Posted tagged ‘software’

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.

Weekly SALT News Update

October 11, 2011

State DOR Letters and Administrative Rulings

The Tennessee Department of Revenue rules that software configuration services are not subject to sales tax. The industrial equipment exemption does not apply as to sales tax in connection with the sale of compressed air with compressors on site. The assembly of leased equipment is subject to sales tax as services necessary to complete a sale.

In a shift, the Indiana Department of Revenue issues a statement that it will no longer impose sales tax on digital goods unless specific circumstances exist, citing the Streamlined Sales and Use Tax Agreement.

The Louisiana Department of Revenue issues guidance on the new exemption from sales tax for breastfeeding equipment.

The Missouri Administrative Hearing Commission upholds a retaliatory insurance tax against a Kansas insurance company.
The Montana Revenue Tax Appeal Board rules on property tax assessments based on comparables, and lays out how not to fight a property tax dispute.

New Jersey issues guidance on the sales tax treatment of manufacturer and seller coupons. It states that the coupons should be treated “like cash” since the seller gets the coupon value from the manufacturer. Thus sales tax is charged on the face value of the coupon. However, coupons issued by sellers are treated as discounts, and not as cash. Sales tax is imposed on the discounted value of the sale. Note that the sales tax treatment for coupons varies from state to state. For example, the Texas Comptroller seems to treat Groupon discounts as cash , while other coupons are reductions in price for sales tax. See also New York’s policy here.

The Kansas Department of Revenue clarifies that layaway charges are not subject to sales tax.

 

State Regulations and Public Notices

Arkansas and Kentucky revise their taxability matrix for the streamlined sales and use tax agreement.

The California Franchise Tax Board lays out the state franchise tax treatment of series LLCs. While California law does not provide for series limited liability companies, it does accommodate them for tax purposes.

The Mississippi Attorney General opines that property manufactured in Mississippi does not qualify for the free port warehouse exemption as it goes beyond the purpose of the exemption and does not comply with a strict reading of the statute.

 

State Legislative Affairs

None noted.


Judicial and Administrative Decisions

New York Tax Appeals Tribunal rules that a taxpayer must consolidate its returns. Presumption for consolidation when wholly owned and combined group engages in unitary business. Ernst & Young LLP was engaged to provide multistate tax planning ideas and strategies. No business purpose as transactions entered into had no potential for profit and unnecessary for credit and collection functions. E&Y report showing met Section 482 principles irrelevant as no proof that transaction “merits tax respect.”

The 9th Circuit rules in Confederated Tribes and Bands of the Yakama Indian Nation that a state requirement imposed by Washington for tribal members to collect sales tax does not violate the U.S. treaty with the tribe. The requirement imparts a minimal interference into the business of the tribe, and is constitutional.

The United States Supreme Court denied petition to both the KFC and the Lamtec cases. The two cases used an expansive interpretation of nexus to that has been hotly contested. The Court, without comment, declined the opportunity to clarify Quill.

The Maryland Court of Appeals in Timothy A. Frey, et al v. Comptroller holds that the nonresident tax on in-state income is constitutional. It is a compensatory tax, and should be upheld pursuant to Oregon Waste Systems, Inc. v. Department of Environmental Quality,511 U.S. 93 (1994).

The Commonwealth Court of Pennsylvania in Kurbatov v. Department of Labor elevated its decision to a published ruling, laying out the line on whether a person is an employee or an independent contractor.

 

Other Documents

Rutgers issues a study showing New Jersey lost up to $171 million in sales and use tax as a result of uncaptured Internet sales.

The Texas Taxpayers and Research Association sides with the Texas Comptroller and the Attorney General in the Allcat case, opining that the Texas franchise tax cannot be viewed as a net income tax, but is a tax on an entity not the natural partner. TTARA also pointed to the U.S. Bureau of the Census as declaring the Texas franchise tax to be a fee for doing business, and not a net income tax. The Texas Attorney General filed its brief on the merits. A detailed analysis is here.

Weekly SALT News Update

October 3, 2011

State DOR Letters and Administrative Rulings

The Indiana Department of Revenue provided guidance on what constitutes tangible personal property. That guidance includes the specific view that electricity is tangible personal property. It also discusses the taxation of intangibles in the state. It also ruled that medical devices are not exempt if there is not a prescription. So a sale of a medical device to a doctor or a hospital is not exempt as a device being prescribed. It may qualify for the sale for resale exemption, as the doctor resells the device to a patient, but the requirements to claim a sale for resale exemption must be followed.

The Connecticut Department of Revenue offered guidance on new sales tax changes for the sale of vehicles and extended warranties as a result of 2011 legislation. New taxable services include motor vehicle towing and road services, and motor vehicle storage services.

The Maine Department of Revenue revised guidance regarding warranty agreements, service contracts, and maintenance agreements.

Tennessee’s Department of Revenue ruled that an out-of state provider of telecommunication services is not subject to sales tax, but that the services are taxed where the services are actually performed. In another ruling, it found that a person who delivers rented tangible personal property to provide services must charges sales tax on those delivery charges. And over the counter sales of fuel are not exempt from sales tax, strictly construing the exemption for sales of fuel for residential use against the taxpayer. Last, software configuration services are not subject to sales tax.

 

State Regulations and Public Notices

Prior to the publication of Indiana Commissioner’s Directive #41, Indiana Department of Revenue imposed sales and use tax on products transferred electronically based on whether the products were taxable in their tangible forms. Citing compliance with the Streamlined Sales and Use Tax Agreement, the Department will impose sales and use tax on products transferred electronically only if the products meet the definition of specified digital products, prewritten computer software, or telecommunication services.

 

State Legislative Affairs

The bill in Michigan to institute a New York style Amazon tax has been introduced and numbered.

California adds olive trees to those items taxed at the 1% gross sales tax rate for deciduous pome and stone fruit trees, nut trees, and grapevines.

Massachusetts Senate pushed forward S.2015 that would authorize casinos and one slot parlors in the state. It levies a 25 percent gross gaming revenue tax, and a 40 percent daily tax on gross gaming revenue from a single slot parlor.

The National Conference of State Legislatures met in San Antonio, and reportedly ended with the Multistate Tax Commission (“MTC”) and Chainbridge Software, LLC playing defense. The MTC came under attack for not being quite up front and public in the decision making process, while Chainbridge was attacked for using unreliable data to calculate potential audit candidates for government authorities.

 

Judicial and Administrative Decisions

Texas Third Court of Appeals hears oral argument of DTWC Corp. v. Combs. The case involves a potential expansion of the sale for resale exemption to include any transfer of tangible personal property in connection with services, regardless of whether the services have been subject to sales tax. Also, potentially it loosens the requirement of consideration to be paid with a sale for resale. Oral argument appeared to go better for the taxpayer, the appellant, than the Texas Attorney General.

In Ivory Homes, Ltd. v. Utah State Tax Comm’n, No. 20090679, (Utah 2011), the Utah Supreme Court ruled against the taxpayer’s argument that charges for shipping that were not separately stated should be excluded from the imposition of sales tax. Utah does not impose sales tax on shipping charges so long as they are separately stated. Because there was no written evidence of an intent by the parties to separately charge sales tax, and the amount charged was presented as one amount (including shipping), sales tax was appropriate on the entire amount.

New York Tax Appeals Tribunal required a company to file a consolidated return with wholly-owned subsidiaries as taxpayer failed to rebut the presumption of distortion under 20 NYCRR 6-2-3.

The Ninth Circuit, in Confederated Tribes and Bands of the Yakama Indian Nation v. Gregoire, Dkt. No. 10-35776 (9th Cir. Sept. 23, 2011), ruled in favor of the State of Washington, finding that the requirement for retailers of an Indian tribe to collect tax was not a tax imposed on the tribe, but a pass through tax. Further, collection of the tax is a minimal burden imposed on the tribe and permitted pursuant to Washington v. Confederated Tribes of the Colville Indian Reservation, 447 U.S. 134 (1980).

 

Other News

Good article regarding the current status of the Amazon legislation across the country, including Amazon’s current “play nice” strategy with California.

Study by Rutgers University for the New Jersey Retail Merchants Association shows New Jersey lost between $52 million and $171 million due to non-payment by New Jersey residents of sales use taxes on Internet purchases.

Weekly SALT News Update

September 21, 2011

State DOR Letters and Rulings

Florida ruled that when a cleaning service provider uses cleaning supplies to perform the cleaning services, sales and use tax is due on those supplies. However, to the extent those supplies are not used, but sold to a customer for their use, the transaction is exempt as a sale for resale.

The Texas Comptroller ruled that a series LLC would be treated as a single entity for Texas franchise tax purposes. The entity cannot be broken up into separate parts, but must file as one.

Alabama ruled that winter park provided amusement services subject to sales tax. The amusement services included hay rides, Christmas plays, and Christmas displays.

The Illinois Department of Revenue published a letter on the sales tax treatment of software maintenance agreements. It is a fairly aggressive position, with any transfer of “patch” code constituting a taxable transfer.

 

State Regulations and Public Notices

Both Georgia and West Virginia filed updated Section 328 taxability matrices for their respective states. Under the Streamlined Sales and Use Tax Agreement (SSUTA), each state must maintain a taxability matrix that defines the manner in which that state treats all defined items. It must make them available to the public.

New Jersey released guidance on sales tax imposed for investigation and security services that are sourced to that state. It opined that the taxable base is quite expansive, and should include the actual costs to perform the service, any materials or labor used, including interest, taxes paid, and any other expense. Reimbursable expenses such as meals and mileage must also be included.

Rhode Island issued a public notice of the revised regulation for the taxation of software, whether in electronic form or on physical media. A source at the Division of Taxation has advised that the proposed regulation has received little comment, and is not expected to change. The effective date for the taxation of prewritten software delivered electronically by download or other electronic means is effective October 1, 2011. The regulation also addresses the taxation of maintenance for prewritten software.

Indiana issued guidance on the taxation of drop shipments. It opined that generally the drop shipment, if properly followed, would not be subject to sales tax based on the sale for resale exemption. The purchaser requesting the drop shipment must present the prescribed Form ST-105.

 

State Legislative Affairs

Maryland’s legislative services staff presented the argument that a gross receipts tax would benefit the state and increase tax revenues. It used a Power Point presentation to make the sale.

At the federal level in an issue directly impacting the several states, unions are applying political pressure for legislators to vote “no” on HR 1439. HR 1439, known as the “Business Activity Tax Simplification Act,” would regulate the state taxation of interstate commerce and deal with the nexus issues being raised at the state level, employing the Joyce approach as opposed to the Finnigan approach. As an aside, Texas uses the Joyce approach for its franchise tax. The Congressional Budget Office has estimated that the act would “cost” the states $2 billion. The Multistate Tax Commission echos the concern of the cost to the states, and passage seems highly unlikely.


Judicial and Administrative Decisions

The Louisiana Court of Appeals for the First Circuit has ruled in favor of the taxpayers, Utelcom Inc. and UCOM, Inc., and reversed the trial court’s decision. The taxpayers owned limited partnership interests in three Delaware limited partnerships that were Sprint affiliates. They had not commercial domicile in Louisiana, and but for these limited partnership interests they had no connection with Louisiana. The taxpayers argued that Louisiana’s assessment of franchise tax against them violated the privileges, immunities, and protections afforded them by the Commerce Clause of the United States Constitution and the Due Process and Equal Protection Clauses of the United States and Louisiana Constitutions. Louisiana argued that “unity of purpose” caused the actions of related Sprint entities to create nexus with taxpayers. The Court found that there was no statutory basis for this proposed incident of taxation, that the entities were all separate juridical entities, and there was no “Louisiana codal, statutory, or jurisprudential authority” to attribute the actions of one Sprint entity against the other.

Louisiana also argued that the actions of the general partner of US Telecom acting as the general partner for Sprint Communications LP should be attributed to the taxpayers as some form of agent for the taxpayers. The Court found that the general partner has the authority to bind Sprint Communications LP, but it lacks the authority to act as the agent for the taxpayers.

Louisiana pointed to a regulation that allows taxation where a person conducts business in Louisiana through a partnership, joint venture, or otherwise. However, the Court pointed to the fact that the statute limits this to corporations, and that the Department of Revenues attempt to expand the taxing statute beyond the scope set by the legislature must fail. Though determining that the franchise tax would not extend to the taxpayers by statute, the Court, nonetheless, addressed the argument in Secretary, Dep’t of Revenue, State of La. v. Gap (Apparel), Inc., 886 So.2d 459 (La.App. 2004) (finding that a company’s receipt of royalties from the use of its intangible property in Louisiana). Because the property being used was not owned by the taxpayers, Gap did not apply.

Weekly SALT News Update

August 22, 2011

Tax Foundation Report Opines Texas Margin Tax Not a Model Act

A recent Tax Foundation report concludes that the Texas margin tax – untried when enacted in 2006 – collected less revenue than expected, caused significant confusion and compliance costs, resulted in litigation and controversy, and should not be tried in other states.

Tennessee and New York Opine Electronic Goods Not Subject to Sales Tax

Tennessee provided a written opinion that paper shop drawings would be subject to sales tax, but not a digital (paperless) version of the same. New York authorities similarly concluded that the sale of an electronic PDF would not be subject to sales tax, while a printed version of the PDF would be.

New Jersey Issues Apportionment Guidance

In the wake of the new apportionment guidelines set forth by the New Jersey Legislature, New Jersey authorities have outlined the manner for the phase-in of the single factor formula in replacement of the three-factor allocation formula for the Corporation Business Tax. For privilege periods beginning on or after January 1, 2012 but before January 1, 2013, the sales fraction will account for 70% of the allocation, and the property and payroll fractions will each account for 15% of the allocation. The following year will be 90% sales, and the next will be 100% sales fraction.

Louisiana Appeals Court Finds Sale of BP Refinery in Normal Course of Business

BP prevailed in its motion for partial summary judgment, arguing that its sale of a refinery in Louisiana should be classified as apportionable income, taxed proportionate to all the states in which BP does business, as opposed to allocable income and thus taxed only by Louisiana. Because BP was able to show that it regularly sold refineries, the Louisiana appeals court found that such sale was deemed to be part of its regular course of business, and thus the income to be taxed proportionate to its income in all states in which it does business.

Virginia Opines In-state Employees Do Not Constitute Nexus If No In-state Projects

Virginia tax authorities have opined that because the only link between an out-of-state company and Virginia was the presence of two employees who lived in Virginia but did not work on any in-state projects, there was not a sufficient contact to constitute nexus for income tax purposes.

Texas Comptroller Rules Any Filed Method Can Be Used for New Group

Previously, when a Texas Comptroller auditor determined that separate companies needed to amend their filings to report as one consolidated group, the auditor would insist that the only proper methodology would be that methodology used by the reporting entity. The Texas Comptroller has reversed this practice, and opined that the resulting entity can file using any methodology that had been previously filed by the combined entities.

Texas Comptroller Reverses on Software License As Tangible Personal Property

Previously, the Texas Comptroller had issued audits in which it would not treat a license of software as a sale of tangible personal property. As a result, taxpayers who licensed software could not receive the full benefit of the cost of goods sold methodology. This decision has been reversed, and the Texas Comptroller now agrees with taxpayers that the license of software does constitute a sale of tangible personal property for franchise tax purposes.