October 2017 California Guidance on Water s-edge Elections Expanded The California Franchise Tax Board (FTB) extended earlier guidance addressing the treatment of a water's-edge election when the expansion of the corporation franchise and income tax "doing business" definition results in a unitary foreign affiliate becoming subject to tax in California. Background Beginning with the 2011 tax year, California expanded the list of activities that constitute "doing business" in the state. Corporations that are doing business in the state are subject to the California franchise tax (i.e., they are taxpayers). Consequently, a corporation that was not a taxpayer prior to the 2011 tax year could become a taxpayer after the 2011 tax year because of the expanded "doing business" standards. In addition, a taxpayer may elect to determine its income derived from or attributable to sources in California under a water's-edge election; however, the election is effective only if every member of the combined reporting group that is subject to tax makes an election. Earlier Guidance FTB Notice 2016-02 established the treatment to be followed in situations where a unitary foreign affiliate of a water's-edge combined reporting group could not make an election at the time of a water's-edge election because it was not subject to tax in California, but would have been required to make an election after the "doing business" list was expanded. 1
If certain conditions are satisfied, the FTB will apply the treatment described in FTB Notice 2016-02 and not seek to terminate the water's-edge election of a water's-edge combined reporting group that is unitary with a foreign affiliate that is now a taxpayer. However, FTB Notice 2016-02 applies only to a group of taxpayers with a valid water's-edge election in effect on or before September 9, 2016, and only to unitary foreign affiliates that become taxpayers in California in a taxable year ending on or before December 31, 2016. New Guidance The FTB s new guidance modifies the applicability dates found in FTB Notice 2016-02. As a result, the treatment described in FTB Notice 2016-02 now applies to a group of taxpayers with a valid water s-edge election in effect on or before October 16, 2016, and to unitary foreign affiliates that become California taxpayers for taxable years beginning on or before December 31, 2017, solely due to the expansion of the "doing business" standards. FTB Notice 2017-04, California Franchise Tax Board, October 16, 2017 Michigan U.S. Supreme Court Declines to Review Removal of Pension Benefit Exemptions In a Michigan personal income tax case involving certain retired state and public school employees whose definedbenefit pensions were exempt at the time of their retirement, the U.S. Supreme Court has denied a request to review legislation, enacted in 2011, that eliminated the exemptions for the retirees. The Court had been asked whether Michigan s retraction of the retirement tax benefits for the retirees violated the retroactivity principles stated in Landgraf v. USI Film Prods., 511 U.S. 244 (1994), and principles underlying the rule of law. Okrie v. State of Michigan, U.S. Supreme Court, Dkt. 17-34, petition for certiorari denied October 2, 2017 Principal Residence Exemption Claim Procedures Amended, Penalties for Duplicative Claims Enacted Enacted Michigan legislation provides that, in order to claim a principal residence property tax exemption, a taxpayer must file an affidavit stating that he or she had not claimed a substantially similar exemption, deduction, or credit on property in another state. Additionally, a person who has already claimed an exemption may be required to file such an affidavit within 30 days of request. Further, in cases where an existing claim for exemption has been denied, the law prohibits taxpayers from rescinding a substantially similar exemption, deduction, or credit claimed in another state in order to qualify for the Michigan principal residence exemption. A person who claimed a principal residence exemption in Michigan and a substantially similar exemption, deduction, or credit in another state is subject to a penalty of $500, or a misdemeanor criminal penalty if the person acted with intent to claim a Michigan exemption while simultaneously claiming a similar exemption, deduction or credit in another state. Act 121 (H.B. 4335) and Act 122 (H.B. 4336), Laws 2017, effective October 5, 2017 2
Taxpayer Did Not Qualify for MBT Deduction, Exclusion or Credit The Michigan Tax Tribunal granted summary disposition to Department of Treasury (Department) after finding: (1) the Michigan Business Tax (MBT) materials and supplies deduction did not include leases and rental agreements, (2) that the taxpayer was not an agent under Michigan law and therefore could not take the MBT exclusion for amounts received in an agency capacity, (3) that the Department s published interpretation of the compensation credit that states it is based on where employees work was performed, rather than where the employees reside, did not conflict with the statute, and (4) that the taxpayer had not adequately set out nor supported its contention that it was not part of a unitary business group under LaBelle Management, Inc. v Department of Treasury, No. 324062, March 31, 2016. For the tax years at issues, the taxpayer filed MBT returns as the designated member of a unitary business group. The taxpayer had claimed the MBT deduction for "purchases from other firms" of "material and supplies" found in Sec. 208.1113(6)(c), M.C.L. for transportation services. It was uncontested that the items at issue were all intangibles: lease agreements, purchased transportation, and vehicle rental. The Department argued that the material and supplies deduction was limited to tangible goods. The Tax Tribunal found the taxpayer provided no authority for the proposition that materials and supplies was broader than its plain statutory meaning. Deductions are strictly construed. Materials and supplies must tangible goods, items kept on hand as supplies. The performance of transportation services could not be deducted from gross receipts under Sec. 208.1113(6)(c), M.C.L. The taxpayer had also claimed that it was engaged in the business of providing transportation services because it was contractually engaged with certain independent contractors, as their agent, to secure and obtain transportation jobs. The taxpayer had written agreements with the independent contractors. The taxpayer claimed the payments derived from the jobs should qualify for the exclusion from gross receipts for amounts received in an agency capacity as provided in Sec. 208.1111(a) or (b), M.C.L. To this end, the taxpayer relied upon the Black s Law Dictionary definition of "principal" and "agent", which provided, "[t]he employer or constitutor of an agent; the person who gives authority to an agent or attorney to do some act for him." However, the Department argued the terms "principal" and "agent" had specific meaning under common law in Michigan and that without control by the principal, there was no agency. Here, the Department argued that the taxpayer could not qualify as an agent as it was not controlled by the independent contractors. Further, the taxpayer controlled the conduct of the independent subcontractors, rather then the other way around. Accordingly, the Tax Tribunal found the taxpayer could not be the agent of the independent contractors. The amounts collected and paid to the subcontractors could not be excluded from gross receipts under Sec. 208.1111, M.C.L The taxpayer argued that the compensation credit allowed against the MBT and gross direct (insurance) premiums tax for work performed in the state under Sec. 208.1403(2), M.C.L. was for compensation paid to Michigan residents. The Department argued that "compensation in this state" only referred to compensation paid for work performed in Michigan. To this end, the Department had previously issued MTB FAQ C57, which stated that the phrase "compensation in this state" meant actual compensation for that portion of the services that each of the taxpayer s employees provided at one or more locations in Michigan. Further, it stated that compensation for any services provided by an employee at a non-michigan location could not be used to calculate the credit. The legislative history did not shed any additional light on the phrase. Where this is an ambiguity, Michigan courts will defer to the interpretation by the agency changed with interpreting the provision. Thus, the Tax Tribunal agreed with the Department that there was no cogent reason to overrule the Department s interpretation of Sec. 208.1403(2), M.C.L. At the prehearing conference the taxpayer raised the issue of whether it and seven other entities met the control test of a unitary business group based upon the decision in LaBelle Management, Inc. v Department of Treasury, No. 324062, March 31, 2016. In that case, the Michigan Court of Appeals eliminated constructive ownership or ownership through attribution as a means of satisfying the unitary business group control test. Here, the Tax Tribunal issued an order requiring the taxpayer to file a supplemental brief explaining its theory of, the applicability, and specific tax consequences to the assessments at issue in the case from the LaBelle decision. The taxpayer filed a short brief that set out the ownership structure of the taxpayer and other member of the unitary group. 3
But the taxpayer did not set out specific tax consequences for itself or for the other entities combined in the return. The taxpayer failed to set out any contention of taxes owed or refunds due based on LaBelle. The Tax Tribunal found the taxpayer failed to comply with its order and had not supported its contention. Further, the Tax Tribunal went on to address other issues that could occur if it made a determination on the taxpayer s LaBelle contention. Unlike LaBelle, no standalone return was filed in the taxpayer s case. The Department was dealing with a hypothetical filing. Also, the LaBelle decision did not have to discuss or decide the tax consequences of nonparties to the litigation. It was unclear whether only the taxpayer, or the other entities on the unitary return, would be parties and whether the taxpayer s representative could speak for all or any of them. The Tax Tribunal would have to address whether to dismiss non-named parties to the unitary filing for failing to exhaust administrative remedies or for failing to pay undisputed portions. Finally, the Department could risk criminal sanctions if it divulged facts and information about entities beyond the named taxpayer. Total Armored Car Service, Inc. v. Michigan Department of Treasury, Michigan Tax Tribunal, No. 16-003017, July 13, 2017; released October 6, 2017 Distributions from IRAs Discussed The Michigan Department of Treasury (department) has issued a new revenue administrative bulletin addressing the personal income tax treatment of individual retirement arrangements (IRAs). The bulletin specifically addresses common transactions and issues related to IRAs as a subtractable "retirement or pension benefit" in Michigan. Michigan law does not authorize a subtraction for contributions to IRAs, but since Michigan taxable income is based on federal adjusted gross income (AGI), the provisions of the Internal Revenue Code (IRC) indirectly allow for certain plan contributions to reduce the Michigan income tax base. Accordingly, contributions made to a "Roth IRA" are not deductible but certain pretax contributions to "Traditional IRAs" may be deducted in computing AGI. The overall extent of the deduction is subject to annual limitations based on the age, plan type, and compensation level of the taxpayer. A distribution from an IRA included in AGI may qualify for a subtraction if (1) the distribution is not made until a participant has reached 59-1/2 years of age, except in certain cases; (2) the distribution is made by a disabled taxpayer; (3) the distribution is made after the death of a participant and may only be subtracted by a spouse, provided that the distribution qualified as a subtraction for the participant at the time of death; or (4) the distribution is received from a retirement annuity policy for which payment is made for life to a senior citizen. Further, as stated in Magen v. Department of Treasury, Michigan Court of Appeals, No. 302771, February 21, 2013, an IRA distribution may also be deductible where the IRA is funded from the rollover of an otherwise exempt retirement plan. Generally, Magen requires that the underlying source of any retirement or pension benefits must be considered in determining whether those benefits are subtractable on the Michigan return. Nonqualifying distributions include: (1) distributions from plans that allow an employee to set the amount of compensation to be deferred and do not prescribe retirement age or years of service, including IRC 457 deferred compensation plans, certain distributions from 401(k) plans, and most plans qualified under IRC 403(b); (2) premature distributions paid on separation, withdrawal, or discontinuance of a plan prior to the earliest date a recipient could have retired under the provisions of the plan; or (3) payments received as an incentive to retire early unless the distributions are from a pension trust. 4
Further, the bulletin discusses applicability of annual deduction limits to IRAs; treatment of rollovers; effect of distributions, contributions, and rollovers on the calculation of "total household resources" for the homestead property tax credit and the home heating credit; and withholding on nonqualifying distributions. Revenue Administrative Bulletin 2017-21, Michigan Department of Treasury, October 10, 2017 Minnesota Impact of Ashland Inc. v. Commissioner of Revenue Addressed The Minnesota Department of Revenue has issued a bulletin discussing how the Minnesota Supreme Court s recent decision in Ashland Inc. v. Commissioner of Revenue may affect corporations that owned foreign disregarded entities and filed corporate franchise tax returns in Minnesota for tax years 1997-2012. As a result of the decision, the department must now recognize the income, losses, and deductions of a foreign entity owned by a U.S. corporation when the entity elects to be treated as a disregarded entity for federal income taxes. Corporate franchise taxpayers who filed a Minnesota return for the tax years at issue may be entitled to a refund of taxes paid, owe additional tax, or have to adjust net operating loss carryforwards for the affected periods. Taxpayers filing or amending returns for the affected tax years must include the income and apportionment factors of all foreign disregarded entities in the calculation of net income and apportionment percentage. The department notes that it will not assess or collect latepayment, late-filing, or substantial understatement penalties from corporations that report additional tax liabilities related to the decision. Bulletin, Minnesota Department of Revenue, October 5, 2017 Ohio Sales and Use Tax Changes to Nexus Standard Explained The Ohio Department of Taxation has released sales and use tax guidance on the nexus changes enacted by H.B. 49, Laws 2017. Beginning January 1, 2018, an out-of-state seller will have Ohio use tax collection responsibility if it uses in-state software to sell tangible personal property or services to consumers and has gross receipts exceeding $500,000 in the current or preceding calendar year from the sale of property or services used in Ohio. Furthermore, an out-of-state seller must collect Ohio use tax if it enters into an agreement with another party to provide a content distribution network in Ohio to enhance the delivery of its website to consumers and has gross receipts exceeding $500,000 in the current or preceding calendar year from the sale of property or services used in Ohio. Sales Tax Information Release ST 2017-02, Ohio Department of Taxation, October 20, 2017 Rhode Island Amnesty Program Highlighted The Rhode Island Division of Taxation has issued an advisory containing highlights of the upcoming amnesty program. The division notes that it will begin accepting applications on Friday, December 1, 2017 and will mail account 5
statements beginning in early November notifying taxpayers of their account balances. In addition, the division is developing an application, a website, and a phone bank to answer calls about the program. Advisory 2017-29, Rhode Island Division of Taxation, September 27, 2017 If you have any questions, please contact your tax advisor or: Curtis Ruppal 877-622-2257, Ext. 34069 curtis.ruppal@plantemoran.com Mike Merkel 877-622-2257, Ext. 33264 michael.merkel@plantemoran.com Julie Corrigan 877-622-2257, Ext. 26509 julie.corrigan@plantemoran.com Ron Cook 877-622-2257, Ext. 03211 ron.cook@plantemoran.com The information provided in this alert is only a general summary and is being distributed with the understanding that Plante & Moran, PLLC, is not rendering legal, tax, accounting, or other professional advice, position, or opinions on specific facts or matters and, accordingly, assumes no liability whatsoever in connection with its use. 2017 CCH Incorporated and its affiliates. All rights reserved. 6