financial institution corporations had substantial nexus with OR and were subject to either the corporate income tax or excise tax The financial institutions did not have a physical presence in OR, but purposely solicited OR customers, extended credit, loaned money, pursued collections and utilized the court system in OR Subjecting the financial institutions to taxation in OR did not violate the Commerce Clause Grant Thornton LLP. All rights reserved. 8

9 Unitary Filings

10 California ComCon Production Services In ComCon Production Services I, Inc. v. California Franchise Tax Board (unpublished opinion), CA Court of Appeal held that: Unitary relationship did not exist between Comcast and its majority-owned subsidiary, QVC, and $1.5 billion termination fee received by Comcast as result of failed merger with another cable system operator was business income subject to apportionment Comcast and QVC were not unitary because they were not vertically integrated, lacked centralized management, generated no economies of scale and produced no other flow of value As a result, they were not integrated with each other and neither company was dependent on or contributed to the other under legal standards for determining unitary business Merger termination fee satisfied transactional test for determining business income because Comcast had history of engaging in cable acquisitions Grant Thornton LLP. All rights reserved. 10

11 Iowa Myria Holdings In Myria Holdings Inc. v. Iowa Department of Revenue, IA Supreme Court rejected inclusion of parent company in consolidated return because parent did not have nexus with IA Owning and controlling subsidiaries and their activity does not establish nexus with IA Corporation is allowed to join in filing of consolidated return only if it has both taxable IA source income and taxable nexus in state Could this decision have been different if the LLCs involved were treated as flowthrough entities rather than corporations? Grant Thornton LLP. All rights reserved. 11

12 Massachusetts - TechTarget In TechTarget, Inc. v. Massachusetts Commissioner of Revenue, MA Appellate Tax Board held that a subsidiary that was not classified as a securities corporation was properly included in a combined reporting group Subsidiary was not entitled to classification as a securities corporation because it failed to file proper application Assessments of additional tax, based on determination that subsidiary did not qualify as securities corporation and that it should have been included in the combined group, were proper Grant Thornton LLP. All rights reserved. 12

13 Minnesota - Ashland In Ashland Inc. v. Commissioner of Revenue, MN Supreme Court held DOR had improperly adjusted a taxpayer's combined MN taxable income to exclude income and apportionment factors of a foreign subsidiary that had elected to be disregarded for federal income tax purposes State's income tax law could be reconciled with the taxpayer's federal election to disregard a foreign entity, resulting in inclusion of disregarded foreign entity in taxpayer's combined income tax report Because law has been amended, decision only applies to tax years prior to 2013 Grant Thornton LLP. All rights reserved. 13

14 Business / nonbusiness income

15 California Fidelity National In Fidelity National Information Services v. Franchise Tax Board (unpublished opinion), CA Court of Appeal held that trial court erred in ruling that taxpayer's capital gains from sale of its stock in a company in which it owned a 29% interest was business income Trial court failed to address taxpayer's argument that, even if the stock was an integral part of the taxpayer's business operations at one time, it was a nonbusiness investment long before it was sold Whether sale of stock was integral is different from whether stock itself was integral Grant Thornton LLP. All rights reserved. 15

16 New Jersey Xylem Dewatering Solutions In Xylem Dewatering Solutions, Inc. v. Director, Division of Taxation, NJ Tax Court held gains from deemed asset sale of S corporation under IRC Sec. 338(h)(10) was nonoperational income and therefore not subject to apportionment Because corporation was a NJ-based S corporation, entire gain was allocated to NJ on nonresident shareholders' gross income tax returns pursuant to NJ corporation business tax rules governing sourcing of non-operational income Grant Thornton LLP. All rights reserved. 16

17 New Mexico ConAgra Foods In ConAgra Foods Food Ingredients Co., NM Taxation and Revenue Department held interest income on taxpayer's payment-in-kind (PIK) notes following sale of business constituted nonbusiness income At the time that the taxpayer disposed of its grain elevator business, it fully apportioned and paid tax on the proceeds of that sale, including face value of PIK notes, to NM Taxpayer's subsequent interest income from PIK notes was nonbusiness income because the income did not meet transactional test, dispositional test, or functional test Because the taxpayer was not a unitary business with the entity that purchased the business and because the interest income on PIK notes was not integral to taxpayer's line of business, the income was not apportionable to NM consistent with Due Process and Commerce Clauses Grant Thornton LLP. All rights reserved. 17

18 Indiana E.I. DuPont De Nemours In E.I. DuPont De Nemours and Co. v. Indiana Department of State Revenue, IN Tax Court held DOR erred in reclassifying corporation's gain on 2001 sale of subsidiary from nonbusiness income to business income Transactional test Gain from sale did not constitute business income because sale did not occur in regular course of trade or business Functional test No evidence that taxpayer played a role in management of subsidiary Grant Thornton LLP. All rights reserved. 18

19 Apportionment

20 Oregon Market-based sourcing On July 3, 2017, OR enacted legislation adopting market-based sourcing, effective for tax years beginning on or after Jan. 1, 2018 Corporate income from sales of services and intangibles such as software will be subject to market-based sourcing Change does not apply to allocation of income for financial organizations, utilities and telecommunications taxpayers Grant Thornton LLP. All rights reserved. 20

21 Montana Market-based sourcing MT enacted legislation revising its Multistate Tax Compact provisions, as recommended by the Multistate Tax Commission, to adopt market-based sourcing for sales other than sales of TPP, change definitional terms for "business income" and "sales," and expand alternative apportionment provisions Applies to tax years beginning after Dec. 31, 2017 Grant Thornton LLP. All rights reserved. 21

22 California Chief Counsel Ruling Clarifies sourcing of sales from non-marketing services under market-based sourcing When taxpayer receives income from subcontracting services that its customers would otherwise be required to perform themselves for ultimate end-user customers, benefit is received by taxpayer's direct customer and not the ultimate customer Benefit received by direct customers is release of obligation to perform subcontracted services themselves for ultimate customers Grant Thornton LLP. All rights reserved. 22

23 Connecticut Special Notice 2017(1) CT Department of Revenue Services issued guidance on single-sales factor apportionment and market-based sourcing Under CT law enacted in 2016, gross receipts from services assignable to CT if, and to extent, market for services is in state Taxpayer's market for service is in CT to extent service is used at a location in state Gross receipts from rental, lease or license of intangible property are assigned to CT to extent property is used in state Special Notice includes guidance interpreting statutes, generally specifying that use occurs at location where taxpayer's customer either directly or indirectly receives value from service or intangible property Provides procedures and detailed examples illustrating how to source receipts from sales of services or intangible property using newly adopted sourcing methodology Must consider specific facts and circumstances of transaction Grant Thornton LLP. All rights reserved. 23

24 Massachusetts Genentech In Genentech, Inc. v. Commissioner of Revenue, MA Supreme Judicial Court rejected claim that single sales factor apportionment and credit regimes applicable to manufacturers violate Commerce Clause MA provides tax credits for manufacturing corporations that invest in specified tangible property or undertake R&D activity, but only if such investments or activities take place within MA Taxpayer argued that MA single sales factor coupled with availability of credits only for in-state activities, contravened dormant Commerce Clause s prohibition against states burdening or discriminating against flow of commerce across state lines Court rejected argument and noted that U.S. Supreme Court has repeatedly held that single-sales factor is presumptively valid Also, Court held that tax credits did not infringe on interstate commerce Grant Thornton LLP. All rights reserved. 24

25 Minnesota Associated Bank In Associated Bank, N.A., v. Commissioner of Revenue, MN Tax Court affirmed financial institution's apportionment planning by denying Commissioner's alternative method Allowed financial institution to treat captive partnerships as non-financial institutions for apportionment purposes for 2007 and 2008 tax years Commissioner did not meet burden of proof to apply alternative apportionment failed to show that standard apportionment formula did not fairly and correctly apportion taxpayer's income to MN Grant Thornton LLP. All rights reserved. 25

26 New Jersey Elan Pharmaceuticals In Elan Pharmaceuticals, Inc. v. Director, Division of Taxation, NJ Tax Court held certain receipts were not subject to exclusion under former throwout rule NJ Division of Taxation incorrectly removed from the sales factor denominator all of the receipts from states in which taxpayer did not file an income tax return Part of series of cases in which NJ courts prohibited Division from applying former throwout rule in unconstitutional manner Grant Thornton LLP. All rights reserved. 26

27 New York CheckFree In CheckFree Services Corp., NY administrative law judge (ALJ) determined taxpayer's receipts from electronic bill payment and presentment transactions constituted receipts derived from performance of services Highlights difficulties that arose under former NY law when trying to determine whether sales should be classified as services or other business receipts Provides interpretation of "services" that accounts for new and emerging technology used in today's markets Grant Thornton LLP. All rights reserved. 27

28 Oregon Apollo Education Group In Apollo Education Group, Inc. v. Department of Revenue, OR Tax Court applied broadened transactional approach, narrowed cost analysis to source receipts for online university For purposes of apportioning income from online courses under the cost of performance (COP) method, "income-producing activity" related to the provision of a course section to multiple students, rather than an individual transaction with each student Income-producing activity of providing course sections was composed of faculty, curriculum development, and software platform activities, but only the faculty costs were direct costs to be used in the COP calculation Application of transactional approach to sourcing income from online university may provide helpful guidance on a how a proper COP study should be constructed for many types of companies earning substantial service-based revenue Grant Thornton LLP. All rights reserved. 28

29 Virginia Corporate Executive Board In Corporate Executive Board v. Department of Taxation, Arlington County Circuit Court denied a taxpayer's appeal challenging the Department's statutory apportionment method and seeking use of alternative single sales factor formula using market-based sourcing Taxpayer asserted formula was unconstitutional and inequitable, but failed to meet its burden of proof Grant Thornton LLP. All rights reserved. 29

30 Wisconsin Microsoft In Microsoft Corp. v. Wisconsin Department of Revenue, WI Tax Appeals Commission held DOR could not assess additional taxes on royalty income received by Microsoft from licensing its software to out-of-state original equipment manufacturers (OEMs) that ultimately sold computers containing the software to WI purchasers Commission rejected DOR's argument that it must look-through the OEM purchasers to the end-users of the software to properly source the royalty receipts Limitation on applying look-through analysis potentially could apply to receipts from other forms of intangible property Grant Thornton LLP. All rights reserved. 30

31 Other Developments

32 Kansas 2017 Legislation SB 30 repealed effective for Tax Year 2017 the exemption on individual returns for nonwage business income in effect since Tax Year Allows 50% deduction for itemized deductions for medical expenses, mortgage interest and property taxes for 2018, 75% of these deductions for 2019 and 100% of deductions beginning in 2020 and thereafter. Individual income tax rates are increased beginning in Tax Year 2017 utilizing a threebracket system of 2.9%, 4.9% and 5.2%. For Tax Year 2018 and thereafter the rates are 3.1%, 5.25% and 5.7%. The formulaic provisions that could have provided for rate reductions in future years based on growth in certain general fund tax receipts has been repealed. Grant Thornton LLP. All rights reserved. 32

33 Missouri Tax Reform The Missouri governors Committee for Simple, Fair, and Low Taxes was formed to study tax reform in the state in general as well as make recommendations regarding existing tax incentive programs. The Committee issued its initial report on June 30, 2017 which focused primarily on Tax Credit Reform. For all tax credits it recommended much stronger claw back provisions as well as transparency of credit application process. Recommendation to establish a Tax Credit Stabilization Fund to pre-pay for new tax credit authorizations and cap annual spending credit/incentive progams Convert Low Income Housing Credit Program to low or no interest loan program. Consolidate Historic Preservation Credit and Brownfield Remediation Credit programs. In a recent article the chairman of the committee discussed the possibility of eliminating the corporate income tax and reducing the individual income tax by putting forth a gross receipts tax in Missouri. Grant Thornton LLP. All rights reserved. 33

34 State Issues - Federal Tax Reform Timing of effective date and potential impact on income tax accounting. States different conformity provisions to Internal Revenue Code. Significant revenue impacts could cause many states to de-couple from provisions such as full cost recovery/depreciation changes. Interest expense limitations and NOL changes to federal could create more complexity for states. There can already be significant differences in the state treatment of these items under current federal law. Grant Thornton LLP. All rights reserved. 34

35 Questions?

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