what’s on the horizon with state and local tax controversy?: … · 19-05-2017 · this...

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TEI Los Angeles Chapter

What’s on the Horizon With State and Local Tax Controversy?: Case Developments & Updates

May 19, 2017 Jeff Friedman Partner

Carley Roberts Partner

Eversheds Sutherland

− U.S. Supreme Court

− Transfer Pricing

− Class Action Lawsuits & False Claims Act

− Deductions

− Gross Receipts Taxes and Surtaxes

− Other Controversy Updates

− State Tax Outlook on US Federal Tax Reform

Agenda


U.S. Supreme Court


U.S. Supreme Court Docket

─ Retroactivity Tax Laws up for Potential Review • Dot Foods Inc. v. Wash. Dep't of Revenue, 185 Wash.2d 239

(Wash. 2016) • Gillette Comm. Ops. N. Am. v. Mich. Dep’t of Revenue, 312

Mich.App. 394 (Mich. Ct. App. 2015), denying appeal, 499 Mich. 960 (Mich. 2016)

─ Recent Denied Petitions • First Marblehead Corp. v. Comm’r of Revenue, 475 Mass.

159 (Mass. 2016) • Fl. Dep’t of Revenue v. American Business USA Corp., 191

So.3d 906 (Fl. 2016) • Direct Marketing Ass'n v. Brohl, 814 F.3d 1129 (10th Cir.

2016)

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CSX Aftermath – Disparity Permissible in Alabama & Tennessee

─ In March 2015, the U.S. Supreme Court held that a tax disparity is permissible under the 4-R Act if the competitors are subject to another “roughly comparable” tax from which the rail carrier is exempt or if the state offers another sufficient justification.

─ Alabama: On remand, the district court found that Alabama did not force rail carriers to use dyed diesel and sales tax and fuel-excise tax paid by motor carriers were roughly equivalent to tax paid by rail carriers, and thus Alabama's tax scheme did not violate 4–R Act. On April 14, 2017, taxpayer appealed. CSX Transp., Inc. v. Ala. Dep’t of Revenue, No. 2:08-cv-00655-AKK, 2017 WL 1164766 (N.D. Ala. 2017), appeal filed, No. 17-11705 (11th Cir. Apr. 14, 2017).

─ Tennessee: State’s imposition of a 7% sales tax on railroad fuel purchases, while motor carriers pay an 18.4% excise tax, is found not discriminatory. Ill. Cent. R.R. Co. v. Tenn. Dep't of Revenue; No. 3:10-cv-00197, 2017 WL 1347269 (M.D. Tenn. 2017)

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Expressions Hair Design v. Schneiderman, 137 S.Ct. 1144 (Mar. 29, 2017)

Taxpayers’ 1st Amendment Right to Pass Through Fees

─ On March 29, 2017, in a unanimous ruling, the U.S. Supreme Court ruled that a New York statute, which prohibits identifying a surcharge to customers for credit card payments, regulates speech and is therefore subject to heightened scrutiny.

─ Case remanded to the U.S. Court of Appeals for the Second Circuit to determine whether New York’s statute violates the First Amendment.

─ Decision likely implicates state and local tax laws that either prohibit, or require, taxpayers to identify taxes and fees in customer invoices.

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Transfer Pricing


State Use of Transfer Pricing Authority Overview of State Transfer Pricing Issues

─ Historically, few states have actively utilized 482 equivalent authority • States rely on formulary apportionment for determining where

corporate income is earned. By contrast, the U.S. and virtually every other nation rely on transfer pricing for sourcing cross-border income.

• States have limited experience with transfer pricing and few resources trained to apply transfer pricing rules as compared with the IRS or foreign taxing authorities.

─ States have also utilized other solutions for policing related party transactions. • E.g., asserting nexus, addback provisions, etc.

─ Rather than engaging in a substantive pricing analysis, states are increasingly either: • Disregarding intercompany transactions; or • Disallowing 100% of tax outcome by arguing that the

transactions are per se distortive.

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Increased Interest in State Transfer Pricing Overview of State Transfer Pricing Issues

─ Over the last few years, interest in transfer pricing has increased among the states.

─ In part, this is due to the global attention accorded to the problem of cross-border income taxation and to the OECD Base Erosion and Profit Shifting (BEPS) Project.

─ It is also attributable to the publicity surrounding the Multistate Tax Commission’s (MTC) State Intercompany Transaction Advisory Service (SITAS) project.

─ In particular, many states with separate entity reporting have expressed interest in expanding their transfer pricing audit capabilities. • Non-arm’s length intercompany transactions can impact the clear

reflection of income in separate entity or partial combination reporting states.

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Courts Reigning in Use of State Transfer Pricing Adjustments

─ States are using transfer pricing authority to scrutinize intercompany management fee arrangements

─ In Rent-A-Center East, the Indiana Tax Court rejected forced combination and partially relied on the taxpayer’s transfer pricing study

─ In See’s Candy, the Utah District Court found that the Utah State Tax Commission abused its discretion by denying the taxpayer’s entire intercompany royalty expenses when the transfer was supported by a transfer pricing study

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Rent-A-Center East, Inc. v. Indiana Dep’t of Revenue, No. 49T10-0612-TA-00106 (Ind. Tax Ct. 2015)

See’s Candies, Inc. v. Auditing Div. of the Utah State Tax Comm’n, No. 140401556 (Utah Dist. Ct. 2016)


Class Action Lawsuits & False Claims Act


Damned If You Do (Collect)

Consumer Class Action Lawsuits

─ Over-collection

─ Targeting large retailers

─ Targeted transactions • Delivery fees • Coupons • Rebates • Returns


Damned If You Don’t (Collect)

False Claims Act

─ Under-collection

─ Approximately 30 jurisdictions currently have False Claims Acts • Some states have expanded False

Claims Act “whistleblower” actions to include tax

─ Extremely high stakes: • Generally treble damages plus

substantial penalties for each return filed

• Extended Statute of Limitations period

• Public relations issue: tried in the public domain, often labeled tax fraud

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─ Illinois and New York have seen the most aggressive False Claims Act litigation • People of the State of New York, et al. v. Sprint Nextel Corp, et al.,

26 N.Y.3d 98 (N.Y., Oct. 20, 2015)


Deductions


Background Statutory Disallowance

─ States using statutory disallowance to combat intercompany transactions

─ Addback statutes disallow otherwise allowable deductions for expenses paid to affiliates

─ Common exceptions to addback statutes • Recipient subject to tax on income in excess of a benchmark rate • Recipient is in a foreign country with US income tax treaty • Specific industry exceptions • Recipient is a conduit for payment to third parties • Parties elect to file on a combined basis • Unreasonable exception

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Kohl’s Dep’t Stores, Inc. v. Virginia Dep’t of Taxation, 91 Va. Cir. 499 (Va. 13th Jud. Cir. Ct. 2016)

Virginia – “Subject to Tax” Addback

─ On February 3, 2016, a Virginia trial court held that royalties paid to related members must be added back to a taxpayer’s federal taxable income unless such payments are subject to actual income taxation to the related member.

─ Even where the royalties are reported by the related members to other states, such royalties do not qualify for the exception to the corporate income tax addback statute if the other states do not impose tax on such royalties.

─ Virginia Supreme Court granted cert. on October 31, 2016.

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American Multi-Cinema Inc. v. Hegar, No. 03-14-00397-CV, 2017 WL 74416 (Tex. App. 2017)

Texas – Narrowing the Cost of Goods Sold Deduction

─ In April 2015, the Texas Court of Appeals held that film exhibition costs are includable in the cost of goods sold (COGS) deduction because the films met the definition of “tangible personal property” in that they were “perceptible to the senses.”

─ In June 2015, the Comptroller filed a motion for rehearing and published an article concluding that the expanded COGS deduction had a fiscal impact of $1.5 billion each year.

─ In January 2017, the Texas Court of Appeals released a substituted opinion resulting in the same outcome, but a different reasoning. The court held that the film exhibition costs are includable because films and other media products that are “mass-distributed” meet the definition of “tangible personal property.”

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Ameris Bank v. Ala. Dep’t of Revenue, No. BIT. 16-255, 2017 WL 581479 (Ala. Tax Trib. 2017)

Alabama – Dividends From REIT Are Deductible

─ The Alabama Tax Tribunal held that a taxpayer banking corporation properly deducted dividends received from an affiliated real estate investment trust (REIT) for financial institution excise tax purposes because the REIT qualified as a “corporation.”

─ The Tribunal rejected the Department of Revenue’s assertion that the REIT was not a corporation based on its tax treatment as a REIT, explaining that the deduction applies more broadly to dividends received from payor entities that are corporations organized and existing under Alabama law.

─ The Tribunal held that the REIT did not meet the requirements to qualify as a bank.

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Gross Receipts Taxes and Surtaxes


Gross Receipts Taxes and Surtaxes

─ Portland, Oregon CEO-to-Average Wage Ratio Surtax • On December 7, 2016, the Portland City Council passed A.B. 1368 to

create a surtax based on the company’s CEO-to-average wage ratio. • Applies to companies subject to the Dodd-Frank Act wage ratio disclosure

requirements.

─ Nevada Commerce Tax • Commerce Tax, effective July 1, 2015 (S.B. 483), is imposed on all

business entities engaged in a business in Nevada, including pass-through entities, with over $4 million Nevada gross revenue.

─ 2017 Proposals • Oregon Business Privilege Tax

• Multiple gross receipts tax proposals following the failure of Measure 97 in November, including L.C. 3548, a legislative referendum to amend the Oregon Constitution to create a new Business Privilege Tax on all Oregon business entities at a maximum 0.7% rate.

• Louisiana Commercial Activities Tax (CAT) • Governor’s Tax Reform Plan proposes a CAT modeled after Ohio’s CAT to address

$1.3 billion deficit.

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Other Controversy Updates


LaBelle Management, Inc. v. Dep’t of Treasury, 888 N.W.2d 260 (Mich. Ct. App. 2016), leave to appeal denied, 889 N.W.2d 250 (Mich. 2017)

Michigan - Meaning of “Indirect Ownership”

─ The Michigan Court of Appeals held that three companies did not constitute a statutorily defined “unitary business group” for Michigan Business Tax (MBT) purposes because there was insufficient “direct” and “indirect” ownership. • Under the MBT, a unitary group is defined, in part, as a group of

US persons one of which owns or controls directly or indirectly more than 50% of the ownership interest of the other members.

• Department of Treasury adopted a constructive ownership requirement using IRC § 318 attribution rules to determine indirect ownership.

─ Court determined that the Department’s adoption of a constructive ownership test in determining unitary group control was improper.

─ On February 28, 2017, the Department of Treasury issued a notice addressing the impact of LaBelle and announced its retroactive application.

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Matkovich v. CSX Transportation, Inc., 238 W.Va. 238 (W.V. 2016)

West Virginia – Credit for Taxes Paid to Municipalities

─ The Supreme Court of Appeals of West Virginia held that a use tax credit must be granted to an interstate company for sales taxes paid to the municipalities of other states on purchases of motor fuel.

─ The court ruled that the Tax Commissioner’s interpretation that the credit was only available if the sales taxes were paid to other states, but not states’ subdivisions (e.g., cities, counties, etc.), violates the dormant Commerce Clause because it fails the fair apportionment and discrimination prongs of the Complete Auto test.

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ComCon Prod. Serv. I Inc. v. Cal. Franchise Tax Bd., No. B259619, 2016 WL 7229830 (Cal. Ct. App. 2016)

California – Unitary Relationship & Business Income

─ The California Court of Appeals affirmed that Comcast did not establish a unitary relationship with its 57% owned subsidiary, QVC, because Mobil Oil’s three hallmarks of a unitary relationship – centralized management, functional integration, and economies of scale – were not present.

─ On the second issue, the court held that Comcast’s receipt of a $1.5 billion termination fee from its failed mergers with MediaOne Group, Inc. constituted apportionable business income.

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Upper Moreland Twp. v. 7 Eleven Inc., No. 11 C.D. 2016, 2017 WL 1365591 (Pa. Commw. Ct 2017)

Pennsylvania – Franchise Tax Struck Down

─ A Pennsylvania township’s application of its local privilege tax on 100% of 7-Eleven’s receipts from franchise stores in Pennsylvania is found to violate the fair apportionment prong (externally inconsistent) of the Complete Auto test because the activities that generated those receipts resulted from interstate economic activities.

─ The court found that the receipts were at least partially from interstate commerce – e.g., receipts from support services that came from 7-Eleven’s corporate headquarters in Texas.

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State Tax Outlook on US Federal Tax Reform


The Blueprint

─ Business Tax • Corporate rate reduced

from 35% to 20% • Eliminate AMT • Immediate expensing of

business investments • No deduction for net

interest expenses • Net operating losses

carried forward indefinitely

─ Pass-Through Businesses • 25% capped tax rate • Permit deduction for

compensation to owners of pass-through businesses

─ Destination-Based Cash Flow Tax • Border adjustments

─ International Tax • Move from worldwide to

territorial tax system • 100% exemption for

dividends from foreign subsidiaries

• Unrepatriated foreign earnings would be subject to a 8.75% tax, if held in cash, or otherwise subject to a 3% tax

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Trump’s Tax Plan

─ Business Tax • Corporate rate reduced from 35% to 15%

• Eliminates “tax breaks for special interests”

─ Pass-Through Businesses • 15% capped tax rate

─ Destination-Based Cash Flow Tax • Ignores border

adjustments

─ International Tax • Implements territorial tax system

• One-time repatriation of offshore earnings (possibly subject to 10% tax)

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State Independence from Federal Tax Law

─ Due to state conformity with federal tax laws, changes at the federal level flow to state level.

─ As a result, federal legislation may increase or decrease state tax revenues.

─ States may diverge from federal tax law via state “decoupling” modifications.

─ Taxpayers must separately track, monitor, and implement state modifications to federal provisions.

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State Impact Based on Conformity to Federal Tax Law

Federal States Tax rate reductions States have own rates Broadened tax base State conformity Eliminated deductions State conformity Fully expensed investments State conformity Indefinite NOL carryforward Limited application due to

decoupling Reduced repatriation rate Modest impact Territorial tax regime Minimal conformity

Border adjustments (Blueprint) Depends on implementation method

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Contact us

Jeff Friedman Partner Eversheds Sutherland (US) LLP 202.383.0718 [email protected] Carley Roberts Partner Eversheds Sutherland (US) LLP 202.383.0718 [email protected]

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