Recent State and Local Tax Developments

Online CLE

Recent State and Local Tax Developments

1.25 General CLE credits

From the Oregon State Bar CLE seminar 18th Annual Oregon Tax Institute, presented on June 7 and 8, 2018

© 2018 Annie Huang, Jeffrey Vesely. All rights reserved.

Chapter 7

Recent State and Local Tax Developments—Presentation Slides

Annie HuAng

Pillsbury Winthrop Shaw Pittman LLPSan Francisco, California

Jeffrey Vesely

Pillsbury Winthrop Shaw Pittman LLPSan Francisco, California

Chapter 7—Recent State and Local Tax Developments—Presentation Slides

7–ii18th Annual Oregon Tax Institute


7–118th Annual Oregon Tax Institute

18th Annual Oregon Tax InstitutePortland, OregonJune 8, 2018

Recent State and Local Tax Developments

Jeffrey M. VeselyPillsbury Winthrop Shaw Pittman LLP

Annie H. HuangPillsbury Winthrop Shaw Pittman LLP

AGENDA

Case of the Millennium, aka South Dakota v. Wayfair Impact of Federal Tax Reform on States Other SALT Legislation of Note Recent SALT Cases Alternative Apportionment/Sales Factor Issues

2 | Recent State and Local Tax Developments



Case of the Millennium—Wayfair

• When are remote sellers required to collect sales/use taxes?• National Bellas Hess, Inc. v. Department of Revenue (1967)• Quill Corp. v. North Dakota (1992)• Direct Marketing Association v. Brohl (2015)• South Dakota v. Wayfair Inc. (2018)


National Bellas Hess (1967)

• Mail order case in which remote seller with no physical presence in Illinois was not required to collect use tax on sales of tangible personal property in the state

• “The many variations in rates of tax, in allowable exemptions and in administrative and recordkeeping requirements could entangle National’s interstate business in a virtual welter of complicated obligations to local jurisdictions with no legitimate claim to impose a fair share of the cost of local government…the very purpose of the Commerce Clause was to ensure a national economy free from such unjustifiable local entanglements.”




Quill (1992)

• Remote catalog sellers with no physical presence in North Dakota were not required to collect use tax on sales of tangible personal property in the state

• Supreme Court focused on the burdens on interstate commerce• “The bright-line rule of Bellas Hess furthers the ends of the dormant

Commerce Clause.”• Settled expectations• Compliance burdens• Invited Congress to act


Responses to Quill Physical Presence Requirement• States enacted legislation and promulgated regulations

o Agency nexus rules• Affiliate nexus• Click-through nexus

o Purchaser Information Reporting (Colorado)

• Sought federal legislation imposing use tax collection responsibility on vendors without physical presence

o Marketplace Fairness Act; Remote Transactions Parity Act• Collection obligation triggered if certain in-state sales thresholds met




Direct Marketing Association (2015)

• Use tax information reporting requirement for out-of-state vendors found to be constitutional

• Justice Kennedy concurring opinion calling for a case to reexamine Quill.


Wayfair (2018)

• South Dakota enacted remote use tax collection legislation in response to Justice Kennedy’s comments in DMA

o Economic nexuso Remote sellers required to collect use tax if $100,000 in sales or 200

separate transactions during the previous or current yearo Legislation designed to get a case before the US Supreme Court as quickly as

possibleo Prospective application




Wayfair—Other States’ Actions

• Many other states enacted similar economic nexus legislation with varying sales/transaction thresholds

• Some states’ laws require use tax collection to the extent permitted by the US Constitution, with or without physical presence

• Some states enacted information reporting laws similar to Colorado• Some states enacted laws with innovative nexus theories such as

cookie/software nexus, among others


Wayfair

• Wayfair became the vehicle to challenge Quill• An extremely limited record in the courts below• Lower courts held the South Dakota law to be unconstitutional• In January 2018, US Supreme Court agreed to review the case• Numerous amicus briefs• April 17, 2018, oral argument held • Decision expected in June




Wayfair

• Possible Outcomes/Issueso Quill is upheld

• Invitation to Congress to act…againo Quill is overturned

• Retroactive vs. prospective application• Uniform nexus standard? Number of sales? Is one sale enough?• Different taxable items? Exemptions?

o Case is remanded because record is limited• Further proceedings to examine the extent of burdens on sellers


Wayfair—Why Important to Oregon Taxpayers?• Sales by Oregon taxpayers into other states—what standards apply for

requiring use tax collection?• What nexus standards should apply to other taxes in Oregon or other

states?• Is physical presence a viable standard for income taxes, gross receipts

taxes, B&O taxes, other taxes?• Will information reporting be endorsed by the Court




Impact of Federal Tax Reform on States

• Repatriation• Global Intangible Low-Taxed Income (GILTI)• Foreign Derived Intangible Income (FDII)• Base Erosion Anti-Abuse Tax (BEAT)• Cap on SALT Deduction


Impact on States—General Principles

• Key is how an individual state conforms to the IRCo Rolling conformityo Automatic conformityo Selective conformity

• Another key is how the state defines its tax baseo Is it a line 28 state?o Line 30?




Repatriation (IRC 951(a), 965(a), 965(c))

• Does the state conform to the new provisions?• Relevance of statutory dividends received deduction provisions under

state lawo Is the 951(a) income a dividend for state income tax purposes?o Is the 965 income a dividend for state income tax purposes?

• Potential constitutional issueso Kraft v. Iowa—Different treatment of domestic vs. foreign dividends?o Sales factor—If the receipts are not included in the sales factor, does this

violate the external consistency test of the Commerce Clause?


Deemed Repatriation—California

• Selective conformity state• Conforms to the IRC as January 1, 2015—selectively• Déjà vu all over again?• In 2004-2005, when IRC 965 was enacted, many of the same issues arose• California does not currently conform to IRC 965

o Raises issues of dividend elimination vs. partial deduction and foreign investment interest offset• Water’s Edge Elections

o Subpart F income means Subpart F income as defined in IRC 952o Inclusion ratio not affected by IRC 965

• Effect of RTC 25116o For water’s edge purposes, California automatically conforms to amendments to the IRC,

provided there was already conformity to the IRC provisions being amended




Actual Repatriation—California

• California does not conform to IRC 245A• Deduction of dividends depends upon whether filing on a worldwide or

water’s edge basiso Full elimination under RTC 25106o 75% dividends received deduction under RTC 24411

• Foreign investment interest offset under RTC 24344

• Are the dividends business or nonbusiness income?


Actual Repatriation—California

• Sales factor reflectiono Should the dividends be included in the sales factor?o Should they be excluded because they are occasional and substantial?o How should they be sourced?

• Distortion and factor representation issues• Earnings and profits issues

o California and federal differenceso Ordering of dividends—Apple and Fujitsuo Were the earnings and profits already taxed by California in 2004/2005 when taxpayers took

advantage of the original enactment of IRC 965?o Deferred intercompany stock account




Repatriation—Oregon Response

• SB 1529 (signed by Governor)o Gross, not net, repatriation amount included in the tax base, with such gross

amount subject to the dividends-received deduction of 70 or 80 percent depending on ownership

o Ensures taxpayers do not receive double deductiono Tax haven law repealed

• Under tax haven law (ORS 317.716), Oregon may already have taxed some of the income now deemed repatriated

• Credit for taxes attributable to this income allowed to alleviate any double taxation


GILTI (IRC 951A and IRC 250)

• Purpose is to discourage US companies from moving business operations to low tax foreign countries

• Carrot and stick approach• Stick

o US corporation must include in income certain income of a foreign affiliate that is taxed abroad at a rate lower than the US rate and that exceeds a 10% return on the affiliate’s tangible property (IRC 951A)

• Carroto US parent can deduct 50% of its GILTI (IRC 250(a)(1)(B))




GILTI—State Impact

• Conformity to IRC 951A and/or IRC 250?• Is the income a dividend?

o Not E&P related?o Does the particular state’s dividends received deduction provisions apply?

• Potential constitutional issueso Should the receipts be included in the sales factor?o Separate vs. combined stateso Is factor representation required?


GILTI—California

• California does not conform to IRC 951A• GILTI is not subpart F income for California purposes (IRC 952)• If filing worldwide, earnings should have already been taxed

o Possible elimination of the income, if considered to be a dividend

• If filing water’s edge, earnings should not yet have been taxedo If a dividend, a 75% dividends received deduction possibleo Foreign investment interest offset may apply

• Federal/ California basis and E&P differences




FDII—State Impact

• States may feel that they do not need to provide an added incentive to that provided by the US

• Possibly separate FDII from the GILTI• States that conform to federal taxable income would have to

affirmatively decouple• FDII deduction is a special deduction under IRC 241-250

o Several states now decouple from special deductions


Base Erosion Anti-Abuse Tax—State Impact

• The BEAT is a federal alternative minimum tax• States that use federal taxable income as a base will not automatically

conform to the BEAT because it does not adjust federal taxable income• Many states already have an AMT. Why add a new one?• Potential constitutional issues




Cap on SALT Deductions

• Number of states have enacted legislation to attempt to avoid the new cap on SALT deductions

• New Yorko Optional employer-based payroll tax systemo State charitable contribution funds

• New Jerseyo Taxpayers who donate to a newly created charitable fund can receive a credit up to 90% toward their

property tax bills and the contributions may be claimed as charitable deductions

• IRS Responseo Notice 2018-54 (May 23, 2018)o IRS announced that it will be proposing regulations which will address federal income tax treatment of

some payments made by taxpayers in an attempt to circumvent the new limit on SALT deductions


Other SALT Legislation of Note

• Head Taxeso Seattle (Amazon Tax)

• Apply to businesses with $20 million or more in gross annual receipts• Rate of $.14 per hour worked by their employees (approximately $275 per

employee per year)• Tax would apply to 585 businesses or 3% of the city’s employers• Generate $47 million annually• Fund housing and services to combat homelessness

o Cupertino and Mountain View considering head taxes• Aimed at Apple and Alphabet

o Constitutional Issues?





• City taxes on transportation network company services and private transit vehicle services

o San Francisco• Ballot proposal to add a new gross receipts tax category• Aimed at Uber and Lyft• Is it constitutional?

o Oakland• Ballot proposal to charge a tax per pick up• Aimed at Uber and Lyft• Is it constitutional?



• Californiao Sales tax on services

• Senate Bill No. 993o 3% tax on services specifically purchased by businesses with income over $100,000o Intended to be revenue neutral and would broaden the tax baseo State’s 7.25% sales tax rate would be reduced by 2 percentage points by 2020o Would not apply to services sold by California businesses to out-of-state buyerso Some out-of-state businesses selling services into California would have to collect

and remit the tax




Recent SALT Cases

• Oregono Comcast Corporation and Subsidiaries v. Department of Revenue, Supreme Court

No. S064698• Argued January 18, 2018• Case involves the application of Oregon’s interstate broadcaster special apportionment

formula• Should it be applied to all members of a consolidated group, even those members

which are not interstate broadcasters?o Capital One Auto Finance Inc. v. Department of Revenue, Supreme Court No.

S064803• Argued May 7, 2018• Case involves the issue whether the corporate excise tax may be applied to a business

with no physical presence in the state


Recent SALT Cases

• New Jerseyo Kraft Foods Global Inc. v. Division of Taxation, NJ Superior Ct., App. Div. No.

A-1157-16T1 (May 17, 2018)• Taxpayer’s deduction of interest paid to its parent on intercompany loans was

disallowed• Court concluded that the taxpayer did not meet the unreasonable exception• Compare with Beneficial New Jersey v. Director of Taxation, NJ Tax Docket No.

009886-2007 (2010)• Compare with Apple Inc. v. Franchise Tax Board, 199 Cal.App.4th 1 (2011)




Recent SALT Cases

• Pennsylvaniao Nextel Communications of the Mid-Atlantic, Inc. v. Commonwealth of Pennsylvania,

Department of Revenue, Supreme Court of Pennsylvania No. 6 EAP 2016 (2017)• Court held that the net loss carryover which restricted the amount of loss a

corporation could carry over from prior years as a deduction against its 2007 taxable income to whichever is higher, 12.5% of the corporation’s 2007 taxable income or $3 million, violated the State’s Uniformity Clause

• The Court refused to grant a refund to the taxpayer• Taxpayer has filed a petition for a writ of certiorari to the US Supreme Court arguing

that under the 14th Amendment it should be granted its request for a refund• May 18, 2018, the DOR issued Corporation Tax Bulletin 2018-02, stating that the

Supreme Court’s decision in Nextel will not be applied to other taxpayers for years before 2017


Recent SALT Decisions

• Utaho See’s Candies, Inc. v. Auditing Division of the Utah State Tax Commission, No.

140401556 (Utah 4th Judicial Dist. Ct. 2016)• Court held that the Utah State Tax Commission abused its discretion by denying

the taxpayer a deduction for royalty expenses paid to a related party when the transaction amount was supported by a transfer pricing study

• Case pending on appeal to the Utah Supreme Court




Recent SALT Cases

• Michigano Honigman Miller, et al., v. City of Detroit, Case No. 336175, Mich. Ct. App.

(January 18, 2018)• Court concluded that for purposes of the City of Detroit Income Tax Act, law firm

services rendered by an attorney physically located in Detroit on behalf of a client located outside the City must be sourced for sales factor purposes based on where the client received the services

• Conversely, the Court held that services provided to a client in Detroit is considered to be in-city services and sourced to the City

• Detroit is aggressively pursuing nexus issues where a taxpayer has no physical presence in the City or is a member of a unitary business, part of which is being conducted in the City


Alternative Apportionment

• Uniform Division of Income for Tax Purposes Act (UDITPA) was approved by the National Commission on Uniform Laws as a Model Act in 1957

o Addressed equitable allocation and apportionment of income via 3-factor formula (property, payroll, and sales)

o Sec. 18 provided for variation when standard formula did not fairly represent the extent of the taxpayer’s business activity




UDITPA Section 18 Standard

• Principal drafter of the Act, Professor William Pierce, wrote:o Departures from the basic formula should be avoided except where reasonableness

requires. Nonetheless, some alternative method must be available to handle the constitutional problems as well as the unusual cases, because no statutory pattern could ever resolve satisfactorily the problems for the multitude of taxpayers with individual business characteristics


Fair Apportionment

• State apportionment formula must satisfy Due Process and Commerce Clauses

o Commerce Clause requires that income be fairly apportioned. Container Corp. of Am. v. Franchise Tax Bd., 463 U.S. 159, 169 (1983)

o Fairness means internally/externally consistent, not discriminatory

• But Sec. 18 is “not confined to correcting unconstitutional distortions”o Microsoft Corp. v. Franchise Tax Bd., 39 Cal.4th 750 (2006); Twentieth Century Fox

Film Corp. v. Department of Revenue, 700 P.2d 1035, 1039–1040 (Or. 1985)




Improper Use of Section 18

• Professor Walter Hellerstein expressed his concerns as follows:o “ [R]eliance on UDITPA’s Section 18 (the ‘equitable apportionment’ provision) to get

to the ‘right’ conclusion is troublesome not merely because it overrides the standard statutory provisions (as does every variation from UDITPA based on equitable apportionment), but because it does so in a context that hardly seems to constitute one of the ‘unusual fact situations’ that the UDITPA draftsmen identified as justifying a deviation from the statute…”


Burden of Proof

• MTC Report of the Hearing Officer, Oct. 25, 2013o Professor Richard Pomp stated in the Report that:

• “It seems obvious to many courts that the burden should be placed on the party invoking alternative apportionment because that party is asking permission to deviate from the general rules on apportionment an allocation. On the other hand, there is a presumption of correctness that accompanies a department’s assessment. If that applies in the context of alternative apportionment, the taxpayer would always have the burden of proof.”

• “The Hearing Officer concludes that the view that the party invoking alternative apportionment has the burden of proof reflects general principles of American jurisprudence…”




Application of UDITPA 18

Vodafone Americas Holdings, Inc. v. Roberts, 486 S.W.3d 496 (2016)• Upheld Commissioner’s imposition of market-based sourcing as an alternative

apportionment method instead of cost of performance as provided by statute

• Vodafone’s sales factor included only its sales of tangible personal property to Tennessee customers

• Under cost of performance, Vodafone excluded all revenues from its delivery of wireless services to Tennessee customers

• Commissioner acted within scope of discretion



ESPN Productions, Inc. v. Indiana Dep’t of State Revenue, No. 49T10-1312-TA-00076 (Ind. Tax Ct., Apr. 22, 2016)• The Department refused to apply cost of performance methodology with respect to

licensing and advertising revenues• Instead, the Department applied an audience factor methodology, which does not

appear in any statute or regulation• Taxpayer challenged the use of the audience factor on various grounds, including

violation of the APA• After a hearing on Taxpayer’s summary judgment motion in August 2015, the

Department agreed to a complete abatement of the assessments issued to Taxpayer





Target Brands, Inc. v. Department of Revenue, Case No. 2015CV33831, Colorado District Court (Jan. 27, 2017)• Target Brands (TBI) was an IP holding company which the Court found was doing business in the State,

because it licensed its IP for use by its parent, Target Corporation, in the State• Under the standard three-factor formula for 1999-2008 and single sales factor formula beginning in 2009,

TBI had no property, payroll or sales in Coloradoo Colorado was a cost-of-performance state

• The Court held that the Department’s application of the alternative apportionment provisions was proper• However, the Court concluded that the Department’s proposed alternative formula was not reasonable

o The Department eliminated all of TBI’s three factors and substituted a single new factor to apportion TBI’s income – the sales factor of TBI’s parent, Target Corporation

o The Court held that TBI’s property and payroll factors needed to be included


Sales Factor/Market-Based Sourcing

States are moving away from the traditional income-producing activity/cost of performance methodology for sourcing receipts from services and income from intangible assets




Sales Factor/Market-Based Sourcing (California)RTC 25136• Receipts from services

o Where was the benefit of the service received?

• Receipts for intangible propertyo Where was the intangible property used?

• Receipts from marketable securitieso Where is the customer located?

• Effective for tax years beginning on or after January 1, 2013


Sales Factor/Market-Based Sourcing (California)Regulation 25136-2• Detailed set of rules

• Separate rules for services for individual and business customers

• Separate rules for income from marketing and non-marketing intangibles

• Applies cascading approach for analyzing marketo Contract with customer or taxpayer’s books and recordso Reasonable approximation

• Population approach permittedo Customer/License billing address

• Supposed to take into account the taxpayer’s effort and expense for compliance

• RTC 25137 special industry rules incorporated




Alternative Apportionment Gaining Significance

Single Sales Factor Apportionment Plus

Market-Based Sourcing = ?


Alternative Apportionment Gaining Significance

• Professor Pomp Commentso Transition to market-based sourcing is a demonstration of economic

development trumping good policyo Combined with the trend to single sales factor apportionment, market-based

sourcing distorts income by focusing on the customer’s location and ignoring capital and labor that helped generate the income




Questions?

Jeffrey M. VeselyPillsbury Winthrop Shaw Pittman LLP

San Francisco, CA(415) 983-1075

[email protected]

Annie H. HuangPillsbury Winthrop Shaw Pittman LLP

San Francisco, CA(415) 983-1979

[email protected]


Recent State and Local Tax Developments

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