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Top State Corporate Income Tax Cases of 2019: Nexus, Business

Income, Combined Reporting, and Apportionment

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November 13, 2019

Top State Corporate Income Tax Cases of 2019: Nexus, Business Income, Combined Reporting, and Apportionment

Michael J. Cataldo, Shareholder

Cataldo Tax Law

michael@cataldotaxlaw.com

Jeffrey S. Reed, Partner

Kilpatrick Townsend & Stockton

jsreed@kilpatricktownsend.com

Notice

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY

THE SPEAKERS’ FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY

OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT

MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR

RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.

You (and your employees, representatives, or agents) may disclose to any and all persons,

without limitation, the tax treatment or tax structure, or both, of any transaction

described in the associated materials we provide to you, including, but not limited to,

any tax opinions, memoranda, or other tax analyses contained in those materials.

The information contained herein is of a general nature and based on authorities that are

subject to change. Applicability of the information to specific situations should be

determined through consultation with your tax adviser.

By Michael J. Cataldo and Jeffrey S. Reed

Top State Corporate Income Tax Cases of 2019: Nexus, Business Income, Combined Reporting, and Apportionment

Top State Corporate Income Tax Cases of 2019 - Agenda• Nexus

• Tax Base

• Business Income

• Combined Reporting

• Apportionment

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Top State Corporate Income Tax Cases of 2019

NEXUS

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Nexus

Santa Fe Natural Tobacco Company v. Oregon Department of Revenue, TC-MD 170251G, February 26, 2019 • wholesalers paid by company to accept returns on the

company’s behalf found to exceed the protections of P.L. 86-272.

• wholesalers found to be independent contractors under state law, but not P.L. 86-272.

• Long-standing agreement between taxpayer and wholesaler to accept returns was not trivial connection to state.

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Nexus

Stanislaus Food Products Company v. NJ Div of Tax, Tax Court of New Jersey, Docket No. 011050-2017, June 28, 2019

• New Jersey’s Alternative Minimum Assessment imposed exclusively on entities protected from New Jersey net income tax under P.L. 86-272 found invalid in violation of Supremacy Clause.

• AMA imposed only on P.L. 86-272-protected entities frustrates Congressional intent.

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NexusCrown Packaging Technology, Inc. v. NJ Div of Tax’n, NJ Tax Court, Docket No. 003249-2012, 02/26/2019

• The taxpayer is an R&D company with research facilities in IL and England and it owns the IP for Crown.

• It licenses Crown’s IP to a related Crown entity that was audited by NJ. As part of the audit, TP sought injunctive relief that it was not subject to NJ tax, filed summary judgment motion.

• TP distinguishes Lanco – Crown has no NJ retail stores. Argues Lanco inapplicable.

• NJ Tax Court denies summary judgment, says more factual development is needed but acknowledges distinction with Lanco.

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NexusConagra Foods RDM, Inc. v. Comptroller, Maryland Court of Special Appeals, Case No. C-02-CV-15-000993, June 27, 2019

• Out-of-state subsidiary (“Brands”) owned intellectual property originally created by its parent and other affiliates.

• Brands licensed the intellectual property to its affiliates and to unrelated third parties and generated royalty income.

• Brands had 23 employees, office space, and administered a national advertising program relating to the underlying product brands.

• The court concluded that Brands had substantial nexus with Maryland because it lacked economic substance separate from its parent.• centralized management provided by parent (payroll, corporate

personnel, etc.)• circular flow of funds (Brands’ royalty income was distributed to its

parent and affiliates via dividend).

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Nexus

Swart Enterprises, Inc. v. Franchise Tax Board, 7 Cal.App.5th 497 (2017)• Swart owned a 0.2 percent passive minority interest in LLC

which was doing business in California.

• LLC was managed by a manager, not by the members.

• Court of Appeal held that passive interest in LLC that was doing business in California insufficient to find Swart was doing business in California.• Swart’s interest in the LLC was comparable to a limited partnership interest

• Appeals of Amman & Schmid Finanz AG, 96-SBE-008

• FTB Notice 2017-01 (2/28/17)

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Nexus

Appeal of Satview Broadband, Ltd., OTA Case No. 18010756, Sept. 25, 2018• Foreign corporation which held a 25 percent

passive, non-managing member interest in an LLC which did business in California, was not itself doing business in California simply because it held that 25 percent interest.

• Nonprecedential decision.

• FTB Legal Ruling 2018-01, October 19, 2018: Swartholding narrow exception and limited to “same facts.”

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Nexus

Appeal of Jali, LLC, OTA Case No. 18073414, July 8, 2019• Membership interest in an in-state LLC was between

1.12 to 4.75 percent during years at issue.

• Non-managing membership interest for all years.

• No evidence the out-of-state member had any ability or authority, directly or indirectly, to influence or participate in the management or operation of the LLC.

• OTA rejected FTB’s 0.2 percent ownership threshold as a new bright-line standard for determining whether an out-of-state LLC member is actively “doing business” in California.

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Nexus

Appeal of Wright Capital Holdings LLC, OTA Case No. 18010842, August 21, 2019• An out-of-state single-member LLC (SMLLC) held a 50%

membership interest in an LLC doing business in California (CA LLC).

• The OTA held that SMLLC was doing business in California by virtue of its interests in CA LLC.• No evidence admitted concerning the SMLLC’s management or

control of the California LLC.

• While SMLLC’s 50 percent interest in CA LLC was not a controlling interest, “no other member had a larger interest, and appellant presumably could have used its 50 percent interest to block CC-LLC from taking action it disagreed with if it was so inclined.”

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Nexus

Arizona v. California, No. 220150 (U.S.S.C. Mar. 4, 2019).

• Arizona filed action against California with the United States Supreme Court alleging that FTB’s application of its “doing business” standard to passive investors of LLCs doing business in California violates constitutional rights of Arizona investors.

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NexusAppeal of Larsen, 2018-OTA-073, July 25, 2018 (nonprecedential)• Individual Idaho resident received 1099 from a business with a

California.

• FTB asserted the individual was a sole proprietorship required to file a California tax return and pay tax on income sourced to California under the market-based sourcing rules for services (to where the customer received the benefit of the service).

• The OTA ruled that because the FTB could not prove that the taxpayer conducted a unitary business within and without California, it was not considered an apportioning business and therefore the market-based sourcing rules did not apply.

• The OTA ruled that simply showing a 1099 from a California business was not enough to show that the taxpayer conducted a unitary business within and without California.

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Nexus

Appeal of Bindley, 2019-OTA-179P, May 30, 2019• Screen writer (Bindley) based in Arizona agreed to write

screen plays for California-based production companies.

• Bindley was issued 1099s reflecting payment for screen writing.

• OTA found Bindley was required to file a California tax return because he was conducting a unitary trade or business as a sole proprietorship within and without California, and, under market-based sourcing rules for services, the payments were sourced to California.

• Compare Appeal of Larsen.

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Nexus

Goldman Sachs Petershill Fund Offshore Holdings (DE) Corp., NYC TAT (H) 16-9 (Dec. 6, 2018)

• Del corporation managed by GS employees in London (outside NYC).

• Stipulated no connection to NYC. • Corp buys a 9.98% interest in Claren Asset Management

in 2008. Sells it in 2010 for $55M gain. • TP’s position: $55M gain not taxable by NYC (non-unitary

income), 0% apportionment anyway. • NYC DOF position: non-unitary irrelevant, sufficient

nexus for us to tax it. 100% apportionment – have to use Claren’s apportionment.

• NYC DOF wins at ALJ level; appeal pending.

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Top State Corporate Income Tax Cases of 2019

TAX BASE

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Tax Base

The Walt Disney Company and Consolidated Subsidiaries, NY DTA No. 828304 (May 30, 2019)

• Statute (since changed) generally allowed the exclusion of royalty income from related members.

• “Loophole”: royalty income from foreign affiliates excluded from the tax base.

• Statute specifically amended to alter this result.

• Nevertheless, ALJ ruled against the TP on the grounds: (1) did not meet burden that payments from foreign affiliates were “royalties”; and (2) related member royalty payor had to be a NY taxpayer for exclusion to apply.

• An appeal has been filed.

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Tax Base

Sunbelt Rentals Inc. v. Comptroller of Maryland, Case No. 18-IN-00-0241 (September 9, 2019)

• The taxpayer merged with companies called NationsRentUSA, Inc. and NationsRent, Inc. (two loss companies) in 2006 with the taxpayer surviving.

• The NationsRent entities did not file Maryland corporate tax returns.

• On its 2007-2013 Maryland corporate income tax returns, the taxpayer deducted NOLs that had been generated by the NationsRent entities for years during years in which they did not file Maryland returns.

• Using a statutory interpretation analysis, the Maryland Tax Court allowed Sunbelt’s NOL deductions.

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Tax BaseLorillard Tobacco Company v. NJ Div of Tax’n, NJ Tax Court, Docket No. 008305-2007 (NJ Tax Court 2019)

• Subsidiary of TP was assessed and started paying NJ corporate tax.

• Taxpayer filed a standalone NJ corporate tax return and requested an exception from addback on its payments to the related subsidiary.

• NJ DOT denied the exception. • NJ Tax Court holds that denial of addback

exception unreasonable because amounts paid to subsidiary were subject to NJ tax.

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Tax BaseDaimler Investments US Corp v NJ Div. of Tax’n, Docket No. 008165-2016 (NJ Tax Court 2019)• Taxpayer made payments to a related entity

pursuant to a tax sharing agreement.

• Argued that the addback statute did not apply to require that the payments be added back.

• NJ Director: payments represent intercompany reimbursements for State income taxes paid or State income tax payments.

• Tax Court: intercompany payments are an accounting mechanism not subject to addback.

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Tax Base

Deere & Company v. Wisconsin Department of Revenue, Wisconsin Tax Appeals Commission, Docket No. 18-I-135, August 21, 2019)

• DRD permitted for distributions from foreign LLP which elected to be taxed as a corporation for federal income tax purposes.

• Commission rejected DOR argument that election did not apply for purposes of state DRD statute.

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Top State Corporate Income Tax Cases of 2019

BUSINESS INCOME

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Business Income

Appeal of Bank of America, OTA Case No. 18010006, February 21, 2019

• Dividends from foreign investments held to be nonbusiness income

• FTB request for rehearing from State Board of Equalization (SBE) decision rejected.• SBE did not rely on incorrect

business/nonbusiness income standard in rendering its decision.

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Business Income

YAM Special Holdings, Inc., v. Commissioner of Revenue, Minnesota Tax Court, Docket No. 9122-R, 06/12/2019 • Sale of roughly 75% interest in GoDaddy.com business

or nonbusiness income?• Taxpayer argued ownership of GoDaddy.com was

purely an investment and proceeds from sale NBI• MN argued that use of proceeds indicate proceeds

from sales were business income.• Court denied MSJ due to lack of sufficient facts in

record but allowed additional briefing which is due in December 2019.

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Business Income

Mississippi v. Comcast of Georgia/Virginia, Inc. N/K/A Comcast Cable Communications, LLC, Mississippi Chancery Court, Case No. G-2017-1147, June 13, 2019

• capital related to non-unitary investments held by subsidiaries with no Mississippi activity excluded from pre-apportioned franchise tax base

• Court sustained Board of Tax Appeals decision on summary judgment

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Top State Corporate Income Tax Cases of 2019

COMBINED REPORTING

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Combined ReportingAgilent Technologies Inc. v. CO DOR, 2019 CO 41 (Colo. S. Ct. May 28, 2019)

• By statute, a company is not an “includable corporation” for CO purposes if more than 80% of its property and payroll is outside the US.

• Holding company World Trade, Inc. owned stock in foreign subsidiaries that operated outside the US.

• CO DOR made an adjustment to include World Trade in the company’s CO combined return.

• CO Supreme Court ruled for the taxpayer and held that the holding company was not an includable corporation by statute. It also rejected the many alternative arguments offered by the CO DOR for including the holding company in the combined return.

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Combined Reporting

Exxon Mobil Corp. v. Montana Dept. of Rev., 2019 MT 156 (Mont. S.Ct. July 9, 2019)• Exxon filed Montana corporate income tax returns for

the years at issue making a water’s-edge election. • This involved excluding foreign subsidiaries and also

80/20 corporations. • Members of ExxonMobil’s water’s-edge group received

dividends from the 80/20 corporations and claimed full DRDs.

• MT DOR argued that only 80% DRD should be allowed. • Montana Supreme Court ruled for Exxon based on a

statutory construction analysis.

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Combined Reporting

Steiner v. Utah St Tax Commn., Docket No. 20180223 (August 14, 2019)

• Taxpayers were resident shareholders of an S corporation.

• 98% of the S’s income was outside Utah (other states, foreign). In Utah, subject to taxation on worldwide income at a flat rate.

• Utah allowed credit for income earned in other states, not in other countries.

• On tax return, claimed credit for income earned in other states, abroad.

• Utah Tax Commission disallowed the credit associated with foreign income.

• Utah Supreme Court sees no constitutional problems, viewed the taxpayer as trying to “extend Wynne to foreign commerce.”

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Combined Reporting

Abercrombie & Fitch Co. v. California Franchise Tax Board, 5th Appellate District, Case No. F074873, August 28, 2019 (unpublished)• Intrastate unitary businesses permitted to use separate

accounting did not create unconstitutional discrimination against interstate business taxpayer that was required to use combined reporting.

• Court found that taxpayer would have been provided benefits unavailable to intrastate businesses if permitted to file on separate accounting basis.

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Combined Reporting

Premier Auto Finance, Inc. v. Illinois, 2019 IL App (1st) 172472-U (June 14, 2019)• entity was properly considered a “financial

organization” because it satisfied the definition of a “sales finance company”

• The court found that the entity was a “sales finance company” because it was in the business of making loans to clients to fund purchases of commercial property and casualty insurance

• Entity must file returns separate from general corporation affiliates under then-existing Illinois law.

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Combined Reporting

Taxpayer v. Auditing Division, Utah State Tax Comm'n, Appeal Nos. 14-608; 14-735, 06/15/2018 , released 08/04/2019)

• Dividend income from foreign subsidiary business income because unitary

• Taxpayer initially filed as unitary and failed to prove non-unitary relationship

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Top State Corporate Income Tax Cases of 2019

APPORTIONMENT

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ApportionmentCorporate Executive Board v. Va Dep’t of Tax’n, Virginia Supreme Court No. 171627 (Feb. 7, 2019)• The taxpayer is headquartered in VA.

• It provides research and advisory services. Over 95% of its receipts are from customers outside VA.

• VA assigned 100% of the company’s sales to VA under VA’s cost of performance rule. But most states have market-based sourcing, so many of its sales were sourced to multiple states (stipulated that its apportioned income is over 120%).

• Argued it is entitled to alternative apportionment.

• Virginia Supreme Court: taxpayer did not meet burden of showing result unconstitutional or that it is entitled to alternative apportionment.

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ApportionmentComcast of Mass. V. MA Comm’r of Rev., 95 Mass. App. Ct. 1110 (2019)• Theoretical issue in applying COP – how thin to slice the pie?

• Take into account taxpayer’s entire operation (costs from running the entire operation)

• Or look more narrowly at costs associated with specific transactions

• Specific issue was how to source receipts from video, internet, telephone services. Look at costs from overall operation, or costs just for MA transactions?

• MA Appeals Court affirms MA ATB ruling that the income-producing activity was signing franchise agreements with MA cities and towns. Don’t even get to costs. Source to MA.

• Compare Comcast Holdings Corporation v. Department of Revenue, Tennessee Court of Appeal, Case No. M2017-02250-COA-R3-CV, April 25, 2019

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ApportionmentMatter of Catalyst Repository Systems, NY DTA No. 826545 (NY TAT Docket No. 826545, July 24, 2019).

• Corporation provides online litigation support services, hosting data. Its system and technical staff are located in CO.

• It did not source any receipts to NY on its sale of its services to NY customers.

• NYSDTA audits and sources the receipts from NY customers to NY.

• NY TAT finds for the taxpayer, sales of a license (not a service) are an OTB under the statute, source to where earned (in this case CO).

• ALJ had also sided for the taxpayer, but under different theory (sales of services sourced to where performed).

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Apportionment

John Paz v. Director, Division of Tax’n, NJ App. Div. Docket No. A-4452-16T4 (NJ App. Div. 2019).

• The stock of a New Jersey S corporation is sold and the parties make a 338(h)(10) election to treat the stock sale as an asset sale.

• How should the gain be sourced in the case of nonresident shareholders?

• NJ sources it all to NJ (nonoperational income assigned to domiciliary state).

• Taxpayer non-resident shareholders argue that PIT sourcing should apply and it goes to their state of residence.

• NJ Appellate Division affirms the NJ Tax Court and the assessment – all the income on the sale sourced to NJ.

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Apportionment

Matter of Franklin C. Lewis, NY DTA No. 827791 (June 20, 2019).

• Nonresident S corporation electing shareholders.

• How to source gain from 338(h)(10) election.

• NY – source based on S corporation’s allocation percentage.

• TP: source to residence (outside NY).

• Earlier case held that TP wins (source to state of residence).

• Legislation changes that result retroactively.

• TP fights the retroactive legislation and the imposition of penalties.

• ALJ upholds the retroactive legislation and the penalties.

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Questions

Jeffrey S. Reed, PartnerKilpatrick Townsend & Stockton LLPphone: 925.395.4645email: JSReed@kilpatricktownsend.comwww.kilpatricktownsend.com

Michael J. Cataldo, ShareholderCataldo Tax Law, P.C.phone: 925.395.4645email: michael@cataldotaxlaw.comwww.cataldotaxlaw.com

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