State income and franchise tax

Transcription

1 Second quarter 2016 State income tax developments State income and franchise tax Quarterly update Key developments To our readers: The following provides a summary of the significant legislative, administrative and judicial actions that affected state and local income/franchise taxes during the second quarter of Connect with us Follow us on Twitter Page 2 Page 2 Page 3 Connecticut adopts market based sourcing North Carolina enacts law modifying corporate income tax provisions Internal Revenue Service s proposed IRC Section 385 debt-equity regulations have state income tax implications Other noteworthy developments Page 4 Page 5 Page 5 Page 6 Page 6 Page 7 Legislative developments in AL Legislative developments in AZ, FL, HI, KY, MS, NY, SC and VT Judicial developments in MA Judicial developments in NJ, NY and TX Administrative developments in AL and AR Administrative developments in HI, LA, NYC, SC, TX and VA Developments to watch Page 8 Appendix A Page 9 Page 10 Page 10 Page 10 Developments to watch in CA, CO, DC and TX Legislative developments in LA and NH Judicial developments in MI, MN, NJ and PA Administrative developments in AL and TX Developments to watch in NC and OR

2 Key developments Connecticut adopts market-based sourcing On 2 June 2016, Governor Dannel Malloy signed SB 502, the state s budget implementer bill (the Bill) that includes various tax law changes. The most notable tax law changes contained in the Bill are the establishment of market-based sourcing for sales of non-tangible property and services for corporate and individual income tax purposes and the use of single-sales factor apportionment for individual income tax purposes. Effective for tax years beginning on or after 1 January 2016, gross receipts, for corporate income tax purposes, are sourced as follows: Gross receipts from sales of tangible personal property are assignable to Connecticut if the property is delivered or shipped to a purchaser within the state (unless an election is made to be treated like a Domestic International Sales Corporation), regardless of the FOB point or other conditions of the sale. Gross receipts from services are assignable to Connecticut if the market for services is in Connecticut, which occurs if and to the extent the service is used in a location in Connecticut (note: this is a departure from the former origin-based sourcing method). Gross receipts from the rental, lease or license of real or tangible personal property are assignable to Connecticut to the extent the property is situated within Connecticut. Gross receipts from the rental, lease or license of intangible property are assignable to Connecticut if and to the extent the property is used in Connecticut. Gross receipts from interest managed or controlled within Connecticut are assignable to Connecticut. Gross receipts from the sale or other disposition of real property, tangible personal property or intangible property are excluded from the apportionment fraction calculation if the property is not held by the taxpayer primarily for sale to customers in the ordinary course of the taxpayer s trade or business. Gross receipts not specifically enumerated above are assignable to Connecticut to the extent the taxpayer s market for the sales is in the state. The market-based sourcing provisions for personal income tax purposes (including nonresident non-corporate pass-through entity owners) are similar but with some differences and applicable to income years beginning on or after 1 January Under both the corporate and personal income tax provisions, if a taxpayer cannot reasonably determine the assignment of its receipts in accordance with the new sourcing provisions, the taxpayer may petition the commissioner to use a methodology that reasonably approximates the assignment of the receipts. Effective for and applicable to income years beginning on and after 1 January 2017, the Bill implements single sales factor apportionment for personal income tax purposes. The portion of a nonresident partner s distributive share of partnership income, a nonresident shareholder s pro rata share of S corporation income, and a nonresident beneficiary s share of trust or estate income that is derived from or connected with sources within Connecticut is determined under the amended market-based sourcing provisions. Ernst & Young LLP s insights Connecticut s adoption of market-based sourcing was expected by many after the state adopted single-sales factor apportionment as part of the corporate tax reform effective for tax years beginning on or after 1 January The corporate and personal income tax sourcing provisions, which currently vary widely, will be uniform (although the implementation dates vary 2016 for corporations and 2017 for individuals). The personal income tax provisions in the Bill, which also apply to nonresident non-corporate passthrough entity owners, provide much-needed clarity around sourcing of receipts other than sales of tangible personal property, particularly as applied to Connecticut businesses. Corporate taxpayers will need to consider this change when calculating their estimated tax payments for the 2016 tax year and consider the impact of this change for financial accounting purposes. As with market based sourcing rules in other states, there will likely be some degree of ambiguity in determining the location of the market for certain services. North Carolina enacts law modifying corporate income tax and other tax provisions On 11 May 2016, North Carolina Governor Pat McCrory signed SB 729, provisions of which modify the corporate income tax, franchise tax, and sales tax. Key corporate and franchise tax law changes are discussed below. Royalty income reporting option: Pursuant to N.C.G.S. Section A, royalty payments between related members can be either (i) deducted by the payer and included in the income of the recipient, or (ii) added back to the income of the payer and excluded from the income of the recipient. 2 State income and franchise tax quarterly update

3 SB 729 adds a provision indicating that exercising the royalty reporting income option does not prevent the taxpayer from having nexus in the State nor does it permit the recipient of the income to exclude royalty payments from the calculation of the sales factor. Interest expense disallowance conduit exception: Under prior law, a deduction was allowed only for qualified interest expense paid or accrued to a related member for tax years beginning on or after 1 January Qualified interest expense was defined as the amount of net interest expense paid or accrued to a related member in a taxable year not to exceed 30% of the taxpayer s adjusted taxable income. As a result of SB 729, the deduction is now limited to the greater of (1) 15% of the taxpayer s adjusted taxable income, or (2) the taxpayer s proportionate share of interest paid or accrued to a non-related person during the same taxable year. SB 729 defines proportionate share of interest as the amount of a taxpayer s net interest expense paid or accrued directly to or through a related member to an ultimate payer divided by the total net interest expense of all related members that is paid or accrued directly to or through a related member to the same ultimate payer, multiplied by the interest paid or accrued to a person that is not a related member by the ultimate payer. The term ultimate payer is defined as a related member that receives or accrues interest from related members directly or through a related member and pays or accrues interest to a person that is not a related member. SB 729 also modifies one of the exceptions to the limitation on the deduction of interest expense paid or accrued to a related member the related member pays a net income tax or gross receipts tax to another state with respect to the interest income by indicating that the limitation does not apply if another state imposes an income tax or gross receipts tax on the interest income of the related member. Additionally, amounts eliminated by combined or consolidated return requirements do not qualify as interest that is subject to tax. Sales factor receipts: For taxable years beginning on or after 1 January 2016, the definition of sales has been updated to exclude the following: receipts from financial swaps and other similar financial derivatives that represent the notional principal amount that generates the cash flow traded in the swap agreement, and receipts in the nature of dividends excluded for federal tax purposes and North Carolina corporate income tax purposes. Apportionment factor of a qualified air freight forwarder: For taxable years beginning on or after 1 January 2016, a qualified air freight forwarder is required to use the revenue ton mile fraction of its affiliated air carrier to determine income apportioned to North Carolina. Franchise tax: SB 729 provides that the effective date of changes to the corporate franchise tax base enacted through HB 97 is for taxable years beginning on or after 1 January 2017, and will apply to the franchise tax calculation reported on the taxpayer s 2016 and later year income tax returns. Previously, the changes were effective on, and for taxes due on or after, 1 January Ernst & Young LLP s insights SB 729 affects various corporate income and franchise tax provisions. Of significance to corporate income taxpayers, it reduces the deductible interest expense limitation from 30% to 15% but provides an exception if the interest expense can be traced to an unrelated party. The reduction in the percentage limitation may reduce deductions for some corporations, while the new conduit exception may increase deductions for other taxpayers. Taxpayers with intercompany interest expense deductions should review these changes in conjunction with N.C. Gen. Stat. Section B to evaluate the potential implications. Additionally, taxpayers with intercompany royalty payments should evaluate whether and how they exercise the royalty reporting option provided under N.C. Gen. Stat. Section A to ensure proper compliance with SB 729. Taxpayers should consider potential implications on prior year returns as well as current and future filings. Internal Revenue Service s proposed IRC Section 385 debt-equity regulations have state income tax implications On 4 April 2016, as part of a broader package of regulations targeting corporate inversion transactions in the international tax arena, including the practice of earnings stripping, the Treasury Department and the Internal Revenue Service (IRS) released proposed regulations (REG ) under IRC Section 385 (the Proposed Regulations). The Proposed Regulations would establish rules treating certain related-party interests in a corporation as stock, in whole or in part, rather than debt, and they would have three major effects, if finalized in their current form: 3 State income and franchise tax quarterly update

4 Create a general operating rule under which the IRS (but not taxpayers) may treat certain related-party debt instruments partially as debt and partially as stock, based on the substance of those instruments under general federal tax principles (Prop. Treas. Reg. Section ). Certain related-party debt instruments will automatically be recharacterized as stock unless specific contemporaneous documentation and information requirements are met (Prop. Treas. Reg. Section ). Certain related-party debt instruments will automatically be treated as stock if issued as part of specific relatedparty transactions (Tainted Transactions) or if an entity borrows from a related party 36 months before or after engaging in a Tainted Transaction (Prop. Treas. Reg. Sections and -4). A critical exception to the application of these rules, however, is that the Proposed Regulations would not apply to relatedparty debt when the parties are members of the same federal consolidated group, since the corresponding interest income and interest expense offset in the consolidated federal income tax return (Prop. Treas. Reg. Section (e)). This is known as the consolidated group exception or the single entity rule. Not only do the Proposed Regulations signal a significant change in federal tax policy, they also would affect the realm of state income tax because they affect the determination of the tax base. For instance, if the states follow the Proposed Regulations but do not conform to the consolidated group exception, or if they attempt to independently police or apply the Proposed Regulations, it could create significant crossequity ownership issues within a federal consolidated group and possibly dilute stock ownership in some members below the 80% threshold for state income tax purposes, thus creating nonconformity problems in M&A transactions, subsidiary liquidations, distributions (including ineligibility for state dividends received deductions) and internal reorganizations. A disregarded limited liability company for federal tax purposes with deemed cross-equity ownership that could technically be a partnership solely for state income tax purposes, might also be ineligible for entity classification elections. In addition, certain intercompany interest deductions could be disallowed even if they might otherwise qualify for an exception from a state s related-party interest expense addback statute, among other implications and unintended consequences. Ernst & Young LLP s insights If the states directly or indirectly conform to the Proposed Regulations, it is unclear whether all or most states must also conform to the consolidated group exception under Prop. Treas. Reg. Section (e). In addition, there is a risk that some states may attempt to independently police or apply the Proposed Regulations. As a result of such uncertainty, and in an effort to minimize state tax risk, taxpayers might want to consider: (1) meeting the documentation and information requirements under Prop. Treas. Reg. Section as a leading practice for debt instruments between members of the consolidated group even if they are not required to for federal tax purposes; (2) avoiding future domestic transactions that would risk being classified as Tainted Transactions under Prop. Treas. Reg. Section and -4 if they applied; (3) making more domestic entities co-obligated on third-party debt in an effort to reduce reliance on intercompany debt in the future; and (4) cleaning up intercompany accounts since there is a risk of these balances being recharacterized as equity, which poses significant cross-ownership concerns. Treasury Department and IRS officials have publicly indicated that the Proposed Regulations could be finalized as early as Labor Day 2016 (or thereabouts). Consequently, it is important for taxpayers to understand the Proposed Regulations and quickly consider their possible state income tax implications. Other noteworthy developments Legislative Alabama: Legislation (HB 451) enacted 10 May 2016 eliminates, for the purposes of the financial institution excise tax, the requirement that Alabama s allocation and apportionment formula prescribed by the Alabama Department of Revenue for financial institutions be substantially the same as the allocation and apportionment formula recommended by the Multistate Tax Commission (MTC). This change took effect upon becoming law. HB 400, enacted 10 May 2016, provides that any law enacting or amending tax credits allowed to a financial institution that becomes effective on or after 1 January 2016, can be applied only to the state portion of the taxpayer s financial institution excise tax liability and cannot be used to offset or reduce the financial institution excise tax paid to municipalities and counties. The new law does not amend, repeal or supersede any financial institution excise tax credit in effect on 31 December State income and franchise tax quarterly update

5 Arizona: Legislation (SB 1288) enacted 11 May 2016 updates the state s date of conformity to the Internal Revenue Code (IRC) to the IRC as amended and in effect on 1 January This update includes the provisions that became effective during 2015 with the specific adoption of all federal retroactive effective dates, but excluding any change to the IRC enacted after 1 January HB 2708, enacted 10 May 2016, requires the Director of the Arizona Department of Revenue (AZDOR) to establish a tax recovery program that will run 1 September 2016 through 31 October The recovery program applies to taxes and surcharges administered or collected by the AZDOR. For taxpayers filing annually, the recovery program applies to any tax period ending before 1 January 2014, and for all other taxpayers it applies to any taxable period ending before 1 February For taxpayers participating in and complying with the terms of the recovery program, the AZDOR will abate or waive all civil penalties and interest without the taxpayer having to show reasonable cause or absence of willful neglect. Certain taxpayers are not eligible to participate in the recovery program. Florida: Legislation (HB 7099) enacted 13 April 2016 updates the state s date of conformity to the IRC to the IRC of 1986, as amended and in effect on 1 January Florida continues to decouple from bonus depreciation provisions for property placed into service after 31 December 2007 and before 1 January 2021, but adopts the permanent increase expensing limitation. Hawaii: SB 2921, enacted 29 April 2016, updates the state s conformity to the IRC to 31 December 2015, applicable to taxable years beginning after Kentucky: HB 80, enacted 27 April 2016, updates Kentucky s date of conformity to the IRC to 31 December 2015 (from 31 December 2013). Mississippi: Legislation (SB 2858) enacted 13 May 2016 phases out the Mississippi Franchise Tax and reduces the income tax rates for individuals, corporations, trusts and estates. Specifically, SB 2858 will phase out the Mississippi Franchise Tax over 10 years starting in Currently, the tax applies to corporations and is imposed at a rate of $2.50 for each $1,000 of the value of a corporation s capital used, invested or employed within Mississippi. In 2018, the franchise tax rate will be reduced by $0.25 per year until it is eliminated for tax years after Provisions of SB 2858 also will exempt, starting in 2018, the first $100,000 of the value of capital used, invested or employed in Mississippi from the franchise tax. SB 2858 also reduces the income tax rates applicable to individuals, corporations, trusts and estates. Under current law, the first $5,000 of taxable income is taxed at 3%, the next $5,000 of taxable income is taxed at 4%, and all taxable income over $10,000 is taxed at 5%. SB 2858 gradually reduces income tax rates between 2018 and 2022 to 0% on the first $5,000 of income, to 4% on income greater than $5,000 and up to $10,000, and to 5% on all income in excess of $10,000. New York: On 13 April 2016, the New York Governor Andrew Cuomo signed the fiscal year budget, A9009 C/ S6409 C (Final Bill), which provides technical amendments to New York State and New York City corporate tax reform as previously enacted in 2014 and For New York State and City corporate tax purposes, the technical amendments modify the definition of qualified financial instrument and amend various special bank subtractions. In addition, the New York State corporate tax amendments allow taxpayers to elect to treat the unused portion of special additional mortgage recording tax credits as an overpayment of tax to be credited or refunded rather than carried forward. Other technical amendments to the New York City corporate tax provisions include an amendment to the calculation of the unincorporated business tax credit. The Final Bill also extends the tax shelter reporting requirements through 1 July 2019, conforms New York State and New York City filing deadlines to the new federal tax filing dates, and generally looks to the second preceding year s tax to determine the amount of the mandatory first installment. South Carolina: HB 4328, enacted 21 April 2016, updates South Carolina s IRC conformity date to the IRC as amended through 31 December 2015, and includes the effective date provisions contained in it. In addition, if IRC sections adopted by South Carolina expired on 31 December 2015 are extended, but otherwise not amended, by congressional enactment during 2016, these sections or portions thereof also are extended for South Carolina income tax purposes in the same manner as they are extended for federal income tax purposes. Vermont: HB 873, enacted 25 May 2016, updates the state s adoption of federal income tax statutes to the law in effect for taxable year This change is effective retroactively to 1 January Judicial Massachusetts: The Massachusetts Supreme Judicial Court (MSJC) affirmed the Appellate Tax Board ruling in National Grid Holdings and held that a multinational electricity and gas utility company s deferred subscription arrangements (DSAs) did not qualify as bona fide debt for Massachusetts tax purposes because the DSAs did not require payments to satisfy 5 State income and franchise tax quarterly update

6 the obligations. 1 As a result, the company could neither deduct the interest expense component of its payments pursuant to the DSAs in determining its taxable net income nor deduct as liabilities the book value of the DSAs in determining its taxable net worth. In a separate decision, the MSJC further held that the company s closing agreement with the IRS, which allowed a federal deduction for a portion of the amount claimed by the company as interest on DSAs, is not binding on the revenue commissioner as to the deductions allowed for Massachusetts corporate excise tax purposes. In reaching this conclusion, the MSJC agreed with the tax commissioner s argument that since Massachusetts deductions are determined by reference to the IRC, the closing agreement by permitting only a portion of the claimed federal interest deductions for the DSA payments (and not all), did not establish that the DSA payments qualified as interest. 2 New Jersey: The New Jersey Tax Court (Court) held that a multistate corporate subsidiary was not entitled to deduct from its New Jersey taxable income interest payments it made to its parent and instead was required to add it back, because it failed to prove by clear and convincing evidence that inclusion of such income would be unreasonable. In reaching this conclusion, the Court found that the Director of the New Jersey Division of Taxation (Director) did not abuse his discretion by determining that the subsidiary failed to satisfy this burden. 3 New York: In the Matter of the Petition of TD Holdings II, Inc., 4 the New York Tax Appeals Tribunal (the Tribunal), reversed a determination of an administrative law judge and held that a bank should reduce its 2006 entire net income because its New York net operating loss deduction was not limited by the measure of franchise tax liability on an alternative non-income base. Texas: In Hallmark Marketing, 5 the Texas Supreme Court (TX Court) reversed the lower courts and held that net losses from the sale of investments and capital assets are not includable in the gross receipts apportionment factor denominator of the taxpayer s Texas franchise tax (i.e., margin tax) because the applicable Texas statute provides that only net gains from such sales can be included. In reaching its conclusion, the TX Court found that a conflicting administrative rule requiring businesses to include net gain or net loss in the apportionment factor denominator conflicted with the plain language of the Texas Tax Code and required no deference. Administrative Alabama: The Alabama Department of Revenue (ALDOR) will conduct a two-month tax amnesty program from 30 June 2016 to 30 August Amnesty applies to taxes due before 1 January 2015 or taxes for taxable periods that began prior to 1 January In exchange for participating in, and fully complying with the terms of, the amnesty program, the ALDOR will apply a three-year look-back period (i.e., the last three full years of delinquent returns) and waive penalties and one-half of interest. Taxpayers eligible to participate in the program include those who have not been contacted by the ALDOR regarding the tax types included in the amnesty application within the last five years. Taxpayers that participate in but fail to fully comply with the terms of the amnesty program may be subject to a negligence penalty. Arkansas: In Administrative Hearing Decision Nos and (27 May 2016), the Office of Hearings and Appeals of the Arkansas Department of Finance and Administration (Department) upheld the Department s denial of a corporate income tax refund claim based on amended returns using the standard apportionment formula for sourcing receipts from services. The taxpayer filed its 2009 and 2011 Arkansas corporate income tax returns using marketbased sourcing (based on customer location) related to its sales of management services. In reviewing its tax returns, the taxpayer concluded that it had erroneously filed the 2009 and 2011 returns, since it did not use the prescribed apportionment method (e.g., cost-of-performance method), nor did it request a deviation as required by law. The taxpayer then filed amended 2009 and 2011 returns based on the standard apportionment formula, which resulted in a claim for refund. The Department denied the refund claim, finding that the taxpayer s proposed change in the sales factor did not fairly reflect its Arkansas business activity and that the marketbased methodology used on the original filings effectuated a more equitable apportionment method. In the Department s view, sourcing based on customer location provided a known quantity of the actual revenue received from Arkansas sources versus the apportionment of those services based on a somewhat attenuated segment of the taxpayer s business (i.e., sale of goods). On appeal, the hearing officer determined that the Department did not abuse its discretion in denying the refund claim as the cost-of-performance method, though otherwise prescribed by Arkansas law, did not fairly reflect the taxpayer s Arkansas activity and the market-based methodology used on the originally filed returns fairly reflected that activity. 6 State income and franchise tax quarterly update

7 Hawaii: Amended administrative rule (Admin. Rules , , and ) on alternative apportionment lists alternative methods of apportionment and provides examples of when it would be sufficient for the Hawaii Department of Taxation to impose an alternative apportionment method. The amended rules were adopted 2 April Louisiana: In Revenue Information Bulletin No (8 April 2016), the Louisiana Department of Revenue (LADOR) issued guidance on recent legislative clarification to limitations placed on net operating loss (NOL) deductions enacted in Act 6 (2016) provides that the deduction for NOLs is equal to 72% of the NOL carried over to such taxable year, but never more than 72% of Louisiana net income for the taxable year. Thus, if after reducing the NOL carried forward to a given taxable year by 28%, the taxpayer will be limited to claiming a NOL equal to 72% of Louisiana net income for the taxable year. Excess amounts can be carried forward for up to 20 years. Act 6 took effect 1 January 2016 and applies to any and all returns filed on or after 1 July 2015, regardless of the taxable year to which the return relates. New York City: A federal savings and loan association and its affiliates were not required to include an out-of-state wholly owned passive investment company subsidiary that held its non-new York mortgages in their combined New York City bank tax return because the subsidiary was not a sham corporation, as it had economic substance and the intercompany transactions were at arm s-length. 6 South Carolina: In Dish DBS Corporation, 7 a South Carolina Administrative Law Judge (ALJ) held that South Carolina is not a cost-of-performance state or a market-based sourcing state. Instead, South Carolina statutes provide an apportionment standard based on where the income-producing activity takes place. South Carolina s apportionment statute states that receipts from the sale of services are sourced to South Carolina if the income-producing activity is performed in South Carolina. If the income-producing activity is performed partly within and partly outside South Carolina, sales are attributable to South Carolina to the extent the income-producing activity is performed within South Carolina. The ALJ noted two distinct differences between the method described by South Carolina statute and the cost-of-performance method provided in Section 17 of the Uniform Division of Income for Tax Purposes Act (UDITPA). First, South Carolina chose not to include the phrase cost of performance in its statute. Second, the statute does not include language indicating that the sourcing of receipts to South Carolina is determined on an all-or-nothing basis as it appears to be in UDITPA, in which revenues from sales of other than tangible personal property are sourced solely to the state in which the greatest proportion of the income-producing activity is performed. As such, the ALJ concluded that South Carolina is not a strict cost-ofperformance state. Additionally, the South Carolina statute does not reference a proxy (e.g., costs of performance) to measure the income-producing activity. Therefore, the ALJ further concluded that South Carolina is not a pro rata cost-ofperformance state. The ALJ also found that South Carolina is not a market share or audience state. Instead, the South Carolina statute focuses solely on the extent to which the income-producing activity is performed in South Carolina. The ALJ ultimately agreed with the Department s position that the income-producing activity is the delivery of a signal into the customer s home and onto the customer s television. The ALJ noted that preparatory activities identified by the digital television service provider contribute to the delivery of its signal to subscribers, but they are not activities that customers would pay for separately without access to the service provider s programming on their television sets. Because the South Carolina subscription receipts are directly tied to the income-producing activity and most accurately reflect the service provider s proportion of business carried on within South Carolina, all of the income-producing activity the delivery of the service provider s signal into South Carolina subscribers homes and onto their television sets occurs within South Carolina. Therefore, 100% of the service provider s South Carolina subscription receipts are sourced to South Carolina. Texas: In Letter Ruling No L (21 April 2016), the Texas Comptroller of Public Accounts (Comptroller) concluded that a Texas-based national radio network may determine Texas receipts from national advertising revenue based on the ratio of licensee radio stations in Texas to total licensee radio stations. In Letter Ruling No L (12 April 2016), the Comptroller determined that an Arizona transportation management company that has employees and independent contractors in Texas, primarily engaged in solicitation activities but who spend 5% of their time providing customer support services, does not provide revenue-generating services and, therefore, no portion of the commissions it earns from providing these services is apportioned to Texas. Virginia: In Ruling of the Tax Commissioner No (11 April 2016), the Virginia Tax Commissioner found that royalties paid as part of a joint venture s distributive share to a participating out-of-state corporation qualified for the foreign 7 State income and franchise tax quarterly update

8 source income subtraction because the royalties were received for the use of intellectual property by foreign business entities operating overseas and were properly excluded from the taxpayer s sales factor denominator. Generally, royalty income from licensing intellectual property is included in the sales factor, but Virginia law permits the taxpayer to subtract foreign source income (which includes royalties such as those here) from federal taxable income (FTI) to the extent it is included and not otherwise subtracted from FTI. Developments to watch California: The taxpayers have appealed to the US Supreme Court to review the California Supreme Court s ruling in Gillette, 8 in which it held that corporate taxpayers cannot elect to use the equally weighted three-factor apportionment formula under the Multistate Tax Compact (Compact) for reporting income to California in lieu of the statutorily mandated formula (e.g., double-weighted sales or single sales factor formulae). In reaching this conclusion, the California Supreme Court agreed with the Franchise Tax Board that the Legislature s enactment of a new apportionment formula controls, and that the state is not bound by the Compact election. Colorado: A multistate company is challenging the determination of the Colorado Department of Revenue that it was not allowed make an election to use the Multistate Tax Compact s equally weighted three-factor apportionment formula instead of the state mandated single sales factor apportionment formula, for the tax year ending 31 December District of Columbia: The proposed Fiscal Year 2017 budget bill (B ) would delay for a five-year period (from 2016 to 2021) the ability to take the FAS 109 deduction related to the enactment of combined reporting. Texas: The Texas Comptroller of Public Accounts (Comptroller) has issued proposed amendments to 34 Tex. Admin. Code Section regarding franchise tax reports and payments, defining previously undefined terms and implementing various laws enacted in 2011, 2013 and Among the provisions in the draft are new definitions (including a new definition of primarily engaged in retail or wholesale trade ), franchise tax and information reports due dates, franchise tax calculations, taxability thresholds, electronic filing requirements, and discounts, among others. As currently drafted, the new definition of primarily engaged in retail or wholesale trade would in effect retroactively limit certain taxpayers ability to qualify for the reduced franchise tax rate. 8 State income and franchise tax quarterly update

9 Appendix A The following provides a summary of the significant legislative, administrative and judicial actions that affected state and local income/franchise taxes during the period from 16 June 2016 through 30 June Legislative Louisiana: On 28 June 2016, Louisiana Governor John Bel Edwards signed a number of bills that impact the state s corporate income tax. Effective for taxable years beginning on or after 1 January 2016, HB 20 requires all taxpayers, other than those in the oil and gas exploration and production industry, to use a single sales factor apportionment formula. The apportionment formula for the oil and gas exploration and production industry has been changed from a three-factor formula using equally weighted sales, property and payroll factors, to a four-factor formula using a double-weighted sales factor. In addition, provisions of HB 20 adopt marketbased sourcing for sales of non-tangible personal property and services and provide new apportionable sourcing rules for leases and sales of intangible property, providing specific examples of how to source these items. If the sourcing methodology specified for sourcing services does not clearly reflect the taxpayer s market in Louisiana, the taxpayer may use, or the Louisiana Department of Revenue may require, other criteria and methodologies that will reasonably approximate the taxpayer s market in the state. Lastly, HB 20 adopts a sales factor throw-out rule for sales to states in which the taxpayer is not taxable or if the sale s state of assignment cannot be determined. Effective for any return filed on or after 1 July 2016, SB 6 changes the refundable treatment of inventory tax credits. SB 6 creates three categories of taxpayers based on the amount of credits claimed and requires that all taxpayers included in one consolidated federal income tax return be treated as a single taxpayer for purposes of determining the inventory tax credit limitation. These taxpayer categories are as follows: Taxpayers with eligible credit of zero to $500,000 will be refunded the entire amount of the excess credit. Taxpayers with eligible credit more than $500,000 but less than or equal to $1,000,000 will be refunded 75% of the excess credit and the remaining 25% will be carried forward for five years. Taxpayers with eligible credit of more than $1,000,000 will be refunded 75% of the first $1,000,000 of excess credit and the remaining amount of the credit will be carried forward for five years. SB 6 allows a taxpayer to claim the credit on its separately filed income or corporate franchise tax return; however, SB 6 limits the application of the refundability by treating all taxpayers included in one consolidated federal income tax return as a single taxpayer when determining the credit limitation. SB 10 prohibits certain manufacturers and all related parties, affiliates, subsidiaries, parent companies or owners of such manufacturers that claim the industrial property tax exemption from claiming a refund of the inventory tax credit in the same year. This change applies to claims filed for these credits on any return filed on or after 1 July 2016, regardless of the date of the taxpayer year to which the return relates. HB 25 reduces the amount of the Louisiana Citizens Property Insurance Corporation Assessment income tax credit from 72% to 25% of the amount of the surcharges, market equalization charges or assessments paid. In addition, HB 25 repeals the sunset of the reductions, rendering the reductions permanent. The change applies to all credits claimed on any return filed for any taxable year beginning on or after 1 January HB 47 (enacted 22 June 2016) addresses prior Net Operating Loss (NOL) changes by clarifying that application of the present law will not apply to an amended return filed on or after 1 July 2015 if the claim refers to a NOL deduction properly claimed on an original return filed prior to 1 July New Hampshire: On 21 June 2016, New Hampshire Governor Maggie Hassan signed two bills (SB 342 and SB 239) that modify the New Hampshire Business Profits Tax. SB 342 limits the inclusion in the business profits tax of the net increase due to certain sales or exchanges of an interest or beneficial interest in a business organization. Specifically, where an ownership interest in a business organization is sold or exchanged and the transaction results in an increase in the basis of the assets for federal income tax purposes, the business organization must: (1) add to the gross business profits of the business organization an amount equal to the annual depreciation or amortization attributable to the increase in the basis of the assets recognized by the parties to the transaction for federal income tax purposes; and (2) calculate the gain or loss on the sale or other disposition of an asset without regard to the basis increase recognized by any party to the transaction for federal income tax purpose, from the sale or exchange of the ownership interest in the business organization. A business organization can make an irrevocable election to recognize the basis increase of the asset. This change is effective for sales and exchanges of interests in 9 State income and franchise tax quarterly update

10 business organizations occurring on and after 1 January SB 239 updates New Hampshire s date of conformity to the IRC, to the IRC of 1986 in effect on 31 December 2015 (from 31 December 2000), applicable for all taxable periods beginning on or after 1 January Under the new law, however, New Hampshire decouples from various IRC provisions, including: (1) bonus depreciation under IRC Section 168(k), (2) the production deduction under IRC Section 199, and (3) the deduction for certain film and television productions under IRC Section 181. In addition, New Hampshire modifies its conformity to the increased expense deduction under IRC Section 179, by capping the deduction at $100,000 (from $25,000) for property placed in service on or after 1 January On the other hand, the update of the IRC conformity date (the first in more than 16 years) means that New Hampshire s business profits tax law is no longer inconsistent with the holding company/subsidiary five-year trade or business attribution rule under IRC Section 355(b)(3). Judicial Michigan: The Michigan Supreme Court denied the applications by a group of taxpayers for leave to appeal the decision by the Michigan Court of Appeals upholding the 2014 retroactive repeal by the Michigan Legislature of the Multistate Tax Compact (Compact) under 2014 PA Minnesota: In Kimberly-Clark Corporation & Subsidiaries, 11 the Minnesota Supreme Court upheld the tax court s ruling that the Legislature s repeal of the Multistate Tax Compact s (Compact) apportionment election provision and apportionment formula (Articles III and IV of the Compact, respectively) is constitutional. As such, Kimberly-Clark is not entitled to a refund of corporate income tax based on the use of the Compact s equally weighted three-factor apportionment formula, rather than the state s standard formula, which in this case resulted in a more heavily weighted sales factor formula. New Jersey: The New Jersey Supreme Court will not review the appellate court s affirmation of the tax court s ruling in Lorillard Licensing Co., regarding the appropriate standard the New Jersey Division of Taxation (Division) must use when applying the since-repealed throw-out rule in determining a multistate company s receipts for corporate business tax apportionment purposes. 12 Pennsylvania: In RB Alden Corp. 13 the Pennsylvania Commonwealth Court (court) held that Pennsylvania's $2 million statutory cap on net loss carryforwards (NLCs) in place for tax year 2006 is unconstitutional in violation of the Pennsylvania Constitution's Uniformity Clause. In 2015, the court similarly ruled in Nextel 14 that the $3 million statutory cap on NLCs in place for tax year 2007 violated the Pennsylvania Constitution's Uniformity Clause. Administrative Alabama: The Alabama Department of Revenue (AL DOR) repealed rules related to the Compact apportionment provisions (Rules ; -.02; -.09 through -.19) and adopted renumbered rules, with some amendments (Rules ; -.02; -.09 through -.19). 15 Among the amendments are: (1) a new requirement that taxpayers obtain preapproval from the Department before using an alternative allocation or apportionment method; (2) new definitions of business activity and gross receipts; (3) inclusion in the property factor of intangible drilling and development costs whether or not they have been expensed for either federal or state tax purposes; and provisions regarding when to include in the payroll factor compensation paid to leased employees and temporary employees for personal services. These changes take effect 25 June Texas: In Memo L (issued 30 June 2016), the Texas Comptroller of Public Accounts (Comptroller) revised its policy regarding payments eligible for exclusion under Tex. Tax Code Section (g) and qualifying activities for the cost of goods sold (COGS) deduction under Tex. Tax Code Section (i) in light of the Texas Court of Appeals ruling in Titan Transp., 16 overturning the Comptroller s prior policy. Under the revised policy, the Comptroller s office stated that among other things, it was expanding the interpretation of what is considered to be furnishing labor or materials to a project for the construction, improvement, remodeling, repair or industrial maintenance of real property and will no longer require an entity to actually physically touch the property or make a change to the property to qualify for the COGS deduction. Developments to watch North Carolina: A provision of the pending budget bill (HB 1030), if enacted, would cause North Carolina to adopt market-based sourcing for sales of non-tangible personal property and services. Oregon: The Oregon Supreme Court has scheduled oral arguments for 19 September 2016 in the appeal of the Health Net Inc. decision of the Oregon Tax Court (Ore. Tax Ct.). The taxpayer, a multistate corporation, is appealing the Ore. Tax Ct. s ruling that it was not entitled to a refund of corporate excise tax based on making an election to use the Compact s three-factor apportionment formula because the state s enactment of a statute requiring the use of a single sales factor apportionment formula by disabling the Compact election was valid State income and franchise tax quarterly update

11 Endnotes 1 National Grid Holdings, Inc. v. Commissioner of Revenue, No. 14-P-1662 (Mass. Ct. App. 8 June 2016). 2 National Grid Holdings, Inc. v. Commissioner of Revenue, No. 14-P-1861 (Mass. Ct. App. 8 June 2016). 3 Kraft Foods Global Inc. v. New Jersey Director, Division of Taxation, No (N.J. Tax Ct. 25 April 2016) (unpublished). 4 In the Matter of the Petition of TD Holdings II, Inc., DTA No (N.Y. Tax App. Trib. 7 April 2016). 5 Hallmark Marketing Co., LLC v. Hegar, No (Texas S. Ct. 15 April 2016). 6 In the Matter of the Petition of Astoria Financial Corp. & Affiliates, No. TAT(E)10-35(BT) (NYC Tax. App. Trib. 19 May 2016). 7 Dish DBS Corp, f/k/a/ EchoStar DBS Corp., and Affiliates v. South Carolina Department of Revenue, South Carolina, Administrative Law Judge Division, No. 14-ALJ CC (S.C. Admin. Law Ct. 20 May 2016). 8 The Gillette Co. v. Franchise Tax Board, No. S (Cal. S. Ct. 31 December 2015), petition for cert. filed, Dk. No (US S. Ct. filed 27 May 2016). 9 The Sherwin-Williams Co. v. Colorado Dept. of Rev., Case No. 2016CV31072 (Colo. Dist. Ct., Denver Cnty., filed 25 March 2016). 10 Gillette Comm Operations N Am & Subsidiaries v. Department of Treasury, No (Mich. S. Ct. 24 June 2016) (consolidated with 49 other appeals). 11 Kimberly-Clark Corporation & Subsidiaries vs. Commissioner of Revenue, A (Minn. S. Ct. 22 June 2016). 12 Lorillard Licensing Company LLC v. Director, Division of Taxation, No. A T1 (N.J. Super. Ct., App. Div., 4 December 2015) (unpublished), cert. denied, N.J. S. Ct. (17 June 2016). 13 RB Alden Corp. v. Commonwealth, 73 F.R (Pa. Cmwlth. Ct. 15 June 2016). 14 Nextel Communications of Mid Atlantic, Inc. v. Commonwealth, 129 A.3d 1 (Pa. Cmwlth. Ct. 2015). 15 Ala. Dept. of Rev., Ala. Regs (filed with the Legislative Reference Service 11 May 2016). 16 Titan Transp., LP v. Combs, 433 S.W.3d 625 (Tex.App. Austin 2014, pet. denied). 17 Health Net Inc. v. Ore. Dept. of Rev., No. TC 5127 (Ore. Tax Ct. 9 September 2015), cert. granted (Ore. S. Ct., arguments scheduled for 19 September 2016). 11 State income and franchise tax quarterly update

12 For additional information, please contact one of the following Ernst & Young LLP professionals: EY Assurance Tax Transactions Advisory About EY National Tax Chris Gunder National Director State Income Tax Financial Services Organization Michael Memmolo Central Region Brian Liesmann Canada Kathryn Toal Ernst & Young LLP (Canada) Northeast Region Scott Shreve Southeast Region Sid Silhan Southwest Region David Jackson West Region Todd Carper EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com. Ernst & Young LLP is a client-serving member firm of Ernst & Young Global Limited operating in the US Ernst & Young LLP. All Rights Reserved. SCORE No US NE ED None This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax or other professional advice. Please refer to your advisors for specific advice. ey.com