State Tax Return. Presents Under The Tree Becoming Unclaimed Property? December 2008 SCHEDULE. Green and Red. Happy Holidays - Free CLE and CPE!

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1 December 2008 Volume 15 Number 5 SCHEDULE 1 Presents Under The Tree Becoming Unclaimed Property? State Tax Return Presents Under The Tree Becoming Unclaimed Property? 2 Dashing Through The Snow, Passing New Pass-Through Withholding Requirements 3 State Tax Return (Green Edition) 8 Save The Date: University of Wisconsin Milwuakee 13th Annual Multistate Tax Institute June 18, Texas And Oklahoma Courts Disagree On Whether A Taxing Jurisdiction can Impose Property Tax On Natural Gas Stored In An Interstate Pipeline 14 Opportunity Calling? Texas Court Rules Certain Telephone Access And Operator Charges Are Sourced To Texas 17 Vermont Supreme Court Requires Maximization Of Taxation 19 New Jersey Legislative Update What Was Thrown Out, What Will Be Carried Forward? 23 Massachusetts Applies The Operational Approach For Sourcing Of Sales Other Than Sales Of Tangible Personal Property 28 Third And Fourth Quarter Nexus Update 54 Further Information State Tax Return is a Jones Day newsletter reporting on recent developments in state and local tax. Please send changes in address, requests for permission to reproduce this publication, in whole or in part, and comments or suggestions to Teresa M. Barrett-Tipton (214/ or statetaxreturn@jonesday.com) in Jones Day s Dallas Office, 2727 N. Harwood Street, Dallas, TX Charolette Noel Dallas (214) As 2008 rings up a year of financial turmoil, it may seem ironic that 2009 is expected to be a big year for unclaimed property. Not everyone is cashing in on their credit. Recent reports indicate about a third of last year s holiday gift cards remain unused. That s just one of many types of property required to remit under state unclaimed property laws. Green and Red States expect more green from unclaimed property in As audits heat up, businesses that are not reporting unclaimed property are more likely to see red. To avoid accounting and compliance problems that have triggered multi-million dollar fines for several large companies and their officers, every business should confirm that its accounting controls include procedures for proper reporting of unclaimed property. Happy Holidays - Free CLE and CPE! Jones Day has an offer we hope will not go unclaimed. We are hosting FREE unclaimed property CLE and CPE programs in Dallas and Columbus. The Dallas program, What Executives Need to Know About Unclaimed Property, will be the morning of February 12, It is cohosted by Deloitte & Touche. Space is limited. Contact Teresa Barrett-Tipton at to register soon! The Columbus, Ohio program will be in early May. 1

2 Dashing Through The Snow, Passing New Pass-Through Withholding Requirements Rachel A. Wilson Dennis Rimkunas Dallas New York (214) (212) Given the current economic times, it is not surprising that states are doing all they can to increase tax compliance without significantly increasing overhead. Rather than burn resources tracking nonresident partners, more states are adopting pass-through entity withholding requirements to shift the burden to pass-through entities to withhold taxes from nonresident partners. Most recently, Massachusetts and Illinois join the ranks of passthrough entity withholding states. Background Most states treat partnerships as pass-through entities; income earned by the partnership is not taxed at the partnership level, but is passed through to the partners in accordance with their distributive share. Resident partners are usually taxed in their state of residence on their entire distributive share of partnership income, regardless of where the income is earned. Nonresident partners are generally taxed by a state only with respect to their distributive share of partnership income derived from sources in that state. The majority of states now take the position that they have nexus to tax nonresident partners by virtue of the partner s ownership interest (whether limited or general) in a partnership doing business or owning property in the state. The obligation of nonresident partners to file returns and pay taxes in every state in which a partnership does business has created an administrative burden for taxing authorities as well as for partnerships and partners attempting to comply. Partners of large multistate partnerships might be obligated to file returns and pay taxes in virtually every state, even if their share of the partnership s income is minuscule. Many nonresident partners choose to ignore their filing and payment obligations, and taxing authorities have difficulty enforcing compliance of nonresident partners. Most states have responded to this problem by allowing partnerships in certain instances to file composite returns on behalf of nonresident partners. More recently, states have begun State Tax Return Editorial Board Charolette Noel Executive Editor Jones Day 2727 N. Harwood Street Dallas, Texas / (direct) 214/ (fax) cfnoel@jonesday.com Maryann B. Gall Senior Editor Jones Day 325 John H. McConnell Blvd., Ste. 600 Columbus, Ohio / (direct) 614/ (fax) mbgall@jonesday.com Carolyn Joy Lee Eastern Regional Editor Jones Day 222 East 41st Street New York, New York / (direct) 212/ (fax) lcjlee@jonesday.com Laura Kulwicki Midwestern Regional Editor Jones Day 325 John H. McConnell Blvd., Ste 600 Columbus, Ohio / (direct) 614/ (fax) lakulwicki@jonesday.com Rachel A. Wilson Western Regional Editor Jones Day 2727 N. Harwood Street Dallas, Texas / (direct) 214/ (fax) rawilson@jonesday.com 2

3 requiring partnerships to withhold an amount equal to a partner s share of income multiplied by the state s highest individual tax rate. In addition to Massachusetts and Illinois, states that have adopted some form of pass-through entity withholding include: California, Colorado, Georgia, Indiana, Kansas, Kentucky, Michigan, Minnesota, Missouri, Nebraska, New Jersey, New Mexico, New York, North Carolina, North Dakota, Oklahoma, Oregon, Pennsylvania, South Carolina, Virginia, and Wisconsin. Massachusetts On August 8, 2008, Massachusetts Department of Revenue issued a new pass-through entity withholding regulation, 830 CMR 62B.2.2, which applies to tax years beginning on or after January 1, The regulation arose from recent legislation, which on June 1, 2008 authorized the Commissioner to require pass-through entities to withhold if he deems such action necessary for the protection of the revenue of the commonwealth. 1 The stated reason for the regulation is to improve Massachusetts personal income or corporate excise tax compliance by recipients of Massachusetts sourced income from pass-through entities. 2 The obligation to withhold is separate from the member s or the pass through entity s obligation to file a return. General Rule Pursuant to the regulation, a pass-through entity that maintains an office or is engaged in business in Massachusetts must withhold Massachusetts personal income or corporate excise from the nonresident member s distributive share of Massachusetts-source income, unless the pass-through entity or member is exempt Mass. Gen. L CMR 62B.2.2(1). 830 CMR 62B.2.2(3)(a). Fast, Efficient, and Environmentally Friendly State Tax Developments... The State Tax Return (Green Edition) The State Tax Return really is Going Green. Hundreds of readers have responded already! To convert your subscription to electronic delivery, please send your name, company affiliation, and the e- mail address to which you would like to receive the newsletter to StateTaxReturn@JonesDay.com. 3

4 A nonresident is any natural person, estate, or trust that is not a resident or domiciliary of Massachusetts; any pass-through entity without a usual place of business in Massachusetts; or any corporation that does not file a tax return in Massachusetts. 4 A member includes an S corporation shareholder, a partner, a limited liability company member treated as a partner for tax purposes; and a beneficiary of an estate. 5 A pass-through entity is defined as: an entity whose income, loss, deductions and credits flow through to members for Massachusetts tax purposes, including a general partnership, limited partnership, limited liability partnership, or limited liability company with a member treated as a partner under Massachusetts tax law, an S corporation, an estate not taxed at the entity level, and a trust not taxed at the entity level, including a grantor-type trust. Exempt Pass-Through Entities A pass-through entity is not required to participate in pass-through entity withholding if it is an investment partnership; a trust required to withhold under another Massachusetts provision; or an upper-tier pass-through entity in a tiered structure where the lower tier pass-through has fully withheld. An investment partnership is a partnership (including LLCs treated as partnerships for tax purposes) in which: (a) substantially all of the partnership s assets consist of investment securities, deposits at banks or other financial institutions, or office equipment and office space reasonably necessary to carry on the activities of an investment partnership; (b) substantially all of the partnership s income is from interest, dividends and capital gains; AND (c) the partnership is not engaged in a trade or business in Massachusetts. 6 For the tired-structure exemption, the uppertier pass-through entity must demonstrate that a lower-tier pass-through entity has previously withheld and made estimated payments of all of the Massachusetts tax on Massachusetts-source income derived by the upper-tier pass-through entity that would otherwise be subject to withholding by the upper-tier entity. 7 Exempt Members In general, withholding is not required for members that are (1) exempt from federal income tax under I.R.C. 501; (2) Massachusetts residents; (3) corporations otherwise subject to Massachusetts corporate tax and that file Massachusetts returns; (4) pass-through entities that have a usual place of business in Massachusetts; (5) upper-tier passthrough entities that certify that all of their members are exempt from withholding; and (6) taxable non-resident members who establish that they are compliant with Massachusetts tax laws by (a) participating in a composite return prepared by the pass-through entity, or (b) filing a certification with the pass-through entity, stating that they agree to file tax returns, make quarterly estimated tax payments, and accept personal jurisdiction in Massachusetts state courts for the determination and collection of taxes, including estimated tax payments, and related interest, penalties, and fees imposed with respect to the income of the pass-through entity. 8 For a member to be treated as exempt, the pass-through entity must obtain annual certification by the member claiming to be exempt from withholding. Backup Withholding Notwithstanding these exemptions, a passthrough entity must withhold and make tax payments on behalf of a member if notified by the Commissioner that the resident or non-resident CMR 62B.2.2(2). 830 CMR 62B.2.2(2). 830 CMR 62B.2.2(2), (3)(b)(1). 830 CMR 62B.2.2(3)(b)(3). 830 CMR 62B.2.2(3)(c). 4

5 member has not met the member s obligation to file and pay timely. Generally, backup withholding is required for a five-year period following the Commissioner s notification. 9 Withholding Amount The annual amount to be withheld on behalf of each member subject to withholding is calculated by multiplying the withholding rate by the lesser of 80% of the member s distributive share for the taxable year, or 100% of the member s prior year distributive share. The pass-through must make quarterly payments on the required annual withholding amount on behalf of each subject member for the taxable year. 10 Annual Return and Schedule If withholding is required for any member, a pass-through entity must file an annual withholding return showing the total amount withheld for the taxable year. 11 Non-exempt pass-through entities with non-resident members must file an annual schedule with its return showing the Massachusettssource distributive share and filing method of its nonresident members. 12 Publicly traded partnerships are not required to withhold on their members, but must file the annual schedule for pass-through entities including members receiving more than $500 (the partnership is not required to report the method of compliance of its members). 13 Electronic Composite Returns Withholding is not required for flow-through members who elect to participate in composite returns. Members may elect to participate in a pass-through entity s composite return even if the member has Massachusetts-source income other than distributive share from one or more passthrough entities. In such situation, the member must file a separate return for income not covered in a composite return. Individual non-residents may participate in more than one composite return. Composite returns for tax years beginning on or after January 1, 2009 (filed in 2010) must be filed electronically. Estimated tax payments must be made electronically through ACH Debit, beginning the first quarter of tax years beginning on or after January 1, Penalties For Failure To Withhold A pass-through entity required to withhold is jointly and severally liable with each member subject CMR 62B.2.2(3)(d). 830 CMR 62B.2.2(4). 830 CMR 62B.2.2(8)(b). 830 CMR 62B.2.2(8)(a). 830 CMR 62B.2.2(3)(e). 5

6 to withholding for the member s Massachusetts tax liability, including interest and penalties, with respect to its distributive share of income from the pass-through entity. Any pass-through entity required to withhold that fails to meet its withholding obligation is subject to all applicable penalties for failure to adequately withhold. 14 Credit for Tax Paid Notwithstanding the regulation, members are responsible for payment of estimated taxes on all of their income, including income from passthrough entities. Amounts previously withheld and paid to the Commissioner by the pass-through entity on behalf of a member, applicable to the entity s taxable year ending within or with the taxpayer s tax year, may be allowed as a credit on the member s estimated tax obligation. Timing differences may result in interest and penalties being due on estimated tax payments. 15 Tiered Structures Unless exempted, each pass-through entity withholds applicable tax on behalf of its members subject to withholding, including members that are pass-through entities. To prevent multiple withholding on the same income, an upper-tier pass-through entity that recognizes distributive share income may subtract amounts withheld by a lower-tier entity from amounts required to be withheld. Upon approval of the Commissioner, a lower-tier entity may meet its withholding obligation for an upper-tier entity by directly withholding from the distributive share of members of the upper-tier entity. 16 Illinois Illinois recently enacted a pass-through entity withholding statute, effective January 11, The Illinois Department of Revenue s Pass-through Entity Payments Q&A (Nov. 18, 2008) provides some insight into why Illinois adopted the passthrough withholding requirements. In answer to why the law was passed, the Q&A states: First to insure compliance with Illinois tax laws. A large number of nonresident partners and shareholders were not filing Illinois tax returns and paying their Illinois tax liability. For the past two years, the Department of Revenue has been manually reviewing partner and shareholder information provided on Illinois income tax returns and contacting partners and shareholders who were not filing returns. This project revealed both widespread ignorance and deliberate disregard of Illinois law. To date, the department has recovered $22.5 million in unpaid tax. Second to provide a method for pass-through entities to pay tax on behalf of their nonresident owners that is more flexible and taxpayer-friendly than using composite returns. Recently Enacted Withholding Statute For each taxable year ending on or after December 31, 2008, every partnership (other than a publicly traded partnership under IRC 7704 or investment partnership), S corporation, and trust must withhold from each nonresident partner, shareholder or beneficiary (unless tax exempt under IRC 501(a) or 35 ILCS 5/205 or included on a composite return filed by the pass-through entity under 35 ILCS 5/502(f)) an amount equal to the partner, shareholder or beneficiary s distributable share of the business income of the pass-through entity apportionable to Illinois multiplied by the applicable tax rate. 18 A pass-through entity is not required to withhold tax with respect to any nonresident partner, shareholder or beneficiary (who is not an individual) from whom the entity has received a certificate of exemption stating that such nonresident partner, shareholder or beneficiary will: (A) file all returns they are CMR 62B.2.2(7). 830 CMR 62B.2.2(6). 830 CMR 62B.2.2(5). 35 ILCS 5/ ILCS 5/709.5(a). 6

7 required to file under 35 ILCS 5/502 and make timely payment of all Illinois taxes imposed on them with respect to income of the pass-through entity; and (B) be subject to personal jurisdiction in Illinois for income tax purposes with respect to the income of the partnership. 19 A pass-through entity must annually report the amounts withheld and from whom the amounts were withheld, and pay over the amounts withheld in quarterly estimated installments. 20 The passthrough entity is liable for the tax it withholds or is required to withhold. 21 If a pass-through entity required to withhold fails to withhold, the entity is liable for applicable penalties and interest for failure to timely withhold even if the owner subsequently pays the tax. 22 Amounts withheld and paid to the Illinois Department of Revenue are treated as payments of the estimated tax liability or of the liability for withholding of the partner, shareholder or beneficiary to whom the income is distributable for the taxable year in which liability for such income is incurred. 23 Proposed Regulations In light of the newly enacted statute, the Illinois Department of Revenue proposed new regulations to implement the withholding statute, and to amend the composite return regulations to be consistent with the new statute. The regulations are currently in the first notice period, which ends December 14, Of the proposed new and amended regulations, 86 Ill. Admin. Code is the primary pass-through entity withholding regulation. The proposed regulation provides for the treatment of overpayments and underpayments of the withholding obligation, 24 rules regarding recordkeeping and revocation of certificates of exemption, 25 and an exempt owner s remedy if the pass-through entity withholds. 26 Owners have no right of action against a pass-through entity for withholding tax from that owner despite being exempt under the statute; instead, the owner must file a timely claim for funding of the withholding. With respect to tiered pass-through entities, the proposed withholding regulation provides that if the owner is a pass-through entity itself, it may claim some or all of the amount withheld as a credit against the amount it is required to withhold from its owners in lieu of claiming the credit against its liability for Illinois taxes under 35 ILCS 5/ Once an owner has filed a return claiming an amount of credit against its withholding or other tax obligation, the owner may not claim that amount as a credit against any other liability. Other Guidance In addition to the proposed regulations, the Illinois Department of Revenue issued Information Bulletin FY (Oct. 2008) and Pass-through Entity Payments Q&A (Nov. 18, 2008). The Passthrough Entity Payments Q&A provides examples of how the withholding requirements apply. The Information Bulletin sets forth general instructions for complying with the requirements. Interestingly, the Information Bulletin FY states that if the pass-through entity s payments cover the nonresident owner s Illinois Individual Income Tax obligation, that owner does not need to file Form IL-1040, Individual Income Tax Return. This differs ILCS 5/709.5(c)(1). 35 ILCS 5/711(a-5), 5/ ILCS 5/ ILCS 5/ ILCS 5/709.5(b). 86 Ill. Admin. Code (e), (f) (proposed). 86 Ill. Admin. Code (h) (proposed). 86 Ill. Admin. Code (g)(2) (proposed). 86 Ill. Admin. Code (d)(1). 7

8 from states that require an owner to file a return even if taxes were fully withheld and paid by the pass-through entity. Differences in New Nonresident Partner Withholding Rules There are important differences between the pass-through withholding rules in Massachusetts and Illinois. For example, in Massachusetts withholding is not required for nonresident members that provide the pass-through entity with certification stating that the member agrees to file tax returns, make quarterly estimated tax payments, and accept personal jurisdiction in Massachusetts state courts for the determination and collection of taxes. 28 Illinois allows nonresident members to provide a similar certificate of exemption to pass-through entities only if the nonresident member is not an individual. 29 These differences add to the tax compliance burden of multistate partnerships. Revenue Raisers In both Massachusetts and Illinois, the passthrough withholding requirements were enacted to improve compliance and increase state revenues. It remains to be seen whether the new rules will have the desired effects on revenue. As state budgets continue to tighten, we should expect more states to add pass-through entity withholding requirements. Multistate pass-through entities are well advised to periodically examine the applicable withholding rules in all the states in which they do business given the frequency of changes in this area of law CMR 62B.2.2(3)(c). 35 ILCS 5/709.5(c)(1); 86 Ill. Admin. Code (h) (proposed). See also Illinois Dept. of Rev. General Information Letter IT GIL (Apr. 14, 2008). 8

9 Austin Texas And Oklahoma Courts Disagree On Whether A Taxing Jurisdiction Can Impose Property Tax on Natural Gas Stored In An Interstate Pipeline. Phyllis J. Shambaugh Charolette Noel Columbus Dallas Oklahoma City Does a taxing jurisdiction s imposition of ad valorem tax on the value of stored natural gas violate the Commerce Clause? Two state courts recently reached the opposite conclusion on this question. The Texas Court of Appeals in Texarkana said YES in Peoples Gas, Light, and Coke Company v. Harrison Central Appraisal District. 1 However, the Oklahoma Supreme Court said NO in In Re Assessment of Personal Property Taxes. 2 Factual Background In both cases, the local distribution companies had no property in the taxing jurisdiction except the stored natural gas. Here s a short summary of the facts of both cases. Peoples Gas, Light and Coke Company Peoples is a local distribution company that purchases natural gas from suppliers and delivers it to customers in Chicago, Illinois. 3 Peoples buys natural gas for transportation on an interstate pipeline owned and operated by Natural Gas Pipeline Company of America ( Pipeline ). Peoples had no Texas office, no employees or other representatives in Texas and delivered no gas to Texas customers. 4 Pipeline uses its storage facilities to provide the natural gas required during peak usage periods. Peoples buys natural gas at lower prices during off-peak times and stores it on Pipeline s system for use during peak demand periods. 5 The Harrison Central Appraisal District (the District ) assessed ad valorem tax on a portion of Peoples natural gas stored in Pipeline s North Lansing storage facility. 6 The District Court upheld the District s assessment and Peoples appealed to the Court of Appeals. Before the Court of Appeals, Peoples contended that it did not own, for ad valorem tax purposes, any of the natural gas lying beneath Harrison County and, even if it did, the Commerce Clause shielded it from taxation by the District because the gas was in interstate commerce. 7 In Re Assessment of Personal Property Taxes In the Oklahoma case, the Woods County Assessor (the Assessor ) issued an ad valorem tax assessment to Missouri Gas Energy ( MGE ) for natural gas stored in Oklahoma. MGE is a local distribution company headquartered in Kansas City, Missouri. 8 It purchases natural gas from suppliers in Texas, Kansas and Oklahoma and contracts with Panhandle Eastern Pipe Line Company ( Panhandle ) for transportation services No CV, (Tex. App.- Texarkana Sept. 24, 2008), 2008 WL , motion for rehearing pending. No (Oct. 21, 2008), 2008 WL WL at *1. Id. at *8. Id. at *6. Id. at *1. Id. at * WL at 0 and 2. 9

10 to customers in Missouri. 9 MGE sells no natural gas in Oklahoma and has no facilities or employees in Oklahoma. During transportation some natural gas is removed from the pipeline and stored in Panhandle s storage facility in North Hopeton, Oklahoma. 10 The Woods County District Court found in favor of MGE and the Assessor appealed to the Oklahoma Supreme Court. 11 The Texas Court of Appeals Held That The District s Assessment Violates the Commerce Clause of the United States Constitution. The District asserted that the storage of the natural gas beneath Harrison County took the gas outside interstate commerce, leaving it subject to taxation as a part of the mass of property within the State of Texas. 12 Relying on Independent Warehouses, Inc. v. Scheele, 13 a United States Supreme Court case decided in 1947, the Court of Appeals easily rejected this claim. The Court of Appeals found that the crucial question is whether there is continuity of transit. 14 If the stoppage is due to the business purpose of the property owner, the continuity of transit is terminated and the goods are subject to tax. 15 Here, the Court of Appeals found that stoppage of natural gas in North Lansing did not remove the natural gas from interstate commerce because the stoppage did not serve the business purpose of Peoples since Peoples had no control over where natural gas was stored. 16 The Court of Appeals then applied the fourpart test the United States Supreme Court set forth in Complete Auto Transit, Inc. v. Brady 17 to determine if a tax violates the Commerce Clause. These tests are: 1. Is the tax applied to an activity with a substantial nexus with the taxing state? 2. Is the tax fairly apportioned? 3. Does the tax discriminate against interstate commerce? and 4. Is the tax fairly related to the services provided by the state? The Court of Appeals concluded that there was no nexus because the storage of natural gas was too tenuous a connection to subject Peoples to ad valorem tax in Texas. 18 Since the gas was part of interstate commerce, in order to tax the gas, there must have been some definite link, some minimum connection, between [the] state and the person, property, or transaction it [sought] to tax. 19 The Court of Appeals found that Peoples did not have a physical presence in Texas and there was no evidence that the gas was delivered to customers in Texas. 20 The only connection that Peoples had to Texas was through the structure and location of Pipeline s pipeline and Pipeline s Id. at 2. Id. Id. at 4. Peoples, 2008 WL at * U.S. 70 (1947). Peoples, 2008 WL at *5. Id. Id. at * U.S. 274, 279 (1977) 18 Peoples, 2008 WL at * Id. Id. 10

11 decision to store the gas in North Lansing. The Court of Appeals found this connection insufficient to subject Peoples to ad valorem taxes. The Court of Appeals also considered whether the tax was fairly related to the services provided by Harrison County. The Court said no the services provided to the storage facility benefit Pipeline, owner of the facility, not Peoples. 21 The Court ultimately held that the taxation of natural gas owned by Peoples violated the Commerce Clause. 22 Less Than A Month Later, The Oklahoma Supreme Court Held That Ad Valorem Tax On Stored Natural Gas Does Not Violate The Commerce Clause. On similar facts, the Oklahoma Supreme Court reached the opposite conclusion. The Oklahoma Supreme Court rejected the parties claims that it should rely on cases decided prior to Complete Auto which looked at: Whether there was an interruption in transit that took goods out of interstate commerce; and The reason for interruption in transit. 23 In so holding, the Court stated: While the Supreme Court has cautioned state and lower federal courts to follow directly applicable precedents that may appear to have been rejected in some other line of cases and leave to it the prerogative of overruling its own decisions, application of a traditional rule that leads only to the inconclusive result that goods are either in transit or at rest would not resolve the issue before us today. 24 Instead, the Court applied the four part Complete Auto test and found that the tax satisfied all four tests. Regarding the substantial nexus requirement, the Court stated that this test insures that a state cannot tax goods merely passing through the state. 25 The Court rejected the characterization of MGE s storage as merely passing through the state. The Court stated: Large volumes of gas are stored in Woods County for a substantial part of the year, being gradually injected for months and then being gradually withdrawn over another period of months. While the volume of gas increases and decreases over the year, some volume is stored in the county at all times during the year. The gas in storage at North Hopeton thus has a substantial presence in Woods County The Court also found the tax satisfied the fair apportionment prong of Complete Auto because it was internally and externally consistent. A tax is internally consistent if every state imposes an identical tax and there is no multiple taxation. Here, the Oklahoma Supreme Court found the tax was internally consistent because no other Id. Id. at * WL at 45. Id. at 46. Id. at 50. Id. 11

12 state except Kansas and Oklahoma could tax the stored gas at issue and Kansas recently rejected ad valorem tax on stored bas based on a state statute that exempts public utilities from that tax. 27 On the issue of external consistency, the Court stated that a tax is externally consistent if does not reach beyond the part of the value of the property fairly attributable to economic activity in state. Since only gas stored in Woods County is taxed, the court found the tax was externally consistent. 28 MGE claimed that the tax discriminated against interstate commerce because the storage was in interstate commerce. 29 The Court rejected this contention because, for Commerce Clause purposes, discrimination means differential treatment of in-state and out-of-state economic interests that benefits the former and burdens the latter. 30 The Court found the Woods County ad valorem tax non-discriminatory because it falls on anyone owning property located in the county. 31 Finally, the Court found the ad valorem tax was reasonably related to state services. Under this test, the question is whether the state has given anything for which it can ask return. In other words, is the tax reasonably related to extent of taxpayer s contact with the state? 32 The Court found that MGE s stored gas is asked to shoulder no more than its fair share to support governmental services because the tax is on personal property located in Woods County. 33 Two Courts Two Different Results. Does The Commerce Clause Analysis In These Cases Comport With Current Commerce Clause Jurisprudence? In both cases, the parties asked the Court to decide if the stored natural gas remained in interstate commerce. The Texas Court agreed and went through this analysis. However, the Oklahoma Court found this analysis unnecessary, concluding that whether or not the natural gas was in interstate commerce did not answer the question of whether the taxation of the stored natural gas violated the Commerce Clause. Recent United States Supreme Court commerce clause cases have not turned on whether the property remains in interstate commerce. Instead, the United States Supreme Court has consistently applied the four part Complete Auto test. In that case, Complete Auto, relying on Spector Motor Service v. O Connor, 34 asserted that a tax on the privilege of engaging in an activity in the state may not be applied to an activity that is part of interstate commerce. The Court rejected this blanket prohibition against taxing an interstate transaction stating the Court consistently has indicated that interstate commerce may be made In re Director of Property Valuation, 161 P. 3d 755 (Kan. 2007) WL at 61. Id. at 62. Id. at 63. Id. Id. at 65. Id. 12

13 to pay its way The Court went on to set forth the four prong test to determine if a tax violates Commerce Clause. 36 In subsequent cases, the Court has reaffirmed that interstate commerce may be required to pay its fair share of taxes. In D.H. Holmes Company, Ltd. v. McNamara, 37 the Court stated that the distinction of whether goods have come to rest or are still in stream of interstate commerce is largely irrelevant for Commerce Clause analysis. Id. The Court went on to analyze the tax using the Complete Auto tests. Likewise, in Oklahoma Tax Commission v. Jefferson Lines, Inc., 38 the Court rejected a Commerce Clause challenge against sales tax on bus tickets sold in Oklahoma for trips that originated in Oklahoma but ended in other states. The Court again analyzed Commerce Clause challenge using the Complete Auto tests. These natural gas cases raise some interesting questions affecting the evaluation under the Complete Auto test. Might the differing results be attributed to different findings of fact? Can the precise molecules owned by the local distribution company be identified? If the Texas case is affirmed, will the U.S. Supreme Court resolve the apparent conflict? Will Congress decide to establish controlling regulations? We will keep you informed of the developments U.S. 602 (1951). Complete Auto, 430 U.S. at 281. See footnote U.S. 24, 31 (1988). 514 U.S. 175 (1995). FARCUS is reprinted with permission from LaughingStock Licensing Inc., Ottawa, Canada. All Rights Reserved. 13

14 Austin Opportunity Calling? Texas Court Rules Certain Telephone Access And Operator Charges Are Sourced To Texas Paul Broman David J. Schenck Houston Dallas (832) (214) Editor s Note: The State Tax Team is grateful to David Schenck for his assistance with this article and our telecom projects. David is a partner in our Issues & Appeals Practice in Dallas. He has successfully represented telecom companies in various appellate cases including: AT&T v. City of Dallas, 243 F.3d 928 (5th Cir. 2001) (set aside adverse order concerning competitive neutrality among competing local telephone service providers); Northrup v. Southwestern Bell, 72 S.W.3d 16 (Tex. App. Corpus Christi 2002, pet. denied) (successful defense of first ever cy pres class action settlement in Texas); CoServ v. Southwestern Bell, 2003 WL (5th Cir. 2003) (successful representation jurisdictional questions under the Federal Telecommunications Act and arbitration of interconnection arrangements); Southwestern Bell v. City of El Paso, 346 F.3d 541 (5th Cir. 2003) (successfully opposed local governmental agency s imposition of a fee on utilities crossing the agency s property); and Grande Communications v. Verizon, No (211th Tex. Dis. Ct. 2007) (set aside order and defeated action to bar Verizon's access in purportedly exclusive development). David has also worked with the State Tax Team on several other cases. We are proud to include him on the State Tax Team! In Southwestern Bell Telephone Co. v. Combs, 1 the Texas Court of Appeals denied Taxpayer s appeal for summary judgment that receipts from certain telephone access and operator assistance charges should be excluded from the numerator of the receipts factor as services not performed in Texas or as exempted receipts from interstate calls. The decision affirmed the trial court s decisions that: 1) Taxpayer s access and operator assistance charges are sourced to Texas; 2) the apportionment statute and regulations as applied to the Taxpayer did not violate equal protection; and 3) that certain testimony was properly excluded. Industry Background American Telephone and Telegraph Company dominated the telecommunication industry in the United States until 1982 when an antitrust consent decree, known as the Modification of Final Judgment, was entered. AT&T was required to divest its local exchange subsidiaries, known as Bell Operating Companies ( BOC ). Taxpayer was one such BOC with customers in Kansas, Arkansas, Oklahoma, Missouri and Texas. The United States was divided into 161 Local Access Transport Areas, known as LATAs. Within the LATAs, the BOCs provided local telephone service. Within the LATAs, Local Exchange Carriers ( LECs ) connected the individual telephone customer with the telephone network and provided local telephone service. Taxpayer acted as an LEC within Texas LATAs. The LECs continued to operate as monopolies in their local service areas, and the states acted as the regulators. LECs were restricted from offering any long distance telephone service between LATAs. Instead, long distance service was provided by interexchange carriers ( IXCs ). In the case of long distance calls, the LEC connected the originating customer to the IXC s network, and the IXC transmitted the signal across state lines 1 Southwestern Bell Telephone Co. v. Combs, No CV, 2008 WL (Tex.App.-Amarillo, Oct 28, 2008, no pet. h.). 14

15 where another LEC would connect that signal to the receiving customer. In order to open a two way telephone communication, the process was simultaneously reversed to carry a signal from the receiving customer back to the originating customer. The IXCs paid Taxpayer for use and maintenance of its LEC network as part of long distance telephone calls. The payment by the IXC was based upon a uniform access charge rule. Taxpayer s Revenues at Issue Three types of revenue collected by the Taxpayer were at issue for the years 1995 through Firstly, End User Common Line Charges were a flat rate charged regardless of whether long distance calls were made. These charges compensated Taxpayer for providing use of its local network to customers making long distance calls. Secondly, Special Access Charges were a fixed monthly fee charged to customers for dedicated telephone lines between the customers and the IXC s long distance network. Lastly, Operator Assistance Charges were charged on a pay per use basis for directory or dialing assistance. Since Taxpayer operated as an LEC in several states, it was required to apportion its taxable capital and taxable earned surplus components of the Texas franchise tax. Texas employed a single sales factor apportionment methodology for both the taxable capital and taxable earned surplus components. The same apportionment rule continues under the new margin tax. In general, the numerator of the sales factor includes sales of tangible personal property delivered or shipped to a buyer in Texas and each service performed in Texas. However, the Comptroller adopted a regulation providing that receipts from interstate calls are exempted from being included as Texas receipts. Taxpayer asserted that: 1) the revenues at issue were not services performed in Texas ; 2) the revenues at issue were from interstate calls and therefore not Texas receipts; and 3) characterizing the revenues at issue as Texas receipts violated the equal protection guarantees. Sourcing of Access and Operator Assisted Charges The statutes and regulations do not clearly define the phrase services performed in Texas. When interpreting a vague or ambiguous statute, the courts look to the appropriate agency s interpretation unless it is plainly erroneous or inconsistent with the statute. Numerous Comptroller Hearing Decisions/Letters classified access charges for use of local telephone networks as services. In light of these administrative rulings, the court found that the Comptroller s interpretation of access and operator assistance charges as a service was reasonable. As to whether the access and operator assistance services were performed in Texas, the court considered that the customers requesting service were located in Texas and the Taxpayer s network, facilities and/or personnel were also in Texas. Therefore, the court found that the Comptroller s determination that the services were performed in Texas and are classified as Texas receipts was reasonable. However, before concluding that the access and operator assistance charges are included in the apportionment formula as Texas receipts, a second inquiry was required to determine whether such receipts were exempted from apportionment as interstate calls as provided in the regulations. Since exemptions from taxation are narrowly construed, uncertainties are weighed in favor of the taxing authority. 2 Taxpayer asserted that the interstate long distance calls are a single transmission across state lines and that customers could not make interstate calls without use of Taxpayer s local telephone network. Accordingly, the Taxpayer asserted that the access charges for use of the local network for the interstate call were a portion of the charges for interstate calls. 2 Bullock v. National Bancshares Corp., 584 S.W.2d 268, 272 (Tex. 1979). 15

16 The court concluded that Taxpayer s access services were independently contracted for and wholly performed in Texas, and that its customers were charged the flat or fixed access fees regardless of whether any interstate calls were actually placed. Therefore, the court found that Taxpayer s services were performed entirely in Texas. Although the services facilitated long distance calls, customers and IXCs paid Taxpayer for its facilities so that they could engage in interstate commerce. The court also considered the Federal C o m m u n i c a t i o n C o m m i s s i o n s ( F C C ) characterization of the services provided by Taxpayer. The FCC interprets such services as interconnection of a customer to an IXC and that there is no transmission or routing of telephone calls. It was found that Taxpayer s access service was completed when the local customer was connected to the IXC. Regarding the operator assistance charges, the Taxpayer stated that such services are associated with a customer trying to make or place an interstate call, but the court found that such charges were for the use of facilities and personnel located in Texas and were not revenue from calls. Equal Protection Comparison of LECs and IXCs Taxpayer asserted that as an LEC, it was similar to an IXC since it also participated in the transmission of interstate communications via similar equipment in Texas. Taxpayer noted that the portion of receipts reflecting intrastate service for IXCs and certain transportation companies are not sourced to Texas, and Taxpayer was therefore treated differently from IXCs and other transportation companies. States have broad powers to impose taxes, but classifications among taxpayers may not be arbitrary, unreasonable or capricious. 3 Although IXCs and LECs have similarities such as equipment and facilities, the court noted there are differences in that LECs serve a local area while IXCs transmit across state lines. The difference in service areas was found to be a rational basis upon which the state may classify IXC s revenue differently from an LEC such as Taxpayer. Exclusion of Evidence The trial court had sustained Comptroller s objections to certain testimony in the form of affidavits. The appellate court ruled that Taxpayer was prevented from raising the issue. As a result, the Taxpayer had the burden of bringing forth a record to show that the trial court abused its discretion in sustaining the Comptroller s objections to the evidence. The appellate court concluded that such burden was not met in this case. Unfortunately, a procedural hurdle may have prevented influential testimony from being considered. Opportunity Calling? Although the appellate court s decision was not favorable to the Taxpayer, the decision may provide, or at least leave open, apportionment opportunities for taxpayers in other industries. Fully interstate transactions may qualify for the exemption. The court s holding does not require a taxpayer to bifurcate an interstate transaction into in-state and out-of-state portions. If a taxpayer contracts to provide a full interstate service (e.g. communication or transportation), the interstate exemption may still be available and present savings opportunities. Use of personnel outside the state might also trigger the exemption. The court s holding was based on the finding that Taxpayer s customers in Texas were serviced by network, facilities and/or personnel also located in Texas, thus the service transactions were determined to begin and end in Texas. This precise wording may provide an opportunity for certain taxpayers earning revenue from interstate facilities to favorably characterize such revenue as inter-state if non-texas employees are involved in providing such service. One thing is certain, sourcing and proper tax treatment of interstate services continue to provide many challenges for taxpayers and taxing authorities. 3 Hurt v. Cooper, 130 Tex. 433, 110 S.W.2d 896, 901 (Tex. 1937). 16

17 Montpelier Vermont Supreme Court Requires Maximization Of Taxation Maryann B. Gall Jennifer L. E. Bierlein Columbus Columbus (614) (614) Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one s taxes. - Judge Learned Hand 1 In the legal arena, a legal doctrine spoken by Judge Learned Hand typically carries much respect and deference. However, the Vermont Supreme Court was not persuaded by Judge Hand s position in the recent case of TD Banknorth, N.A. v. Department of Taxes. 2 In TD Banknorth, the Court upheld the assessment of the Bank Franchise Tax ( BFT ) against a parent company because the Court found that the parent company s three holding companies were set up merely to avoid taxation. Background TD Banknorth, N.A. ( Taxpayer ) was a parent company to three banks. Each of the banks established a wholly-owned holding company. Each holding company was a Vermont corporation. The banks capitalized their respective holding companies by assigning certain loan assets to the holding companies and also by entering into participation agreements whereby the holding company received 100% of the economic interest of the assets but Taxpayer retained full management of the assets. The structure that Taxpayer used resulted in tax avoidance. Prior to the establishment of the holding companies, the banks reported income from the assets. When the loans were transferred to the holding companies, the related income stream from the assets was assigned to the holding companies. Without the loan income, the banks incurred a loss for purposes of federal income tax. By reporting the loss, the bank could almost eliminate any payment of the Vermont BFT, which is generally capped not to exceed the bank s federal taxable income. Meanwhile, the 1 2 Helvering v. Gregory, 69 F.2d 809, 810 (2d Cir. 1934) (citing United States v. Isham, 84 U.S. (17 Wall) 496, 506, 21 L.Ed 728 (1873)) VT 120 (Sept. 19, 2008). 17

18 holding companies paid virtually no tax on the income based on a carve out in the Vermont law for corporations whose activities are confined to maintenance and management of certain intangible investments (the Carve Out ). Upon audit, the Department of Taxes (the Department ) found that the holding companies had no economic substance or legitimate business purpose and were formed merely to evade the [BFT]. The Commissioner of Taxes assessed additional BFT, attributing the holding companies income to its parent company bank and also imposed a penalty. The tax was upheld by the superior court and Taxpayer appealed to the Vermont Supreme Court. Taxpayer s Claim On appeal, Taxpayer claimed, among other things, that the Commissioner erred in concluding that the holding companies lacked sufficient business purpose and independent economic substance to properly be considered separate taxable entities and thereby eligible for the Carve Out. Taxpayer claimed that the transfer of incomeproducing assets to a corporation was sufficient to shift the taxability of the income to that corporation and that the holding companies engaged in sufficient business activity to be distinct from their parent for purposes of the BFT. The Court s Decision The Court adopted the economic substance doctrine to determine that the holding companies were not taxable entities separate from Taxpayer. The doctrine uses a two prong approach, looking at both the motivation in creating the entity and the economic activities of the entity. Because the Court concluded that the holding companies failed both prongs of the analysis, the Court declined to decide whether the two prongs were conjunctive or disjunctive. The Court found that the motivation for forming the holding companies was solely for avoiding taxes. The Court relied heavily on evidence that Taxpayer s accountant advised Taxpayer that the formation of the holding companies was a slam dunk strategy for achieving substantial BFT savings. The Court found that the holding companies conducted insufficient independent business activity to qualify as taxable entities separate from Taxpayer because (i) Taxpayer operated the holding companies out of its back office without any independent property, tangible assets or staff, (ii) through the use of the participation agreements, the holding companies received a 100% undivided interest in the loan while the banks maintained control, (iii) the holding companies carried no economic risk and (iv) the holding companies did not engage in meaningful business with independent third parties. According to Judge Learned Hand, the accountant s advice was appropriate and Taxpayer should have been free to structure its business in a manner so as to pay the lowest amount of taxes possible. However, the Vermont Supreme Court upheld the assessment because, although the holding companies met the literal requirements for the Carve Out, they were disregarded under the economic substance doctrine because the Court concluded they were nothing more than a vehicle for tax avoidance. 18

19 Trenton New Jersey Legislative Update What Was Thrown Out, What Will Be Carried Forward? Dennis Rimkunas New York (212) New Jersey Senate and Assembly passed legislation that will result in significant tax benefits to corporate taxpayers conducting business in New Jersey. The new and proposed legislation extends the NOL carryforward from seven to 20 years, repeals the throwout rule and eliminates the regular place of business requirement, and may, if enacted, require manufacturers to apportion their income on a single factor (receipts only) formula. Throwout Rule To Be Thrown Out Under New Jersey law, corporate taxpayers apportion their income to New Jersey based on the three-factor apportionment formula with the doubleweighted receipts factor. 1 For periods beginning before July 1, 2010, to determine the receipts factor of the apportionment formula, any sales sourced to states, U.S. possessions, or foreign countries where the taxpayer is not subject to income tax or tax on profits are removed from the denominator of the receipts factor. 2 This is known as the throwout rule. The application of the throwout rule to the apportionment formula increases the New Jersey receipts factor, and consequently increases taxpayer s income apportioned to New Jersey. Until the new law becomes effective, if the taxpayer believes that the application of the throwout rule results in improper apportionment, the taxpayer s remedy is to contact the New Jersey Division of Taxation (the Division ) and request a discretionary adjustment of the apportionment formula. 3 It should be noted, however, that the constitutionality of the throwout provision is in the process of being challenged in New Jersey state courts. 4 In the meantime, the New Jersey Legislature voted to eliminate the throwout rule altogether. Assembly Bill No. 2722, introduced May 19, 2008 (identical Senate Bill No. 3, introduced October 27, 2008), 5 was signed by Gov. Jon Corzine on December 19, It will eventually eliminate the throwout of receipts in apportionment of entire net income under the corporation business tax. The Bill deletes the language contained in N.J. Rev. Stat. 54:10A-6(B) that removes the receipts from the denominator of the receipts factor. The Bill also deletes the language contained in N.J. Rev. Stat. 54:10A-5(i) that limits the effect of the throwout rule on members of an affiliated group or controlled group to $5 million. The repeal of the throwout rule will not be applied retroactively. The revised statutes will be effective for privilege periods beginning on or after July 1, According to the Fiscal Note dated September 16, 2006, the Division estimates that the repeal of the throwout rule will reduce New Jersey tax revenues by $89 million per year. The Office of Legislative Services estimates that N.J. Rev. Stat. 54:10A-6. N.J. Rev. Stat. 54:10A-6(B); N.J. Admin. Code 18: N.J. Rev. Stat. 54:10A-8; N.J. Admin. Code 18:7-8.7(d). See Pfizer, Inc. v. Division of Taxation, N.J. Tax Ct., No (May 29, 2008), cert. granted N.J. Supr. Ct., Docket No (Oct. 30, 2008). Senate Bill No. 1874, introduced on May 22, 2008, sought to eliminate the throwout rule. It was subsequently incorporated into Senate Bill No

20 the revenue impact might be even higher once the municipalities and counties collections are considered. Nevertheless, the Assembly Commerce and Economic Development Committee voted favorably in support of the Bill. 6 In fact, on October 27, 2008 the Assembly passed the Bill with 79 votes in favor and 0 votes against. The Senate version of the bill eliminating the throwout rule passed unanimously on November 24, 2008 and was adopted by the Assembly on December 15, Out-of-State Regular Place of Business Limitation Limited The Bill discussed in the throwout section also eliminates the regular place of business requirement effective for privilege periods beginning on or after July 1, Until the effective date of the legislation, corporate taxpayers with presence in New Jersey are permitted to apportion their income to other states, only if they maintain a regular place of business outside of New Jersey. 8 Currently, if the taxpayer does not maintain a regular place of business outside of New Jersey, the taxpayer s New Jersey apportionment factors shall be 100%. 9 The regulations define the regular place of business as an office in which an employee in attendance performs significant duties related to the business of the taxpayer. 10 A token office, facilities of a public warehouse, facilities of an independent contractor, and any facility not regularly maintained would not constitute a regular place of business. 11 The constitutionality of this provision was recently upheld by the New Jersey Tax Court, 12 but further constitutional challenges are inevitable, particularly if the taxpayer has no regular place of business in New Jersey and more nexus outside the state. The Division estimates that the repeal of the regular place of business requirement will reduce New Jersey s tax collections by approximately $60 million per year. 13 Just as in the case of the throwout repeal, the legislation is prospective. As a technical matter, the Bill does not revise the first paragraph of N.J. Rev. Stat. 54:10A-6, which currently states: In the case of a taxpayer which maintains a regular place of business outside this State other than a statutory office,... the portion of its entire net income to be used as a measure of the tax... shall be determined by multiplying such entire net worth and entire net income, respectively, by an allocation factor which is the property fraction, plus twice the sales fraction plus the payroll fraction and the denominator of which is four.... (Emphasis added). The continuing presence of this language in the statute may lead to future confusion; i.e., what is the definition of a regular place of business?; does the definition contained in the regulations still apply?; and how is the income apportioned if the taxpayer does not maintain a regular place of business outside of New Jersey? Statement to Assembly, dated October 6, Assembly Bill No. 2722; Senate Bill No. 3. N.J. Rev. Stat. 54:10A-6 (2008). N.J. Rev. Stat. 54:10A-6(C) (2008). N.J. Admin. Code 18:7-7.2(a). The regulation is set to expire on September 1, See N.J. Admin. Code 18: It is unclear, whether this regulation will be extended. Id. N.J. Natural Gas Co. v. Division of Taxation, 24 N.J. Tax 59 (April 17, 2008). Statement to Assembly, dated October 23,

21 Net Operating Losses ( NOL ) NOL Carryforward May Be Extended Until recently, New Jersey permitted a carryforward of a corporation s net operating losses ( NOL ) only for seven years. 14 Assembly Bill No. 2130, introduced September 22, 2008 (identical Senate Bill No. 2130, introduced October 2, 2008), proposed to extend the carryforward period from seven years to 20 years for privilege periods ending after June 30, The Statement in support of the Bill stated that the carryforward extension would bring New Jersey in line with New York, Pennsylvania, Connecticut, Delaware, and even though it does not turn New Jersey into the state with the business-friendliest system of taxation, it does nonetheless make New Jersey more welcoming to businesses. On November 24, 2008, Governor Jon Corzine signed this legislation allowing businesses to carryforward net operating loses for up to 20 years. 15 Because the impact of this legislation will not take place until fiscal year 2018, the Division did not determine the legislation s impact on New Jersey s tax revenue. 16 Considering that Governor Corzine explicitly stated his support for increasing the NOL carryforward for 20 years, it is not a surprise that this legislation was signed into law this fast. 17 Suspension of NOLs During the Period Was Double Trouble to Liquidated Companies During the period, New Jersey suspended NOL deductions for privilege periods and limited the NOL deduction to 50% of a corporate taxpayer s taxable income during privilege periods. 18 Assembly Bill No. 723, introduced January 8, 2008 (identical Senate Bill No. 263, introduced January 8, 2008), would allow corporate taxpayers to use the NOLs in the period to offset any gain generated from the sale of assets pursuant to a plan of complete liquidation, thus assuring that the liquidating business does not forfeit the entire value of its NOLs. It seems unlikely that this Bill will be enacted, as there is no legislative activity with respect to this Bill other than its initial introduction and referral to the Assembly Appropriations Committee and Senate Budget and Appropriations Committee. This Bill s passage is further unlikely because it does not provide a future tax benefit, but rather gives grounds to a potential refund claim by taxpayers that liquidated between 2002 and 2005, forfeiting their NOLs. Another Senate Bill No. 259, introduced January 8, 2008 (no identical Assembly Bill introduced), N.J. Rev. Stat. 54:10A-4(k)(6)(B). Press Release, Jon S. Corzine, Governor, dated November 24, Fiscal Note, dated October 14, Press Release, Jon S. Corzine, Governor, dated October 16, N.J. Rev. Stat. 54:10A-4(k)(6)(E). 21

22 retroactively restores the former NOL deduction for the period. This Bill has not been acted upon since its introduction in the Senate. Single-Factor (Receipts-Only) Apportionment Under Consideration for Some (or All) As stated above, corporate taxpayers apportion New Jersey income based on the three-factor apportionment formula. Assembly Bill No. 2626, introduced May 12, 2008 (identical Senate Bill No. 2136, introduced October 6, 2008), would require manufacturers to apportion their New Jersey income based on a single-factor (receiptsonly) apportionment formula. A manufacturer is a corporation that is engaged in activities classified under the NAICS Sectors 31, 32, and 33, and generates more than 50% of its federally reported gross receipts from sales derived from those activities and the corporation s federally reported gross receipts from sales for the privilege period are more than 50% of its federally reported income for the privilege period. 19 If enacted, the law applies to periods beginning on or after July 1, On October 6, 2008, the Assembly Commerce and Economic Development Committee voted favorably in support of the Bill. The fiscal impact of changing to the single factor apportionment formula has not been provided. On the date of this article no further action has been taken with respect to this Bill. In his economic stimulus plan, Governor Corzine directed the Treasury to to work with businesses to move toward a single sales factor tax computation. 20 In light of the pending legislation, it is unclear whether this statement is intended to apply only to manufacturers or to all corporations. It should be noted that Assembly Bill No: 1224, introduced January 8, 2008 (no identical Senate Bill introduced), provides single sales factor apportionment for all corporations, and not just manufacturers. However, this Bill has not received consideration by the Assembly after its introduction. Tax Exemption for Manufacturing Manufacturers may get tax breaks in addition to the single-factor apportionment bill discussed above. Senate Bill No. 1578, introduced January 28, 2008 (no identical Assembly Bill introduced), exempts sales of energy and utility services to certain manufacturing facilities from the sales and use tax and the transitional energy facility assessment unit rate surcharge. The purpose of the Bill is to encourage manufacturers to stay in New Jersey and to expand their operations there. 21 The Bill projects that the exemption would result in 10% savings to manufacturers in taxes assessed against their energy use. Subsequent to its introduction, this Bill has not generated any additional legislative activity. New Jersey Appears Destined to Become More Business Friendly Corporate taxpayers with New Jersey tax liabilities will likely see reduced tax bills. The 20 year NOL carryforward was the first stimulus package to become law. The repeal of the throwout and regular place of business rules add to the package. Beginning July 1, 2010, the New Jersey legislature plans to absorb the revenue impact of an estimated $149 million per year to eliminate the throwout rule and the regular place of business requirement to help spur the State s economy. 19 Id. 20 Press Release, Jon S. Corzine, Governor, dated October 16, Id. 22

23 Boston Massachusetts Applies The Operational Approach For Sourcing Of Sales Other Than Sales Of Tangible Personal Property Kirk Kringelis Atlanta (404) In the recent Interface Group decision, 1 the Massachusetts Appellate Tax Board ( Board ) applied a broad operational approach to source receipts from sales of services for income tax apportionment. Under the operational approach, the cost of performance rules look to the taxpayer s entire income-producing operations during the year, not just the specific transaction, to segregate separately identifiable items of income. Using the operational approach, the Board held that all of the taxpayer s receipts from the sale of vacation travel packages should be included in the numerator of its Massachusetts sales factor based on its finding that the greater portion of its overall operational costs, including overhead, were incurred in Massachusetts. The taxpayer had sought to apply the transactional approach to determine cost of performance for out-of-state sales. Under the transactional approach, the direct cost of performance is determined on a transaction-bytransaction basis. In Interface Group, the operating process was considered to be the packaging and selling of travel packages, not the sale of individual components of air travel, hotel accommodations and ground transportation. The costs of the income producing operations included substantial personnel and overhead at the taxpayer s offices in Massachusetts. Taxpayers that are based out of state may find the Massachusetts operational approach more beneficial than a transactional approach because the costs included in a cost of performance analysis under the operational approach are generally broader than under a transactional approach. Where an operational approach is applicable, taxpayers based outside Massachusetts may be able to include a greater amount of their non- Massachusetts overhead in their cost of performance analysis, increasing the likelihood that their sales would be sourced outside Massachusetts. The operational approach is also less burdensome from a compliance perspective because taxpayers are not required to analyze their costs of performance on a transaction-by-transaction basis. As discussed below, the operational approach adopted by Massachusetts appears to cut against the market-based trend for apportionment reflected in the Multistate Tax Commission s (MTC s) recent amendments to the sales factor regulation. Background The Interface Group ( Interface ) 2 was a public charter tour operator that created and marketed vacation travel packages in bulk to destinations primarily in the Caribbean Islands and Mexico. After Interface assembled the travel packages, they were sold to the public through various independent travel agents. The prices of the packages were established by Interface and the travel agents passed on those prices (plus the agents commissions) to their customers, who were the ultimate consumers of the travel packages. 1 2 The Interface Group v. Comm r of Revenue, 2008 WL (Mass. App. Tax. Bd. 2008). Interface involved an S Corporation, so the majority shareholder was also subject to tax on the income attributable to Massachusetts. 23

24 All travel packages included air transportation, hotel accommodations, and ground transfers. Interface had employees in Massachusetts and outside Massachusetts who assembled the travel packages by contracting with various independent air carriers, hotels, and ground transportation providers for the purchase of their respective services. Because most of the vendors were located outside Massachusetts, Interface s employees often traveled outside Massachusetts to negotiate and execute bulk contracts. If Interface could not sell all of the seats or rooms for which it had contracted, it typically was still required to pay for the unused ticket or room. The guaranteed revenue stream to the airlines, hotels, and ground transportation providers enabled Interface to offer competitive prices for the various components of the travel packages. The vast majority of Interface s employees were based in its Needham, Massachusetts office. These Massachusetts based employees acted as liaisons with the destination hotels, coordinated Interface s marketing, and assembled the travel packages. Over 90% of Interface s payroll was paid to employees operating in Massachusetts. Interface also had employees or independent representatives located at each travel destination to meet its customers and assist with the overall servicing of those customers. Interface placed the funds that it received from the customers in an escrow account until the vacation was completed. In its books and records, Interface accounted for the sale of each travel package as a separate transaction for each individual customer. Based on Interface s accounting records, the costs for the airfare, hotel accommodations, and ground transportation accounted for approximately 90% of its direct costs for providing each travel package. However, in analyzing Interface s total costs on a yearly basis rather than a per-transaction basis, the costs allocated to Massachusetts, including overhead and personnel costs, were greater than the costs allocated to any single destination, even when the costs for airfare, hotel accommodations, and ground transportation were included in Interface s costs of performance and sourced to the destination locations. The primary issue in the case was whether, for purposes of determining the numerator of Interface s Massachusetts sales factor, Interface s income-producing activity was each individual sale of the travel packages (a transactional approach) or whether it was the overall operation of assembling, marketing, and selling travel packages (an operational approach). Massachusetts Excise Tax Apportionment Provisions Interface was required to apportion its income to Massachusetts using a three-factor apportionment formula that consisted of a property factor, a payroll factor, and a double-weighted sales factor. 3 Only the computation of Interface s sales factor was at issue. A corporation s sales factor is a fraction, the numerator of which is the total sales of the corporation in Massachusetts during the taxable year, and the denominator of which is the total sales of the corporation everywhere during the taxable year. 4 In situations where a corporation performs income-producing activities both in and outside Massachusetts, a corporation s receipts from sales, other than sales of tangible personal property, are considered Massachusetts sales if a greater proportion of those income-producing activities is performed in Massachusetts than in any other state, based on costs of performance. 5 The Massachusetts Department of Revenue s ( Department ) regulations define an incomeproducing activity as: See Mass. Gen. Laws ch. 63, 38(c)-(f). Mass. Gen. Laws ch. 63, 38(f). Id. 24

25 a transaction, procedure, or operation directly engaged in by a taxpayer which results in a separately identifiable item of income. In general, any activity whose performance creates an obligation of a particular customer to pay a specific consideration to the taxpayer is an income-producing activity. 6 The regulations further provide that a corporation s income-producing activities generally do not include services performed on its behalf by an independent contractor. 7 Appellate Tax Board Decisions This case had an interesting procedural history. The Commissioner of Revenue ( Commissioner ) issued a notice of assessment, which Interface paid while it sought an abatement. In its initial decision, 8 the Board affirmed the Commissioner s denial of the abatement applications. Upon appeal, the Appeals Court of Massachusetts reversed and remanded the Board s decision for a reconsideration of the issues raised in the appeal. 9 Upon remand, the Board reinstated its original decision for the Commissioner. Interface had argued that 830 Code Mass. Regs (9)(d)(2) ( the Regulation ) required its income-producing activity to be determined based on a transactional approach. Specifically, Interface contended that each separate sale of a vacation travel package to an individual customer was an income-producing activity and should be separately analyzed to determine whether the sale proceeds should be allocated to Massachusetts. 10 The Board rejected Interface s transactional interpretation of the Regulation and concluded that the Regulation required an examination of a taxpayer s overall business to determine the taxpayer s income-producing activity and that an income-producing activity is activity in which the taxpayer directly engages which generates sales income to the taxpayer. 11 This analysis requires a close analysis of the particular facts Code Mass. Regs (9)(d)(2). Id. The Interface Group v. Comm r of Revenue, 2006 WL (Mass. App. Tax. Bd. 2006). Interface Group v. Comm r of Revenue, 888 N.E.2d 969 (Mass. App. Ct. 2008). See Interface, 2008 WL , at *7; Interface, 2006 WL , at *10. Interface, 2008 WL , at *8. 25

26 and circumstances of each case to determine the activity that produces all the income which is subject to apportionment. 12 The Board noted that [t]he regulation does not permit a taxpayer to cherry-pick from among its subsidiary activities so as to characterize its income-producing activity in the manner which results in the most favorable tax treatment. 13 Based on Interface s facts, the Board determined that Interface was not directly engaged in the sale of individual vacation tours to individual customers. 14 Rather, Interface purchased the components of its tour packages in bulk and sold the packages indirectly through travel agents. 15 Accordingly, the Board ruled that the incomeproducing activity that generated Interface s sales income was its overall operation of a business which negotiates, purchases, assembles, packages and markets tours in bulk because Interface s performance of this overall operation creates its income which is subject to apportionment. 16 Thus, the Board applied an operational approach to determining Interface s income-producing activity. Based on this operational approach, the Board concluded that the separately identifiable item of income which resulted from Interface s income-producing activity was the annual amount that it received for the sales of its vacation packages. 17 The Board also ruled that Interface s costs of performance necessarily included all the costs that give rise to the sales income to be apportioned, including the substantial personnel and overhead costs incurred in [Interface s] Needham office. 18 Because a greater proportion of these costs of performance were incurred in Massachusetts than in any single state other than Massachusetts, the Board upheld the Commissioner s assessment and ruled that the Commissioner properly characterized Interface s receipts from its sales of vacation travel packages as Massachusetts sales. 19 The Board s application of an operational approach to determining Interface s incomeproducing activity is consistent with its decision in Boston Professional Hockey Ass n, 20 in which the Board also adopted an operational approach. In situations where taxpayers believe that an operational approach should be applied for purposes of determining their income-producing activity, the Interface Group and Boston Professional Hockey Assn n decisions may provide taxpayers with some comfort that the Commissioner and/or Board will agree with their application of such an approach. However, taxpayers should not assume that the Commissioner and/or Board will always apply an operational approach. During the appeal of the Board s initial decision in Interface Group, the Board acknowledged that the Regulation does not stand for the proposition that a corporation s overall operation is, ipso facto, its income-producing activity. 21 Taxpayers based outside Massachusetts may find an operational approach more beneficial than a transactional approach because the scope of Id. Id. Of course, taxpayers would argue that the Regulation does not permit the Commissioner to indiscriminately group together a taxpayer s various activities so as to characterize its income-producing activity in the manner which results in the least favorable tax treatment. Id., 2008 WL , at *9. Id. Id. Id. at *10. Id. at *9. Id. at * Boston Professional Hockey Ass n v. Comm r of Revenue, 820 N.E.2d 792 (Mass. 2005) Interface, 888 N.E.2d 969, 975 (internal quotations omitted). 26

27 costs that are included in a cost of performance analysis under the operational approach is likely to be broader than it would be under a transactional approach. As a result, taxpayers based outside Massachusetts may be able to include a greater amount of their non-massachusetts costs in their cost of performance analysis thereby increasing the likelihood that their sales would be sourced outside Massachusetts. The Regulation generally provides that a taxpayer s costs of performance are its direct costs determined in a manner consistent with generally accepted accounting principles. 22 In situations where a taxpayer s entire operation is considered a single income-producing activity, there may be a wider variety of costs that could be considered direct costs. For example, in Interface Group, the Board included the overhead costs associated with Interface s Massachusetts office as part of its costs of performance even though overhead costs are typically considered indirect costs. For taxpayers based outside Massachusetts, the inclusion of overhead costs in an operational cost of performance analysis may increase the likelihood that their sales would be sourced outside Massachusetts. MTC Comparison It is interesting to compare the operational approach adopted by the Board with the MTC s recent amendments to its model sales factor regulation, MTC Regulation IV.17 ( MTC Regulation ). In August 2007, the MTC amended the MTC Regulation s definition of the term income producing activity to include the transactions performed by independent contracts on behalf of the taxpayer. 23 The MTC also amended the MTC Regulation s definition of the term costs of performance to include payments by the taxpayer to an independent contractor for the performance of personal services. 24 For many service providers, the MTC s amendments place more emphasis on activities performed in states that represent the market for the taxpayer s services. For example, payments made by a taxpayer to independent contractors for services that are performed in the market states would increase the taxpayer s costs of performance in those states. As a result, the proportion of the taxpayer s total costs of performance would increase in the market states. In contrast, the Board s operational approach and inclusion of overhead costs in the cost of performance analysis places additional emphasis on costs incurred by the taxpayer in the state(s) where it is headquartered or performs administrative functions. For taxpayers based outside Massachusetts, these costs would likely be incurred outside Massachusetts. As a result, the proportion of a taxpayer s total costs of performance would increase in the state(s) where its headquarters are located and where its administrative functions are performed. Taxpayers should note that Massachusetts is not an MTC Compact member state that has adopted the Multistate Tax Compact into its laws. It is, however, an Associate member state that consults and cooperates with the MTC and other member states on MTC programs and projects. The Department has not amended its Regulation to conform to the MTC s amendments to the MTC Regulation. It remains to be seen whether the Department will make conforming amendments and, if so, whether the Commissioner and/or Board will continue to advocate an operational approach to sourcing sales other than sales of tangible personal property Code Mass. Regs (d)(4). MTC Regulation IV.17(2). MTC Regulation IV.17(3). 27

28 Nexus: Update on Recent Developments Maryann B. Gall Laura A. Kulwicki Phyllis J. Shambaugh Columbus Columbus Columbus (614) (330) (614) We keep track of nexus developments on a regular basis legislation, administrative interpretations, the passage of rules and regulations, and court cases. This issue of our newsletter updates important nexus developments during the Third and Fourth Quarters of It is organized by the kind of activity that tends to give out-of-state entities nexus planning and litigation difficulties. This issue includes recent decisions in Missouri, New York and Virginia regarding sales personnel who travel in and out of the state, a new development about website nexus in New York, a discussion of the decisions of Oklahoma and Texas courts that reached opposite conclusions on the nexus implications of stored natural gas, affiliate nexus developments in California, Kentucky, Massachusetts and Virginia, a New Mexico case on agency nexus, economic nexus cases in Iowa, Maryland and Massachusetts and administrative rulings in Texas and Virginia regarding the type of activities that exceed the protection of P.L EMPLOYEE VISITS It s no surprise that the Virginia Tax Commissioner found that the presence of the Taxpayer s sales representatives in Virginia creates use tax collection responsibility. Representatives soliciting sales in a state on behalf of a company always create use tax nexus. VIRGINIA Ruling of Commissioner, P.D , CCH (Va. Dep t of Tax., Sept. 11, 2008). 1. An out-of-state corporation (the Taxpayer ) was a provider of broadcast computer equipment (servers) and software used to transmit data via television. In connection with its server sales, the Taxpayer provided installation, customer support, training services, and repair and maintenance services. The taxpayer did not maintain a home office in Virginia and did not employ Virginia residents for sales or active solicitation. Instead, the Taxpayer used traveling sales representatives that solicited sales to Virginia based customers and provided installation and maintenance services to these customers. The Taxpayer sought a ruling that its sales of broadcasting equipment and services were exempt from the Virginia retail sales and use tax. 2. The court found that pursuant to Va. Code A, the sales tax was collectible from all persons who are dealers. Dealers was defined to include every person who imports or causes to be imported into this Commonwealth tangible personal property from any state or foreign country, for sale at retail, for use, consumption, or distribution, or for storage to be used or consumed in this Commonwealth. The statute further provided that a dealer will be deemed to have sufficient activity or nexus in Virginia if the dealer solicits business in Virginia by employees, independent contractors, agents or other representatives. The court held that the Taxpayer satisfied this requirement through its use of traveling sales representatives that solicit sales to Virginia based customers and provide installation and maintenance services to these customers. Therefore the Taxpayer was subject to the registration 28

29 NEW YORK and collection requirements of the Virginia retail sales and use tax. In reaching this conclusion, the court also noted the United States Supreme Court case General Trading Co. v. State Tax Commission of Iowa, in which the presence of traveling salesman in a state constituted sufficient nexus to impose use tax collection responsibilities. See 322 U.S. 335 (1944). In that case the requirement to collect Iowa s use tax was upheld regardless of the fact that the taxpayer did not maintain a branch, office, or warehouse in Iowa. Here s another case in which the New York Tax Appeals Tribunal found that the physical presence of an employee in the state created substantial nexus. In re J.C. Newman Cigar Company, DTA NO , New York Division of Tax Appeals, Tax Appeals Tribunal, (Nov. 06, 2008), CCH Petitioner, J.C. Newman Cigar Company, manufactured cigars at its facility in Tampa, Florida. In addition to manufacturing, it also imported cigars from various countries for sale to customers in the United States. Petitioner s only office was in Tampa. Petitioner sold tobacco products to customers (tobacconists, tobacco outlets, and chain stores; not individuals) in New York State and shipped the products via a common carrier. Petitioner was not registered in New York State as a distributor or wholesaler of tobacco products and did not file tobacco products tax returns in New York State. 2. Petitioner mails catalogs or informational brochures from its Tampa office to promote the sale of its cigars. Petitioner employed a salesperson whose territory consisted of New York and portions of New Jersey and North Carolina. The salesperson visited existing accounts in his designated sales territory from once every six weeks to once every four months. Petitioner filed New York State withholding tax returns and paid New York State withholding tax on this employee. Petitioner argued that its activities in New York were insufficient to satisfy the Commerce Clause and that it should not be subject to tobacco products tax on products sold to customers in New York. 3. Consistent with its prior decisions, the Tax Appeals Tribunal found that the constitutional standard is met if an out-of-state manufacturer engage[s] independent nonexclusive in-state representatives on a commission basis to seek out and maintain business through repeated visits to potential and current retailers to market products, inspect retail displays and inquire 29

30 about problems with the products. Such regular marketing efforts satisfy the requirements of the Commerce Clause. TEMPORARY IN-STATE PRESENCE INDIANA The Indiana Department of Revenue found that a related company s handling of customer complaints and providing onsite technical assistance were solicitation activities protected by P.L However, the Department found that the storage of inventory in Indiana was significantly associated with the Taxpayer s ability to establish and maintain a market and created income tax nexus. Letter of Findings , CCH (Ind. Dep t of Rev. Oct. 1, 2008) 1. Taxpayer corporation was headquartered outside but domiciled in Indiana. It filed a consolidated adjusted gross income tax return which included several related companies. After an audit, the Indiana Department of Revenue issued proposed assessments for additional adjusted gross income tax which added two related companies to the consolidated group. Taxpayer protested claiming that these two related companies did not have nexus with Indiana. 2. The first related company ( Related 1 ) had sales staff in Indiana which would occasionally pick up out-dated or malfunctioning equipment, help with paperwork regarding damaged goods, provide on-site technical assistance, conduct in-state training seminars, and supervise the installation or usage of products. It also owned property in Indiana -- molds and dies -- which it provided to unrelated manufacturers that used the molds and dies to produce containers for Related 1 s products. 3. The Department acknowledged that P.L precludes Indiana from imposing an income tax on a company that only solicits orders in Indiana, and that the Indiana Supreme Court held that acts of courtesy to accommodate a customer do not exceed solicitation. 4. The Department applied Tyler Pipe Industries, Inc. v. Washington State Department of Revenue, 483 U.S. 232 (1987) and asked if the activities performed in [Indiana] on behalf of the taxpayer are significantly associated with the taxpayer s ability to establish and maintain a market in [Indiana] for the sales. 5. Under this standard, the Department found that Related 1 s sales staff s activities were acts of courtesy and, therefore, insufficient to establish nexus. In addition, the molds and dies used by third-party contractors, the Department found, did not contribute to Related 1 s ability to maintain a market in Indiana and did not establish nexus. 6. The second related company ( Related 2 ) had sales staff in Indiana and also had inventory at several Indiana hospitals. The hospitals purchased and removed the goods from the inventory on an as-needed basis. 7. Despite Related 2 s argument that its inventory in the state should not establish nexus because the goods were held on consignment at the hospital, the Department found that Related 2 had a substantial nexus with Indiana because it held property in Indiana for later distribution. Related 2 s actions on behalf of Taxpayer were significantly associated with the taxpayer s ability to establish and maintain a market in Indiana for sales of its goods, so those activities established nexus. 8. Taxpayer also protested the Department s decision to apply Indiana adjusted gross income tax to Taxpayer s sales to foreign countries under a throwback rule. Taxpayer supplied documentation to show that it retained title to its 30

31 INDIANA goods until the goods were delivered to customers in foreign countries. The Department originally found that Taxpayer did not have nexus in the foreign countries, so its sales should be taxed in Indiana. Upon protest, the Department found that, because delivery occurred after entry into those countries, Taxpayer had inventory in those countries and therefore had adequate nexus with them. Thus, its income from those sales was not subject to the throwback rule. In this Letter of Findings, the Department again found nexus based on the presence of the taxpayer s products in Indiana. Here, the taxpayer claimed nexus in other states to circumvent the Department s attempt to throw back sales. Dept. of Revenue, Letter of Findings Nos , , (Oct. 1, 2008). 1. Taxpayer sold replacement parts for recreational vehicles and commercial trucks. Taxpayer often sent parts to repair shops in other states near stranded drivers locations. The Department determined that Taxpayer s income from other states was subject to a throwback rule because Taxpayer lacked nexus with those other states. Similarly, the Department determined that Taxpayer s shareholder owed additional Indiana adjusted gross income tax due to additional income attributable to the corporation. 2. Taxpayer and Taxpayer s shareholder protested the imposition of the Indiana adjusted gross income tax, arguing that the corporation did have substantial nexus with the other states. Taxpayer submitted letters from the various states Departments of Revenue in which the departments found that Taxpayer had sufficient nexus with those states. In addition, Taxpayer explained that it did pay income taxes to those states. 3. The Board read Tyler Pipe Industries, Inc. v. Washington State Department of Revenue, 483 U.S. 232 (1987) and Wisconsin Dept. of Revenue v. William Wrigley, Jr., Co., 505 U.S. 214 (1992) together to provide that an independent contractor s actions may be considered when determining nexus for a taxpayer which has no employees of its own in a state and that the contractor s actions are to be considered with all other activities by the taxpayer in determining whether or not those actions and activities are de minimis. 4. The Department found that Taxpayer was dependent on repair shops activities in other states to maintain sales in those states where it does not have repair shops. Taxpayer also had inventory in those states when it shipped the parts to the repair shops and the shops did not install the parts immediately, since the shops never took title to the parts. In addition, because the Taxpayer proved other states departments had determined it had sufficient nexus and, indeed, Taxpayer had filed income tax returns with all of the states in question, the Department sustained the Taxpayer s protest. This Letter of Findings demonstrates the nexus danger of delivering merchandise in your own vehicles and sending employees into a state to install your products. The Department easily concluded that nexus was present. Letter of Findings , CCH (Ind. Dep t of Rev. October 29, 2008) 1. Taxpayer sold boat docks and lifts to Indiana residents. After an audit, the Indiana Department of Revenue determined that Taxpayer had failed to remit sales tax on the sales of boat 31

32 docks and lifts to Indiana residents. Taxpayer protested the imposition of sales tax. 2. Department ruled that taxpayer s contact was more than the mere solicitation of business or delivery by a third-party carrier, because (1) taxpayer sold and delivered products to Indiana residents using its own vehicles to transport the items; (2) taxpayer s employees helped install the items; and (3) at times, terms of payment such as cash on delivery were fulfilled in Indiana. Two state courts recently reached different conclusions on whether the assessment of ad valorem tax on stored natural gas violates the Commerce Clause. The Oklahoma Supreme Court said NO, and affirmed the assessment. The Texas Court of Appeals said YES, and reversed the assessment on stored natural gas. OKLAHOMA In the Matter of the Assessment of Personal Property Taxes, 2008 OK 94 (Oct. 21, 2008), 2008 Okla. LEXIS The Woods County Assessor (the Assessor ) issued an omitted property tax assessment against Missouri Gas Energy ( Energy ) for natural gas held in an underground storage facility in Woods County, Oklahoma (the County ). Energy appealed to the trial court which ruled in favor of Energy. Assessor appealed to the Supreme Court. 2. Energy was a local gas distribution company with a principal place of business in Kansas City, Missouri. It purchased natural gas from suppliers in Texas, Kansas and Oklahoma and contracted with Panhandle Eastern Pipeline Company ( Panhandle ), an interstate carrier of natural gas, to transport the gas to Missouri. Energy did not sell gas in Oklahoma and did not have facilities or employees in the state. 3. During transport, some of the natural gas was stored at a site in the County. Panhandle offered a storage service to its shippers, whereby the shippers nominated gas into storage. While the shippers made an election to store gas, they could not specify which storage facility was to receive the gas nominated for storage. In addition, the molecules of gas that went into a storage facility were very unlikely to be the same molecules that the shipper purchased. It was not possible to trace the stored molecules of gas. Assessor argued that the gas stored in the County was subject to ad valorem taxation by the County. 4. Upon review, the Court found that (1) the tax was levied upon gas stored in the County and not upon an intangible interest in that gas, (2) the gas stored in the County had a taxable situs in the County, (3) the gas in the County was owned in common by all shippers with storage volume on the Panhandle Pipeline system, (4) the tax was not barred by the Commerce Clause and (5)Energy s stored gas was not covered by the Freeport Exemption. 5. In analyzing the Commerce Clause issue, the Court used the four-part test from Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977). The Court stated that [u]nderlying the Brady analysis and contemporary Commerce Clause jurisprudence in general is the conviction that those engaged in interstate commerce must expect to pay their just share of state tax burdens. The Court rejected the use of an analysis that would focus on whether a tax was proper based on an interruption in transit that took the goods out of interstate commerce (the analysis used by Peoples Gas). 6. The first prong of the Brady test is whether there is substantial nexus between the property taxed and the 32

33 taxing state. The Court found that Energy had substantial nexus in the County. Energy argued that its only contact with Oklahoma was its contractual relationship with Panhandle and regardless of how long the gas was present in the County, it was merely passing through the state and therefore could not have nexus in Oklahoma. The Court found that, because some portion of the gas was stored in the state at all times, it was not merely passing through. Although Energy had no control over the gas in storage or the timing of its return, Energy elected and intended to have the gas stored and because it contracted with Panhandle, Energy knew the gas would be stored in either the County or a facility in Kansas. The Court based its finding on the fact that Panhandle stored gas on behalf of Energy and a certain amount was stored in the County at all times during the year. The stored gas created nexus in Oklahoma. 7. The Court also found that the remaining prongs of the Brady test were met. First, the tax was fairly apportioned to activities carried on by Energy within the state because the County was seeking to tax gas located in the County and nowhere else. Second, the Court found that the tax was not discriminatory TEXAS because it falls on anyone owning property located in the state on the assessment date. Third, the tax was reasonably related to the services provided by the state to the taxpayer. Energy argued that because it had no offices or employees in Oklahoma, did not use the states infrastructure and did not benefit from police or fire protection (because any loss would fall on Panhandle) it was not benefiting from the state s services. The Court found that the analysis is not whether the tax was proportionate to the amount of benefit Energy received from the state, but rather whether the tax was reasonably related to Energy s contact with the state. Energy s gas is taxed to the same extent as all other personal property in the state. 8. Using the Brady test, the Court found nothing in the record to show that the taxation by the County of Energy s gas stored in the County violated the Commerce Clause. The Peoples Gas, Light, and Coke Company v. Harrison Central Appraisal District, No CV, 6 th App. Dist. of Texas at Texarkana (Sept. 24, 2008). a. The Harrison Central Appraisal District (the District ) assessed a large ad 33

34 valorem tax bill against a portion of natural gas owned by Peoples Gas, Light and Coke Company ( Peoples ). Peoples appealed a judgment favoring the District. b. Peoples was a Chicago distribution company that purchased natural gas from suppliers and delivered it to customers in Chicago, Illinois. Peoples bought gas that was already on an interstate pipeline owned and operated by Natural Gas Pipeline Company of America ( Pipeline ). The gas was also stored on the pipeline. Peoples had no employees, representatives, physical facilities or offices in Texas. It had no presence in Texas other than the stored gas which was the subject of the case. c. A portion of gas was stored at the North Lansing storage facility in Harrison County, Texas in order to provide pressure and balance necessary to facilitate the safe and efficient operation of the pipeline. Pipeline paid ad valorem taxes on this portion of stored gas. The District also assessed ad valorem tax against Peoples. d. Peoples contended that it did not own, for ad valorem tax purposes, any of the natural gas lying beneath Harrison County and, even if it did, the Commerce Clause shielded it from taxation by the District because the gas was in interstate commerce. The court found that Peoples did own a portion of the gas, but the District did not have authority to tax Peoples. e. Congress protects interstate business activity by restricting state regulation of interstate commerce. Here, the natural gas entered the stream of interstate commerce when it was placed with the common carrier, Pipeline. In addition, the court found that the gas stored at the North Lansing center was also in interstate commerce because, although there was a stoppage in transit, Peoples had no control over the operations of the pipeline and did not control where the natural gas was stored. Because the stoppage of natural gas in North Lansing did not serve the business purpose of Peoples, storage, in this case, was part of interstate transportation. f. Since the gas was part of interstate commerce, in order to tax the gas, there must have been some definite link, some minimum connection, between [the] state and the person, property, or transaction it [sought] to tax. Peoples did not have a physical presence in Texas and there was no evidence that the gas was delivered to customers in Texas. The only connection that Peoples had to Texas was through the structure and location of Pipeline s pipeline and Pipeline s decision to store the gas in North Lansing. The connection was not sufficient to subject Peoples to ad valorem taxes. The District contended that nexus existed between the natural gas and the state since much of the gas was Texas-produced. However, since there was no way to ascertain the location from which Peoples allocation of gas originated, the storage of the gas in North Lansing was insufficient to create nexus. g. The court relied on an out-moded theory of taxation regarding movement in interstate commerce to conclude that the taxation of gas owned by Peoples violated the Commerce Clause. For a similar case with a different conclusion, see In the Matter of the Assessment of Personal Property Taxes, 2008 OK 94 (October 21, 2008). IN-STATE PERSONNEL INDEPENDENT CONTRACTORS, SALES REPRESENTATIVES, AND MANUFACTURING REPRESENTATIVES MISSOURI It s not surprising that Missouri found instate representatives soliciting orders on a 34

35 company s behalf created use tax nexus. Instate personnel, if working on a company s behalf, always create use tax nexus. Letter Ruling No. LR4724, CCH (Mo. Dep t of Revenue, May 5, 2008). 1. Applicant is an out-of-state business that sells coffee, hot chocolate, tea, coffee mugs, and t-shirts to schools, churches, and other Missouri non-profit organizations. Applicant has two sales representatives who live in Missouri and work out of their homes. 2. Applicant asked whether it has nexus with Missouri for use tax purposes and the Department of Revenue said yes. Under 12 CSR (1), sufficient nexus exists when the vendor has a physical presence in Missouri. Applicant s two sales representatives who live and sell products in Missouri establish nexus. Therefore, the Department found that Applicant must collect use tax unless an exemption applies to the sales. NEW YORK As reported in our September, 2008 nexus update, New York s much publicized new law creates website nexus for out-ofstate companies if the company has an agreement with a New York resident to refer customers. Here s another lawsuit challenging this law. Overstock.com, Inc. v. New York Dep t of Taxation and Finance, No /2008, (N.Y. Supreme Ct. May 30, 2008). 1. Overstock.com has filed a lawsuit challenging the constitutionality of New York Senate Bill Overstock alleges that because some independently operated, New Yorkbased websites post advertisements with links to Overstock.com and are compensated for these advertisements, Overstock is presumed to be engaged in solicitation under the statute. As a result, Overstock contends that the statute requires it to collect and pay New York sales and use taxes on receipts from sales to New York customers despite the fact that it lacks any physical presence in New York and does not actively solicit business there. 3. Overstock seeks a declaratory judgment that the new statute is invalid and unconstitutional on the grounds that it violates both the Commerce Clause and the Due Process Clauses. Overstock also seeks a permanent injunction that prohibits the Department from enforcing the new statute. VIRGINIA Warranty services performed by unrelated distributors, retailers, and contractors were purchases of services by Taxpayer and did not exceed the protection of P.L Ruling of Commissioner, P.D , CCH (Va. Dep t of Tax., Oct. 17, 2008). 1. The Taxpayer was commercially domiciled outside Virginia and maintained no property or employees in Virginia. Sales solicitation activities by the Taxpayer were limited to those permitted under P.L Taxpayer sold two distinct products. Commercial products were sold directly to contractors that installed the products. Residential products were sold to distributors that, in turn, sold to retailers and contractors for sale to residential customers. 2. Both commercial and residential products carried a parts and labor warranty. Commercial warranties were fulfilled by the contractor that did the installation. In contrast, residential warranties claims were handled by the distributor, retailer or contractor. In both cases, the Taxpayer shipped parts to the entity providing the warranty work and reimbursed the entity for the cost of repairs or replacements. The Taxpayer had no ownership interest in any of the distributors, retailers, or contractors operating in Virginia. The 35

36 Taxpayer sought a ruling as to whether the warranty services provided by a third party entity in Virginia subjected the Taxpayer to Virginia income tax. 3. In a previous ruling, the Department of Taxation affirmed that warranty services carried on in Virginia are not an activity protected by P.L (and are therefore subject to Virginia income tax). See P.D , 1999 WL (Va. Dep t of Tax., Oct. 14, 1999). However, that ruling further stated that the provision of services in Virginia by an independent contractor on behalf of a taxpayer was the purchase by the taxpayer of services from a vendor that were then resold to the taxpayer s customers. Accordingly, such activity would not create nexus for the taxpayer purchasing the services. 4. In this case, warranty services were not purchased from a warranty company. Rather, the services were provided by unrelated distributors, retailers, and contractors. The Taxpayer reimbursed these independent contractors for providing the warranty services. Therefore, in accordance with P.D , the performance of warranty services by the distributors, retailers, and contractors in Virginia were purchases of services by the Taxpayer and did not exceed the protection afforded under P.L Thus, the Taxpayer was not subject to Virginia income tax. AFFILIATE NEXUS States continue to be active in the area of affiliate nexus. The California Board of Equalization reached a settlement with barnesandnoble.com. CALIFORNIA barnesandnoble.com LLC v. State Bd. of Equalization, Case No. CGC (Cal. Super. Ct Sept ). 1. On May 29, 2008, the Board and b a r n e s a n d n o b l e. c o m a g r e e d t o KENTUCKY settle the tax determinations totaling approximately $17.7 million for $9 million. The settlement was for sales and use taxes, interest and penalties through November 1, the date on which barnesandnoble.com voluntarily began collecting and remitting sales and use taxes. In this case, the Circuit Court found that the Department of Revenue s inclusion of subsidiaries with no physical presence in Kentucky in a consolidated income tax return violated the Commerce Clause. The Circuit Court also rejected the Department s claim that AT&T waived its constitutional rights by voluntarily filing a consolidated return. AT&T Corp. v. Kentucky Dep t of Rev., No. 08-CI-01272, CCH (Jefferson Cty. Circ. Ct. Sept. 9, 2008) 1. AT&T is organized under laws of New York and has hundreds of subsidiaries across the nation. Approximately 20 of the subsidiaries were located in Kentucky during the tax period at issue. AT&T filed a consolidated income tax return in Kentucky. AT&T included all of its subsidiaries, including those with no physical presence in the state, and then sought refunds for excess income taxes paid due to the inclusion of those subsidiaries. The Department of Revenue denied AT&T s claims, finding that all of the subsidiaries nationwide comprise an affiliated group for taxation purposes and are thus treated as a single corporation. The Board of Tax Appeals affirmed, reasoning that AT&T elected to be treated as a single corporation by filing a single consolidated return, instead of individual returns for each corporate subsidiary. AT&T appealed. 2. The Court held that the income tax imposed upon AT&T violated the Commerce Clause because the great majority of AT&T s subsidiaries that 36

37 essentially have nothing to do with the state of Kentucky have been forced to pay taxes to Kentucky. The Court noted that out-of-state corporations were forced to pay taxes to Kentucky without enjoying the benefits in-state corporations receive. The Court also rejected the Department s argument that AT&T s voluntary election to file a consolidated return, constituted waiver of its constitutional rights. Because the tax disproportionately favored instate interests while burdening foreign corporations, the court found that it violated the Commerce Clause due to a lack of nexus between the state and the entity it sought to tax MASSACHUSETTS The Massachusetts Appellate Tax Board found substantial nexus here because the taxpayer s intrastate and out-of-state activities constitute a unitary business enterprise. NES Group, Inc. & Tomsich v. Commissioner of Revenue, 2008 WL (Mass. App. Tax. Bd. Sept. 30, 2008). 1. Appellant NES Group was incorporated in Delaware and has its principal place of business in Ohio. NES, at all relevant times, acted primarily as a holding company (either as the general or limited partner) in multiple entities, including several entities that either sold tangible personal property, performed services, or had offices in Massachusetts. 2. In Massachusetts, S-corporations with receipts that meet or exceed $6 million are taxable as an entity. 3. A corporate excise deficiency was assessed against Appellant, based on the Commissioner s reclassification of NES Group as a manufacturing corporation. The Commissioner s reclassification of Appellant took into account the activities of six passthrough entities (limited partnerships and qualified subchapter S subsidiaries) engaged in manufacturing outside the Commonwealth of Massachusetts. a. NES was either a 99-percent limited partner or 100-percent owner in each of these six manufacturing entities. b. None of these six entities owned, rented, or used any real or personal property in Massachusetts. None rendered any personal services or paid any compensation in Massachusetts. However, three of these entities sold tangible personal property in Massachusetts. c. These entities either manufactured industrial equipment, printing equipment, trade show displays, or conveyors. 4. Appellant contended that the inclusion of entities that have no connection to Massachusetts in considering 37

38 m a n u f a c t u r i n g c l a s s i f i c a t i o n i s unconstitutional. In essence, Appellant asserted that Massachusetts cannot tax value earned outside its borders. 5. The Appellate Tax Board stated that substantial nexus is present where the taxpayer s intrastate and out-of-state activities constitute a unitary business enterprise. Since Appellants offered no evidence to establish that the various operating entities under common NES Group Control constituted discrete business enterprises the Appellate Tax Board affirmed the assessment. These Rulings of the Virginia Tax Commissioner offer guidance on the types of affiliation that create nexus for corporation income tax and a non-resident s obligation to pay individual income tax on income received from a Virginia limited partnership that owns land in Virginia. VIRGINIA Ruling of Commissioner, P.D , Virginia Dep t of Taxation, June 26, Type of Tax: Individual Income Tax. 2. Taxpayer was not a resident of Virginia, but owned a 13% limited partnership interest in a Virginia limited partnership ( VLP ). The first issue was whether the VLP s income was taxable and the second issue was whether the tax could be assessed against Taxpayer. 3. VLP s primary asset holdings included various investments, holdings in publicly traded partnerships as a limited partner, two plots of unimproved land, coins and a minority interest in two limited liability companies that owned unimproved land in Virginia. Taxpayer claimed that VLP was not engaged in business in Virginia because VLP had no employees and no property for conducting business and the undeveloped land and coins were not employed in a business carried on in Virginia because they did not generate income. 4. Taxpayer relied on Tax Bulletin 05-6 which stated that pass-through entities that are established solely to invest in intangible personal property and that have no employees and no real or tangible property are not considered to be carrying on a trade or business. However, because VLP owned land, tangible assets and a minority interest in two limited liability companies that owned land in Virginia, VLP did not qualify as an investment pass-through entity. All of VLP s income resulted from a business and was taxable in Virginia. 5. Taxpayer further claimed that the Due Process Clause prohibited her from being taxed because she lacked sufficient contacts with Virginia. However, because the Department had the authority to tax the income of VLP, it had the authority to assess the tax against the Taxpayer as a partner of VLP. It was not a matter of whether the income was subject to tax, but who was to pay the tax. Ruling of Commissioner, P.D , Virginia Dep t of Taxation, July 30, Type of Tax: Corporation Income Tax. 2. Corporation A was a corporation not domiciled in Virginia, but subject to Virginia corporate income tax. Corporation A produced and sold tangible personal property nationwide. It wholly owned Corporation B, which wholly owned Corporation C. The issue was whether Corporation B or Corporation C were subject to Virginia income tax. The Commissioner found that only Corporation C had nexus in Virginia, but was not subject to income tax because it was not clear that it had source income or a positive sales factor. 3. Corporation A generated accounts receivables from the sale of the property. 38

39 It sold the receivables to Corporation B for a discount and Corporation B sold them to Corporation C. Corporation A serviced the receivables on behalf of Corporation C, traveling to Virginia to do so. While in Virginia, Corporation A s collection officers engaged in sales promotion on behalf of Corporation A, the periodic review of existing customers creditworthiness, and the discussion of delinquent accounts. 4. Corporation B did not have nexus because its income was limited to the net proceeds from the resale of the receivables to Corporation C, so it did not have any connections with Virginia that created nexus. 5. Corporation C did have nexus in Virginia because Corporation A s employees serviced its receivables in Virginia. Although an independent contractor s services in the same situation would not have created nexus for Corporation C, because Corporation C was indirectly owned entirely by Corporation A, Corporation A s services were imputed to Corporation C for nexus purposes. The following ruling illustrates the nexus consequences of a related brick-and-mortar store accepting returns of merchandise purchased from a related out-of-state mailorder seller. It also demonstrates that nexus risk may result from an unrelated third-party s set-up and installation of merchandise. Ruling of Commissioner, P.D , CCH (Va. Dep t of Tax., September 11, 2008). 1. The Taxpayer was an out-of-state corporation that sold its products to Virginia customers through mail order and via the Internet. Its products were delivered by unrelated third party contract carriers. 2. The Taxpayer was related to an entity (Stores) that had retail stores located in Virginia that sold many of the same products as the Taxpayer. As a service to their customers, the retail stores accepted returns of merchandise purchased from the Taxpayer. The Taxpayer s website did not advertise that returns were accepted at retail stores, but instead instructed customers to ship merchandise directly to its distribution center located outside Virginia. Taxpayer requested a ruling that it did not have nexus with Virginia for purposes of corporate income tax. 3. Delivery. In this case, delivery services were provided by unrelated third party contract carriers. The Taxpayer argued that its use of carriers that were independent contractors was protected by P.L However, the delivery companies unpacked merchandise, provided minor setup s e r v i c e s, i n s p e c t e d p u r c h a s e d property for quality and damage, and removed packaging materials. The Tax Commissioner concluded that depending on the manner in which these activities were carried out, they could exceed the solicitation of sales in Virginia. If the activities of the contract carriers went beyond the solicitation of sales, such activities would not be protected by P.L The Tax Commissioner stated that she did have enough information about the activities of the contract carriers to resolve this issue. 4. Merchandise Returns. Stores operated retail stores and its activities were separate from the Taxpayer. However, the Taxpayer s relationship with Stores was such that there was direct or indirect common ownership so that the two entities were included in the same corporate family. Under such circumstances, the Tax Commissioner found the issue to be whether the agent (Stores) was independent from the principal (the Taxpayer) it represented. According to the Tax Commissioner, the mere potential of an entity to control 39

40 an agent disqualifies the agent as an independent contractor, even if the agent is an unrelated corporation. In a case where a corporation is performing services for a related entity, there is a strong presumption that the right or potential of control is present at minimum, and that actual control likely exists as well. 5. The facts indicated that Stores accepted returns of merchandise from customers who purchased items through the mail or over the Internet. The Tax Commissioner held that because customers regard for the mail order or Internet seller is enhanced by the availability of a place to return merchandise locally, the Taxpayer benefited from Stores policy even if its website did not advertise that merchandise may be returned to Stores locations. Moreover, Stores provided an additional service not provided to unrelated third parties. Stores provided a local shipping point for the Taxpayer s returned merchandise not carried in the retail store; Stores did not provide similar services to unrelated third parties. Again, this illustrated that more services were provided to related entities than to unrelated third parties. 6. The Tax Commissioner has typically found that such internal business policies and accounting practices are a function of a corporate family of business acting in its own best interest and the desirability of portraying the public image of a seamless entity. As such, the Tax Commissioner concluded that Stores return policy, when conducted in Virginia on behalf of the Taxpayer, constitutes sufficient nexus to the state for taxation. UNRELATED IN-STATE PRESENCE States continue to assert nexus based on the in-state activities of unrelated third parties. The New Mexico Court of Appeals found nexus here based on its finding that the unrelated third-party s in-state activities helped the taxpayer establish and maintain a market in New Mexico. NEW MEXICO Dell Catalog Sales L.P. v. New Mexico Taxation and Revenue Dep t, No. 26,843, 189 P.3d 1215 (N.M. Ct. App. 2008). 1. Dell Catalog Sales L.P. (Taxpayer) is a limited partnership with its principal place of business in Texas. Taxpayer does not own or lease property in New Mexico, has no retail stores in the state, and has no sales agents or employees there. The Taxpayer also does not franchise or license its trade name in New Mexico. Instead, Taxpayer, uses a direct to the customer sales model, to sell computers to individual customers. The individual customers contact Taxpayer in Texas to place orders directly by phone, mail, fax, or over the internet. Taxpayer also advertises by mailing catalogs to potential customers in New Mexico. Taxpayer makes all shipments to New Mexico customers by common carrier. 2. Taxpayer s limited warranty is a return to factory. Customers who want athome repair services are offered service contracts provided by an unrelated thirdparty service provider, BancTec U.S.A., Inc. When customers need repair, they contact Taxpayer. About 75% of New Mexico customers purchased the additional service contract. 3. In July, 1999, the Taxation and Revenue Department audited Taxpayer and 40

41 determined that it had not reported or paid gross receipts taxes on computer sales to New Mexico customers or compensating taxes on the value of advertising materials distributed in New Mexico. Taxpayer protested the assessment, but the hearing officer found that taxpayer was liable for gross receipts tax. Taxpayer appealed, arguing in part that the imposition of gross receipts tax and compensating tax violates the Commerce Clause. 4. The court noted at the outset that it had to address the extent to which a third party can establish substantial nexus on behalf of an out-of-state business sufficient to satisfy Commerce Clause limitations on state taxation. In such cases, the crucial factor governing nexus is whether the activities performed in this state on behalf of a taxpayer are significantly associated with the taxpayer s ability to establish and maintain a market [in the taxing state] for the sales. Tyler Pipe Indus., Inc. v. Wash. State Dep t of Revenue, 483 U.S. 232, 250 (1987). 5. The court found that BancTec s activities helped Taxpayer establish and maintain a market, which is the crucial factor in establishing nexus. Taxpayer, through its relationship with BancTec, had substantial nexus with New Mexico and was subject to gross receipts and compensating tax. IN-STATE ADVERTISING/SOLICITATION Local advertising can create nexus risks. In an advisory ruling, the New York Tax Commissioner stated that advertising via satellite or cable television alone does not create nexus. Likewise, in a letter ruling, the Missouri Department of Revenue found that magazine advertising alone does not create nexus. Administrative Ruling, CCH (N.Y. Comm r of Taxation and Finance, Aug. 6, 2008). 1. Petitioner, Gems TV USA Limited, a Delaware Corporation, is a retailer of gemstone jewelry. Petitioner has no locations or employees in New York and does not maintain a place of distribution, sales, storage, or a warehouse in the state. All products are warehoused in Nevada and are shipped from a location outside New York to New York customers via UPS. Petitioner s shopping programs are filmed in its studio located outside New York. Petitioner has an agreement with a satellite television provider (STP) that provides that STP will broadcast its shopping programs via satellite. Petitioner s products are available through a dedicated television home shopping channel owned by STP. Petitioner also has an agreement with a procurer to purchase airtime and distribute petitioner s programming on various cable television networks. All orders are sent to petitioner via internet or toll-free numbers. Petitioner also maintains a sales website. 2. In response to a request for an advisory opinion, the Commissioner found that an out-of-state seller that merely advertises via satellite and cable television stations in New York does not have nexus with New York. In addition, contractual relationships for the purchase of airtime or advertising of the kind described with STP, the procurer, and cable operators do not provide an out-of-state seller the physical presence needed for nexus. Letter Ruling No. LR4991, CCH (Mo. Dept. of Revenue, Aug. 19, 2008). 1. Applicant is an out-of-state company that sells diabetic testing supplies to Missouri 41

42 residents who have a prescription. Applicant does not have any relationship with physicians. Applicant ships the supplies to the Missouri residents via UPS or the USPS. Applicant does not have any physical presence in Missouri. Specifically, it has no sales representatives and no storage facility in the state. Its only advertisements appear in magazines. Applicant does have a website. Missouri residents may contact Applicant directly to place an order, but Applicant does not make sales calls to Missouri. 2. The Department found that, based on the facts presented, Applicant did not have nexus with Missouri and was not required to collect and remit use tax on the retail sale of its supplies. Texas and Virginia issued rulings providing guidance on the type of activities that exceed the protection of P.L Texas Comptroller of Public Accounts, Hearing Nos. 46,233 and 47,108 (April 9, 2008). 1. Type of Tax: Texas Former Franchise Tax 2. Claimant, a Delaware limited liability company, sought a refund of franchise tax paid for the 2002 tax year. Claimant argued that, under the former Texas franchise tax, it did not have nexus in Texas for the earned surplus portion of the tax because it was protected under P.L Claimant had one employee in the state who solicited orders that were subject to approval at the New Jersey home office. 3. First, the Comptroller established that Claimant had the burden of proof to establish that it did not have nexus. The Tax Division generally bears the burden of proof for imposition of a tax; however, because Claimant elected to file a report for the year in question and reported tax for the earned surplus component, it bore the burden of proof to show that it did not have the required nexus. 4. P.L prohibits a state from imposing a tax measured by net income on a foreign corporation when the only business activity within the state is solicitation of orders for sales of tangible personal property where orders are sent outside the state for approval or rejection. To be protected, the business activity must be limited to solicitation of orders and activities that are ancillary to such solicitation, with the exception of certain de minimus activities that only amount to a trivial connection with the state. 5. Claimant s principal evidence was an affidavit from its Texas salesperson stating that all sales solicited by him required approval from the New Jersey office. The Comptroller found that the affidavit alone was not sufficient evidence to meet Claimant s burden of proof. The Comptroller noted that, even if the affidavit was accepted, it contained nothing excluding other activities that may have established nexus, such as performing repairs, maintenance or installation, collecting accounts or securing deposits. 6. The imposition of the tax was upheld because Claimant could not establish lack of nexus. Texas Comptroller of Public Accounts, Hearing No. 41,102 (June 6, 2008). 1. Type of Tax: Texas Former Franchise Tax 2. Taxpayer argued that it did not have nexus in Texas under the earned surplus portion of the former Texas franchise tax because it only solicited business 42

43 2. Taxpayer was a foreign corporation that manufactured and sold medications for animals. Taxpayer employed several sales representatives, a district manager and a veterinarian, all of whom resided and worked out of their homes in Virginia. The issue was whether the employees activities exceeded the solicitation of sales in order to create nexus in Virginia. The Commissioner found that the activities of the district manager and the veterinarian did create nexus. in Texas, did not have any permanent employees in Texas, did not own or lease real or personal property in Texas and did not maintain a place of business in Texas. 3. The Taxpayer had representatives that made at least seven visits to Texas during each year in question for client visits, marketing, client maintenance, customer calls, business entertainment and training. During the visits, the representatives met with specific customers either at their offices or at a third party establishment to promote Taxpayer s products. 3. Taxpayer argued that all of the employees activities were either directly related to the solicitation of sales or were ancillary to the solicitation process and had no independent purpose apart from their connection to the solicitation of orders. As such, Taxpayer argued that the activities did not create nexus. 4. The Comptroller found that solicitation is defined as activities that neither explicitly nor implicitly invite an order, but are entirely ancillary to requests for an order. The Comptroller found that it was reasonable to conclude that the visits were to promote or induce sales and thus constituted doing business in Texas for purposes of the former franchise tax. Ruling of Commissioner, P.D , Virginia Dep t of Taxation, July 30, The sales representatives solicited sales of the Taxpayer s medications at veterinary clinics and distributed samples to customers within the state. These activities did not create nexus. 1. Type of Tax: Tax. 5. The district manager recruited, hired, trained and defined responsibilities Corporation Income 43

44 of the sales representatives and forecasted and evaluated costs and pricing. The district manager was also a tactical coordinator between the regional office and district sales team. The Commissioner found that, although the activities may have served the solicitation function, they were managerial and administrative in nature and therefore did create nexus. 6. The veterinarian conducted product demonstrations and provided technical training to veterinary customers regarding proper use of the products. The Commissioner found that the training created nexus. In so finding, the Commissioner recognized that training provided to customers that is limited to reselling a taxpayer s product, may be ancillary to solicitation and therefore not create nexus. However, training provided for the purpose of enabling customers to use a taxpayer s product in their business is considered a business function separate and apart from the solicitation of sales and does create nexus. TEMPORARY NEXUS In this Letter of Findings, the Department found that the Taxpayer s physical presence in Indiana during January, 2006 required it to file a withholding tax return and withhold tax for non-resident shareholders for the whole year. Letter of Findings No P, P, CCH (Ind. Dep t of Rev. Oct. 1, 2008) 1. Taxpayer was a limited partnership based in Indiana which sold its partnership in January It did not pay its Indiana Withholding Tax for Nonresident Shareholders, Partners, or Beneficiaries of Trusts and Estates for It argued that Indiana lacked the requisite substantial nexus with Taxpayer to impose any continuing tax filing obligation after January of The Indiana Department of Revenue rejected this argument, proclaiming that the fact that Taxpayer s nexus with Indiana terminated sometime in 2006 does not erase its previous nexus status. It maintained a place of business in Indiana and had sufficient contacts with the state to have a substantial nexus. Because Taxpayer had a nexus with Indiana during 2006, it had a statutory duty to file its return and it failed to do so, so the Board denied the Taxpayer s protest. MICHIGAN BUSINESS TAX The Michigan Department of Treasury recently released Revenue Administrative Bulletin which provides guidance regarding the Department s nexus standard for the Michigan Business Tax. The nexus standard in this Bulletin is effective retroactively to January 1, The Bulletin adopts two alternative theories of nexus physical presence OR economic presence. Michigan Department of Treasury, Revenue Administrative Bulletin , CCH (Oct. 21, 2008). 1. Persons have nexus with Michigan and are subject to the Michigan Business Tax (MBT) if the taxpayer has a physical presence in [Michigan] for a 44

45 period of more than 1 day during the tax year OR if the taxpayer actively solicits sales in [Michigan] and has gross receipts of $350,000 or more sourced to [Michigan]. 2. For most companies, the MBT has two components a business income tax and a modified gross receipts tax. P.L protects a company only from the business income tax portion of the MBT, and only if the company s activities in Michigan are limited to solicitation. A company with nexus may be subject to the modified gross receipts portion even if its only activities in Michigan are solicitation. 3. Physical presence is established for one day if the company is physically present in Michigan for any part of a day. 4. However, the following activities, if conducted for less than 10 days, do not create physical presence nexus: meeting with in-state suppliers; in-state meeting with government representatives in their official capacity; attending occasional meetings; holding recruiting or hiring events; advertising; renting to or from an in-state entity customer list; and attending/participating at a trade show at which no sales are solicited or made. INTANGIBLE NEXUS States continue to assert economic nexus over companies with no physical presence in the state. Iowa rejected the taxpayer s claim that physical presence was needed for income tax nexus. Instead, it found economic nexus based on the franchise agreements with Iowa restaurants. Not surprisingly, the Maryland Tax Court found that the activities of out-of-state companies formed to hold trademarks were attributable to the parent company because the subsidiaries did not act independently. IOWA KFC Corporation v. Department of Revenue, Iowa Dep t of Inspections and Appeals, Admin. Hearings Div., No. 07DORFC016 (August 8, 2008). 1. Taxpayer was a fast food corporation with franchisee restaurants in Iowa, and derived royalty and license income from the franchisee s use of the corporation s trademarks, trade names, service marks, and unique system of preparing and marketing fried chicken. In Iowa, income tax is imposed on corporations doing business in the state, as well as corporations that are deriving income from sources within the state. 2. The taxpayer was determined to be deriving income from sources inside Iowa by receiving royalty and license income from the franchised restaurants in Iowa. Additionally, the nature of the franchise agreements required the taxpayer to rely on the services and jurisdiction of Iowa in order to benefit from the agreements, regardless of the taxpayer s physical situs in the state. 3. Iowa s taxation of the taxpayer s income did not violate the Commerce Clause of the United States Constitution because the standard for imposing income tax does not require physical presence. Although the United States Supreme Court has held that physical presence 45

46 was necessary for nexus concerning sales and use tax, this position was determined to be inapplicable here. Instead, the taxpayer was found to have created nexus with Iowa, despite a lack of property or employees in the state. The Department noted that franchise rights are intangible property that have become an integral part of a business activity occurring regularly in Iowa (citing Geoffrey, Inc. v. South Carolina Tax Commission, 437 S.E.2d 13 (S.C. 1993)). 4. With every Iowa purchase by an Iowan at a franchisee s location, the franchisee was obligated to pay the taxpayer based on the gross revenue. Additionally, the tax could be fairly apportioned and/or deducted in the computation of other taxes, did not discriminate against interstate commerce, helped level the field with other foreign corporations doing business in the state, and was related to the governmental functions that all Iowa businesses enjoy. MARYLAND Nordstrom, Inc. et al. v. Comptroller of the Treasury, 2008 WL (Md. Tax Ct., Oct. 24, 2008). 1. N2HC is a wholly owned subsidiary of Nordstrom. NIHC is a wholly owned subsidiary of N2HC. Neither subsidiary had property or did business in Maryland. Nordstrom incorporated these entities to own and license valuable Nordstrom trademarks (the Marks). The parent company, Nordstrom does business in Maryland. 2. The Tax Court said that the issue was whether there is sufficient nexus between Maryland and the subsidiaries to impose income tax on the subs. 3. Income a. The income in question for NIHC arose from the 1999 transfer by NIHC of the right to license the Marks to its parent, N2HC, resulting in a gain. b. The income in question for N2HC arose from a license to use the Marks granted to Nordstrom in exchange for an arm s length royalty fee. Additionally, N2HC loaned back to Nordstrom substantial sums of money (approximately 2/3 of the year s royalties) which was being paid back with interest. 4. The Tax Court stated that the test to use to determine nexus is whether the out-of-state affiliates had real economic substance as separate business entities. The Tax Court, therefore, examined the economic substance of the subsidiaries, as well as the legitimate business activities (other than tax avoidance) of the subsidiaries and their parent. 5. Nordstrom contended that: a. N2HC should not be subject to Maryland income tax because it (i) maintained an office in Portland staffed by a specialist who interfaced with outside counsel; (ii) was actively engaged in maintaining, managing, enforcing, and protecting the Marks; and (iii) employed a full-time paralegal. AND b. NIHC should not be subject to Maryland income tax because the income arising from the 1999 transaction bears no relation to Nordstrom s use of the Marks in 46

47 its Maryland stores or any other activity conducted in Maryland. 6. The Tax Court held that NIHC and N2HC lacked real economic substance as separate business entities. It stated that, fundamentally, the subsidiaries did not act independently, although the financial structure creates an illusion of substance. The Court further held that the activities of NIHC and N2HC must be considered the activities of their parent, Nordstrom, and, as such, there were substantial activities in Maryland. Nordstrom has constitutional nexus with Maryland, and therefore the assessments were affirmed. MASSACHUSETTS Capital One Bank v. Commissioner of Revenue, Docket Nos. C & C262598, CCH (Mass. Appellate Tax Bd. June 22, 2007), Massachusetts Supreme Judicial Court No. SJC (Mass. 2007). 1. Capital One has appealed to the M a s s a c h u s e t t s S t a t e S u p r e m e Judicial Court, arguing that the tax is unconstitutional under the Commerce Clause. Arguments are expected on October 7, VERMONT Applying economic substance doctrine, the Vermont Supreme Court found that holding companies were not separate taxable entities but instead were nothing more than a vehicle for tax avoidance. TD Banknorth, N.A. v. Dep t of Taxes, 2008 VT 120 (Sept. 19, 2008). 1. Type of Tax: Bank Franchise Tax (BFT). 2. Commissioner assessed a BFT on Taxpayer. The tax was upheld by the superior court and Taxpayer appealed to the Vermont Supreme Court. 3. Taxpayer was a parent company to three banks. Each of the banks established a wholly-owned holding company. Each holding company was a Vermont corporation. The banks capitalized their respective holding companies by assigning certain assets to the holding companies and also by entering into participation agreements whereby the holding company received 100% of the economic interest in the assets. However, the Taxpayer retained full management of the assets. Prior to the existence of the holding companies, the banks reported income from the assets. After the loans were transferred to the holding companies, the income stream from the assets was reassigned to the holding companies, resulting in a loss to the bank for purposes of federal income tax. By reporting the loss, the bank could almost eliminate any payment of the Vermont BFT, which is generally capped not to exceed the bank s federal taxable income. Meanwhile, the holding companies paid virtually no tax on the income based on a carve-out in the Vermont law for corporations whose activities are confined to maintenance and management of certain intangible investments (the Carve Out ). 4. Upon audit, the Department found that the holding companies had no economic substance or legitimate business purpose and were formed merely to evade the [BFT]. The Department assessed additional BFT, attributing the holding companies income to its parent company and also imposed a penalty. 5. On appeal, Taxpayer claimed, among other things, that the Commissioner erred in concluding that the holding companies lacked sufficient business 47

48 purpose and independent economic substance. Taxpayer asserted that the transfer of income-producing assets to a corporation was sufficient to shift the taxability of the income to that corporation. Further, the taxpayer argued that the holding companies engaged in sufficient business activity to be distinct from their parent for purposes of the BFT. 6. The Court applied the economic substance doctrine and found that the holding companies were not taxable entities separate from Taxpayer. The doctrine uses a two prong approach, looking at both the motivation in creating the entity and the economic activities of the entity. Because the holding companies failed both prongs of the analysis, the Court declined to decide whether the two prongs were conjunctive or disjunctive. 7. The Court found that the sole motivation for forming the holding companies was to avoid paying taxes because the Taxpayer s accountant advised Taxpayer that the formation of the holding companies was a slam dunk strategy for achieving substantial BFT savings. The Court found that the holding companies conducted insufficient independent business activity to qualify as a taxable entity separate from the Taxpayer because (i) the Taxpayer operated the holding companies out of its back office, without any independent property, tangible assets or staff, (ii) through the use of the participation agreements, the holding companies received a 100% undivided interest in the loan while the banks maintained control, (iii) the holding companies carried no economic risk and (iv) the holding companies did not engage in meaningful business with third parties. 8. Although the holding companies met the literal requirements for the Carve Out, they are disregarded under the economic substance doctrine because they are nothing more than a vehicle for tax avoidance. The Court upheld the assessment of the BFT against Taxpayer. VIRGINIA The Commissioner found that a non-resident taxpayer had nexus with Virginia based on the taxpayer s interest in an S corporation that owned real property in Virginia. Ruling of Commissioner, P.D , Virginia Dep t of Taxation, July 30, Type of Tax: Individual Income Tax 2. Taxpayer was not domiciled in Virginia, but owned a 50% share of an S Corporation incorporated in Virginia. The Corporation held cash, investment securities and a 25% interest in an out-of-state limited partnership that held one parcel of undeveloped real estate in Virginia. 3. The Department concluded that the Corporation s income was Virginia source income to Taxpayer. Taxpayer contended that the Corporation s income was not source income subject to tax of nonresidents. 4. Virginia treats S corporations similar to the Internal Revenue Service. The corporation itself is not subject to taxation but the shareholders will be taxed as individuals on their pro rata share of S corporation income. Even 48

49 so, the Taxpayer contended that the corporation was a pass-through entity established solely to invest in intangible personal property and because the corporation had no employees and no tangible personal property it was not carrying on a trade or a business. Taxpayer argued that the corporation did not own the property in Virginia, but rather, owned a 25% limited partnership interest, which was intangible personal property. 5. The Department considers a taxpayer to be the owner of a share of the passthrough entity s assets and liabilities. Here, the attributes of the real property ownership flowed through the limited partnership to the corporation and ultimately to the Taxpayer. Having real property in Virginia created nexus to the corporation and established authority for the taxation of an appropriate portion of the Taxpayer s income. 6. Although the Commissioner found nexus for the Taxpayer, the corporation had no income from Virginia sources during the taxable years, so the Taxpayer was not subject to Virginia income tax. DOING BUSINESS IN THE STATE ARIZONA The Arizona Department of Revenue issued a ruling clarifying the imposition of transaction privilege tax on sales of tangible personal property by out-of-state mail order or internet-based (remote) vendors and the responsibility for use tax collection by such vendors. Transaction Privilege Tax Ruling TPR 08-1, Arizona Dep t of Revenue (July 30, 2008). 1. Ascertaining whether a remote vendor is liable for transaction privilege tax, is responsible for collecting use tax, or has no liability for either tax requires a determination of the vendor s nexus with the state. 2. After a review of federal and state case law, Arizona provided this guidance: Generally, in circumstances involving an out-of-state vendor, certain factors may increase the likelihood that the vendor will be considered a retailer due to substantial nexus with Arizona, such that it becomes subject to Arizona transaction 49

50 privilege tax liability. An overarching attempt to create a unified face or singular brand recognition among consumers, despite the actual separate corporate existences of subsidiaries, suggests an effort to maintain and improve the name recognition, market share, goodwill, and individual customer relationships of the subsidiaries. The lack of separation between the retail operations and promotional activities of the bricks-and-mortar store and remote vendor subsidiaries would be distinguishable from cases in which the activities of the in-state and out-of-state entities were more clearly separated. 3. While neither exhaustive nor intended to suggest that any one factor would necessarily lead to a finding of substantial nexus, the Department also created a list providing some guidance regarding practices that it would examine in determining whether any vendor liability or responsibility exists: a. Cross-promotion and advertising of remote subsidiary ( e.g., a dotcom or mail-order subsidiary) and in-state subsidiary ( e.g., retail) locations, catalogs, and websites by in-state subsidiaries, excluding the availability of a remote subsidiary s catalogs at a retail location to use for reference purposes or to provide to a retail customer at the customer s request. b. The ability to return and exchange merchandise acquired through different subsidiaries at in-state retail store locations and to receive credit for the return or exchange that can be applied to new transactions across subsidiaries. c. In-state telephone or internet kiosks that allow customers to access inventories and purchase m e r c h a n d i s e f r o m r e m o t e subsidiaries. d. The acceptance of remote subsidiary orders by a retail subsidiary at in-state locations when a product is unavailable at the in-state location. e. T h e o r d e r f u l f i l l m e n t o f merchandise ordered by customers from a remote subsidiary through in-state retail or marketing subsidiaries. f. Other activities that suggest t h a t a n i n - s t a t e r e t a i l o r marketing subsidiary is acting as a salesperson or independent contractor for remote subsidiaries ( e.g., in-state subsidiary employees and agents soliciting names and addresses of customers for a remote subsidiary s catalog mailing list, distribution of discount coupons specifically for use with remote subsidiaries). g. Other in-state sales and marketing efforts that promote the operations of remote subsidiaries to instate retail customers as part of a single business (e.g., by emphasizing a common company name), although they are actually separately organized business entities. h. Arizona case law has held that transaction privilege tax imposed under the retail classification does not require a higher level of nexus 50

51 INDIANA with the taxing state than use tax. Ariz. Dep t of Revenue v. Care Computer Sys., Inc., 197 Ariz. at 416, 4 P.3d at 471 (Ct. App. 2000). If a taxpayer s retail business maintains the required degree of nexus with Arizona, the taxpayer will be subject to transaction privilege tax rather than a use tax collection obligation, unless otherwise provided by statute. i. Arizona use tax functions as a complement to transaction privilege tax: if transaction privilege tax applies, use tax does not. Consequently, if an out-of-state vendor is liable for transaction privilege tax on gross receipts derived from a given transaction, the Department cannot opt to impose use tax instead on the in-state purchaser in the transaction. j. Even if the remote vendor, based on the above factors, does not have sufficient nexus for the imposition of the transaction privilege tax, it could still have sufficient nexus to be subject to Arizona use tax collection requirements for sales to Arizona customers if it has an Arizona presence unrelated to its retail activity. The Indiana Tax Court found economic presence enough to subject a credit card issuer to the Indiana Financial Institutions Tax. In so holding, the Tax Court rejected a mechanical application of [Quill s] physical presence standard to franchise and income taxes.... MBNA America Bank v. Indiana Dep t of State Rev., 895 N.E.2d 140, 2008 Ind. Tax LEXIS 27 (Oct. 20, 2008). 1. MBNA was denied a refund of the Indiana Financial Institutions Tax ( FIT ), and challenged the decision on the basis that MBNA did not have a place of business or employees in Indiana. It did, however, issue credit cards to Indiana customers. 2. The FIT is an excise tax on the corporate privilege of transacting the business of a financial institution in Indiana. Ind. Code Ann (a). MBNA did not dispute that it was engaging in the business of a financial institute, but it argued that mere economic presence in a state does not satisfy the requirement of substantial nexus. 3. The Indiana Tax Court held that the United States Supreme Court has not extended the physical presence requirement for substantial nexus beyond the realm of sales and use taxes. Thus, the court determined whether economic presence can satisfy substantial nexus for purposes of the FIT as a matter of first impression. 4. The Tax Court analogized the situation to that of the intangible nexus cases, as well as those cases where a credit card company was subjected to income tax in a state where it issued credit cards, but in which it had no physical presence. In each set of cases, the Indiana Tax Court found the arguments for finding nexus persuasive. 5. Citing to a West Virginia Supreme Court income tax case involving MBNA, the Indiana court noted that sales and use taxes impose different 51

52 MARYLAND burdens on a collecting entity than franchise or income taxes. Furthermore, mechanical application of a physicalpresence standard to franchise and income taxes is a poor measuring stick of an entity s true nexus with a state in today s world. Thus, the Tax Court held economic presence is sufficient to establish substantial nexus in such a case. Court of Appeals found that a provider of 900 number service was not the agent of an out-of-state vendor for purposes of creating nexus and permitting state taxation of an interstate sale. AT&T Commc ns of Md. v. Comptroller of Treasurer, No. 24-C , 950 A.2d 86 (Md. Ct. App. June 12, 2008). 1. This case involves a sales and use tax assessment on AT&T s provision of 900 number service to Maryland consumers. The Comptroller found that AT&T was the agent of the out-of-state information providers ( Providers ) and created nexus between Maryland and the Providers. In essence, Maryland sought to tax the in-state consumption of information services provided by out-of-state companies by making AT&T their agent. 2. AT&T appealed, arguing that a common carrier cannot be deemed the agent of an out-of-state seller for the purposes of creating nexus and permitting state taxation of an interstate sale. 3. The court agreed, but found that two additional issues had to be addressed: 1) Is a telecommunications provider a common carrier under Bellas Hess and Quill? and 2) Did AT&T act in a manner that took it beyond the role of common carrier? 4. A&T argued that it was a common carrier because it publicly offered to provide 900 number carriage. The court agreed. However, the court went on to determine whether AT&T had transcended the common carrier classification. AT&T did contract with the information providers, review the information providers advertisements and preamble messages, transport the messages over its networks, provide billing and collection services, provide dispute resolution services, and receive funds for the services provided. However, the court found that all of those functions were typically provided by common carriers in analogous contexts. Some functions were also required by the Telephone Disclosure and Dispute Resolution Act (TDDRA). 5. The court found there can be no nexus if a common carrier delivers a service provided by an out-of-state company. The assessment could stand only if AT&T was more than a common carrier, i.e., a co-vendor or agent of the Providers. Since AT&T did not promote or have a vested interest in the success of the Providers, it was not the Providers agent or co-vendor. Thus, under Bellas Hess and Quill, AT&T was not responsible for sales or use tax on transactions between Maryland customers and the 900 information service vendors. The Maryland Comptroller recently updated his administrative release regarding the nexus standards for corporate income tax. Administrative Release No. 2, CCH , Maryland Comptroller of the Treasury (Sept. 1, 2008). 52

53 1. The Maryland Comptroller of the Treasury recently updated his Administrative Release regarding the nexus standards applicable to corporate income tax. 2. This release includes a definition o f b u s i n e s s l o c a t i o n a n d representative. 3. It also includes a list of activities that the Comptroller considers protected under P.L These activities do not cause an entity to be taxable: a. Employees or representatives soliciting orders for tangible personal property. b. Solicitation activity by none m p l o y e e, i n d e p e n d e n t contractors, conducted through their own office in Maryland. c. Delivery of goods to customers by the corporation in its own or leased vehicles from a point outside Maryland. 4. Finally, the Comptroller provided the following non-exclusive list of in-state activities that generally create nexus: a. Maintaining a business location in Maryland. b. Ownership or use of property in Maryland, real or personal. c. Employees soliciting and accepting orders in Maryland. d. Installation or assembly of the corporation s product. e. Maintaining a stock of inventory in a public warehouse or placement of inventory in the hands of a distributor. f. Sales persons making collections o n r e g u l a r o r d e l i n q u e n t accounts. g. Technical assistance and training with Maryland offered by corporate personnel to purchasers or users of corporate products after the sale. h. Corporate personnel repairing or replacing faulty or damaged goods. i. Mobile stores in Maryland from which direct sales are made. 53

54 Further Information: For further information on items covered in State Tax Return, please contact any of the following Jones Day attorneys: Atlanta John M. Allan (404) E. Kendrick Smith (404) Kirk Kringelis (404) Mace E. Gunter (404) Shane Lord (404) Brussels Howard Liebman Chicago Thomas N. Molins (312) Cleveland Charles M. Steines (216) Columbus Maryann B. Gall (614) Todd S. Swatsler (614) Douglas R. Cole (614) Laura A. Kulwicki (330) Phyllis J. Shambaugh (614) Kasey T. Ingram (614) Dallas David E. Cowling (214) Charolette Noel (214) Kirk Lyda (214) Rachel A. Wilson (214) Karen H. Currie (214) Stephen G. Harris (214) Scott Siekierski (214) Houston Paul A. Broman (832) Los Angeles David S. Boyce (213) New York Carolyn Joy Lee (212) Peter Leonardis (212) Gerald S. Janoff (212) Colleen E. Laduzinski (212) Dennis Rimkunas (212) Washington Raymond J. Wiacek (202) Gregory A. Castanias (202) Atlanta, Beijing, Brussels, Chicago, Cleveland, Columbus, Dallas, Frankfurt, Hong Kong, Houston, Irvine, London, Los Angeles, Madrid, Moscow, Munich, New York, Paris, Milan, Pittsburgh, San Diego, San Francisco, Shanghai, Silicon Valley, Singapore, Sydney, Taipei, Tokyo, Washington 2008 Jones Day. State Tax Return is a publication of Jones Day. No portion of this publication may be reproduced or used without express permission. Because of its generality, the information contained herein should not be construed as legal advice on any specific facts or circumstances. The contents are intended for general informational purposes only. December 31, 2008 Charolette Noel, Executive Editor Date Jones Day 2727 N. Harwood Street Dallas, Texas (214) Editor s Address Editor s Telephone Number 54