Archive for the ‘SALT’ category

Hashing Out the SALT Issues Of Pennsylvania’s Medical Marijuana

January 3, 2018



By: Jennifer Weidler Karpchuk

Pennsylvania recently joined 29 other states and D.C. in legalizing medical marijuana. With the growing acceptance of the use of marijuana for medicinal — and in some states, recreational — purposes, a new industry booms. With that boom comes revenue to the states in the form of new taxes.

As with any tax and policy, it is important to understand the history of how we got to where we are today. But it is particularly important to see what has framed our cultural views of marijuana. Medicinal marijuana has a long history, dating back to ancient cultures that used it as an herbal medicine, starting in Asia around 500 B.C. During the 17th century, the government encouraged production of hemp for rope, sails, and clothing.  Virginia went so far as to pass legislation requiring every farmer to grow hemp. Further, hemp was accepted as legal tender in Maryland, Pennsylvania, and Virginia. Hemp production flourished through the late 19th century, until other materials started to replace it.

During the 1830s, Sir William Brooke O’Shaughnessy found that marijuana helped to lessen stomach pain and vomiting in people with cholera. By the late 19th century it became a popular ingredient in many medicinal products and was sold in pharmacies.  Under the Food and Drug Act of 1906, over-the-counter marijuana products were required to be labeled.

Although legal, recreational use of marijuana did not begin in the United States until around 1900. During the Mexican Revolution, Mexicans began immigrating to the United States and introduced into American culture the recreational use of marijuana. Fear and prejudice followed the Spanish-speaking immigrants, and marijuana became associated with the newcomers. Crimes began to be attributed to marijuana and the Mexicans who used it.

The Great Depression further spurred resentment of the Mexican immigrants and public fear of their “evil weed,” which — combined with the Prohibition era’s view of all intoxicants — led 29 states to outlaw marijuana by 1931. The federal Marijuana Tax Act, enacted during 1937, essentially criminalized marijuana use by restricting possession to individuals who paid an excise tax. This was the first time federal law criminalized marijuana.  The Act, which tried to change behavior through taxation and regulation, was seen as less susceptible to legal challenge than outright prohibition.  The arguments supporting the act were not grounded in any scientific research or evidence. Instead, they were grounded in racism, hearsay, and stereotypes, namely that it caused black men to become violent and seduce white women and that it led Mexicans to murder their white neighbors.  This is also the time when the nomenclature changed from “cannabis” to “marijuana” in an attempt to link Mexicans to the drug and garner prohibition support from anti-immigrant sentiment.

In response to the Marijuana Tax Act, New York’s Mayor Fiorello Henry LaGuardia commissioned a report to study the effects of marijuana. After five years of extensive research, in 1944 the New York Academy of Medicine issued the La Guardia Report, which declared that the use of marijuana did not induce violence, insanity, or sex crimes, or lead to addiction or other drug use.

Despite the research, a culture of fear followed marijuana, spurred in large part by Harry Anslinger, then-commissioner of the Federal Bureau of Narcotics. Anslinger campaigned against marijuana for years and condemned the La Guardia Report as unscientific, while using fear and racism coupled with the mass media to propel his anti-marijuana views.

From 1937 through the 1960s, states began outlawing marijuana, culminating in the federal Controlled Substances Act of 1970. The Act was part of the “War on Drugs” and it repealed the Marijuana Tax Act and listed marijuana as a Schedule I drug — in the company of heroin, LSD, and ecstasy.  Schedule I drugs are those with no medical use and a high potential for abuse.

The Shafer Committee, an investigative body appointed by President Nixon, issued a report in 1972 that admitted that Anslinger’s attacks on marijuana had been baseless, recommended the removal of marijuana from the list of Schedule I drugs, and even questioned its designation as an illicit substance. However, Nixon and other government officials vehemently rejected the report’s findings. Marijuana’s designation as a Schedule I drug was, “more due to Nixon’s animus towards the counterculture with which he associated marijuana than scientific, medical, or legal opinion.”

At the same time, state interest in medical marijuana was emerging. During the 1970s, Oregon, Alaska, and Maine decriminalized marijuana, and New Mexico commissioned a short-lived medical marijuana research program. In 1996 California voters approved Proposition 215 (Compassionate Use Act), the first state legalization of marijuana for medicinal purposes. The use of medicinal marijuana was limited to those with severe or chronic illnesses. Other states followed suit and, to date, 29 states allow the use of marijuana for specified medical purposes, while eight states and Washington, D.C., have legalized marijuana for recreational use.

Research from states that have legalized medical marijuana shows that the average doctor in medical marijuana states prescribes 1,826 fewer doses of painkillers and 265 fewer doses of antidepressants annually. Additionally, states with medical marijuana have a 25 percent lower rate of opioid-related deaths than states that do not.

The Medical Marijuana Act (MMA) of 2016 legalized the use of some forms of medical marijuana in Pennsylvania by patients with specified serious medical conditions. The MMA was championed, through a bipartisan effort, specifically for children with extreme seizure disorders and other medical conditions.

The MMA did not legalize recreational marijuana, only medical marijuana. And it is not even a broad grant of legalization for all forms of medical marijuana for all persons. Instead, Pennsylvania limits the forms of medical marijuana that can be used and limits the types of eligible patients. The leaf and plant forms of marijuana are prohibited, with approved forms limited to pill, oil, and topical forms, vaporization or nebulization, tincture, and liquid. Further, only 17 medical conditions qualify for medical marijuana. Patients with any of these maladies must be certified by a practitioner registered to recommend medical marijuana. Patients must submit that certification to the Department of Health to receive a medical marijuana identification card. Practitioners who wish to certify patients must apply with the Department of Health and complete a four-hour training session.

There is a 5 percent tax on gross receipts from the sale of medical marijuana by a grower/processor to a dispensary. Receipts from the tax will be deposited into a fund that is used to pay for operating costs, financial assistance for those with demonstrated financial hardship, drug and alcohol treatment services, enforcement funding for police departments, and research into how medical marijuana can treat other conditions.  The sale of medical marijuana is not subject to Pennsylvania sales tax. The Department of Health, along with the Department of Revenue, may regulate the price of medical marijuana; if they deem the per-dose price excessive, they may impose a price cap.

Apart from the medical marijuana tax, businesses involved in the sale or disbursement of marijuana, like any other business, may be subject to various Pennsylvania taxes, including gross receipts, personal income, and corporate net income. Further, the new jobs the medicinal marijuana industry create will be a source of revenue from wage and employment taxes.

Applicants must also pay $5,000 per dispensary application and $10,000 per grower/processor application. Business licensees pay registration fees of $30,000 for each dispensary location and $200,000 for growers/processors.

While medical marijuana may be legal in Pennsylvania, from a federal perspective it is still an illegal, Schedule I, drug. The Rohrabacher- Blumenauer Amendment prohibits the U.S. Department of Justice from using federal funds to interfere with state medical marijuana programs or from prosecuting medical marijuana businesses that comply with state laws. However, because marijuana is still illegal under federal law, there are tax consequences. Internal Revenue Code (“IRC”) § 280E prohibits any business that is “trafficking in controlled substances” from taking any business expense deductions that would otherwise be available.

Because Pennsylvania follows federal taxable income, a business is likewise unable to use those deductions for purposes of its state tax liability. Despite the inability to take business expense deductions, a marijuana business must meet its federal, state, and local tax obligations.

There are important caveats to the lack of business expense deductibility. First, pursuant to IRC § 164, taxes paid relating to the disposition of property are a reduction in the amount realized on the disposition. Therefore, medical marijuana tax imposed on producers should allow for a reduction in gross receipts. This is not prohibited by IRC § 280E because the tax is not a deduction or credit. Second, those taxpayers who choose or are required to use the accrual method of accounting may skirt some of the effect of section 280E. Under the accrual method, cost of goods (COG) is an offset to gross revenue, not a deduction. Therefore, it is not prohibited by the language of section 280E. However, the IRS has taken the position that the COG deduction applies only to inventory costs allowable under section 471, which was in effect when section 280E became effective. Again, since Pennsylvania follows federal taxable income, corporate taxpayers in the marijuana industry should be able to benefit from the COG deduction allowed under the accrual method of accounting for Pennsylvania purposes as well.

Individuals and pass-through entities not subject to the corporate net income tax (that is, those taxpayers that do not start with federal taxable income) are permitted to deduct ordinary, reasonable, and necessary business expenses associated with the business activity. However, because no case law exists on the issue, it is unclear what will be viewed as “ordinary, reasonable, and necessary” for the medical marijuana industry for purposes of the deduction.

Third, to the extent a business is doing more than selling or producing medical marijuana, it should be able to deduct that portion of business expenses that are not attributable to the “trafficking of marijuana.” In Californians Helping to Alleviate Medical Problems, a medical marijuana facility bifurcated its business: one in which the facility bought and sold marijuana, and the other in which it provided counseling to customers as to which type of marijuana worked best for their ailments. The tax court allowed the facility deductions attributable to the counseling segment of the business.

Of the states that have legalized and are taxing medical marijuana, as the chart indicates, Pennsylvania’s 5 percent excise tax is not out of line with other states.

State Medical Marijuana Tax Recreational Marijuana Tax
Alaska No tax* Wholesale: $50 per ounce on flower; $15 per ounce for stems/ leaves
Arizona 6.6% state tax + 2-3% optional local tax N/A
Arkansas 4% state tax N/A
California Some medical marijuana sales are tax-exempt Retail: 15% excise tax; Wholesale: $9.25 per ounce of flowers; $2.75 for leaves
Colorado 2.9% sales tax Retail: 15% excise tax; Wholesale: 15% excise tax
Connecticut $3.50 per gram N/A
Delaware No tax* N/A
District of Columbia No tax No retail sales allowed
Florida No tax N/A
Hawaii 4% excise tax; 4.5% tax on Oahu N/A
Illinois 1% pharmaceutical tax Wholesale: 7% tax on cultivators/ dispensaries
Maine No tax Retail: 10% sales tax
Maryland TBD N/A
Massachusetts No tax Retail tax:10.75 %;  State tax: 6.25%; Local municipality tax: 2-3%
Michigan 3% sales tax N/A
Minnesota $3.50 per gram N/A
Montana Tax on gross sales* — 4% from July 1, 2017, to June 30, 2018; 2% after that N/A
Nevada 2% excise tax Retail: 10% excise tax; Wholesale: 15% excise tax
New Hampshire No tax* N/A
New Jersey 7% sales tax N/A
New Mexico No tax N/A
New York 7% excise tax N/A
North Dakota No tax N/A
Ohio TBD N/A
Oregon No tax* Retail: 17% state tax + 3%optional local municipality tax
Pennsylvania 5% excise tax on gross receipts from grower to dispensary N/A
Rhode Island $25 per plant tag for patients and caregivers N/A
Vermont Exempt from sales and use tax N/A
Washington 37% excise tax Retail: 8% sales tax + 37% excise tax
West Virginia No tax Wholesale: 10% excise tax
*State does not have a state sales tax.

It is estimated that annual sales in Pennsylvania will start at $125 million and increase at a rate of 180 percent per year for the first few years, resulting in about $6 million in revenue for the first year. If Pennsylvania were to legalize and tax recreational marijuana, it is estimated that would generate between $200 million and $350 million per year. During 2016 marijuana generated tax revenue of $220 million in Washington, $129 million in Colorado, and $65.4 million in Oregon.

Marijuana is a billion-dollar industry, and with that could come needed revenue for Pennsylvania, which has a projected budget shortfall of nearly $3 billion over 2017-2018. Medical marijuana typically has much lower tax rates than recreational marijuana, generally to avoid affecting the medical marijuana marketplace. Recreational marijuana has been approached in different ways by the states that have legalized its use. For instance, Massachusetts and Washington both levy sales taxes, while Alaska and California use a flat per-unit tax.

Typical sources of “sin” tax revenue are on the decline. Cigarette smoking is waning, resulting in declining state revenue.  Gas prices are also relatively low, meaning that states are unable to tap into traditional areas of easy revenue.  Taxpayers don’t want higher income taxes or higher sales taxes, yet they also do not want to give up services provided by the state. The legalized marijuana industry represents what many view as a solution to revenue shortfalls. And since many view marijuana as a vice, the industry accepts high tax rates as a cost of doing business.

Before state legislatures denounce legalization or impose rigid criteria on the medical marijuana industry, they should make sure that they are not acting out of an antiquated and unsubstantiated fear of marijuana, and instead are basing their actions on scientific research and an understanding of what responsible cultivation and use of marijuana could do for those suffering various maladies.  They should also consider the boost it could give the economy.  As acceptance and increased use of marijuana grows, so too will the SALT world surrounding it as the states try to find the best ways to capitalize on their newest “sin” tax.

South Dakota Files Petition for Writ of Cert with US Supreme Court

October 3, 2017

By: Jennifer Weidler Karpchuk

On October 2, 2017, South Dakota filed a petition for writ of certiorari with the United States Supreme Court, bringing the first facial challenge to Quill Corp. v. North Dakota in front of the Court.

As previously reported, during August the South Dakota Supreme Court held oral arguments wherein South Dakota urged the court to reject its petition, which would allow it to expeditiously file a petition for cert with the US Supreme Court.  The South Dakota Supreme Court abided and quickly affirmed a March 2017 trial court decision granting the remote seller’s motion for summary judgment, holding that the economic nexus law (SB 106) was unconstitutional and directly violated the physical presence requirement of Quill. South Dakota v. Wayfair, Inc. S.D., No. 28160.

The “Kill Quill” movement was spurred in large part by comments made by a concurring Justice Kennedy in Direct Marketing Association v. Brohl, 135 S.Ct. 1124 (2015).  Justice Kennedy criticized Quill stating that:

“The Internet has caused far-reaching systemic and structural changes in the economy, and, indeed, in many other societal dimensions…Today buyers have almost instant access to most retailers via cellphones, tablets and laptops. As a result, a business may be present in a state in a meaningful way without that presence being physical in the traditional sense of the term.  Given these changes to technology and consumer sophistication, it is unwise to delay any longer a reconsideration of the Court’s holding in Quill.  A case questionable even when decided, Quill now harms States to a degree far greater than could have been anticipated earlier.”

Justice Kennedy then invited a challenge to Quill, writing: “the legal system should find an appropriate case for this Court to reexamine Quill.”

Since Justice Kennedy’s opinion, a number of state legislatures passed or considered passing legislation requiring remote vendors to collect sales tax – representing overt challenges to QuillSee, e.g., Alabama and Tennessee).  South Dakota’s law is now the first to make it in front of the US Supreme Court for review.  This case will be closely watched by the SALT community to see if it is the “appropriate case” for the Court to revisit Quill.

Oral Arguments Heard in South Dakota’s Challenge to Quill

August 31, 2017

By: Jennifer Weidler Karpchuk

On August 29, oral arguments were held in South Dakota v. Wayfair, Inc. S.D., No. 28160, which challenges the state’s remote sales tax legislation, S.B. 106. 

Enacted during March 2016, S.B. 106 requires remote sellers to collect and remit tax to the state – even if they have no physical presence in the state – if they have more than $100,000 in sales or make more than 200 separate sales into South Dakota annually. The Bill was specifically crafted as a vehicle to undo the U.S. Supreme Court’s ruling in Quill Corp. v. North Dakota, 504 U.S. 298 (1992), which prohibits states from imposing sales and use tax collection obligations on sellers who do not have a physical presence in the state. The lower court found in favor of the taxpayers, holding that the law was unconstitutional pursuant to Quill, and the State quickly appealed to the South Dakota Supreme Court.

During oral arguments at the South Dakota Supreme Court, the State asked the court for an expeditious denial of its appeal so that it can file a writ of certiorari with the U.S. Supreme Court.  Additionally, the State requested that the court provide “a critical and important voice” urging the U.S. Supreme Court to grant cert.

Counsel for the taxpayers explained that the purposeful drafting of an unconstitutional bill in order to challenge a long-standing U.S. Supreme Court decision was unconventional and controversial. Counsel questioned whether purposefully enacting unconstitutional legislation creates bad precedent/practice.

Further, counsel for the taxpayers argued that Congress has the power to regulate interstate commerce and that Congress should decide the fate of state sales tax collection. Currently, there are four different bills pending before Congress seeking to deal with this issue, one of which we previously discussed here.

Counsel for the taxpayers also claimed that important facts were not developed and included in the record at the lower court – such as, what the projected lost revenue is to the State. Counsel for the taxpayers concluded by asking that the decision be affirmed as unconstitutional, without the court weighing in on complex policy issues.

Once the South Dakota Supreme Court issues its opinion, the parties will have 90 day to petition the U.S. Supreme Court for cert.

A Federal-Level Attempt to Codify the “Physical Presence” Nexus Standard From Quill

June 15, 2017

By Adam Koelsch

On June 12, 2017, The Honorable James Sensenbrenner (R. WI 5th District) introduced into the U.S. House of Representatives a bill, designated H.R. 2887, which would codify the nexus standard set forth by the U.S. Supreme Court in Quill Corp. v. North Dakota, 504 U.S. 298 (1992).

The bill is set against the backdrop of multiple recent attempts by the states to persuade the Supreme Court to take a case that would revisit and overturn Quill.  Quill held that the dormant Commerce Clause of the U.S. Constitution prohibits a state (or local taxing authority) from imposing upon a retailer an obligation to collect and remit sales tax from its sales to customers within that state if the retailer does not have a “physical presence” in that state.

Various state court decisions have interpreted Quill to limit the physical presence standard to sales taxes only.  With respect to other taxes, those courts adopted a more expansive “economic presence” standard, that is, broadly speaking, a standard by which a court attempts to determine whether a person exploited the state’s market, received protection from the state, and/or derived some benefit from the state, thereby subjecting the person to tax.

H.R. 2887, however, would prohibit a state from taxing, or regulating, a person’s activity in interstate commerce unless the person is “physically present in the State during the period in which the tax or regulation is imposed.”  H.R. 2887 § 2(a).  Essentially, the bill would roll-back the state court economic nexus decisions and require application of Quill to all tax types.

The bill defines “physical presence” as:  (A) maintaining a commercial or legal domicile in the state; (B) owning, holding a leasehold interest in, or maintaining real property such as an office, retail store, warehouse, distribution center, manufacturing operation, or assembly facility in the state; (C) leasing or owning tangible personal property (other than computer software) of more than de minimis value; (D) having one or more employees, agents, or independent contractors present in the State who provide on-site design, installation, or repair services on behalf of the remote seller; (E) having one or more employees, exclusive agents or exclusive independent contractors present in the state who engage in activities that substantially assist the person to establish or maintain a market in the State; or (F) regularly employing in the State three or more employees for any purpose.  H.R. 2887 § 2(b)(1).

Owning real property in a state has been traditionally recognized as providing sufficient nexus to subject a person to tax.  In addition, practitioners familiar with nexus issues will recognize elements taken from Supreme Court case law interpreting the Quill standard, such as the affirmation in subsection (D) that the presence of a single employee (Standard Press Steel Company v. State of Washington, 419 U.S. 560 [1975]) or an independent contractor (Scripto Inc. v. Carson, 362 U.S. 207 [1960]) is sufficient to subject a person to tax.

But parts of the physical presence standard set forth by the bill are more novel.  Subsection (C) of the above definition would likely have significant impact upon the debate regarding the taxability of computer software, which some states have considered tangible personal property, even when transmitted entirely over the internet.  Indeed, the manner by which courts interpret the term “tangible personal property” in subsection (C) will bear upon the question of whether states will be permitted to tax items such as streaming videos and music, when the taxpayer has no other presence in the state.  Moreover, Courts might interpret subsection (F) to expand the ability of states to claim that an out-of-state business entity has established nexus in the state by allowing any three of its employees to work from their homes in that state, although the allowance was made solely for the employees’ convenience, and although the business otherwise does not have any operations in the state.

The bill also sets forth a definition of “de minimis physical presence,” which includes: (a) entering into an agreement under which a person, for a commission or other consideration, directly or indirectly refers potential purchasers to a person outside the State, whether by an Internet-based link or platform, Internet Web site or otherwise; (b) any presence in a State for less than 15 days in a taxable year (or a greater number of days if provided by State law); (c) product placement, setup, or other services offered in connection with delivery of products by an interstate or in-State carrier or other service provider; (d) internet advertising services provided by in-State residents which are not exclusively directed towards, or do not solicit exclusively, in-State customers; (e) ownership by a person outside of the State of an interest in a limited liability company or similar entity organized or with a physical presence in the State; (f) the furnishing of information to customers or affiliate in such State, or the coverage of events or other gathering of information in such State by such person, or his representative, which information is used or disseminated from a point outside the State; or (g) business activities directed relating to such person’s potential or actual purchase of goods or services within the State if the final decision to purchase is made outside the State.  H.R. 2887 § 2(b)(2).

Finally, the bill also provides that “[a] State may not impose or assess a sales, use, or similar tax on a person or impose an obligation to collect or report any information with respect thereto, unless such person is either a purchaser or a seller having a physical presence in the State.”  H.R. 2887 § 2(c).

That provision that would eliminate remote seller sales and use tax reporting requirements recently enacted by a number of states, most notably, in Colorado.  See Colo. Rev. Stat. § 39-21-112 (3.5).

Furthermore — because that provision provides that a sales and use tax may not be imposed upon anyone who is not a “seller,” and because the term “seller” specifically excludes “marketplace providers” and “referrers,” as defined elsewhere in the bill (H.R. 2887 § 4[a][1], [5], [7][A], [B]) — that provision would prohibit state measures such as Minnesota H.F. 1, which was passed on May 30, 2017, that impose sales tax and use tax collection requirements upon marketplace providers, e.g., eBay and Amazon.

Interestingly, the bill provides that the federal courts will now have jurisdiction to hear civil actions filed to enforce the provisions of the bill.  H.R. 2887 § 3.  Currently, lawsuits involving state taxes are largely absent from the federal system as a result of the Tax Injunction Act, which provides that “district courts shall not enjoin, suspend or restrain the assessment, levy or collection of any tax under State law where a plain, speedy and efficient remedy may be had in the courts of such State.”  28 U.S.C. § 1341.  H.R. 2887, however, allows any taxpayer challenging a state tax based upon nexus may bring suit in federal court.  Obviously, this new “federal option” would change the dynamic of SALT litigation involving nexus questions.

In short, the bill, if passed, would make dramatic changes to State and Local Tax law and litigation landscape.

Don’t Delay – Pennsylvania’s 2017 Tax Amnesty Program Starts Today

April 21, 2017

By Jennifer Weidler Karpchuk

As of today, April 21, 2017, Pennsylvania’s 2017 Tax Amnesty Program has officially commenced.  Those individuals with potential Pennsylvania tax liabilities should consider taking advantage of the program, which is slated to run through June 19, 2017.  During those sixty (60) days, the Pennsylvania Department of Revenue will waive all penalties and half of the interest for anyone who participates.  For more information, see our previous blog post hereContact us to find out if amnesty is the right choice for you.

Update on Supreme Court Retroactivity Litigation

April 6, 2017

By Adam Koelsch

As previously reported on the SALT Blawg, Chamberlain Hrdlicka attorneys Stewart M. Weintraub and Adam M. Koelsch, together with Peter L. Faber of McDermott, of Will & Emery LLP, filed in the U.S. Supreme Court an amicus brief on behalf of the American College of Tax Counsel in support of the petitioners challenging a retroactive repeal of tax legislation by the state of Michigan.  Although the petitioners and the amici had asserted various reasons for granting certiorari, the most prominent of those assertions was that the repeal, stretching seven years into the past, violates the Due Process Clause of the U.S. Constitution.

Subsequent to those submissions, the Supreme Court removed from its conference calendar the petition submitted in another pending retroactive tax legislation case from Washington state (Dot Foods, Inc. v. State of Washington), presumably to consider it jointly with the Michigan cases at a later date, and also ordered Michigan to submit a response to the petitions filed — moves widely seen as signaling that the Court is interested in addressing Due Process issue.

Michigan has since submitted its response, setting forth a novel basis for denying cert.:  that the 2014 legislation challenged by the petitioners — which repealed retroactive to 2008 a statute authorizing a three-factor apportionment election that had existed since 1970 — was a “legislative clarification” of a 2008 Business Tax statute that had supposedly mandated single-factor apportionment for all prospective years, and was therefore not retroactive at all.  Thus, according to Michigan, application of that principle of state statutory-construction law constitutes an adequate and independent state law ground to uphold the decision of the Michigan state court, thereby depriving the Supreme Court of jurisdiction to review the issue.

Not so, replied the petitioners.  IBM and Skadden Arps submitted reply briefs on March 24 and 27, respectively.  IBM’s brief challenged the assertion that the doctrine of “legislative clarification” in fact exists, and asserted that the any new law that applies to activities (or tax years) in the past is, by definition, retroactive.  Skadden Arps, in its brief, added that the Michigan Court of Appeals had never mentioned the doctrine in its decision, while explicitly acknowledging the statute’s retroactive effect, and that, in any event, “the Supremacy Clause does not allow federal retroactivity doctrine to be supplanted by the invocation of a contrary approach to retroactivity under state law.”  On March 28, a brief filed on behalf of Goodyear Tire, Deluxe Financial Services, and Monster Beverage reiterated the arguments of IBM and Skadden Arps.

The briefs for the Michigan petitioners and for the petitioners in Dot Foods will all be considered during the Court’s conference on April 13, and the Court’s decisions could be announced as early as April 17.

Here, you can find copies of:  the Michigan response briefthe IBM reply briefthe Skadden Arps reply brief, and the Goodyear et al. reply brief.

Recent Developments Regarding the “Throw Out Rule” by the New Jersey Tax Court and the Multistate Tax Commission

February 20, 2017

By Adam Koelsch

Recently, in Elan Pharm. v. Division of Taxation, the Tax Court of New Jersey issued a non-binding opinion that further limits the Division of Taxation’s enforcement of the controversial “throw out rule.”

Sometimes, when a multi-state taxpayer apportions its income, that taxpayer will source a receipt to a state in which the receipt is not subject to tax, either because the state has chosen not to tax it or because the state is not able to do so. One reason that a receipt may not be taxable, and a reason at issue in Elan Pharm., is P.L. 86-272 — a federal law that prohibits a state from taxing a business whose activities in that state are limited to the sale and/or the solicitation of sales of tangible personal property shipped from another state. This type of income sourcing creates “nowhere income,” that is, income that is not taxed by any jurisdiction.

In order to combat this, some states have employed a tactic known as a “throw out rule.” Under the rule, non-taxed receipts are ignored in calculating the state’s share of total receipts by subtracting the non-tax receipts from the apportionment denominator. As the Tax Court noted, “[b]y throwing out receipts from the denominator, the sales fraction always increases, causing the apportionment formula and the taxpayer’s resultant CBT [Corporation Business Tax] liability to New Jersey to increase.” The New Jersey throw out rule (former N.J. Stat. Ann. § 54:10A-6[B]), which was repealed by legislation in late 2008, continues to be enforced by the Division for the tax periods between January 1, 2002 and June 30, 2010.

Previously, in Whirlpool Properties, Inc. v. Director, Division of Taxation, 26 A.3d 446 (N.J. 2011), the New Jersey Supreme Court had held that, under the fair apportionment prong of the U.S. Supreme Court’s Complete Auto Transit test, application of the throw out rule to receipts sourced to states that simply choose not to impose a tax (as opposed to being unable constitutionally to impose a tax) is unconstitutional.

Recently, on February 7, 2017, the Multistate Tax Commission, in a staff comment regarding the operation of a proposed throw out rule in its Model Regulations, has suggested that the rule should apply only when a state cannot impose an income-based tax under the constitution or P.L. 86-272, and should not consider whether the state actually chooses to impose a tax.

In Elan Pharm., the taxpayer had filed income tax returns in six states, including New Jersey, for 2002. The taxpayer had received receipts from forty-four states in which it had claimed it was not taxable because the state lacked jurisdiction under P.L. 86-272. The taxpayer had property in thirty-nine states and payroll in forty-eight states. Nevertheless, the Division had included in the apportionment denominator only those receipts from the six states in which the taxpayer had filed, excluding the remainder of the receipts under the throw out rule.

The Tax Court, however, disagreed with the Division’s application of the rule. The Tax Court noted that several states in which the taxpayer conducted business (not just the six in which it had filed) had “throwback rules” — that is, a rule by which sales receipts are reassigned to the state from which goods are shipped when the purchaser’s state cannot impose an income or franchise under the constitution or P.L. 86-272. Thus, because certain receipts captured under the throwback rule could have been taxed by the shipping states, those receipts could not be excluded by application of the throw out rule by New Jersey.

In addition, the Court found that the presence of taxpayer’s property and/or payroll in many of the states from which excluded receipts had been sourced created sufficient nexus to render the receipts taxable in those states despite P.L. 86-272, and therefore could not be excluded using the throw out rule.

Despite its repeal, the throw out rule remains a subject of controversy which will continue to impact businesses operating in New Jersey. Indeed, understanding application of the rule is especially important to business entities that had never previously filed CBT returns in New Jersey — and therefore cannot benefit from the statute of limitations for the years that the rule was effective — because of their mistaken belief that their activities were insufficient to create nexus.

The New Jersey Tax Court opinion can be found here