State Taxation of The Sharing Economy - My Notes From the Paul J. Hartman SALT Forum

As I was sitting in the State Taxation of the Sharing Economy (i.e, Uber, Airbnb, etc.) session at the Paul J. Hartman State and Local Tax Forum presented by Jeremy Abrams, French Slaughter and Reid Okimoto last week, I took some notes. Here are a few of them:

1. How you characterize a charge (i.e., label it) and the contract language will most likely determine how the charge is taxed for sales tax purposes.
2. Will states 'back into' the characterization?
3. How do you source the sharing economy? By service address, billing address, or where the transaction starts or ends?
4. Does the Internet Tax Freedom Act pre-empt any sales taxation of the sharing economy?
5. Is physical presence 'nexus' MORE important, NOT less important due to technology advances and changes in how transactions occur?

CREDITS AND INCENTIVES - My Notes From the Paul J. Hartman SALT Forum

The following are some of my notes and thoughts from attending the Credits and Incentives session at the Paul J. Hartman State and Local Tax forum last week, presented by Chris Grissom, Robert Boehringer and Ron Rabkin.

1. All politics are local.
2. Taxpayers often obtain multiple letter rulings for credit and incentive deals due to the sophistication of the rules.
3. Credits and incentives are the opposite of simplification. Similar to market-based sourcing and single-sales factor apportionment, credits and incentives pick winners and losers - shifting the tax burden to out-of-state taxpayers and/or to other tax types such as property taxes and personal income taxes. How does this impact schools? Does the positive outweigh the negative?
4. Credits and incentives require so much knowledge of the deal, the incentive, the contacts at the jurisdiction, the procedure, etc. So many 'hoops' to jump through to obtain an incentive. Is it fair to have a system that requires so much investment of time, money, and energy? Those who are unwilling, or unable to invest the time, money and energy lose out. Is that fair? You could miss out on a great incentive package simply because you did not hire the right person to negotiate for you? Is that what it should take?
5. If a company makes an investment in a project before getting the credit and incentive, did the company actually need the credit and incentive?
6. Credits and incentives require companies to 'tell the story.'
7. Is everybody 'winning'?
8. What tool are you using to determine the type of credits and incentives that will benefit your company the most? A modeling tool or excel spreadsheet? Using the right tool will allow your company to negotiate with a state/city to get the right incentives package (i.e., incentives you can actually use).

Dot Foods & Washington: A Case Study on Intent, Interpretation and Retroactivity

Regardless of whether you have been following Dot Foods v. Washington Department of Revenue cases for the last several years, we need to pause and review.

According to the decision, Dot Foods 1  involved Dot Foods utilizing an exemption from the Washington Business & Occupation (B&O) tax for many years (note: the statute was originally enacted in 1983). Dot Foods facts changed from 1997 to 2000, but Dot Foods interpreted the exemption to still apply. In 1999, the state revised its interpretation of the statute to narrow the exemption, under which, Dot Foods would no longer qualify.

Washington later audited and assessed Dot Foods additional tax for the 2000 to 2004 tax years based on the state's revised interpretation. Dot Foods paid the tax, and filed a refund claim, eventually winning in the Washington Supreme Court in 2009. In simple terms, the court held the state's new interpretation was incorrect, and the state simply can't change it's long-standing interpretation of a statute without changing the legislation itself. The court said:

"The Department's argument for deference is a difficult one to accept, considering the Department's history interpreting the exemption. Initially, and shortly after the statutory enactment, the Department adopted an interpretation which is at odds with its current interpretation. One would think that the Department had some involvement or certainly awareness of the legislature's plans to enact this type of statute. As a general rule, where a statute has been left unchanged by the legislature for a significant period of time, the more appropriate method to change the interpretation or application of a statute is by amendment or revision of the statute, rather than a new agency interpretation."

 Dot Foods, Inc. v. Dep't of Revenue, No. 81022-2, SUPREME COURT OF WASHINGTON, 166 Wn.2d 912; 215 P.3d 185; 2009 Wash.

While Dot Foods 1 was going on, (2005 to 2009), Dot Foods paid tax under the state's new interpretation of the statute to avoid penalties and interest. When Dot Foods 1 was decided in 2009, Dot Foods filed a refund claim for the 2005 to 2009 tax years.

Washington amended the statute in 2010 after Dot Foods 1 was decided in 2009, and applied the amendment retroactive to when the statute was originally enacted in 1983. According to the Washington State Budget and Policy Center's report in May 2010,

"the legislature enacted technical corrections and clarifications to state tax laws that will prevent steep revenue losses in the current year and in future years. This includes the legislature’s response to a recent State Supreme Court case that greatly expanded an exemption originally intended only for companies such as Avon and Mary Kay that sell products solely through door-to-door salespersons (Dot Foods decision). Without legislative action, the state would have lost about $151 million in the current biennium due to refunds and new firms claiming the exemption."

Under the authority of the retroactive amendment to the statute, Washington denied Dot Food's 2005-2009 refund claim (note, some of these tax years have been settled). Dot Food's challenged the ability of Washington to change the statute retroactively (Dot Foods 2). The Washington Supreme Court ruled in the state's favor in March 2016 holding that the legislature's amendment which retroactively narrowed the exemption and prospectively repealed the exemption, did not violate a taxpayer's rights under the Due Process Clause of the U.S. Constitution, collateral estoppel, or separation of powers principles. The court said:

"Retroactive application of the amendment did not violate due process protections because the amendment served a legitimate legislative purpose and was rationally related to the legitimate legislative purpose. The amendment prevented large revenue losses and removed preferential tax treatment for out-of-state businesses. In addition, the requirements of collateral estoppel were not met because collateral estoppel does not apply to subsequent taxing periods that were not previously adjudicated. Finally, since the taxpayer could not point to any evidence that the legislature intended to affect or curtail a prior judgment in the case, retroactive amendment did not violate the separation of powers doctrine."

Dot Foods, Inc. v. Dep't of Revenue, No. 92398-1, SUPREME COURT OF WASHINGTON, 185 Wn.2d 239; 372 P.3d 747; 2016 Wash.

Dot Foods requested the U.S. Supreme Court to review the case. We are waiting to learn if the Court will. Here are links to briefs filed by various organizations in support of Dot Foods:

• TEI Brief
• COST Brief
• American College of Tax Counsel Brief

Note: I am working on a more in-depth article for my column in Tax Analysts State Tax Notes.

Stay tuned. 

Indiana Releases Combined Reporting and Transfer Pricing Studies

Indiana has released two separate studies, one on combined reporting and one on transfer pricing. The studies were a requirement of SB 323 that was amended on January 28, 2016 to study combined reporting instead of adopt combined reporting, as I reported earlier. 

Combined Reporting

The combined reporting study discusses all of the reasons why states adopt combined reporting - to stop base erosion from taxpayers using intellectual property holding companies, captive real estate investment trusts, captive insurance subsidiaries and overseas management affiliates, etc. However, the study also explains that combined reporting creates new problems that separate reporting states do not have to deal with, such as determining the unitary group, and additional administrative burdens during the transition to combined reporting. 

The study also asserts that the impact of combined reporting on state revenues is mixed, according to evidence from other states. Similar to most state tax laws, implementing combined reporting would provide additional revenue from some taxpayers and less revenue from other taxpayers. Consequently, the question remains as to what the overall revenue impact would be. The study suggests combined reporting would increase revenue in the short term, but be neutral in the long term.

Regardless of the revenue impact, the study confirmed that separate reporting does allow taxpayers with more opportunity to create favorable business structures and utilize intercompany transactions to shift income from affiliates based in high-tax states. Despite this fact, the study appears to be leaning towards a recommendation to not enact combined reporting.

Transfer Pricing

The transfer pricing study is a great report to review if you want to learn more about transfer pricing. The conclusion of the report explains the realities of related party transactions that exist due to complex business structures dominated by parent companies with affiliates in multiple states and countries. As a result, scrutinizing intercompany transactions is a necessity.

The study confirms that transfer pricing examinations and analysis are complex and expensive, and asserts that if a transfer pricing study is not conducted in an efficient and effective manner, it could be detrimental to the taxpayer. To reduce the amount of disputed transactions, Indiana requires the addback of deductions taken for royalties, intangible related-party expenses and intercompany interest. However, other states currently have broader addback provisions or have enacted combined reporting.

So What?

Indiana has had many cases and rulings that reflect the complexities and burdens of analyzing and resolving the proper treatment of intercompany transactions and transfer pricing studies. Consequently, Indiana and taxpayers have spent resources (time and money), which both the state and taxpayers do not have, to resolve these matters. Hence, in my opinion, Indiana should adopt combined reporting to reduce the amount of disputes involving intercompany transactions and transfer pricing studies. The whole question of whether an intercompany transaction is at arms-length doesn't matter when intercompany transactions are eliminated in a combined return. Albeit, there may be some entities that are not a part of the group and the issue could still occur. In addition, combined reporting will create new issues to deal with, such as what entities are part of the unitary group. However, I believe it is less of a burden for states and taxpayers to manage the issues related to combined reporting versus the issues related to transfer pricing studies and analyzing related party transactions.

Transfer Pricing, Treasures in the Attic and Using Social Media

Next week I will be attending the Paul J. Hartman State and Local Tax Forum in Nashville. A few of the sessions on Tuesday that I am extremely interested in are:

1. Transfer Pricing - MTC - ALAS program by Carley Roberts and Marshall Stranburg. The MTC program has been struggling to gain traction among the states. With all of the other activity around transfer pricing (i.e., BEPS, IRC Sec. 385 regulations, etc.), I wonder if traction will be found or will states remain in pause mode waiting for the dust to settle from other initiatives? For more info, check out my previous post - State Tax Transfer Pricing - What's Next?
2. Treasures in the Attic - Tried and True Legal Principles in SALT by Janette Lohman and Brian Kirkell. This should be a good session to refresh our knowledge of principles that we can use to help clients avoid and resolve controversy. If this interests you, you may like my previous post - Should the Federal Government Pre-empt A State's Taxing Power?
3. Ethics and Social Media for Tax Professionals by Brett Carter, Mark Holcomb and Glenn McCoy. I have a personal interest in this session as I have used social media for the last 8 years. Personally, social media has been a great tool to meet new people all over the country and help more companies, firms, publishers and policy organizations. If you haven't read it, here is a link to an interview I did for Bloomberg BNA about blogging.  For more history on my blogging adventure, check out this post.

Other sites I have used as a resource during my blogging years are:

Real Lawyers Have Blogs

Lawyerist

The Greatest American Lawyer

Amazing Firms, Amazing Practices

In Search of Perfect Client Service

Cordell Parvin Blog

Seth Godin Blog    

Adrian Dayton

*Please note that I am not an attorney, just so happens that most of the resources or people blogging when I started in 2009 were lawyers, not accountants.

Nonresident Withholding 'Nightmare'

In a prior life, I worked in a tax department where we managed the filing of multistate income tax returns and the flood of notices received for over 500 pass-through entities. The group of entities included multi-tiered partnerships, limited liability companies with single-member limited liability companies and S corporations with Q-subs. Consequently, nonresident withholding was a major issue for us and the state tax departments with which returns were filed.

If you or your client operates within a pass-through entity such as a S corporation, partnership or limited liability company, then you know what nonresident withholding is.

In basic terms, nonresident withholding is when a state requires a pass-through entity to withhold state income tax (or make a state tax payment) on a nonresident shareholder's pro rata share of the pass-through entity's income sourced to the specific state. In other words, it is a mechanism for states to better ensure that state tax will be paid by nonresident shareholders.

Now, if you or your client operates within a multi-tiered structure of pass-through entities, then nonresident withholding can become a compliance nightmare for both you and state taxing authorities. Most states have difficulty tracking nonresident withholding when it passes through multiple layers before it gets to the ultimate taxpayer. Therefore, state tax notices upon state tax notices can become an unwelcome, but familiar friend.

With that said, here are a few tips or questions to ask when dealing with nonresident withholding in multi-tiered structures:

1. Does the state require quarterly nonresident withholding on actual payments/distributions or on allocated income? To put it simply, some states only require quarterly nonresident withholding if a cash payment is actually made to a shareholder. If states don't require quarterly nonresident withholding, most, if not all states require annual nonresident withholding on "allocated income" whether a distribution is actually paid or not.
2. Is nonresident withholding required to be done for all nonresident shareholders regardless of the type of shareholder? Meaning, is withholding required for C corp, S corp, partnership, LLCs, individual and/or trust shareholders?
3. Does the state allow or have a mechanism for nonresident shareholders to obtain a waiver or exemption from nonresident withholding? Meaning, can a nonresident shareholder provide the pass-through entity or the state with a document to keep the pass-through entity from withholding on its share of the state's source income?
4. Is the nonresident withholding required to be done on a quarterly basis? Or can it be paid one time a year?
5. In a multi-tiered pass-through entity structure, at what level is nonresident withholding required to be done? Meaning, is the lowest entity required to do the withholding or does the state only require the entity before the ultimate taxpayer to do the withholding? This is a key question, because if it is done at the wrong level, it can cause great confusion and an explosion of notices between the state and the taxpayer.

Some of the top problem states when dealing with nonresident withholding are: California, Colorado, Indiana, and Iowa. Kansas used to be a pain, but withholding is no longer required after July 1, 2014.  These are just a few. As I stated earlier, in a multi-tiered structure, nonresident withholding is a tracking 'nightmare' for both the taxpayer and the state. Obviously, it requires meticulous record keeping to get it right.