Should the Federal Government Pre-empt A State's Taxing Power?

I recently read an article by Shirley Sicilian from KPMG where she interviewed Greg Matson, the Executive Director of the Multistate Tax Commission. Good article. Recommended reading.

In the article, Ms. Sicilian asks Mr. Matson what he thinks will 'rock the tax world' in the next few years? Mr. Matson's response included the overturning of Quill, the ripple effect of BEPS on states, and states challenging congressional authority to pre-empt their taxing power.

With all of the court case challenges to Quill and the states trying to impose sales tax collection or reporting requirements on remote sellers, and the proposed federal legislation to reinforce Quill, I have been thinking about the battle between state sovereignty and federalism.

State sovereignty is the concept that states are in complete and exclusive control of all the people and property within their territory. State sovereignty also includes the idea that all states are equal as states.

Sovereignty is the power of a state to do everything necessary to govern itself, such as making, executing, and applying laws; imposing and collecting taxes; making war and peace; and forming treaties or engaging in commerce with foreign nations.

The individual states of the United States do not possess the powers of external sovereignty, such as the right to deport undesirable persons, but each does have certain attributes of internal sovereignty, such as the power to regulate the acquisition and transfer of property within its borders. The sovereignty of a state is determined with reference to the U.S. Constitution, which is the supreme law of the land.

I believe in state sovereignty and as much as I like uniformity and less complexity, I support a state's rights to make their own laws. However, when states overreach and attempt to enact unconstitutional taxes, that is when the federal government or the U.S. Supreme Court has to step in. 

When do you think the Federal government should step in?

Note: For more on federalism and state sovereignty, check out Federalism, State Sovereignty, and the Constitution: Basis and Limits of Congressional Power by Kenneth R. Thomas, Legislative Attorney.

STATE TAX LETTER RULINGS, OBTAINING CLARITY PART 1: THE PROCESS IN TENNESSEE

In our quest for clarity in the maze of continual multistate tax challenges and developments, we search our tax research databases, we contact colleagues, and yet, sometimes, we still don't know what to do. One option is to get a "letter ruling" or "private letter ruling." 

I want to provide you with information on each state's letter ruling process. Then we will explore 'how' to write a letter ruling.

Note: "When" to write a letter ruling is a judgment call based on the facts surrounding your case, and the specific state's process and other rulings the state has issued. 

I plan on writing about each state's letter ruling process in future blog posts. Today, I am focusing on Tennessee's letter ruling process since I recently moved to Tennessee. 

According to Tennessee law, a letter ruling is an interpretation and application of the tax law as it relates to a specific set of facts furnished to the Department by the taxpayer. Assuming the facts are correctly represented by the taxpayer requesting the letter ruling, the Department is bound to follow its decision with respect to that taxpayer. The taxpayer’s identity must be disclosed to the Department in its letter ruling request.

Revenue rulings are statements regarding the substantive application of law and statements of procedure that affect the rights and duties of taxpayers and other members of the public. Revenue rulings are advisory in nature and are not legally binding on the Department. The taxpayer’s identity is not required for a nonbinding revenue ruling.

When exceptional circumstances require immediate consideration of an issue, a taxpayer can request an expedited letter ruling or revenue ruling by expressly making such request in writing and submitting an expedited ruling fee of $10,000 with the request. When an expedited ruling is requested, the Commissioner of Revenue will either issue a ruling within sixty days from the date of the request or deny the request and return the fee to the requesting party within seven days from the date of the request.

Fees

The fee for the issuance of a letter ruling or revenue ruling is $500.
The fee for the issuance of an expedited ruling is $10,000.

To request a ruling, the taxpayer (or the taxpayer’s representative) should send a letter to the Commissioner of Revenue, 500 Deaderick Street, Nashville, TN 37242.

The letter should include the following:

• The taxpayer’s (or representative’s) contact information, including mailing address and telephone number;
• A check for the applicable fee;
• A fully completed Power of Attorney, if required (see below);
• The taxpayer’s question or questions;
• A description of all relevant facts;
• A copy of any pertinent sample invoices, contracts or the like (which may be provided in redacted form); and
• If appropriate, pictures of the equipment, products, or other items that are the subject of the ruling request.
• The letter may also include the taxpayer’s analysis of the law; however, this is not required.

Power of Attorney

The Department places extremely high importance on maintaining taxpayer confidentiality. In many cases, the taxpayer requesting a letter ruling wishes for the Department to communicate with its outside representative, such as a CPA or attorney. In such instances, the taxpayer must sign a Power of Attorney, which is available on the Department's website.

The Power of Attorney must list all outside representatives with whom the Department is permitted to communicate about the letter ruling request. A Power of Attorney is not required if the only people with whom the Department will communicate are the individual taxpayer, or the owners and employees of the taxpayer company.

The Process: From Request to Issued Ruling

Each ruling request is assigned to a Department attorney when received. The attorney will contact the taxpayer (or representative) to request any additional necessary information and to clarify any questions the attorney may have. The attorney works closely with the Department's General Counsel to research and prepare a preliminary draft of the ruling. When completed, the preliminary draft is sent to various divisions within the Department for review. The attorney may further revise the draft ruling, based upon comments received from the reviewers. Once the review and revision process is complete, the final version of the ruling is sent to the Commissioner's office. At least one Deputy Commissioner reviews the ruling before it is given to the Commissioner. In appropriate cases, the Commissioner will meet with the Deputy Commissioners and the Department's legal staff to discuss the ruling. After thorough consideration, the Commissioner will issue the ruling to the taxpayer.

Rulings on the Department of Revenue's Website

It is the policy of the Department that all letter rulings and revenue rulings that are instructive to other taxpayers, and that are not detrimental to the State’s Economic Development efforts, will be made available to the general public on the Department's Web site. All rulings will be redacted to remove identifying taxpayer information before being made public. The taxpayer will have the opportunity to review and comment on the proposed redacted version before it is made public. The Department will consider requests that rulings not be published based on a taxpayer's belief that confidentially cannot be accomplished in a redacted version of the ruling. Any request for non-publication, even in redacted form, should be made in the ruling request and must include a detailed explanation as to why the ruling should not be made public.

Duplicative Ruling Requests

If a tax ruling has been previously issued on a specific topic, the Department is not likely to issue another ruling on the same topic unless the taxpayer can show that its facts are materially different from the facts that serve as the basis for the issued ruling, or that there has been a substantive change in the law. If a taxpayer submits a ruling request that is duplicative of previously issued guidance, the Department will likely respond by informal letter and provide a copy of the applicable previously issued tax ruling, in addition to returning the taxpayer's ruling fee.

Revocation of a ruling

Rulings may be revoked or modified by the Commissioner at any time. The revocation or modification of a letter ruling will be effective retroactively unless the following conditions are met, in which case the revocation will be prospective only:

• The taxpayer must not have misstated or omitted material facts involved in the transaction;
• Facts that develop later must not be materially different from the facts upon which the ruling was based;
• The applicable law must not have been changed or amended;
• The ruling must have been issued originally with respect to a prospective or proposed transaction; and
• The taxpayer directly involved must have acted in good faith in relying upon the ruling and a retroactive revocation of the ruling must inure to his detriment.

Statutory Authority Tenn. Code Ann. Section 67-1-109 gives the Commissioner the power to issue revenue and letter rulings at his discretion.

Global Business and Technology Causes Overreaching Laws and Unintended Consequences

Now that the Organisation for Economic Co-operation and Development (OECD) has released its recommendations and actions under the Base Erosion and Profit-Shifting (BEPS) project, federal legislation and subsequent state law changes may occur causing companies to adapt.

The article by Deloitte entitled, "Global Business and State's Challenges to Taxable Income," reminds us of the various methods or tactics states have taken to reduce or eliminate a company's ability to plan around taxation by using intercompany transactions and out-of-state / off-shore entities.

For example, states have utilized Internal Revenue Code (IRC) Sec. 482 like powers to remove the income distortion created by intercompany transactions not completed at arms-length. States have also enacted combined reporting and various related-party expense addback provisions. The most recent method used by states to tax revenue earned outside their borders is tax haven legislation - look here for more info.

When states enact combined reporting, they usually require water's-edge reporting or allow taxpayers to make an election to use water's-edge reporting. Why don't states require worldwide combined reporting?  Worldwide combined reporting would address the tax haven issue so why don't states require it? The short answer, states may not get more revenue if they required worldwide combined reporting. The inclusion of foreign income and apportionment factor dilution can cause unexpected results. Thus, what seems like a great solution on the surface, may not be in practice. Other factors that come into play include currency, accounting methods, and international tax planning which can cause complications. For more info see, "Are Tax Havens Pushing States to Worldwide Combined Reporting." 

As a result, states that enact combined reporting continue to use other laws to selectively decide when and how a foreign entity is included in a combined group return. For example, states that require water's-edge reporting generally have foreign entity inclusion / exclusion rules. One such law provides that foreign operating companies (a U.S. corporation with substantial operations outside the U.S. and at least 80% of its income is active foreign business income) are generally excluded from combined groups (i.e., 80/20 rule). 

In spite of the 80/20 rule, taxpayers have successfully included foreign operating companies in a combined return. For example, in a recent Minnesota Tax Court case (Ashland Inc. and Affiliates vs. Commissioner of Revenue), the Court ruled that a foreign disregarded entity's income and apportionment factors could be included in a Minnesota combined return because the foreign entity was not a separate entity from it's owner. 

In general, court cases and rulings tell us that states have a variety of rules to capture revenue earned outside their borders. Court cases and rulings also tell us that taxpayers can navigate those rules to plan and effectively choose which foreign entities are included or excluded. 

As the business world becomes even more global, and technology erases the easily identifiable lines of where a transaction begins and ends, taxing authorities have a very complicated job to tax the 'right' amount of a taxpayer's income. 

As tax laws change in response to the OECD and BEPS, companies will continue to adapt in response to those changes. Consequently, if history tell us anything, there will always be laws that overreach, and unintended consequences (planning opportunities). Prepare accordingly.

"Good Enough For Government Work"

My dad was not just a "handyman," but was "the" handyman.  He could work on anything, fix anything and he had every tool known to mankind.  He had a huge workshop with 10 million screwdrivers, hammers, wrenches, saws, etc. (no exaggeration, I counted).

When I was a kid, it seemed like every Saturday he would be working on a project, and I would be pulled in to assist.  

I don't know about your experience, but every project we worked on wasn't easy.  What started out as an easy project often turned into a problem.  Something wouldn't loosen or something wouldn't tighten, something was too big, something was too small, the right tool wasn't acting like the right tool, and so on and so on.  As one problem would get solved, another one would appear like magic.  

In any case, at some point at the end of the project, after all of the problems were resolved (usually using some type of creativity), my dad would often say, "good enough for government work."  Now, I must clarify that my dad did not mean any offense to government work or government workers.  However, when my dad made this statement he was saying that the project was complete, albeit not perfectly, but it was done to a level that was atleast satisfactory or would do the job.  Today, every time I work on a home improvement project, that phrase comes into my head.  I can hear my dad's voice.  

In regards to state and local taxes, it sometimes feels as though each project (compliance, controversy, planning, etc.) runs into problem after problem.  What you think should be simple and straight forward turns into a complex and difficult maze to navigate.  When you get to the end of the project, you often feel like settling or in other words, saying "good enough for government work."  

Based on my experience, I highly recommend you don't take that approach.  Don't settle for satisfactory, but dig in, back-up, take a breath and look at your project from a different angle.  At the end of the project, when you are exhausted, a little extra effort could reap valuable benefits for you and your company or client.

State Tax Haven Legislation (Update and Resources)

The number of states introducing or enacting some form of state tax haven legislation is increasing annually. To help you keep track of it, I have included links to several resources that may be helpful:

• PwC State Tax Haven Legislative Tracker
• Reaching for Revenue Offshore, States Push Tax Haven Laws
• State Tax Haven Legislation: A Misguided Approach to a Global Issue
• Tax Haven Legislation is Growing in Popularity
• Connecticut Limits New Tax Haven Law
• Tax Haven Legislation Was a Hot Topic in State Legislatures in 2015
• State and Local Tax Policy Statement Regarding State Tax Haven Laws
• States Eye Tax Havens
• “Tax haven” state enactment status, with 2015 proposals
• Recent Trends in Combined Reporting and Apportionment

According to EY, arguments for tax haven legislation:

• $20b in state tax revenue loss – multinational corporations hide profits in “island economies.”
• Big business does not pay its “fair share.”
• Small business disadvantaged, unable to use tax haven “loophole.”

According to EY, arguments against tax haven legislation:

• Is it even constitutional?
• Japan Line vs. Los Angeles – US S. Ct. (1979) – US must “speak with one voice” in international relations
• Tax haven “blacklisting” is arbitrary.
• Can’t prove its $20b in state tax losses
• States are adopting a go-it-alone approach, out of sync with the rest of the international community
• (OECD Base Erosion and Profit Shifting project rejects approach these states want to follow!)

Based on reviewing the above resources, 6 states plus D.C. have enacted some form of tax haven legislation (Alaska, Connecticut, Montana, Oregon, Rhode Island, and West Virginia). A multitude of states have proposed some type of tax haven legislation. Most of the proposals have been connected to combined reporting proposals or revisions. Some of the proposed legislation has not gotten very far along in the process before being declared 'dead.' Other proposals were eliminated from the legislation or changed to provide that the state perform a 'study.' States that have introduced legislation include:

1. Alabama (HB 142/ S 202 / S 51 / S 12
2. Colorado (HB 1275 / HB 1346)
3. Florida (HB 1221)
4. Illinois (HB 4300)
5. Indiana (S 323)
6. Kansas (HB 2680)
7. Kentucky (HB 861 / HB 342 / HB 374 / HB 132)
8. Louisiana (HB 74a / HB 775)
9. Massachusetts (HB 2477 / HD 1234 / SD 1699 / S 1524  / H 4200 / HB 3400)
10. Maine (HB 1110 / LD 1634 / HB 235 / LD 341 / HB 273 / LD 407 / S 392 / LD 1120)
11. Minnesota (SF 3318 / HF 3898)
12. New Hampshire (HB 551)
13. New Jersey (A 1720 / S 982 / A 4826)
14. Pennsylvania (HB 1758 / S 117)
15. Vermont (S 138 / HB 489) - enacted, but not*

* Note: Vermont never enacted tax haven legislation. Vermont HB 489, as proposed and introduced, had language requiring the Commissioner of Taxes to make recommendations on how to include income from tax havens in the calculation of Vermont’s corporate tax. That language was struck and not part of HB 489 that was eventually enacted in June 2015. Thus, Vermont never repealed it because it was never enacted.

SALT and STRUCTURE: Keep it Simple Sxxxxx?

Does your company or client operate its business within a simple organizational or entity structure?  Does it operate all of its business activities through one entity or several entities?  

Whether or not your company or client should operate its business through one entity or several entities depends on several factors, such as:

1. Does the company have more than one business line, product or service?
2. Does the company manufacture products and provide services as well?
3. Is the company profitable in general?  Are certain business lines profitable and others are losing money?
4. Does the company sell wholesale and retail? 
5. Does the company sell its products and/or services over the Internet?
6. Does the company have operations in foreign countries?
7. Does the company have valuable trademarks, patents, copyrights, or other intangibles?
8. Does the company want to decentralize or centralize certain functions such as, accounting, legal, tax, purchasing, etc.? 
9. Should the company have separate entities for legal reasons?  Liability reasons?
10. Does the company want to streamline its supply-chain, obtain economies of scale?

The list could go on and on.  Each case is different, but the goal should be the same - create and utilize a legal and organizational structure that helps the company achieve its business, legal and financial objectives.

Tax purposes or ramifications, whether it is federal tax, international tax, and of course, state and local tax, should attempt to be in alignment with the company's business, legal and financial objectives.  

Therefore, when it comes for a company to decide as to if they should keep a relatively simple structure or create multiple entities, the "keep it simple stupid" mantra may or may not come into play.  The key is to complete the cost/benefit analysis of doing so.  This means weighing the business, legal and financial objectives.  It also means evaluating the tax ramifications.

Note: if you are a long-time subscriber to the LEVERAGE SALT blog, this post may seem familiar. Yes, I originally wrote this post a couple of years ago, but it still applies today. I am in the middle of a big move from Virginia to Tennessee, so please bear with me as I still attempt to provide you with meaningful content. Sometimes a reminder is just as good as something new. Another way to put it is, we don't always need new laws if we would simply enforce our current laws.