Eric Tresh Sutherland Jonathan Feldman Sutherland TEI Meeting Petroleum Club Ft. Worth, TX June 25, 2014 State Tax Litigation and Legislation Update
Agenda Group Composition / Unitary Disputes Nexus MTC Election Controversy Apportionment Other Litigation FCA and Class Action Litigation 2
Group Composition / Unitary Disputes
Group Composition: New York Matter of the Petition of IT USA Inc., Nos. 823780 and 823781 (Tax Appeals Tribunal April 16, 2014) Parent company created to reduce subsidiaries overhead costs by centralizing management Parent controlled centralized cash management system; paid subsidiary expenses; all employees transferred from subsidiaries to parent; no formal agreement created Although the taxpayer did not meet the substantial inter-corporate transaction requirement, taxpayer: (1) met capital stock ownership requirement;(2) were engaged in unitary business; and (3) separate filing would distort true nature of income and tax liability 4
Group Composition: New York 5 Matter of the Petitions of Knowledge Learning Corp. and Kindercare Learning Centers, Inc., Nos. 823962 & 823963 (N.Y. Div. of Tax. App. June 27, 2013) The Administrative Law Judge found that taxpayers failed to establish substantial intercorporate transactions existed between affiliates to permit a combined filing First post-2007 law change decombination case The taxpayers attempted to establish that substantial intercorporate transactions existed because: 1) all of Kindercare s employees were paid and employed by KLC; and 2) all of Kindercare s expenses were paid by KLC In rejecting those arguments, the ALJ noted that there was no written agreement documenting the employee transfers between the affiliates and that KLC s payments of Kindercare s expenses were on behalf of Kindercare, using Kindercare s own cash Appealed to Tax Appeals Tribunal, awaiting decision
Group Composition: New York Matter of the Petition of SunGard Capital Corp., DTA No. 823631 (N.Y. Div. of Tax App. Apr. 3, 2014) ALJ determined that taxpayers did not operate a unitary business The ALJ found that the centralized operations and services provided by the parent corporation were stewardship-activities not resulting from the parent s operational expertise The decision rejects many of the traditional indicia of functional integration, centralization of management, and economies of scale Likely to see more unitary disputes now that New York shifted to unitary combined reporting effective for tax years beginning Jan. 1, 2015 6
Group Composition: Oregon Rent-A-Center, Inc. v. Department of Revenue, Dkt. No. TC-MD 111031D (Or. T.C. May 12, 2014). Tax Court determined that Rent-A-Center and its wholly owned franchising subsidiary were not unitary, while it was unitary with its captive insurance subsidiary. The court determined that the presence of all three unitary factors (i.e., flows of value evidenced by centralized management, economies of scale, and functional integration) were required to find a unitary business. The franchising subsidiary only exhibited centralized management with Rent-A-Center, but found that the captive insurance subsidiary exhibited all three unitary factors. The court specifically focused on functional integration and found that providing insurance to Rent-A-Center s unitary relieved the subsidiaries of the burden of finding their own insurance and resulted in a financial benefit to the entire group. 7
Unitary Dispute: California ComCon Production Services I, Inc. v. California Franchise Tax Bd., Case No. BC489779 (Los Angeles Super. Ct. Mar. 6, 2014) The court held that Comcast was not unitary with its subsidiary, QVC The court held that none of the unitary tests were satisfied The court held, however, that Comcast s receipt of a $1.5 billion termination fee constituted business income 8
Nexus
Income and Franchise Tax Nexus Gore Enterprise Holdings, Inc. v. Comptroller of the Treasury, Md. Ct. App., Dkt. No. 36 (Mar. 24, 2014). The Maryland Court of Appeals held that two out-of-state intangible holding companies were a unitary business, but held that the unitary business principle could not be used to establish nexus for the subsidiaries However, sufficient nexus was established because the subsidiaries lacked substance apart from the parent; This decision appears inconsistent because: It treated the subsidiaries as lacking substance for nexus purposes, but treated them as separate companies for assessment purposes. Muddled Maryland s nexus standard even further. 10
Click-Through Nexus Amazon.com, LLC v. New York Dep t of Taxation and Finance; Overstock.com, Inc. v. New York Dep t of Taxation and Finance, 12013 N.Y. Lexis 542 (N.Y. Ct. App. Mar. 28, 2013) New York Court of Appeals upheld the constitutionality of New York s click-through nexus law. U.S. Supreme Court denied cert. in December 2013. Performance Marketing Assn., Inc. v. Hamer., Dkt. No. 114496 (Ill. Oct. 18, 2013) The Illinois Supreme Court upheld an Illinois circuit court decision and determined that the Illinois click-through nexus statute was preempted by federal law. 11
Use Tax Reporting Direct Marketing Assoc. v. Colorado Dep t of Rev., Case No. 13CV34855 (Denver Dist. Ct. Feb. 18, 2014) A Colorado state district court issued a preliminary injunction preventing the Colorado Department of Revenue from enforcing Colorado s out-of-state seller use tax reporting statutes and related regulations Previously, the Tenth Circuit Court of Appeals dismissed a federal district court s grant of a permanent injunction against the Colorado Department of Revenue that prevented the Department from enforcing Colorado s use tax notice and reporting requirements Direct Mktg. Ass'n v. Brohl, 2013 U.S. App. LEXIS 17298 (10th Cir. Aug. 20, 2013) 12
Economic Nexus Quantitative Thresholds Constitutional L.L. Bean, Inc. v. Levin, No. 2010-2853 (Ohio Bd. Tax App. Mar. 7, 2014) The Ohio Board of Tax Appeals sustained the Department of Taxation s assessment of L.L. Bean for the commercial activity tax based on the statutory bright-line presence test (taxable gross receipts of at least five hundred thousand dollars), even though L.L. bean had no physical presence in Ohio. Decision has been appealed to the Ohio Supreme Court. Does the U.S. Supreme Court s continuous and systematic (Goodyear Dunlop, (131 S.Ct. 2846 (2011)) and purposefully directed activity (J. McIntyre Machinery, 131 S.Ct. 2780 (2011)) requirements allow for only a quantitative threshold? 13
Reverse Nexus Allied Domecq Spirits & Wines USA, Inc. Mass Ct. App., June 18, 2014). A corporation transferred employees and business functions to an affiliate Transfer did not have a valid business purpose or economic effect beyond the avoidance of tax Affiliate did not have sufficient nexus with Massachusetts MA Appeals court upholds decision Tax Board s ruling Taxpayer did not meet burden of showing the employee transfer had economic substance other than tax avoidance 14
MTC Election Controversy
MTC Election Controversy - CA Gillette Co. v. Franchise Tax Bd., 147 Cal. Rptr. 3d 603 (Cal. Ct. App. 1 st Dist. 2012). The Multistate Tax Compact is a valid, binding compact that obligates member States to offer multistate taxpayers the option of using either the Compact s equally weighted three-factor formula to apportion and allocate income or the State s own alternative apportionment formula, unless and until the State withdraws from the Compact. On January 16, 2013, the California Supreme Court granted the Franchise Tax Board s petition for review. On September 20, 2013, the briefing was complete. The parties filed their final briefs on January 22, 2014. 16
MTC Election Controversy - MI IBM Corp. v. Dep t of Treasury, No. 306618 (Mich. Ct. App. Nov. 20, 2012). The Michigan Court of Appeals reluctantly found that there was no way to harmonize a Michigan statute that allowed a company to elect to apportion its income according to the Multistate Tax Compact s three-factor formula and the Michigan Business Tax Act, which mandates the use of a single-factor apportionment formula. The court held that the Business Tax Act repealed by implication the election provision found in the Compact. On July 3, 2013, the Michigan Supreme Court granted the company s application for leave to appeal. Oral arguments were heard on January 15, 2014. 17
Compact Activity in Michigan Anheuser-Busch, Inc. v. Mich. Dep t of Treas. (Mich. Ct. Cl., June 6, 2013) Held that Compact was a binding multistate compact that cannot be repealed by separate, subsequent statute Language of Compact plainly and unambiguously demonstrated intent to bind future Legislatures Equal weighted 3-factor apportionment allowed for the BIT component of the MBT for 2008-2010 Held that gross receipts portion of MBT not an income tax Because IBM decision was unpublished, court was free to reach independent conclusion 100+ similar cases pending in Michigan 18
Texas Developments Graphic Packaging Corporation v. Combs, Dkt. No. D-1- GN-12-003038 (353rd Jud. Distr. Ct. Jan. 15, 2014). Texas Trial court denied the taxpayer s claim that it was entitled to the MTC s three-factor formula election for the TMT. The court left some questions open: The order did not address whether the election was actually available. Nor did the order address whether the TMT is an income tax for purposes of the MTC Compact. Two claims remain outstanding: An as-applied constitutional challenge to the single-sales factor apportionment method, and A challenge to the imposition of penalties and interest on the taxpayer. 19
Texas Developments Legg Mason, Inc. v. Combs, No. D-1-GN-14-001897 (250 th Jud. Dist. Ct., June 17, 2014). Combined group filed refund claim asserting right make election to use MTC s 3-factor apportionment formula Taxpayer argues that Compact provisions apply to TMT because Compact Regulations state that the definitions of income tax and gross receipts tax should be read together Any doubt shall be resolved in favor of construction as an income tax in order to more effectually make available the application of the substantive provisions of the [MTC] Single apportionment method, as applied, violates the Contracts Clause of US and TX Constitutions 20
Oregon Developments OR: Health Net, Inc. v. Dep t of Revenue, No. TC- 5127 (Ore. Tax Ct., amend. complaint filed Jan. 17, 2013) Taxpayer filed suit claiming right to elect MTC s equallyweighted three-factor formula rather than single sales factor required by Oregon statute Department protective refund claim guidance issued on Sept. 24, 2012 Both the Oregon Attorney General and taxpayer filed motions for summary judgment (Feb. 11, 2014) Oral Arguments set for July 22, 2014 21
Apportionment
Alternative Apportionment CarMax Auto Superstores West Coast, Inc. v. South Carolina Dep t of Revenue, 397 S.C. 604, 725 S.E.2d 711 (S.C. App., 2012) Retailer used statutory 3-factor apportionment DOR determined statutory apportionment method did not fairly reflect taxpayer s income and used an alternative method: Income from royalty and financing receipts in South Carolina v. everywhere Court of Appeals: DOR had to prove by preponderance of the evidence: Statutory apportionment method did not fairly represent taxpayer s business activity in state; and DOR s proposed alternative apportionment method was more reasonable than any competing method 23
Alternative Apportionment S.C. Supreme Court Granted DOR s leave for appeal in August 2013 Taxpayer asked Court to determine whether Court of Appeals erred in: (1) determining taxpayer was a unitary business; (2) holding receipts at issue should be sourced to South Carolina; and (3) failing to find a violation of taxpayer s constitutional rights DOR requested Court to determine whether Court of Appeals erred in determining Department has the burden of proof to show its alternative apportionment formula is more appropriate than any competing methods Oral arguments heard March 19, 2014, decision pending 24
Alternative Apportionment Subsequent Developments in South Carolina Following the S.C. Supreme Court s grant of cert., the DOR issued a draft revenue ruling citing to the case. South Carolina Dep t of Revenue, Rev. Rul. 14-STAFF DRAFT (Feb. 28, 2014) Revenue ruling clarified that the party asserting alternative apportionment had the burden of proving that the standard apportionment formula did not fairly represent the taxpayer s in-state business activity (citing Carmax) Draft has been withdrawn 25
Alternative Apportionment Equifax, Inc. v. Mississippi Dep t of Revenue, 125 So.3d 36 (Miss. 2013) Taxpayer used cost-of-performance method for sourcing its service provider revenue DOR applied an alternative apportionment method utilizing market-based sourcing Mississippi Supreme Court reversed Court of Appeals and held the taxpayer bears the burden to prove that an alternative apportionment method imposed by the State is arbitrary and unreasonable Mississippi Supreme Court denied Equifax s motion for rehearing on November 21, 2013 Taxpayer s petition to SCOTUS for cert. still pending 26
Alternative Apportionment Legislative Response to Equifax (HB 799) (Eff. 1/1/2015) Placed burden of proof on party invoking alternative apportionment method to prove by a preponderance of the evidence that: Statutory method does not fairly represent activity in the state; and Selected method more fairly represents that activity than any other reasonable method available Requires that alternative apportionment be invoked only in limited and unique, nonrecurring circumstances Prohibits DOR from invoking forced combination until regulations have been promulgated No penalties from forced combination unless DOR finds no reasonable basis or nontax business purpose 27
Apportionment: NJ Throwout Lorillard Licensing Co., LLC v. Dir., Div. of Taxation, No. A-2033-13T1 (N.J. Tax Ct. order issued Jan. 14, 2014) The New Jersey Tax Court held that only one standard the economic nexus standard upheld in Lanco applies in determining whether receipts must be thrown out of the sales factor Under New Jersey s now-repealed throwout rule, receipts attributable to a state or foreign country in which the taxpayer is not subject to a tax on or measured by profits or income, or business presence or business activity are excluded from the sales factor Applying the Lanco standard, licensors of intangibles should be deemed taxable in any state where they have receipts As such, should not have to throw out any receipts New questions: Can this apply beyond throwout? Should you file refund claims? 28
Other Litigation
Double Taxation of Pass-Through Income Maryland State Comptroller of the Treasury v. Brian Wynne, Dkt. No. 107, September Term 2011 (Md. Jan. 28, 2013). Maryland allowed taxpayers to claim a credit against their state income taxes for taxes paid to other states. However, a similar credit was not allowed against a resident s county income tax. The Court of Appeals held that Maryland s scheme for allowing credits violated the dormant Commerce Clause Was not fairly apportioned, as taxpayers earning income outside the state would be taxed at higher rates due to multiple taxation. Discriminated against interstate commerce because taxpayer pays higher rate of tax on income earned out-ofstate Certiorari was granted by the United States Supreme Court on May 27, 2014. 30
Constitutionality of Deductions CDR Systems Corporation v. Oklahoma Tax Commission, Dkt. No. 109886 (Okla. Apr. 22, 2014). Taxpayer was headquartered in Florida, but sold a manufacturing facility in Oklahoma and tried to claim Oklahoma s headquarters deduction, which requires a company to be headquartered in Oklahoma for three or more years. The Oklahoma Supreme Court upheld the deduction as constitutional indicating that dormant commerce clause did not apply since deduction was available to qualified entities regardless of participate in interstate or intrastate commerce. The court further held that the deduction withstood a facial challenge under the dormant commerce clause because: The deduction does not penalize the out-of-state activities of corporations doing business in Oklahoma; Serves a non-discriminatory purpose in attracting out-of-state development; Does not preclude tax neutral decision making or otherwise effect interstate commerce 31
FCA and Class Action Litigation
Third Party Enforcement Actions Approximately 30 jurisdictions currently have False Claims Acts A number of state FCA statutes contain explicit tax bars prohibiting qui tam actions for allegedly false tax claims (e.g., CA, DC, HI, MA, NM, NYC, NC, TN, VA). Some states impose a tax bar only with respect to income tax matters (e.g., IL, IN, RI). A number of states do not appear to restrict the action to a particular subject matter (e.g., DE, FL, NV, NH, NJ). Because of the increased risk and pressures of False Claims Acts suits legislation to expand and/or narrow the scope of False Claims Acts is expected in 2014. 33
False Claims Act Lawsuit (NY) People v. Sprint Nextel Corp., No. 103917/2011 (N.Y. App. Div. Feb. 27, 2014) New York Attorney General Schneiderman took over a whistleblower lawsuit that alleged that Sprint Nextel had failed to collect $100 million in telecommunications sales taxes after unbundling its wireless services. The New York Supreme Court, Appellate Division, affirmed a 2013 trial court ruling denying Sprint Nextel Corporation s motion to dismiss the attorney general s False Claims Act complaint. The New York Court of Appeals has granted view of lower court s ruling denying Sprint s motion to dismiss 34
False Claims Act Lawsuit (NY) New York ex rel. Moore v. Lantheus et al., No. 102892/2012 (NY Sup. Ct., New York Cnty.) (filed May 2012) Lantheus and former parent Bristol-Myers Squibb recently agreed to a $6.2 million settlement to resolve qui tam action alleging failure to pay $2.2 million in NY State franchise taxes The New York FCA suits are expressly applicable to tax cases and allow for civil penalties and treble damages Whistleblower was a tax services provider NY s FCA allows awards up to 30 percent of recovered proceeds Whistleblower here received approximately $1.1 million resulting from settlement 35
False Claims Act Lawsuit (DC) Phone Recovery Services LLC v. Verizon Washington DC Inc., No. 14-0002277 (D.C. Sup. Ct. 2014) Complaint recently filed in a Qui Tam (whistleblower) action on behalf of the District of Columbia against several telecommunication service providers for failure to pay all 911 taxes on all active service lines provided in the District. Providers were sued by Phone Recovery Services LLC in District of Columbia Superior Court for failing to pay over $29 million in 911 taxes. The complaint states that small telephone service providers typically do not pay 911 tax at all, while other companies classify telephone services in a way that evades the tax. 36
Illinois Qui Tam State of Illinois v. Fansedge Inc., Cook County Circuit Court, No. 11 L 9550 (June 5, 2014). The court did not need to rule on whether sales tax actually applied to shipping charges Issue whether the taxpayer intentionally, knowingly, or recklessly concealed from the Illinois Department of Revenue that it was not collecting tax on its shipping charges Taxpayer endured two Illinois DOR audits Taxpayer s employees gave very effective testimony about the audits and the issue Judge found the testimony credible, and in ruling for the taxpayer chided the IDOR: As an aside to this opinion and not part of it, one cannot but wonder why this case is authorized by the State of Illinois and brought under these facts Brian Hamer, IL Rev. Director, states that IL has nearly 400 of these cases 37
FCA and Class Actions Class Actions Uncertainty with respect to the application of income, transaction, and property tax statutes can create substantial risk Telecommunications providers are often forced into a no win situation between aggressive plaintiff s attorneys and aggressive tax jurisdiction Recent AT&T Mobility s global settlement for hundreds of millions; refund litigation pursued in New Jersey, California, Arkansas, and elsewhere; but arbitration win at the U.S. Supreme Court in AT&T Mobility, LLC v. Concepcion, 563 U.S. 321 (2011) 38
Multistate Class Action AT&T Mobility and Cingular Wireless Sales Tax refund litigation 2009: class actions filed in 44 states on behalf of AT&T customers Class actions seek refunds of tax charges erroneously included in customer bills AT&T and customers reached global settlement agreement requiring AT&T to seek tax refunds from hundreds of local governments across the country CA: AT&T may pursue refund claims without first having to repay customers NJ: New Cingular could pursue a $32M refund claim from the NJ Division of Taxation 39
Charter Class Action Case State ex rel. Collector of Winchester, MO v. Jamison, No. SC91631 (MO 2012)(Charter Communications). City of Winchester and several other Missouri cities file class action against Charter Communications to recover unpaid license taxes on gross receipts derived from: Similar suits brought and settled against Verizon, AT&T, T-Mobile, Sprint and virtually every other telecom provider. Exchange access, State USF fees, intrastate telecom services, etc. MO statute imposes tax on gross receipts derived from exchange access intrastate telephone service and other sources. 40
Charter Class Action Case State ex rel. Collector of Winchester, MO v. Jamison, No. SC91631 (MO 2012)(Charter Communications). Circuit court strikes and dismisses class action claim Supreme Court of MO issues a permanent writ of mandamus directing the trial court to vacate order MO statute disallowing cities to bring class actions is unconstitutional because it purported to amend procedural rule of the court without expressly stating intent to do so 41
Consumer Class Actions Rasschaert v. Frontier Communications Corp., Civil No. 12-3108 (DWF/JSM), 2013 WL 1149549 (March 19, 2013) Class Action suit filed in 2011: Plaintiffs Allege- Frontier charged HSI fee not included in advertised price Frontier included 911 and USF fees on customer bills (also not included in advertised price) despite internet service not being subject to such fees Frontier placed HSI fee (for High-Speed Internet) on customers bill in close proximity to the regulatory fees, giving the appearance that the HSI fee was governmentmandated 42
CA Consumer Class Action Loeffler v. Target Corp., No. S173972 (Cal. Sup. Ct. 2014). Consumer class action seeking reimbursement of overcharged sales tax Unique Party Alignment: Business & SBE v. CA Attorney General and Consumers California Supreme Court ruled in favor of Target in a 4-3 decision, holding that consumers have no judicial remedy to seek reimbursement for overcharged sales tax But see Moshiri v. Saks & Co., No. BC548335 (Sup. Ct. of Los Angeles filed June 11, 2014). Filed in federal court claiming clothing retailer must include sales tax in refunds to customers without a receipt Suit seeks class cert., damages, restitution, injunctive relief and attorneys fees 43
Class Action: FET Decision In re: Long-Distance Telephone Service Federal Excise Tax Refund Litigation - MDL 1798, No. 12-5380 (D.C. Cir. 2014). Class action lawsuit to recover improperly collected FET amounts on long-distance service. In 2006, the IRS issued Notice 2006-50, which established a procedure for taxpayers to request a refund of the illegally collected excise taxes. The Notice was invalidated because it was not properly noticed under the APA. The IRS, however, never issued another refund procedure. The D.C. Circuit ruled that the plaintiffs who challenged the IRS s illegal tax on long-distance telephone calls can't force the agency to issue a new procedure for refunding its gains after its initial procedure was invalidated on procedural grounds. 44
Questions? Eric Tresh Partner Sutherland Asbill & Brennan LLP 404.853.8579 eric.tresh@sutherland.com Jonathan Feldman Partner Sutherland Asbill & Brennan LLP 404.853.8189 jonathan.feldman@sutherland.com 45
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