State Taxation: 'Food For Thought'

My recent posts have contained some of my notes and questions I recorded from attending the Paul J. Hartman State and Local Tax Forum last week. This is my last post which lists 20 takeaways or 'food for thought.'

1. The Organisation for Economic Co-operation and Development (OECD) does not identify tax havens, so why are the states?
2. Discretionary Authority is no warning. It doesn't allow taxpayers to know what a state will do (i.e., using alternative apportionment or combined reporting to force a taxpayer to deviate from the standard apportionment formula; or modifying a costs-of-performance statute to get a market-based sourcing result).
3. International taxation is starting to use state tax concepts such as combined reporting and apportionment.
4. "Are 'bright-line' tests knee-jerk reactions?" - quote from one of the speakers
5. "Tax Haven legislation should be trashed. Tax haven legislation picks winners and losers." - quote from one of the speakers
6. The only way to fight retroactive legislation is to monitor it and lobby against it before it is enacted.
7. Should states be able to enact retroactive legislation to protect the state budget from financial loss?
8. Should judicial decisions only apply to the taxpayer involved in the litigation if it involves a refund?
9. Retroactive legislation should not be able to increase revenue.
10. Ask yourself, if a 'technical correction' is creating new law or changing the interpretation of the law from the original interpretation that has been followed by taxpayers for years. If the answer is yes, do something.
11. Should retroactive legislation be limited to a state's statute of limitations?
12. Prior legislatures can't bind future legislatures.
13. New legislatures can't determine, or know, the intent of prior legislatures. Shouldn't be able to unbind or unwind prior legislation.
14. "Retroactive legislation is telling you what the law was." - quote from one of the speakers
15. Are we moving from apportionment to allocation when we use single-sales factor apportionment and market-based sourcing?
16. Is single-sales factor apportionment 'fair apportionment'? Moves income to customer states, not to states where the activities occurred that generated the income. Income is not based solely on sales.
17. "Throwback and throwout rules are unconstitutional because they look beyond the borders of the state." - quote from one of the speakers
18. If alternative apportionment is wide open and anything goes, why have statutes?
19. "To gain true insight, read the entire case - don't just read the blurb. See what it says and what it doesn't say." - quote from one of the speakers. Get creative. See the case, the issue from a different perspective. Ask "why not."
20. Does common sense apply? If so, is your definition of 'common sense' the same as mine?

Obviously, I obtained all of the thoughts above from the Forum. Some are quotes from speakers, some are ideas paraphrased from a speaker's discussion, and others are personal reflections. 

The 'Most Significant State Tax Policy Issues'

David Brunori will be in Las Vegas this week speaking at the Council On State Taxation annual meeting (Friday morning) with Doug Lindholm, Helen Hecht, and Richard Pomp. They are leading a debate/discussion on the most significant issues in state tax policy. I can't be there, but thought I would give my two cents. 

I think some of the most significant state tax policy issues are:

• the imposition of sales tax collection obligations on remote retailers;
• expanding the sales tax base to services;
• whether states should ramp-up transfer pricing training/positions or join the MTC ALAS program;
• whether states should adopt tax haven legislation which allows them to cherry-pick the taxation of foreign income or simply adopt mandatory worldwide combined reporting;
• whether states should continue to enact unconstitutional legislation forcing taxpayers to go to court;
• whether states should continue to enact retroactive legislation;
• whether states should continue to enact legislation that benefits in-state taxpayers vs. out-of-state taxpayers (i.e., market-based sourcing, single-sales factor apportionment, credits and incentives).

What do you think are the most significant issues in state tax policy?

State Tax Transfer Pricing - What's Next?

Recent media reports reflect that transfer pricing in the state tax area is gaining more scrutiny and attention due to international tax developments like OECD BEPS, but also the Multistate Tax Commission's Arms-Length Adjustment Service (ALAS) initiative, previous state litigation and growing interest in tax haven legislation. 

A nice presentation delivered by Michael Bryan, Karl Frieden, Jeff Friedman and Marshall Stranburg at the Federation of Tax Administrators Annual Meeting on June 13, 2016, provides good background information on the basics and importance of transfer pricing while describing the current environment.  

The presentation defines transfer pricing as "the pricing of transactions between related entities for goods, intangible assets, services, and loans." Transfer pricing is "designed to prevent tax avoidance among related entities by requiring pricing equivalent to prices available with an uncontrolled party:

• Transactions must (generally) be at arm’s length
• Non-arm’s length intercompany transactions can impact the clear reflection of income in states where income is reported on a separate or partial combination basis
• Tax evasion or avoidance generally not a pre-requisite for making a transfer pricing adjustment"

According to the presentation, the "key intercompany transactions subject to transfer pricing" are: 

• Transfer and licensing of intangible assets
• Providing and charging for common services
• Financing
• Factoring accounts receivables
• Sale of tangible goods that contain a trademark or other intangible
• Purchase and resale of tangible goods

WHAT'S NEXT?

The presentation ends with a question - "What's Next?" This is the most important question.

What should companies do now? How can companies plan? What path will states take to combat this perceived abuse? Will states piggyback off of BEPS? Will states get involved with the MTC initiative? Will states actually enact and enforce tax haven legislation? Or will states simply adopt worldwide combined reporting? Worldwide combined reporting seems to be a simpler approach. However, as I have noted before, making a simple general rule may not be beneficial to a state if applied to taxpayers across the board.

Consequently, it makes more sense for states to have discretionary authority and make case-by-case adjustments so they can better control the impact on revenue. Therefore, I think states will continue to use a combination of all of the tools that will allow them to retain discretionary authority and control. 

In the words of Dave Brunori, "when proving arm’s-length pricing, the side that can spend the most on good lawyers, accountants, and economists almost always wins." We shall see.

For more information, check out my previous post on the MTC ALAS program.

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.

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.

14 STATE TAX DEVELOPMENTS YOU MAY HAVE MISSED

I have been extremely busy with work and managing a move from Virginia to Nashville, TN. We bought a fixer-upper on 16 acres near Nashville and are set to close on the sale of our house in Virginia in June. We will be physically and permanently in the Nashville area in June. Can't wait. Because of the multitude of tasks involved in moving, I haven't had the time to blog as much. I hope you understand. 

Note: if you are located in the Nashville area, please contact me or connect with me on LinkedIn. If you are ever in the area for work or attend the Paul J. Hartman State and Local Tax Forum in October, let me know.

I have however, posted several things in the LEVERAGE SALT LinkedIn group that you may find interesting, if you haven't seen them.

1. State Rundown 4/21: Scraping the Bottom of the Revenue Barrel

2. 90 Reasons We Need State Corporate Tax Reform? - Interesting.

3. State Rundown 5/6: Energy Boom Goes Bust

4. Iowa Tax Reform Options: Building a Tax System for the 21st Century

5. Oregon Initiative Petition 28: The Threat to Oregon’s Tax Climate

6. Graduated Income Tax Amendment Stalls In Illinois House

7. 2016 State Tax Amnesty Programs (According to COST)

8. COST Issues Comments on Georgia's Waiver of Interest Provision

9. TEI Issues Policy Statement on Statutes of Limitation for State and Local Taxes

10. TEI Holds Liaison Meeting with the Illinois Department of Revenue

11. New Jersey Can Strike Blow Against Tax Havens

12. If Everyone Is a Tax Haven, No One Is

13. Unclaimed Property Litigation Update – Spring 2016

14. Pennsylvania Illustrated: A Visual Guide to Taxes & The Economy

I hope you find something useful from the links provided. If you do, please drop me a line and let me know. Also, send me a topic or question you would like me to cover in a future blog post.

I started the LEVERAGE SALT LinkedIn group to encourage interaction. To be honest, there really isn't much interaction on LinkedIn. It appears to be more of a bullhorn than true conversation. I know we are extremely busy and don't have time to wander the halls of LinkedIn. But I challenge you to start a conversation. Let's really talk.