are you using ambiguity to your advantage?

If you are following state income tax developments to any degree, then you are aware of the ambiguity in state tax law that is leading to strange outcomes in court cases, new legislation by state legislatures, policies and procedures by departments of revenue, and even positions taken by taxpayers. Recent developments in tax reform, economic nexus, market-based sourcing, Multistate Tax Commission three-factor apportionment election cases, alternative apportionment, combined reporting, transfer pricing, OECD (Organization of Economic Co-Operation and Development) BEPS (Base Erosion and Profit Shifting), and tax haven legislation are creating risks and opportunities for corporate taxpayers.

Ambiguity, in general, creates challenges in the form of complicated laws (changing daily), vague statute of limitations, unreasonable audit positions, and computer generated notices. Ambiguity is allowing states to re-interpret current law so they can obtain different results without actually changing their law. States are also enacting new legislation retroactively to avoid payouts of large tax refunds. 

An example of ambiguity causing controversy is the recent Texas Margin tax case (Hallmark Mktg Co. v. Hegar, Tex., No. 14-1075, 10/9/15). The issue in the case surrounded the Texas regulation that requires “only the net gain” to be included in the apportionment factor (denominator). The state’s position was that the regulation requires both ‘net gain’ and ‘net loss’ to be included in the apportionment factor. Consequently, the state's position is that the regulation is ambiguous. The taxpayer's position is that the regulation only requires net gain. Hence, the taxpayer holds that the regulation is not ambiguous and not open to interpretation. The Texas Court of Appeals held that Texas’ interpretation of regulation was ‘reasonable’ (November 2014). Taxpayers are concerned the ruling “creates uncertainty about whether numerous sections of Texas' franchise tax regulations can be reinterpreted  by the Comptroller under the guise of ambiguity.” The Texas Supreme Court is set to hear oral arguments on December 9, 2015. 

The Texas case is only one example. I could discuss many more and may do so in future blog posts. 

The question we  should be asking is - can current law be interpreted more than one way? The law you are analyzing for your company at this very moment - is it ambiguous or is it clear? Will the state you are dealing with reinterpret the law under audit or litigation? 

Regardless of the answers, ambiguity requires action. Ambiguity requires corporations and taxpayers to be proactive and find solutions and reduce risk. Corporations need tools to determine whether a trend (i.e., court case, ruling, etc.) is a risk or opportunity. Even more than planning, corporations need to be able to determine what position they "should" take. What is reasonable? What is "more likely than not"? Compliance, controversy and provision requirements demand companies to answer these questions. How do you answer these questions? What tools do you use? Who do you talk to? 

We must eliminate ambiguity or use it to our advantage.

STATE OF STATE: COMING TO CHICAGO!

I will be co-presenting a complimentary (free) Bloomberg BNA lunch-n-learn presentation with Diane Tinney in Chicago on November 11, 2015 from 11:30 am to 2:00 pm.  

We will have an interactive discussion about the latest state income tax developments, advances in technology solutions driving change, and how you can make a positive impact on state income tax management in your organization.

If you will be in the Chicago area on November 11th, I would love the opportunity to meet you, and talk about your state income tax experiences as corporate tax executives or accounting/law firm tax professionals. I will be talking about how recent developments continue to create a complex and uncertain environment that makes it difficult to comply, plan, and obtain a fair result. I will also share some recent comments from an auditor that left me dumbfounded and even more determined to fight for fairness.

If you are planning to attend, I would love it if you sent me an e-mail regarding an issue or concern that you would like me to discuss. This would make our meeting even more valuable.

If you are unable to attend, I would still love it if you sent me an e-mail regarding an issue or concern that you have had. If we discuss it during our meeting, I will get back to you with our thoughts and conclusions.

I hope to see you there.

Fight the good-fight.

To register, go here.

the game we love/hate; and a little test

Imagine playing a game against an opponent who also makes all of the rules. An opponent that constantly changes the rules as the game is in-progress. Now imagine there are 50+ opponents. 

That is the multistate tax profession. That is what multistate corporations deal with every day.

Let's work together to fight bad audit policies and procedures, the lack of independent tribunals, and the computerized notices that cause us to surrender. 

When we feel trapped in a box or against the wall, let's fight for direction, freedom and resolution.

knowledge test

Did you know that 7 states require corporations to file separate entity income tax returns?

Did you know that 10 states allow corporations to file separate entity income tax returns or to elect to file consolidated returns?

Did you know that 1 state requires corporations to file a nexus consolidated return?

Did you know that 14 states (plus DC) require corporations to file a combined return or allow taxpayers to elect to file a combined return?

Did you know that 12 states require corporations to file a combined return or allow taxpayers to elect to file a combined return or consolidated return?

TEST:

Can you categorize the states into the above categories?

Which states are not included in the above categories?

$750 million in refunds at stake in California

The California Supreme Court heard oral arguments yesterday regarding a taxpayer's right to use the Multistate Tax Compact's (MTC) income apportionment formula (Gillette Co. v. Franchise Tax Bd., Cal. No. S206587, oral arguments held, 10/6/15). The Court must issue a ruling within 90 days.

If you have a subscription to the Bloomberg BNA Daily Tax Report, then you may have read an excellent article summarizing the proceedings yesterday by Laura Mahoney and Ryan Tuck.

In brief, the taxpayers are arguing the Compact is a "binding, reciprocal agreement between the states." California is arguing that the Compact is not a binding contract. Consequently, as the the article by Laura and Ryan suggests, a win for California may actually weaken the Compact and the move by states to uniformity. A win for taxpayers would reinforce the value of the Compact and the MTC would simply need to improve its weaknesses or flaws. Who will win? Stay tuned.

Nevada Commerce Tax Draft Regulations Released: Comment Now!

Nevada has released draft regulations for the new Commerce Tax. Taxpayers and tax practitioners have until October 10th to submit comments. 

As I previously mentioned, the new Commerce Tax is similar to the Ohio CAT tax or the Washington B&O tax with deviation. The Commerce Tax uses market-based sourcing to source receipts from services, so out-of-state service providers must look closely at the impact of this new tax on their operations.

PwC has released a nice summary of the draft regulations and takeaways. Check it out here.

Oregon within the 'range of permissible interpretations'

The Oregon Supreme Court's recent decision in AT&T Corp. interprets and applies Oregon's "cost of performance" statute in a manner that produces a market-based sourcing result. In reaching its decision, the Court stated:

"while there is room for doubt at the statutory level, it appears to us that the department’s interpretation of the statute is more likely to be within the range of permissible interpretations."

Consequently, the Department wins and the taxpayer loses.

This case is another example of where the grey area of state tax law creates litigation, and then when litigated, the Court relies on the Department's view because it is reasonable. The Court could have easily ruled in the taxpayer's favor based on the taxpayer's interpretation of the statute.

The parties offered two competing interpretations of what constitutes AT&T’s income-producing activity. AT&T’s interpretation focused on the operation of the network broadly, which was part of its justification for treating network costs as “costs of performance.” The department’s interpretation focused on individual transactions with customers, and that was part of its justification for concluding that network costs should be left out of the “costs of performance” analysis.

According to the Court, Oregon statutes (ORS 314.665(4)) do not look to the market where the sales occur. There is nothing specified about the geographic location of the taxpayer’s customers, which one would expect from a factor focused on a state’s contribution to the market. Instead, the provision looks to where the taxpayer effectively produces the income. The state where the taxpayer conducts its “income-producing activity” for a sale or class of sales may or may not happen to be the market state. 

The Court asserts that Oregon statutes seem to connect the term “income-producing activity” with particular “sales.” According to the Court, the statutory purpose is to assign the income from sales to particular states, and to do that, the provision directs taxpayers to identify the activity that produces that income—the income from that particular sale. The statute suggests that the focus may be on individual sales. Such a reading parallels the treatment of sales of tangible personal property. Just as that statute attributes each individual sale of tangible personal property to a particular state, so ORS 314.665(4) arguably attributes other individual sales to a particular state. That would imply, then, (according to the Court) that the income-producing activity means the activity that produces the income associated with a particular sale.

Regardless of the Court's assertions, the Court also declared that this is not the only possible way to read the state's provisions.

"Commentators have routinely criticized UDITPA section 17 for its ambiguity: “[T]he commentators have found the rules to be ‘confusing and indefinite’ and plagued by ‘vagueness,’ ‘ambiguity,’ ‘substantial debate,’ ‘lack of clear guidance,’ ‘whipsaw[ing],’ ‘tremendous flexibility, and hence [tax planning] opportunity,’ ‘frequent litigation,’ ‘inconsistency,’ and ‘confusion for taxpayers and taxing authorities alike.’”"

Despite the criticism and confusion, the Court deferred to the department’s position regarding the meaning of “item of income” because it is "not inconsistent with the text of the rule in its context, or with the statute, or with any other source of law." 

As always, the burden is on the taxpayer to prove the Department is wrong. In this case, the burden of proof was on AT&T to demonstrate that it was entitled to a refund. As a practical matter, that means AT&T had to introduce evidence showing that, in connection with its sales of interstate and international voice and data transmission, a greater share of the “costs of performance” for each “income-producing activity” was incurred in a state other than Oregon.

Based on the Department's interpretation and the Court's ruling, AT&T was required to identify the relevant non-network costs for each income-producing activity. In other words, AT&T was required to use a transaction-based interpretation of "income-producing activity." AT&T's cost study did not identify the non-network costs because AT&T had used network-based interpretation of "income-producing activity" implying that network costs counted as direct costs.

ruling opens door for assessments?

The Oregon Supreme Court ruling allows Oregon to utilize market-based sourcing without actually changing its current statutes to impose market-based sourcing. In other words, the interpretation supported by the ruling opens the door for the state to audit taxpayers and make assessments on taxpayers that once felt 'safe' or reasonably certain about their sourcing methodology and subsequent result.

re-examine your sourcing methodology

Taxpayers providing services to customers in Oregon should re-examine their sourcing methodology to determine if the ruling and interpretation will change the amount of sales apportioned to Oregon and ultimately, the taxpayer's tax liability.