STATE AND LOCAL TAX IPT ANNUAL CONFERENCE. Eran Liron. Arthur J. Parham

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1 STATE AND LOCAL IPT ANNUAL CONFERENCE TAX Eran Liron State and Local Tax Partner PricewaterhouseCoopers, LLP San Jose, CA Arthur J. Parham General Tax Advisor Entergy Services, Inc. The Woodlands, TX

2 BACKGROUND Eran Liron, Partner, PricewaterhouseCoopers, LLP Eran Liron is a Partner with PricewaterhouseCoopers, and is in the State and Local Asset Management Group. Eran has 15 plus years of experience in the state and local tax area. Since joining PwC in 1998, he has assisted clients with audit support and representation in California, and other jurisdictions, tax planning, mergers & acquisition, due diligence work, large compliance outsourcing arrangements, ASC 740 (FIN 48) compliance and credit & incentive projects. Eran has worked extensively with the venture capital, private equity and high tech industries. Eran holds a BA in Economics from U.C., Berkeley and is a California CPA. Arthur Parham, General Tax Advisor, Energy Services, Inc. Arthur Parham is General Tax Advisor at Entergy Corporation in The Woodlands, TX. Entergy is a Fortune 500 integrated energy company engaged primarily in electric power production and retail distribution. Arthur focuses on corporate income tax planning and has over thirty-five years of state tax planning experience. Arthur is a Board member and officer of the Council on State Taxation and is a frequent speaker at corporate tax conferences.

3 MAIN TOPICS Overall State Opportunities General State Nuances State Specifics: California New York Texas Illinois

4 COMBINED REPORTING WA OR ID MT WY ND SD MN WI MI NY VT NH MA CT ME RI IA PA NV NE NJ OH UT IL IN DE CA CO WV MD KS VA MO DC KY NC TN AZ OK NM AR SC AK MS AL GA TX LA HI FL Combined Reporting Proposals Unitary/Combined States Remaining Separate Entity or Elective Consolidated Reporting/Other PwC

5 COMBINED REPORTING 2013 WA OR ID MT WY ND SD MN WI MI NY* VT NH MA CT ME RI CA NV UT CO NE KS IA MO IL IN OH KY WV PA VA NJ DE MD DC AZ NM* OK AR TN NC SC AK MS AL GA TX LA HI FL Combined Reporting Proposals Considered Recently and/or Currently Proposed Unitary/Combined States (now including the Ohio CAT, Texas Margin Tax and Michigan Business Tax) *New York adopts unitary combined reporting in 2015 Remaining Separate Entity or Elective Consolidated Reporting/Other PwC *New Mexico requires certain unitary large retailers to file combined returns (2014).

6 APPORTIONMENT FORMULAS* WA CA OR NV ID AZ UT MT WY CO NM ND SD NE KS OK MN IA MO AR WI IL MI IN KY TN OH PA WV VA NC SC NY ME VT NH MA CT RI NJ DE MD DC AK MS AL GA TX LA HI FL *Does not address industry-specific or optional formulas PwC Equally weighted three factor formula Double weighted sales factor Triple or greater weighted or single sales factor Slide 6

7 APPORTIONMENT FORMULAS* WA CA OR NV ID AZ UT MT WY CO NM ND SD NE KS OK MN IA MO AR WI IL MI IN KY TN OH PA WV VA NC SC NY ME VT NH MA CT RI NJ DE MD DC AK MS AL GA TX LA HI FL *Does not address industry-specific or optional formulas Equally weighted three factor formula Double weighted sales factor Triple or greater weighted or single sales factor PwC Slide 7

8 CALIFORNIA APPORTIONMENT California mandatory Market Based Sourcing for services effective beginning tax year 1/1/2013 and for taxpayers electing single sales factor in tax year 1/1/2011 or 1/1/2012 General rule: Benefit of a service is received means the location where the taxpayer s customer has either directly or indirectly received value from delivery of that service

9 CALIFORNIA APPORTIONMENT General Sourcing Regime for Services: Individuals Customer s billing address Contract or books & records show benefit Reasonable approximation Corporation Contract or books & records show benefit Reasonable approximation Office service ordered from Billing Address

10 CALIFORNIA APPORTIONMENT Reasonable Approximation "Reasonably approximated" means that, considering all sources of information other than the terms of the contract and the taxpayer's books and records kept in the normal course of business, the location of the market for the benefit of the services or the location of the use of the intangible property is determined in a manner that is consistent with the activities of the customer to the extent such information is available to the taxpayer Information that is specific in nature is preferred over information that is general in nature.

11 CALIFORNIA APPORTIONMENT General Sourcing Regime for Intangibles: 4 Cascading rules Complete transfer of all IP Marketing IP (Copyrights) Mixed IP Marketing and non-marketing Non marketing/manufacturing IP (e.g. patents)

12 CALIFORNIA APPORTIONMENT Sale of a Portfolio Company, gross receipts from dividends, interest, or goodwill: If greater than 50% of assets, real property, or TPP sold: Sourcing method average of property and payroll factors If less than 50% of assets, real property, of TPP sold: Sourcing method sales factor of the corporation or pass-through entity

13 CALIFORNIA SOURCING NUANCE Sale of a portfolio company that has significant CA presence A taxpayer is doing business in CA if any of the following conditions has been satisfied: The taxpayer is organized or commercially domiciled in this state. 500,000 in sales or 25% of the taxpayer s total sales should be determined using the rules for assigning sales under section ,000 or 25% of the taxpayer s real property and tangible property, the value of the property should be determined using the rules contained in ,000 or 25% of the total compensation paid by the taxpayer, the amount of compensation should be determine using the rules for assigning payroll contained in

14 CALIFORNIA FUN FACTS Loss company with no sales and offices in California and New York How does it source its NOL?

15 CALIFORNIA FUN FACTS Fun with UDIPTA Section 18 If the allocation and apportionment provisions of this act do not fairly represent the extent of the taxpayer's business activity in this state, the taxpayer may petition for or the Franchise Tax Board may require, in respect to all or any part of the taxpayer's business activity, if reasonable: 25137(d): The employment of any other method to effectuate an equitable allocation and apportionment of the taxpayer's income. State showing recent aggression with this long dormant authority FL, MS, and PA

16 CALIFORNIA FUN FACTS California combined reporting common mistake: partially included CFC entity (when the 5471 does not tell the whole story ) 25110(d)(2)(E)1. In determining Subpart F income for a given year the limitation and recharacterization provisions of Internal Revenue Code section 952(c) shall not apply. Subpart F income does not include income defined in Internal Revenue Code section 956.

17 NEW YORK APPORTIONMENT AND SALES SOURCING AFTER 2014 BUDGET REFORM NY remains single sales factor, but will become entirely market based sourcing state Customer focused MBS will apply to all receipts used to define the sales factor. Cost of performance approach to sales of intangible property and services will be abandoned. Finnigan principles will still apply

18 NEW YORK PPORTIONMENT AND SALES SOURCING AFTER 2014 BUDGET REFORM NY Market Based Sourcing Benefit is generally assumed to be received at customer location. Customer location is highly subjective and subject to wide interpretation. A statutory methodology has been created to address sourcing when customer location is not easily determinable. Additional regulations will be necessary to provide more detailed guidance.

19 NEW YORK APPORTIONMENT AND SALES SOURCING AFTER 2014 BUDGET REFORM MBS Methodologies: differ depending on what is being sold Taxpayer must first identify and categorize what is being sold. Taxpayer may sell multiple types of products and services and may utilize multiple MBS apportionment methodologies. Results may differ depending on how a receipt is categorized Taxpayers may be incented to categorize a type of receipt differently than the taxing authority.

20 NEW YORK APPORTIONMENT AND SALES SOURCING AFTER 2014 BUDGET REFORM Categories of sales receipts and their sourcing include the following (the easy ones first): Tangible personal property Ultimate destination Rents- Location of property being rented Royalties Location of use of underlying intangible asset Financial instruments/transactions another subject for another day Aviation services Miles approach Gas transportation/transmission Transportation units approach Railroad and trucking Miles approach

21 NEW YORK APPORTIONMENT AND SALES SOURCING AFTER 2014 BUDGET REFORM Categories of sales receipts what is left and how is it sourced? Digital products (includes receipts from sales of services and receipts from bundled sales of property and services) Other services and business receipts (a catchall default category into which is placed receipts not otherwise fitting into any of the other categories)

22 NEW YORK APPORTIONMENT AND SALES SOURCING AFTER 2014 BUDGET REFORM Digital products defined: Any property or service, or combination thereof, of whatever nature delivered to the purchaser through the use of wire, cable, fiber optic, laser, microwave, radio wave, satellite, or similar successor media or any combination thereof Digital products include audio, audiovisual, electronic books, games, digital storage and software.

23 NEW YORK APPORTIONMENT AND SALES SOURCING AFTER 2014 BUDGET REFORM Sourcing of receipts from sales of digital products requires taxpayer due diligence Importance of first year sourcing protocol Statutory due diligence requires the use of information known to the taxpayer based on both taxpayer records and information available from other sources via reasonable inquiry. Law generally assumes that the location to which a digital product is delivered provides a good indication of where the digital product is used.

24 NEW YORK APPORTIONMENT AND SALES SOURCING AFTER 2014 BUDGET REFORM Four Steps of sourcing of receipts from sales of digital products by applying cascading approach: Step 1 Location at which primary use occurs Step 2 Location where the benefit is received or the product is accessed Step 3 Prior year apportionment factor applied to the digital product at issue Step 4 Default to the current year sourcing being applied to all other digital products already categorized using steps 1 and 2.

25 NEW YORK APPORTIONMENT AND SALES SOURCING AFTER 2014 BUDGET REFORM Is MBS for intangible property and services more or less difficult to apply than cost of performance sourcing? Disputes between taxpayers and the taxing authority are certain due to the high degree of subjectivity required to apply the MBS rules. No matter how well-intentioned, any regulations to be provided for additional guidance will still be deficient in their attempt to cover all possible fact patterns faced by taxpayer.

26 NEW YORK APPORTIONMENT AND SALES SOURCING AFTER 2014 BUDGET REFORM Sourcing of sales receipts from default category of other services and business receipts Numerous types of receipts are expected to be covered by this default category. Default category also follows a step approach to source receipts.

27 NEW YORK APPORTIONMENT AND SALES SOURCING AFTER 2014 BUDGET REFORM Four Steps of sourcing of receipts from sales of digital products by applying cascade approach Step 1 Location at which benefit is received Step 2 Delivery destination, defined using buyer s billing address or zip code Step 3 Prior year apportionment factor applied to the type of receipts at issue Step 4 Default to the current year sourcing applied to all other services and business receipts already categorized using Steps 1 and 2

28 NEW YORK FUN FACT Fact - NY has a rich history of both forced combination and redefining taxpayer filing groups. Prediction 1 Scrapping the 10 Step Approach and the use of substantial inter corporate transactions to define the filing group will not discourage NY from challenging taxpayers unitary group definitions in 2015 and beyond. Prediction 2 Scrapping the use of cost of performance after 2014 for sourcing of sales of certain services and intangible property will produce numerous challenges to taxpayers sourcing methodologies, particularly in the first few years after implementation of the 2014 budget reform legislation.

29 TEXAS APPORTIONMENT METHODOLOGY Margins tax, Single sales factor Apportionable base is computed by subtracting one of several alternative measures of expense from gross receipts

30 TEXAS APPORTIONMENT METHODOLOGY With limited exception, the apportionment factor is defined using gross receipts. The numerator of the apportionment factor attempts to capture business done in Texas. Whether business is done in Texas is a function of the source and nature of the receipts used to define the apportionment factor.

31 TEXAS APPORTIONMENT METHODOLOGY Receipts are sourced to Texas if: Tangible personal property Property is delivered or shipped to a Texas buyer Service Service is performed in Texas (irrespective of where costs of performance are incurred) Rental of tangible property Property being rented is located in Texas Use of (different than sale of) intangible property Property is used in Texas

32 TEXAS APPORTIONMENT METHODOLOGY Texas is unique with respect to sales of intangible property State has adopted a concept called location of payor to source gross receipts from sales of intangible property. Creative use of the location of payor rule can result in substantial state tax savings.

33 TEXAS APPORTIONMENT METHODOLOGY Location of payor defined as: The legal domicile of the payor. Legal domicile defined as: The legal domicile of a corporation or limited liability company is its state of formation. The legal domicile of a partnership, trust, or joint venture is the principal place of business of the partnership, trust, or joint venture. The principal place of business of a partnership, trust, or joint venture is the location of its day-to-day operations. If the day-to-day operations are conducted equally or fairly evenly in more than one state, then the principal place of business is the commercial domicile.

34 TEXAS APPORTIONMENT EXAMPLE Example 1 - Texas taxpayer sells stock in a corporation to another corporation and does so at a gain. Good planning and good result Buyer (i.e., payor) is a corporation formed under Delaware law. Gain from the sale is included in the denominator of the Texas apportionment factor, but excluded from the numerator. Bad planning and bad result Buyer is a corporation formed under Texas law and seller did not encourage buyer to create a special purchase entity formed under the laws of a state other than Texas to serve as the buyer.

35 TEXAS APPORTIONMENT EXAMPLE Example 2 Texas taxpayer sells financial instruments (e.g., hedges, swaps, derivatives, etc.) to another corporation and does so at a gain. Good planning and good result Buyer is a corporation formed under Delaware law. Gain from the sale is included in the denominator of the Texas apportionment factor, but excluded from the numerator. Bad planning and bad result Buyer is a corporation formed under Texas law and seller did not encourage buyer to create a special purchase entity formed under the laws of a state other than Texas to serve as the buyer.

36 TEXAS PLANNING SUGGESTIONS When negotiating terms of sale of intangible assets, Texas taxpayer should perform due diligence on buyers legal domiciles or principal place of business If a Texas seller cannot sell intangible assets to a buyer that enables the seller to exclude gains from the numerator of the Texas gross receipts factor, seller should consider adjusting the sales price accordingly. The Texas location of payor rule makes Texas an ideal state for the commercial domicile of a seller of intangible property

37 TEXAS APPORTIONMENT METHODOLOGY Default rule: If the volume of gains from the sale of financial instruments makes it difficult to accurately track the legal domicile of each buyer: Receipts from the sale of loans and securities are apportioned based on the location of the payor. If securities are sold through an exchange, and the buyer cannot be identified, then 7.9% of the revenue is a Texas receipt. The Comptroller has historically applied this rule very liberally.

38 TEXAS FUN FACT Loss of Unitary Reporting NOL Tax Credits Independent Audit Review Cost of goods sold definition revised

39 ILLINOIS APPORTIONMENT IL mandatory market based sourcing: For services effective for tax years ending on or after 12/31/2008 IL Sales of Services - Individual Sales of services are sourced to Illinois if the services are received in the state by a customer who is an individual

40 ILLINOIS APPORTIONMENT In the case of services provided to a corporation, partnership, or trust, the sales are sourced to the state under the following cascading rules: (1) If the services were provided at a fixed place of business in Illinois (2) If (1) is not readily determinable or a fixed place of business is not in Illinois, the office of the customer from which the services were ordered in the regular course of the customer s trade or business is in Illinois; or (3) If (2) cannot be determined, the office of the customer to which the services were billed in the Illinois

41 ILLINOIS APPORTIONMENT IL Throw-out Rule: Finally, where a taxpayer is not taxable in a state in which the services are received, the sale must be excluded from both the numerator and denominator of the sales factor

42 ILLINOIS SALES SOURCING FOR INTANGIBLES Determining the place of utilization: Patents state where employed in production, fabrication or manufacturing Copyrights state where printing or publication originates Trademark state in which commercial domicile of the license or purchaser is located

43 ILLINOIS FUN FACTS IL: Inclusion of gross receipts from the license, sale, or other disposition of patents, copyrights, trademarks, and other intangible personal property only included if: receipts are more than 50% of the total gross receipts included in income during the current period and prior two periods before

44 ILLINOIS FUN FACTS Please provide all correct subsidiary FEINs or Unitary Partnership FEINs or pay $500,000,000, and do not pass Go Also know as please provide all correct subsidiary FEINs or Unitary Partnership FEINs of entities in the combined group. Otherwise the state may determine 100% IL apportionment and assess additional tax due.

45 THANK YOU! Questions and Comments?