The Georgetown University Law Center held its 35th annual Advanced State and Local Tax Institute on August 6 and 7, 2012. The program included sessions dealing with a wide variety of state tax topics, including alternative apportionment formulas, combined reporting, sales and use, and property taxes.
Alternative Apportionment Formulas
The request for alternative apportionment relief under UDIPTA Sec. 18 was discussed in a number of sessions at the conference. Section 18 provides an alternative apportionment method that offers relief when the application of the standard apportionment formula provides arbitrary and unreasonable results. However, there are a number of hurdles a taxpayer or tax administrator must overcome in order to invoke this type of relief. Marc. A. Simonetti of Sutherland Asbill & Brennan LLP noted that courts have generally held that the party seeking alternative apportionment bears the burden of proof in showing first that distortion exists and then that an alternative method proposed by the moving party is reasonable. However, Simonetti also cautioned practitioners that the burdens of proof vary greatly depending on the jurisdiction. Distortion and a reasonable alternative may be required to be demonstrated by “clear and convincing evidence,” “a preponderance of the evidence,” “clear and cogent evidence,” or “prima facie evidence.” Therefore, while alternative apportionment relief may be available, the moving party must understand the burdens of proof in order to succeed.
There was also a discussion of the recently decided Gillette case (The Gillette Company et al. v. Franchise Tax Board, Court of Appeal of California, First District, No. A130803, July 24, 2012), which held that California’s adoption of a double-weighted sales factor apportionment formula to apportion its taxable income for corporation franchise and income tax purposes did not override the Multistate Tax Compact’s (Compact) provision adopted by California that provides multistate taxpayers an option to utilize either the Compact’s equally-weighted three factor formula to apportion and allocate income for state income tax purposes or a signatory state’s alternative apportionment formula.
In response to this decision, California’s participation in the Compact has been withdrawn, thereby prospectively repealing the three-factor formula election for California corporation franchise and income tax purposes. Donald M. Griswold of Reed Smith LLP commented that California’s withdrawal from the Compact “is one of those watershed moments.” Griswold also remarked that seeking alternative apportionment as the taxpayer did in Gillette “is the next big wave of full employment for us.”
Shirley Sicilian of the MTC noted in a later session that California’s decision to withdraw from the Compact was made before it had a final decision by the highest court in the state and that the decision to withdraw may have been driven by factors unique to California. She urged states to “(1) win the case, (2) consider repeal or amendment of the Compact, or (3) consider allowing the election.”
Most significantly the session on combined reporting focused on the District of Columbia’s combined reporting requirements. Aaishah Hashmi from the District’s Office of Tax and Revenue discussed the promulgation of the highly anticipated combined reporting regulations. Hashmi stated that the finalized regulations “will be released imminently.” Practitioners in the audience voiced concerns that the finalized regulations have not yet been made available because the extended due date for first returns under the new combined reporting regime is September 15, 2012. Hashmi assured the audience that there will not be any “significant departure” from the proposed regulations released for practitioner comment earlier this year. She indicated that the Office of Tax and Revenue has merely filled in gaps in the regulations that were identified by practitioners during the comment period. However, if the regulations require a substantive change, they must be reproposed with an additional seven-day comment period.
Hashmi also stated that the District’s combined reporting requirements were based largely on the MTC model, which was also the basis for West Virginia’s regime. However, there are some provisions that are unique to the District. Specifically, the revenue test for Qualified High Technology Companies must be determined on a separate-company basis. Also, the FAS 109 deduction currently has an unlimited carryforward period; this is in contrast to the Massachusetts deduction, which only allows the taxpayer to carry forward the deduction for a seven-year period. Hashmi indicated that the unlimited carryforward period may be changed statutorily because the deduction as it stands would have a significant negative impact on the anticipated revenue benefit to the District.
Sales and Use Tax Issues
There were also a number of sessions dealing with sales tax issues. Fred Nicely, Senior Tax Counsel at COST, led a discussion of current developments in the sales and use tax area with Carolynn Iafrate Kranz, founder and Managing Member of Industry Sales Tax Solutions, and Jeremiah Lynch, Principal in Charge at Ryan. The group kicked off the session with a conversation about sales tax trends, such as limitations on exemptions, expansion of the base (e.g., tax on digital products, sin taxes on candy and soda, bag taxes), rate increases, Internet coupons (e.g., Groupon, Living Social, Daily Deals), and banning zappers. In the nexus area, the panel noted that states are continuing to follow New York’s lead on click-through nexus, pointing specifically to Pennsylvania’s adoption of the concept in an administrative bulletin (rather than through legislation). The experts also discussed class action suits alleging that sales tax was improperly collected and proposed federal legislation (Main Street Fairness Act, Marketplace Equity Act of 2011, and Market Place Fairness Act – Nicely indicated that the Market Place Fairness Act has the best chance of passing). The Streamlined Sales Tax Project, amnesty programs, and various cases of interest were also discussed.
A session addressed cloud computing, which has caused many headaches for sales tax practitioners and administrators. Before trying to determine the taxability of cloud computing transactions, one must be able to define cloud computing, which, for most people, is a difficult task. Reid Okimoto, Senior Manager in the state and local tax practice of KPMG, described the five elements that must be present in order for software to be classified as cloud computing: (1) broad network access (available on any device); (2) metered use (pay for what is used); (3) resource pooling (virtualization); (4) rapid elasticity (can upgrade or downsize when needed); and (5) on-demand self-service (can self-procure without help from IT). Without all five elements, cloud computing does not exist (despite what marketers might say). After defining cloud computing, Okimoto and Faranak Naghavi, Ernst & Young’s National Director of Sales and Use Tax Services, delved into other sales tax issues involving cloud computing, such as the relationship between IaaS, PaaS, and SaaS; private clouds v. public clouds; nexus; the taxability of a cloud product or service; and sourcing (e.g., deciding where the customer is located). Okimoto and Naghavi also touched upon certain income tax issues, such as nexus (e.g., Okimoto predicted that P.L. 86-272 will not protect cloud computing transactions from the finding of nexus), apportionment (e.g., where is property located for property factor purposes), and credits/incentives (e.g., some require creation or manufacture of a “good” ).
As noted by Francina Dlouhy, Practice Leader of Faegre Baker Daniels’ Tax Advocacy Group, there has also been a “substantial uptick” in the use of certain income tax “equitable doctrines” in the sales tax (and other non-income tax) area. In fact, according to Dlouhy, courts are raising the business purpose, economic substance, step transaction, sham transaction, and substance over form doctrines in non-income tax cases even when practitioners are not. In a session covering the expanded use of these doctrines, Dlouhy and Kathleen King Parker, a partner in the Boston office of Pierce Atwood, examined a number of significant sales tax (and other non-income tax) cases where the doctrines were applied.
Expanding Property Tax Base to Include Intangibles
There is a trend in the income and sales tax areas towards greater taxation of intangibles. According to Stephanie Anne Lipinski Galland, who led the lone session devoted to a property tax issue, imposing property taxes on intangibles is “probably the next step in the progression.” During the session, Erica Horn, counsel to Stoll Keenon Ogden in Lexington, Kentucky, examined the various definitions of “intangibles” and noted that, for many businesses, intangible property makes up a significant portion of the company’s total property (e.g., approximately 34% of E-Bay’s assets are intangible), thus making the potential revenue from the expansion of the property tax base to include intangibles substantial. Marty Dakessian, a partner with Reed Smith, laid out the history of California’s taxation of software to show how “the ground keeps shifting” in this property tax area. Mike Pellegrino, President of Pellegrino & Associates, wrapped up the session by pointing out some of the challenges in properly valuing intangible property.
Georgetown Advanced State and Local Tax Institute and State Tax Symposium, Washington, D.C., August 6-7, 2012