Current Developments in State and Local Taxes

Current Developments in State and
Local Taxes
North Bay Tax Directors
San Francisco, California
June 22, 2016
Jeffrey M. Vesely
Annie H. Huang
Pillsbury Winthrop Shaw Pittman LLP
4841-1305-6307
Overview
 Alternative Apportionment
 Sales Factor
 Personal Income Tax Residency/Source of Income
 Gross Receipts Taxes
 San Francisco Business Tax
 Nexus
 California Tax Reform Study
1 |
Alternative Apportionment
2 |
Background: Dividing the Corporate Income Tax Base
 States have significant leeway in adopting an apportionment formula
to apportion taxpayers’ business income for purposes of imposing
their income taxes
 The apportionment method selected by a state cannot be arbitrary
and must not produce unreasonable results. Underwood Typewriter
Co. v. Chamberlain, 254 U.S. 113 (1920)
3 |
Background: Dividing the Corporate Income Tax Base
 However, in Hans Rees' Sons v. State of North Carolina, 283 U.S.
123 (1931), the U.S. Supreme Court found that an apportionment
formula did act arbitrarily when applied to the taxpayer’s facts
4 |

Department apportioned 80% of taxpayer’s income to North Carolina and taxpayer
offered proof that approximately only 21% of its income was attributable to its
business activity in North Carolina

“It is sufficient to say that, in any aspect of the evidence, and upon the assumption
made by the state court with respect to the facts shown, the statutory method, as
applied to the appellant's business for the years in question operated unreasonably
and arbitrarily, in attributing to North Carolina a percentage of income out of all
appropriate proportion to the business transacted by the appellant in that state.”
Background: Dividing the Corporate Income Tax Base
 Many states early on adopted a 3-factor apportionment formula using
the following equally weighted factors:
 Property factor
 Payroll factor
 Sales factor
5 |
Background: UDITPA
 The Uniform Division of Income for Tax Purposes Act (“UDITPA”)
adopted the same 3-factor formula
 July 1957 -- Approved by the National Conference of Commissioners of Uniform

6 |
State Laws and the American Bar Association
UDITPA Section 9:
 “All business income shall be apportioned to this state by multiplying the
income by a fraction, the numerator of which is the property factor plus the
payroll factor plus the sales factor, and the denominator of which is three.”
Background: UDITPA
 Because the standard apportionment formula may produce
unreasonable results, UDITPA Section 18 provides an alternative
apportionment method
 Acts as a pressure valve for when the standard apportionment formula provides
arbitrary and unreasonable results.
7 |
Background: UDITPA
 UDITPA Section 18 provides:
 If the allocation and apportionment provisions of this Act do not fairly represent the
extent of the taxpayer’s business activity in this state, the taxpayer may petition for
or the tax administrator may require, in respect to all or any part of the taxpayer’s
business activity, if reasonable:
 Separate accounting;
 The exclusion of any one or more the factors;
 The inclusion of one or more additional factors which will fairly represent the
taxpayer’s business activity in this state; or
 The employment of any other method to effectuate an equitable allocation
and apportionment of the taxpayer’s income
8 |
Alternative Apportionment
 Alternative apportionment was originally intended by drafters of
UDITPA to apply only in unusual circumstances:

William Pierce (Prof. Univ. of Michigan, chairman of UDITPA committee, writing
about Section 18 in Taxes: The Tax Magazine, Vol. 35, No. 10 (Oct. 1957) p. 748):
“Of course, departures from the basic [apportionment] formula should be
avoided except where reasonableness requires. Nonetheless, some
alternative method must be available to handle the constitutional problem
[arbitrary and unreasonable apportionment] 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.”
9 |
Alternative Apportionment
 Multistate Tax Commission’s Regulation IV.18(a) provides:
 Article IV.18 permits a departure from the allocation and apportionment provisions
of Article IV only in limited and specific cases where the apportionment and
allocation provisions contained in Article IV produce incongruous results
 However, states have increasingly applied alternative apportionment
methods where the statutory apportionment rules result in less income
apportioned to the state than the state believes is fair
10 |
Invoking Alternative Apportionment: Burden of Proof
 Many states have either adopted UDITPA Section 18 or similar
language granting them the authority to use an alternative
apportionment method
 When a state or taxpayer wants to use an alternative apportionment
method, the party seeking alternative apportionment bears the
burden of proof in showing:
 Distortion exists; and
 That a proposed alternative method is reasonable
11 |
Invoking Alternative Apportionment: Burden of Proof
 Example: In Microsoft Corp. v. Franchise Tax Board, 39 Cal. 4th 750
(2006), the California Supreme Court stated:
 As the party invoking section 25137 [California’s version of
Section 18], the [Franchise Tax] Board has the burden of proving
by clear and convincing evidence that (1) the approximation
provided by the standard formula is not a fair representation, and
(2) its proposed alternative is reasonable.
12 |
Invoking Alternative Apportionment: Burden of Proof
Alternative Apportionment Procedure
Moving
Party
(Taxing Authority
Or
Taxpayer)
13 |
Assert
Distortion
Yes
Proposed Alternative
Reasonable
Yes
No
No
No Alternative
Apportionment
No Alternative
Apportionment
Alternative
Apportionment
Cases
 CarMax Auto Superstores West Coast, Inc. v. South Carolina Dep’t of
Revenue, 2014 S.C. Lexis 550 (Dec. 23, 2014)
• The S.C. Supreme Court ruled that the party seeking an
alternative apportionment formula bears the burden of proof by a
preponderance of the evidence that “(1) the statutory formula does
not fairly represent the taxpayer’s business activity in South
Carolina and (2) its alternative accounting method is reasonable.”
 S.C. Rev. Proc. 15-2 (June 1, 2015)
 S.C. Rev. Ruling 15-5 (June 1, 2015)
14 |
Cases

Equifax, Inc. v. Miss. Dep’t of Revenue, 125 So. 3d 36 (Miss. 2013), rehearing denied
(Miss. Nov. 21, 2013), cert. denied,134 S.Ct. 2872 (2014)
•
•
•
•

15 |
Georgia corporation in the business of consumer credit reporting employed three
Mississippi residents and had approximately 800 customers in Mississippi.
Using the standard apportionment formula, taxpayer did not apportion its income to
Mississippi because none of its income-producing activity occurred in the State.
The Department held that the standard apportionment method did not reflect the
extent of the taxpayer’s business in the State. Instead, the Department used
market-based sourcing.
The Mississippi Supreme Court placed the burden of proof on the taxpayer and
upheld the Department’s use of market-based sourcing.
Legislative response (effective Jan. 1, 2015)
Cases
 Vodafone Americas Holdings, Inc. v. Roberts, Tenn.
Supreme Ct. (March 23, 2016)
•
•
•
•
16 |
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.
Cases
 Rent-A-Center East, Inc. v. Indiana Dep’t of State Revenue, No.
49T10-0612-TA-00106 (Ind. Tax Ct., Sept. 10, 2015)
 Columbia Sportswear USA Corp. v. Indiana Dep’t of State Revenue,
No. 49T10-1104-TA-00032 (Ind. Tax Ct., Dec. 18, 2015)
 Indiana Letter of Findings No. 02-20130402 (Feb. 1, 2015)
17 |
Improper Use of Section 18
 Professor Walter Hellerstein expressed his concerns as
follows:
•
18 |
“ [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, 2013
•
19 |
Professor Richard Pomp stated in the Report that:
o “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.”
o “The Hearing Officer concludes that the view that the party
invoking alternative apportionment has the burden of proof
reflects general principles of American jurisprudence…”
One More Case
 ESPN Productions, Inc. v. Indiana Dep’t of State Revenue
• 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 case settled on the basis of a complete
abatement of the assessments issued to the Taxpayer.
20 |
Sales Factor
21 |
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.
22 |
23 |
24 |
25 |
26 |
Sales Factor/Market-Based Sourcing
 California Revenue and Taxation Code (RTC) § 25136




27 |
Receipts from services
 Where was the benefit of the service received?
Receipts for intangible property
 Where was the intangible property used?
Receipts from marketable securities
 Where is the customer located?
Effective for tax years beginning on or after January 1, 2013
Sales Factor/Market-Based Sourcing
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 market
•
•
•
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Contract with customer or taxpayer’s books and records
Reasonable approximation
• Population approach permitted
Customer/Licensee billing address
•
Supposed to take into account the taxpayer’s effort and expense for
compliance
•
RTC 25137 special industry rules incorporated
Sales Factor/Market-Based Sourcing
 Multistate Tax Commission Draft Uniform Market-Based Sourcing
Regulations
 Professor Pomp Comments


29 |
Transition to market-based sourcing is a demonstration of economic
development trumping good policy
Combined with the trend to single sales factor apportionment, marketbased sourcing distorts income by focusing on the customer’s location
and ignoring capital and labor that helped generate the income
Sales Factor/Franchisor Regulation
Regulation 25137-3
• Fees/royalties received for the use of licensor’s trademark or
service mark or the right to market a product or service are
sourced to the state in which the licensee is located
• Throwback rule
• Interplay between factor presence standard of RTC 23101 and throwback rule
• Pre-2011 versus post-2010
• Appeal of DTS
• Throwback issue settled at SBE
• Appeal of Dresser
• Taxability under U.S. Constitutional nexus standards
30 |
Sales Factor/Throw Out Rule
Appeal of Craigslist, Inc., SBE Case No. 725838 (2015)

On December 16, 2015, the SBE ruled that Craigslist must exclude sales from paid job
listings from other states from its sales factor because it was not subject to tax in those states
under United States constitutional standards.

Craigslist was apportioning its income under a special formula approved by the FTB for tax
years 2007 to 2010 that allowed Craigslist to use a market-based sourcing method, rather
than the cost of performance rule in effect during the year at issue. Under this special
formula, FTB required sales to states where Craigslist was not subject to tax under “United
States constitutional standards for nexus” be excluded from the sales factor.

Craigslist argued that sales to other states should not be excluded from the sales factor
because it was subject to tax in those jurisdictions under US constitutional standards,
pointing to California adoption of “factor presence nexus” in 2011.

FTB argued that the United States constitutional standards for the years at issue (prior to
California’s adoption of “factor presence nexus”) required an in-state physical presence.

The SBE’s decision in Craigslist, Inc. is consistent with FTB Technical Advice Memorandum
2012-01.
31 |
Sales Factor/Broker-Dealers
 Controversial issue involving combination of banks with its brokerdealer subsidiaries
 Banks and financial corporations include net gains in the sales factor
 Broker-dealers, which are considered general corporations, include
gross receipts in the sales factor
 Query, is it distortive to allow broker-dealers to include gross receipts
in sales factor?
 Numerous cases pending. A number of cases have been settled
 FTB has held two interested parties meetings to consider whether
they should promulgate a regulation dealing with this issue.
32 |
Personal Income Tax
33 |
Personal Income Tax/Residency/Source of Income
 Appeal of Michael and Mary Bills
 Summary decision issued May 24, 2016
 Mr. and Mrs. Bills moved from California to Washington following Mr. Bills’


34 |
retirement and withdrawal from an investment partnership in California
Questions were (1) When did they become nonresidents of California?
(2) Should any of the payments Mr. Bills received from the partnership
upon his withdrawal, over a 5-year period, be sourced to California?
SBE ruled in favor of the taxpayer on both issues.
Gross Receipts Taxes
35 |
Nevada Commerce Tax
 Nevada Senate Bill 483 (signed June 9, 2015)
• Included new Commerce Tax and extension of other tax programs
• The measure passed despite reservations regarding the
package’s structure, particularly the gross receipts-based
Commerce Tax, which failed to obtain voter approval in 2014
• Commerce Tax is effective July 1, 2015
• Estimated to raise $243 million over the biennium
• Imposed on all business entities engaged in a business in
Nevada, including pass-through entities, corporations, persons
engaging in business with limited exception
• Tax based on Nevada sitused gross receipts; $4 million
exclusion from tax, but not from filing requirement
36 |
Nevada Commerce Tax (cont.)
 Final regulations adopted on April 11, 2016
• Based on the Ohio CAT regulations
• See Department’s website for final draft
 Forms and instructions are currently being drafted
• Drafts can be found on the Department’s website
• Nevada Tax Commission instructed the Department to hold an
interested party meeting before finalizing
 Initiative to repeal the Commerce Tax that was approved by a Nevada
District Court is currently pending before the Nevada Supreme Court; oral
arguments heard on May 2, 2016
• Signatures are being gathered; deadline in June 2016
• Nevada Taxpayer’s Association is opposed to the initiative based
upon the confusing nature of its wording and, if “approved” by voters,
the Commerce Tax could only be amended by a vote of the people
37 |
Oregon Gross Receipts Tax on 2016 ballot
 Ballot Initiative Certified for Ballot – In November, Oregon voters
will decide whether to approve an initiative (IP 28) which would modify
the annual minimum tax (capped at $100k), to impose a 2.5 percent
gross receipts tax on Oregon C corporations with sales exceeding $25
million – with no cap
 “Maximum Tax” - If passed, the tax would turn Oregon’s current
minimum tax into a “maximum tax” – a 2.5% gross receipts tax on all
in-state sales exceeding the $25 million threshold
 Although this tax will not replace the Oregon Corporate Excise Tax
(Oregon’s corporate income tax), most corporations with Oregon
sales in excess of $25 million will pay the gross receipts tax as
opposed to the excise tax
38 |
Oregon Gross Receipts Tax on 2016 ballot

Legislature Declines to Derail IP 28 – An attempt by Senate Revenue
Chairman Mark Has, D-Beaverton, to implement an alterative (i.e., Ohio-style
CAT) was not successful during Oregon’s short 2016 legislative session
 Legislature to hold hearings regarding an Legislative Revenue Office
analysis of IP 28 on May 23, 2016
 Analysis rumored to show major negative consumer impacts

Campaign in Opposition – A unified employer and consumer coalition is
opposing IP 28
Defeat The Tax On Oregon Sales –
info
Information can be found at
http://www.defeatthetaxonoregonsales.com/
 Contact Erica Hagedorn, Campaign Treasurer for more information:
503-544-8973 or Erica@defeatthetaxonoregonsales.com
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Puerto Rico VAT


Governor signed Act. No. 72 that significantly alters the current sales and use tax
(“IVU”) and creates a value added tax (VAT) to replace the IVU effective April 1,
2016.
Sale and Use Tax Changes
 Increase of the current IVU rate from 7% (6% Commonwealth; 1% municipal) to 11.5%

(10.5% Commonwealth; 1% municipal), effective July 1, 2015
Increase in the scope of taxable services, effective October 1, 2015
 IVU at 4% will be applicable to:


Business-to-business services that are currently exempt from IVU
 Except designated services to be taxed at regular IVU rate (11.5%)
such as security services, cleaning services, bank charges, and
repair services
Designated professional services, including legal services, architects,
engineers, appraisers, and CPAs
 Regular IVU remains applicable to all other services, except
designated services such as educational services; interest
charges; insurance commissions; and services provided within
a controlled group
40 |
Puerto Rico VAT
 Puerto Rico will replace the 10.5% Commonwealth IVU with a 10.5%
value added tax (VAT), effective April 1, 2016 (the 1% municipal IVU
will remain in place)
 VAT will generally apply to


The introduction of taxable goods into Puerto Rico (except for by bonded
merchants)
the sale of goods or services by a merchant in Puerto Rico



Not included – intangibles, electricity, water, goods or services sold by Puerto
Rico or U.S. governments, services rendered within the same group, etc.
Exempt – provision of health care, financial, education, and child care
services; the sale of unprepared food, prescriptions drugs, medical equipment
to hospital, printed books, etc.
“Zero-Rated” (i.e., subject to VAT at 0%) – export of goods or services, sale of
raw material or equipment to a manufacturer
 When a person in Puerto Rico receives services from a non-resident,
the service recipient will generally be liable to self-assess VAT on
these services
 Merchants are allowed to a credit of VAT paid on purchases directly
linked to taxable sales (i.e., at 10.5% or 0%)
41 |
San Francisco Business Tax
42 |
San Francisco Gross Receipts Tax

Beginning in 2014, the Gross Receipts Tax (“GRT”) is imposed on a broad
array of persons doing business in the City, including:
• Sole proprietorships
• Limited liability companies (“LLCs”)
o Entities that are disregarded for federal income tax purposes (e.g.,
single-member LLCs) will not be treated as separate taxable entities
for GRT purposes. (Tax Collector Regulation 2014-2.)
• Corporations
• S-corporations

GRT will be phased-in, and the existing Payroll Expense Tax phased-out over
a 5-year period.

In 2016, GRT is 50 percent of the business tax while the Payroll Expense Tax
is 50 percent as well
43 |
San Francisco Gross Receipts Tax
 “Doing Business” in the City includes:
• Presence in the City for more than 7 days during the year soliciting
sales, performing services, or using City roads for business
purposes
• Owners of businesses that are “pass through” entities for federal
income tax purposes (e.g., partnerships) are not doing business in
the City solely because that entity is doing so
• Single-owners of entities that are disregarded for federal income tax
purposes (e.g., single member LLCs) are doing business in the City
if the disregarded entity is doing so (Tax Collector Regulation 2014-2)
44 |
San Francisco Gross Receipts Tax
 “Gross receipts” subject to the GRT are defined broadly as the total
amount received from whatever source derived. There are several
exclusions, including:
• Certain types of investment income and distributions from
business entities
• Cost basis of sold real property excluded
• Sales of real property subject to the City’s Real Property Transfer
Tax
• Cost basis to acquire financial instruments excluded
• Gifts and certain grants
• Taxes required to be collected and remitted to the governmen
45 |
San Francisco Gross Receipts Tax
 For taxpayers conducting business within and outside of the
City, the gross receipts attributable to the City are generally
determined by:
• A payroll factor (payroll within the City to all payroll); or
• Gross receipts allocation rules, depending on type of receipt
o Receipts from the performance of services are allocated
to where the purchaser received the benefit of the
service
o Receipts from intangibles are allocated to where and to
the extent the property is used
• A combination of the above
46 |
San Francisco Gross Receipts Tax
 A person subject to the GRT and its related entities must file a
single GRT combined return
• “Related entities” are those permitted or required by the
Franchise Tax Board to have their income reflected on the
same California Corporation Tax combined report under
CRTC section 25102, et. seq.
o Partnerships?
• A water’s edge election made for California Corporation Tax
purposes is effective for GRT combined returns
47 |
San Francisco Gross Receipts Tax
 Procedural Issues:
• GRT tax returns are due by the last business day of February.
o Before the extended due date of federal and California income
tax returns for calendar-year taxpayers
• Deficiency notice may be served within three years of filing
(San Francisco Business and Tax Regulation section 6.11-2(a))
• Refunds must be claimed within one year of overpayment
(San Francisco Business and Tax Regulation section 6.15-1(a))
o No special statute of limitation provisions for assessments or
refunds where California or federal adjustments have been
made
48 |
San Francisco Payroll Expense Tax
 Key Issues
 What is payroll expense?
 Not limited to typical employees
 Apportionment of time within and without the City
 Exclusions
 Biotech
 Central Market Street
 Stock-based compensation
 Classic “bait and switch”
 Beware of procedural foot faults
49 |
Nexus
50 |
Nexus/Quill Challenges
 Following the U.S. Supreme Court’s decision in Direct Marketing and
Justice Kennedy’s concurring opinion, there has been a renewed
effort by the states to overturn Quill
 Two states to watch are South Dakota and Alabama
 Alabama promulgated a rule requiring all retailers with sales in and
into the state in excess of $250,000 to remit the state’s sales tax,
regardless of whether the retailer has any physical presence in the
state
 Newegg, Inc. has filed a challenge to said rule in the Alabama Tax Tribunal
51 |
Nexus/Quill Challenges (cont.)
 South Dakota enacted an economic presence law which requires
sellers who do not have a physical presence in the state to remit sales
tax if the seller meets either of the following two criteria in the current
year or prior year
 Seller’s gross revenue from sales delivered into South Dakota exceeds $100,000,

or
Seller made sales for delivery into South Dakota in 200 or more separate
transactions
 South Dakota has sued several major on line retailers including
Newegg, Wayfair and Overstock.com. In turn, two trade associations
have sued South Dakota.
52 |
California Tax Reform Study
53 |
California Tax Reform Study
 In June 2016, the Controller issued a study entitled “Comprehensive
Tax Reform in California: A Contextual Framework”
 “Many believe the current tax system does not serve California as well
as it might, and that a review of the entire structure is long overdue.
Post-Proposition 13 revenues from the sales and use tax, the
corporation tax, and the property tax have diminished. This has
increased California’s dependence on the personal income tax.”
 “The time for comprehensive tax reform is now. No more kicking the
can down the road.”
 No specific proposals
 Split roll?
 Sales tax on services?
54 |
Questions
55 |
Jeffrey M. Vesely
San Francisco
jeffrey.vesely@pillsburylaw.com
(415) 983-1075
Annie H. Huang
San Francisco
annie.huang@pillsburylaw.com
(415) 983-1979
56 |