state income tax: controversy and legislation update · 2020. 7. 16. · • overview •...

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2018 Hotel Tax Executive Committee Meeting

State Income Tax: Controversy and Legislation Update

April 30, 2018Jeff Friedman PartnerMichele Borens Partner

Eversheds Sutherland

Agenda

─ Apportionment• Diverging from Standard Apportionment• Wide-Ranging Application of Standard Apportionment

─ Expense Disallowance─ Income Tax Nexus & Jurisdiction

• Impact of Wayfair on Income Tax Nexus• Other Controversies

─ Group Composition─ Transfer Pricing─ State Responses to Federal Tax Reform

• Overview• Transition Tax• Global Intangible Low Taxed Income & Foreign Derived Intangible

Income • Other Provisions

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ApportionmentDiverging from Standard Apportionment


Matter of Gerson Lehrman Group, Inc., TAT(E) 08-79 (GC) (N.Y.C. Tax App. Trib., Dec. 28, 2017)

New York City – “Reasonable Method”

─ The New York City Tax Appeals Tribunal rejected the taxpayer’s and the Department of Finance’s positions and the methodology adopted by an administrative law judge (ALJ) and determined its own “reasonable method” for allocating lump-sum consulting services receipts.

─ The taxpayer’s non-commissioned salespeople entered into lump-sum subscription agreements with clients providing access to the taxpayer’s network of independent industry expert consultants. Its research consultants paired clients with the appropriate expert consultants.

─ The Tribunal determined that the taxpayer’s receipts for consulting services should be allocated based on the activities of the salespeople, expert consultants, and research consultants.

4


Corporate Executive Board v. Va. Dep’t of Taxation, No. CL16-1525, 2017 WL 3879140 (Va. Cir. Ct. Sept. 1, 2017)

Virginia – Statutory COP Method Upheld

─ The Virginia Circuit Court held in favor of the Department of Taxation’s use of the statutory costs of performance (COP) method to apportion income from the sales of subscription-based services because use of the COP method did not lead to inequitable results and was not unconstitutional.• The court found that under the COP method, most of the

taxpayer’s sales originated in Virginia and were attributable to the state.

─ The court rejected the taxpayer’s request for alternative apportionment using market-based sourcing and characterized the request as “arbitrary.”

5


Rent-A-Center West Inc. v. S.C. Dep’t of Revenue, 418 S.C. 320 (S.C. Ct. App. 2016), rehearing denied (S.C. Ct. App. Jan. 20, 2017), cert. denied (S.C. Dec. 13, 2017)

South Carolina – Burden of Proof Not Met

─ Under the statutory method, the numerator of Rent-A-Center West Inc.’s (R-A-C West) receipts factor included South Carolina receipts from licensing IP and the denominator included all revenue from retail stores and licensing activities.

─ The Department of Revenue argued that including the retail sales in the denominator diluted the receipts factor; the Department’s expert opined that including both royalty and retail receipts in the denominator was like putting apples in the numerator and apples and oranges in the denominator.

─ The South Carolina appellate court held that the Department failed to satisfy its burden of showing that the statutory formula did not fairly represent the taxpayer’s in-state business activity.

─ On December 13, 2017, the South Carolina Supreme Court denied the Department’s petition for writ of certiorari.

6


Associated Bank, N.A. v. Comm’r Revenue, No. 8851-R, 2017 WL 1430657 (Minn. Tax Reg. Div. Apr. 18, 2017)

Minnesota – Alternative Apportionment Struck Down

─ The Minnesota Tax Court found that the Commissioner could not invoke alternative apportionment to include interest income and intangible property in the apportionment factor of LLCs subject to the general apportionment formula, which excludes these items from the factors. The taxpayer’s lawful business structure could not be disregarded.• The taxpayer created two LLCs to conduct business in Minnesota,

which defines a “financial institution” as a “corporation”. For the 2007 and 2008 tax periods, the taxpayer excluded the LLCs’ interest income under the general apportionment rules and avoided the LLC interest income inclusion rules applicable to financial institutions.

─ The case is on appeal with the Minnesota Supreme Court.

─ In a special legislative session, the Minnesota Legislature amended the definition of a “financial institution” to include both “corporations” and “other business entities” effective after December 31, 2016.

7


Michigan Host Inc. v. Comptroller, No. 12-IN-OO-1187 (Md. Tax Feb. 1, 2017)

Maryland – Alternative Apportionment Upheld Again

─ The Maryland Tax Court affirmed a corporate income tax assessment against a Delaware corporation, Michigan Host, Inc. (MHI), with a principal place of business in Michigan. • Under Maryland’s three-factor formula, MHI’s apportionment factor

would have been zero. • The Comptroller assessed MHI for interest income it received from

its Maryland-based parent company, Host International, Inc. (Host).

─ The court held that taxation of MHI was justified because it:• Earned intangible income from Host’s activities; and • Had no operational existence as a separate entity independent from

Host.

─ The court upheld using Host’s exact apportionment factors to compute MHI’s Maryland taxable income.

8


Multistate Tax Compact Three-Factor Formula Denied

─ Gillette (California)• Denied use of the Compact’s three-factor apportionment formula.

Cert. petition denied on October 11, 2016.

─ Gillette (Michigan)• Retroactive repeal upheld. Cert. petition denied on May 22,

2017.

─ Kimberly-Clark (Minnesota)• Denied use of the Compact’s three-factor apportionment formula.

Cert. petition denied on December 12, 2016.

─ Health Net (Oregon)• The Oregon Supreme Court denied use of the Compact’s three-

factor apportionment formula on April 12, 2018.

─ Graphic Packaging (Texas)• The Texas Supreme Court denied use of the Compact’s three-

factor apportionment formula on December 22, 2017.

9


ApportionmentWide-Ranging Application of Standard Apportionment


Univ. of Phoenix, Inc. v. Indiana Dep’t of Revenue, No. 49T10-1411-TA-00065 (Ind. Tax Ct. Nov. 30, 2017)

Indiana – Sourcing Online Educational Services

─ The Indiana Tax Court applied the operational approach, finding that income from the university’s online campus cannot be sourced to Indiana because a greater proportion of the university’s income producing activities was performed in another state.

─ The court rejected the Department of Revenue’s argument that the taxpayer’s income producing activity was providing an opportunity for students to attend online classes.

─ The court explained that the online university’s income producing activities are those that the university engages in for the purpose of generating revenue, including the creation of the online course content and curriculum development activities that occurred at the university’s Arizona headquarters.

11


Apollo Educ. Grp. Inc. v. Or. Dep't of Revenue, TC-MD 150352C, 2017 WL 3635621 (Or. Tax Ct. Aug. 24, 2017)

Oregon – Sourcing Online Educational Services

─ The Oregon Tax Court applied the transactional approach, finding that the university’s faculty costs were the only direct costs that should be used in calculating its sales factor numerator.

─ The course instructor costs were the only “incremental” direct cost to be considered in determining the location of the costs of performance.

─ The court upheld the Department’s assignment of revenue from online educational services to the location of the course instructors.

12


DIRECTV Inc. v. S.C. Dep’t of Revenue, 804 S.E.2d 633 (S.C. Ct. App. Aug. 30, 2017)

South Carolina – Narrow Transactional Approach

─ The South Carolina Court of Appeals applied the transactional approach and affirmed the administrative law court’s (ALC) decision, finding that DIRECTV’s income producing activity is solely the delivery of a signal to its customers nationwide. Accordingly, 100% of subscription receipts to South Carolina customers is attributed to South Carolina.

─ The court found the proper burden of proof (preponderance of evidence) was applied to DIRECTV.

─ The court affirmed the ALC’s assessment of underpayment penalties because there was no reasonable cause for DIRECTV’s underpayment.

13


Microsoft Corp. v. Wis. Dep’t of Revenue, No. 13-I-042 (Wis. Tax App. Comm’n Aug. 10, 2017)

Wisconsin – Can’t Tax Remote Manufacturer Licenses

─ The Wisconsin Tax Appeals Commission ruled in favor of Microsoft holding that the Department of Revenue could not assess additional corporate franchise tax on Microsoft’s royalty income earned from licensing its software to out-of-state “original equipment manufacturers” that made sales to Wisconsin users.

─ The licensing is an activity that takes place outside of Wisconsin and cannot be taxed regardless of where the ultimate customer is located.

14


Honigman Miller Schwartz & Cohn LLP v. City of Detroit, No. 336175 (Mich. Ct. App. Jan. 18, 2018)

Michigan – Market-Based Sourcing Applied

─ The Michigan Court of Appeals held that sales of a Detroit attorney’s services can be included in the sales factor numerator for the Detroit income tax only if the client received the services in Detroit. • Gross revenue is included in the sales factor numerator if derived

from sales made and services rendered in the city.

─ The law firm contended that its services are “rendered” where the client receives the services, rather than where the work is performed.

─ The court compared the sales factor term “services rendered” to the payroll factor term “services performed” and concluded that the terms must have different meanings.

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New York – Services Allocable to Activity Location

In the Matter of Catalyst Repository Systems Inc., No. 826545 (N.Y. Div. Tax. App. Aug. 24, 2017)─ The Administrative Law Judge (ALJ) determined that online litigation

support services receipts are “services” and allocated to the location where the services were performed, which were outside of New York.

In the Matter of the Petitions of Checkfree Services Corp., Nos. 825971 & 825972, 2017 WL 163932 (N.Y. Div. Tax. App. Jan. 5, 2017)─ The ALJ determined that a taxpayer’s electronic bill payment and

presentation receipts constitute service receipts and not “other business receipts,” and are properly sourced where the service is performed.

The analysis in both cases largely mirrors the analysis in In the Matter of the Petition of Expedia, Inc.:─ A “service” does not require human involvement; and

─ Service receipts are properly sourced where performed, which is the taxpayer’s location, not the customer’s location.

16


Agman La. Inc. v. Taxation and Revenue Dep’t, No. 14-74 (N.M. Admin. Hearing Office Dec. 5, 2017)

New Mexico – Application of the Business Income Tests

─ The New Mexico Administrative Hearings Office affirmed the Taxation and Revenue Department’s assessment of Agman Louisiana Inc. (Agman) based on the taxpayer’s gain from the sale of stock of a corporation in which the taxpayer owned less than a 50% interest.

─ The Hearings Office ruled that such gain was apportionable business income subject to New Mexico corporate income tax.

─ Agman argued that the gain was non-business income and must be allocated to its commercial domicile. The Hearings Office disagreed and determined that Agmanmet New Mexico’s three-prong business income test in NMSA 1978 § 7-4-2(A).

17


Defender Security Company v. Testa, No. 2016–1030 (Ohio Bd. Tax App. Mar. 6, 2018)

Ohio – Determining Where the Benefit is Received

─ The taxpayer sold security services contracts to Ohio customers and then resold those contracts to an out-of-state company, ADT. ADT then provided the security monitoring services.

─ The Ohio Board of Tax Appeals concluded that underOhio law the receipts from the sales of the service contracts to ADT were properly sitused to Ohio. • Ohio Rev. Code § 5751.033(I) situses gross receipts from

services and other gross receipts not otherwise sitused based on the purchaser's benefit received in Ohio.

• The Board found that “[t]he contracts would not exist without property in Ohio to be monitored and equipment located within such property in Ohio by which the monitoring is performed.”

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Expense Disallowance


Kohl’s Dep’t Stores, Inc. v. Virginia Dep’t of Taxation, No. 160681 (Va. Mar. 22, 2018)

Virginia – “Subject to Tax” Addback

─ In August 2017, the Virginia Supreme Court found that only the portion of royalties that are actually taxed by another state falls within its “subject to tax” exception to Virginia’s addback statute for corporate income tax purposes. • The Court acknowledged that the plain language of the statute is

ambiguous and that both parties’ respective positions could be supported by the statute. The Court deferred to the Department of Taxation’s interpretation.

─ On rehearing, the Virginia Supreme Court’s held that the Department’s interpretation, which was not contained in regulations, is not entitled to any weight. Its substantive conclusion remained the same – the exception was ambiguous and applies only to the extent that the royalties are actually taxed by another state.

20


BMC Software, Inc. v. Dir., Div. of Taxation, 30 N.J.Tax 92 (N.J. Tax Court May 24, 2017)

New Jersey – Satisfying the Unreasonable Exception

─ The New Jersey Tax Court found that a subsidiary’s intangible expenses paid to its parent qualified for the state’s “unreasonable” addback exception because the payments were substantively equivalent to an unrelated party transaction.

─ The court held that:1) The “unreasonable” exception does not require showing that the

related-party recipient paid Corporation Business Tax on the income.

2) Showing that the related-party transaction was “substantively equivalent” to an unrelated third party transaction is sufficient evidence for the addback is unreasonable.

21


Income Tax Nexus & JurisdictionImpact of Wayfair on Income Tax Nexus


Physical Presence Nexus

─ Quill Corp. v. North Dakota, 504 U.S. 298 (1992): The Court reaffirmed the physical presence nexus standard, but distinguished the Due Process and Commerce Clause nexus standards for the first time:• Due Process Clause: Court overruled Bellas Hess to say that a

taxpayer’s “purposeful availment” of the market place – i.e., its economic presence – satisfied Due Process.

• Commerce Clause: Still requires “substantial nexus,” which equals physical presence that is not de minimis.

─ What is a “physical presence”? Whose physical presence?• The physical presence must be more than de minimis.

• The presence need not be related to the in-state sales activities.• More than slightest presence, e.g., in-state property or

employees.

23


South Dakota Enacts Remote Seller Legislation

─ On March 22, 2016, South Dakota enacted S.B. 106, which effective April 1, 2016, imposes a South Dakota sales and use tax reporting and collection on retailers without a physical presence in South Dakota if such retailers have in the current year or had in the prior year either:• $100,000 of gross revenue from the sale of tangible personal

property, electronic products, or services delivered into South Dakota; or

• 200 separate transactions in which tangible personal property, electronic products, or services were delivered into South Dakota.

─ The law permits the State to bring a declaratory judgment action in any South Dakota Circuit Court against “any person [that South Dakota] believes meets the criteria of section 1 of [S.B. 106] to establish that the obligation to remit sales tax is applicable and valid under state and federal law.”

─ The law enjoins the State from enforcing the obligation while a constitutionality dispute is pending.

24


South Dakota v. Wayfair, Inc., et al., 901 N.W.2d 754 (S.D. Sept. 13, 2017)

─ On March 6, 2017, the South Dakota Sixth Judicial Circuit Court ruled in favor of the remote sellers because the sellers lacked physical presence in South Dakota, under Quill. The court held that S.B. 106 fails to satisfy Quill’s physical presence requirement and its application of the Commerce Clause.

─ On September 13, 2017, the South Dakota Supreme Court upheld the lower court’s decision finding S.B. 106 unconstitutional under Quill and stated that “[h]oweverpersuasive the State’s arguments on the merits of revisiting the issue, Quill has not been overruled.”• The court saw “no distinction between the collection obligations

invalidated in Quill and those imposed by S.B. 106.”

─ On January 12, 2018, the U.S. Supreme Court granted the South Dakota’s petition for a writ of certiorari. Oral arguments were held on April 17, 2018.

25


Waiting for Oral Arguments at 5 AM

26


Bleary Eyed, But Excited

27


Waiting for Oral Arguments at 9 AM

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Oral Arguments

29

Malcolm StewartDeputy Solicitor General

On Behalf of the United States

Marty JackleyAttorney General of South Dakota

On Behalf of South Dakota

George IsaacsonBrann & Isaacson

On Behalf of Wayfair, Inc.

https://urldefense.proofpoint.com/v2/url?u=https-3A__us.eversheds-2Dsutherland.com_people_Jeffrey-2DA-2DFriedman-3Futm-5Fcampaign-3D12-2D13-2D17-2520Dec2017-2520TEI-2520webinar-2DYrEndCorpTaxRndUp-2DJonathanDavis-26utm-5Fmedium-3Demail-26utm-5Fsource-3DEloqua-26site-5Fid-3D82769734-26elqTrackId-3Def060e5e174b47f8bff014877203f3d3-26elq-3D681ead35b1984ee3b1dad3300b8467dd-26elqaid-3D16356-26elqat-3D1-26elqCampaignId-3D12234&d=DwMGaQ&c=4ZIZThykDLcoWk-GVjSLmy8-1Cr1I4FWIvbLFebwKgY&r=KagRWvPXIE2zwWP-zkLP0-z5JXb0wX9mJNFb3gu1_SLeqI8aOdWc9t3wHroybRp7&m=gZI7BXSefFRjX65rNeMfbFKlnF9bj5HMjnR3SGJlrcY&s=ag_I4mZ56bgkMVxT1_G3TzlhWm0K7TEMzvdjiXtTP4w&e=

https://revenue.alabama.gov/about/joe-w-garrett-jr/

https://home.kpmg.com/xx/en/home/contacts/s/shirley-sicilian.html


Concerns and Impact on Income Tax NexusWayfair and Oral Arguments

─ Although the US Supreme Court is being asked to address whether or not to uphold Quill’s physical presence nexus standard for sales tax purposes, it is possible that a decision would impact income tax nexus.

─ Income Tax Nexus Overview• The state income tax nexus standards vary.• Some protection is afforded to sellers of tangible personal

property through PL 86-272.• Economic nexus is enough.• Some states are adopting sales-thresholds or “factor presence”.


Concerns and Impact on Income Tax Nexus (cont’d)Wayfair and Oral Arguments

─ Is one sale enough to authorize a state to tax? • States increasingly apply income and business taxes to out-of-

state businesses without an in-state physical presence, based on as little as one transaction.

• See Tax Comm’r v. MBNA Am. Bank, 640 S.E.2d 226 (W. Va. 2006) (Credit card companies with customers, but no employees or property, in the state establishes substantial nexus for corporate income tax purposes).

─ What should Congress’ role be? Should Congress establish a national standard?

─ What are the constitutional limits to retroactive taxation?


Concerns and Impact on Income Tax Nexus (cont’d)Wayfair and Oral Arguments

─ What’s the role of Complete Auto’s four-prong test and Pike’s balancing test?• Tax assessments vs. economic impact on interstate commerce

─ Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977) provides that the constitutionality of a tax is evaluated under a four-prong test: • Substantial nexus; • Fair apportionment; • Nondiscrimination; and • Fair relation between tax and services provided by the state.

─ Pike v. Bruce Church, Inc., 397 U.S. 137 (1970) provides that the power of states to pass laws interfering with interstate commerce is limited when the law poses an undue burden on businesses.


Income Tax Nexus & JurisdictionOther Controversies


Blue Buffalo Company, Ltd. V. Comp. of the Treasury, No. 16-IN-00-0364 (Md. Tax Ct. 2017)

Maryland – Exceeding P.L. 86-272 Protections

─ The Maryland Tax Court held that Blue Buffalo Company’s (Blue) business activities in Maryland exceeded solicitation protected by P.L. 86-272 because the activities were not de minimis. • Blue employed a Maryland distributor sales manager, two

regional demonstration managers, and several dozen in-store sales representatives. The sales representatives were assigned to specific stores and interacted with consumers, reported to management when products were defective, and conducted training and demonstrations on their products.

─ The court held that gathering competitive information, engaging in quality control, and training key customers personnel exceeded solicitations protected by P.L. 86-272.


Nat’l Auto Dealers Exch., L.P. v. Dir., Div. of Taxation, No. 000028–2014 (N.J. Tax Ct. Feb. 26, 2018)

New Jersey – Partnerships Not Subject to Tax

─ The New Jersey Tax Court held that the New Jersey Division of Taxation cannot assess corporation business tax (CBT) against a partnership whose nonresident partners filed Form NJ-1065E with the partnershipbecause a partnership is not a “taxable entity” for CBT purposes.• National Auto Dealers Exchange, L.P. (NADE) was a Delaware

limited partnership that did business in New Jersey. • Its limited partner Manheim NJ Investments, Inc. (Manheim)

provided NADE with Form NJ-1065E, reporting that Manheim maintains a regular place of business in New Jersey, and filed CBT returns.

• Manheim subsequently filed a refund claim asserting that it lacked nexus with New Jersey.

• The Division issued an assessment to NADE.

35


Romantix Holdings Inc. v. Iowa Dep’t of Revenue, No. 16-0416 (Iowa Ct. App. May 3, 2017)

Iowa – Holding Company Lacks Nexus

─ The Iowa Court of Appeals upheld the Department’s determination excluding an out-of-state holding company from an Iowa consolidated return due to lack of nexus even though it held intangible property used in Iowa by its subsidiaries.

─ Citing Myria Holdings Inc., the court reasoned that it was clear the Iowa subsidiaries and their intangible property were not enough to establish a taxable nexus with Iowa sufficient to remove the parent from the Iowa safe harbor provisions.• In Myria Holdings Inc. v. Iowa Dep’t of Revenue, 892 N.W.2d 343,

2017 WL 1103175 (Iowa March 24, 2017), the Iowa Supreme Court determined that: (1) the parent company’s management and administration activities performed on behalf of the subsidiaries doing business in Iowa did not create nexus; and (2) ownership of subsidiary stock and money from reimbursements fell within the ownership and control safe harbor.

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Group Composition


Agilent Technologies, Inc. v. Dep’t of Revenue, No. 16CA849, 2017 WL 4986232 (Colo. App. Nov. 2, 2017)

Colorado – “Includable” Under the 80/20 Test

─ The Colorado Court of Appeals held that a corporate parent doing business in Colorado was not required to include in its Colorado combined report its subsidiary holding company that had no property or payroll in Colorado.

─ Colorado requires affiliated C corporations to file a water’s-edge combined corporate income tax report and provides an 80/20 test to determine when a C corporation is included in the combined report.

─ The court found that the holding company was not an “includable” corporation under Colorado’s 80/20 test because it did not have more than 20% of its property and payroll assigned to locations in the US.

38


Ashland, Inc. v. Comm’r of Revenue, 899 N.W.2d 812 (Minn. Aug. 2, 2017)

Minnesota – Inclusion of a Foreign Disregarded Entity

─ The Minnesota Supreme Court affirmed that an election made under federal tax law by a foreign entity owned by the taxpayer, a domestic unitary business, must be recognized in determining the taxpayer's Minnesota tax liability.

─ Including in “net income” the income of a foreign entity that elects under federal tax law to be disregarded as a separate entity does not violate Minnesota’s water’s edge law because the disregarded entity does not retain a nationality separate from its owner under Minnesota tax law.

39


In the Matter of Whole Foods Market Group, Inc., No. 826409 (N.Y. Tax App. Trib. Sept. 11, 2017)

New York – Substantial Intercorporate Transactions

─ The Tax Appeals Tribunal affirmed an administrative law judge's determination and held that that Whole Foods and its related IP holding company must file a combined report based on substantial intercorporate transactions (the combination test under the pre-Tax Reform law).

─ The Tax Appeals Tribunal disagreed with the taxpayer’s assertion that royalty payments that the taxpayer added back in computing entire net income must be excluded from the substantial intercorporate transaction analysis.

40


Transfer Pricing


See’s Candies, Inc. v. Auditing Div. of the Utah State Tax Comm’n, No. 140401556 (Utah Dist. Ct. 2016)

Utah – Limiting State Transfer Pricing Adjustments

─ See’s Candies (See’s) deducted IP royalty payments made to an insurance company that is also owned by its parent company, Berkshire-Hathaway.

─ The Tax Commission argued that it could adjust See’s income for the royalty payments based on the state’s 482-style adjustment statute without reference to federal rules on related-company adjustments.

─ The Utah District Court found that the Tax Commission abused its discretion by denying the entire intercompany royalty expenses when the Tax Commission failed to consider federal 482 guidance and failed to look at the taxpayer’s transfer-pricing study.

─ The case is on appeal at the Utah Supreme Court.

42


Hess Corp., et. al. v. D.C. Office of Tax & Revenue, Nos. 2012-OTR-00027, 2011-OTR-00047, 2011-OTR-00049 (Jan. 26, 2018)

District of Columbia – Summary Judgment Denied Again

─ In 2012, in Microsoft, the Office of Administrative Hearings (OAH) held that the Office of Tax and Revenue’s (OTR) reliance on the transfer pricing methodology employed by Chainbridge was arbitrary, capricious and unreasonable and cannot form the basis for a determination to reallocate income between Microsoft and its affiliated businesses.

─ While Microsoft was pending, ExxonMobil Oil Corp., Hess Corp., and Shell Oil Co. were assessed additional corporate franchise tax by the OTR using the Chainbridge methodology.

─ In 2017, the taxpayers unsuccessfully argued that the OTR was collaterally estopped from re-litigating the Chainbridge methodology.

─ On January 26, 2018, the OAH denied the taxpayers’ motions for summary judgment, holding that they failed to establish that the Chainbridgemethodology was arbitrary, capricious and unreasonable as a matter of law.

─ Several companies, including ExxonMobil Oil Corp., Hess Corp., and Shell Oil Co., have since reached tentative settlement agreements with the OTR, but two other cases are moving to trial.

43


State Responses to Federal Tax ReformOverview


Federal Tax Reform

─ President Trump signed H.R. 1 on Dec. 22, 2017.

─ Popularly known as the “Tax Cuts and Jobs Act” (TJCA).• Officially named "An Act to provide for reconciliation pursuant to

titles II and V of the concurrent resolution on the budget for fiscal year 2018" due to Senate rules.

─ Biggest change to federal taxes in the last 30 years.

─ The TJCA makes numerous changes to the IRC, which will result in corresponding and collateral changes to most state tax codes.

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Overview


State Conformity

─ To determine the SALT impact of the TCJA, you first need to know a state’s level conformity to federal tax laws.

─ Three main types of conformity:• Rolling: These states adopt provisions of the IRC in real time. • Fixed: These states conform to the IRC as of a static or fixed

date. • Selective: States that pick and choose different provisions of

the IRC.

─ All states selectively “decouple" from certain enumerated IRC provisions.

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The Gating Question


State Conformity

─ Updates IRC Conformity Through 2017 Tax Year • Arizona: H.B. 2647 (2018).• Virginia: Conforms to the IRC as in effect on February 9, 2018. Decouples

from most of the TCJA provisions effective in the 2018 tax year. S.B. 230 (2018).

─ Updates IRC Conformity Through January 1, 2018 Without Addressing Corporate Base Expansion• Florida: H.B. 7093 (2018).• Kentucky: H.B. 366 (2018).• Michigan: S.B. 748 (2018).• South Dakota: H.B. 1049 (2018).• West Virginia: H.B. 4135 (2018).

─ Georgia: Conforms to the IRC as in effect on February 9, 2018. Decouples from certain provisions. H.B. 918 (2018).

─ Idaho: For tax years beginning after January 1, 2018, conforms to the IRC as of January 1, 2018. H.B. 463 (2018). For the 2017 tax year, conforms to the IRC as of December 21, 2017. H.B. 355 (2018).

─ Oregon: Conforms to the IRC as in effect on December 31, 2017. Decouples from certain provisions. H.B. 4080 (2018).

47

Recent Changes


State Responses to Federal Tax ReformTransition Tax


OverviewTransition Tax – IRC § 965

─ IRC § 965 imposes a one-time transition tax on a US shareholder with respect to its investment in CFCs and certain other foreign corporations.

─ The tax is imposed on the net aggregate amount of the US shareholder’s pro rata shares of the previously untaxed foreign earnings and profits (E&P) of such CFCs and other foreign corporations.• Effective rate of 15.5% on the amount of cash and cash equivalents,

and• 8% for any amount in excess.

─ Taxpayers are able to elect to pay any resulting liability over an eight-year period.

─ The measurement date for applying the transition tax is either November 2, 2017, or December 31, 2017, depending on which date the undistributed E&P of the specified foreign corporation is greater.


California – State Analysis Shows Revenue Potential

─ On February 12, 2018, the California Franchise Tax Board (FTB) released a preliminary report analyzing the interaction of the Transition Tax and California tax law.

─ California is a selective conformity state and does not conform to the federal treatment of Subpart F income or to IRC § 965.

─ The FTB's review of select tax returns found approximately $950 billion that may be subject to IRC §965.

─ The FTB estimated that the state could collect about $350 million in additional tax revenue if it conformed to IRC § 965.

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California Franchise Tax Board Preliminary Report


2018-19 Fiscal Year BudgetNew York – Excluded from Income

─ The Budget provides that amounts received under IRC § 965 from a corporation that is not included in a combined report with the taxpayer will be considered “exempt CFC income” for New York purposes, similar to New York’s treatment of other Subpart F income. As a result, such income is excluded from New York taxable income.

─ Any interest expense attributable to this income must be added back.

─ Relief from underpayment of estimated taxes that may arise from the interest expense attribution related to the Transition Tax is provided for taxable years beginning on or after January 1, 2017 and before January 1, 2018.

─ The related Transition Tax deduction under IRC § 965(c) will not be allowed for New York purposes, which prevents taxpayers from obtaining a double benefit by taking a deduction related to excluded income.

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Notice #18-05, Tenn. Dep’t of Revenue (Apr. 2018)Tennessee – Excluded from Income

─ The Department of Revenue provides that deemed repatriated earnings should not be included in the Tennessee net earnings calculation because corporations report repatriated earnings on the IRC 965 Transition Tax Statement and not on Federal Form 1120.

─ As a result, repatriated earnings should not be deducted as dividends and should not be included in the apportionment formula.

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Notice, N.J. Div. of Taxation (Mar. 16, 2018)New Jersey – Exclusion Evaluated Under State Law

─ The Division of Taxation issued a notice providing that whether or not deemed repatriated earnings are excludable from entire net income of a corporation for corporation business tax purposes is determined under N.J.S.A. 54:10A-4(k)(5).

─ Under this state law, if the corporation owns 80% or more of a foreign subsidiary, 100% of an amount treated as a dividend is excluded from entire net income.

─ If the corporation owns between 50% and 80% of the foreign subsidiary, 50% of the deemed dividends are excluded.

─ If the New Jersey taxpayer owns less than 50% of the foreign subsidiary, the entire amount of the deemed dividend is includable in entire net income.

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Illinois – Included in Income

─ Due to the Department of Revenue’s reference to the federal IRC 965 Transition Tax Statement, the income inclusion under IRC § 965(a) and deduction under IRC §965(c) is included in determining the Illinois base income.

─ Taxpayers who have already filed a 2017 Illinois income tax return and did not include IRC § 965 net income must amend their return to account for that income.

─ The net amount included will be treated as a foreign dividend eligible for Illinois’ dividend received deduction.

─ Illinois does not follow the election under IRC § 965(h) to pay the tax liability in installments over 8 years.

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2017 Illinois Income Tax Guidance


H.B. 355 and H.B. 684 (proposed) Idaho – Included in Income

─ Adopted the deemed repatriated foreign earnings provisions in IRC § 965.• The deemed repatriated foreign earnings should be included in

the Idaho state tax base because Idaho’s tax base starting point is federal taxable income.

─ The related Transition Tax deduction under IRC § 965(c) will not be allowed for Idaho tax purposes.• Idaho has an 85% dividend-received deduction applicable to

water’s-edge taxpayers to amounts included in income by reference to Subpart F income, which should be applicable to the deemed repatriated foreign earnings.

─ Watch out for proposed H.B. 684, which would remove Idaho’s addback of deductions under IRC § 965(c).

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S.B. 1529Oregon – Included in Income

─ Adopted the deemed repatriated foreign earnings provisions in IRC § 965.• IRC conformity date from December 31, 2016 to December 31,

2017, effective for tax years beginning on or after January 1, 2018.

─ Amounts deducted for income repatriated under IRC §965 must be added back in calculating Oregon taxable income.• Taxpayers should be able to claim a dividend received deduction

based on the amount deemed repatriated.

─ There is no Oregon provision adopting the federal election under IRC § 965(h) to pay the tax liability in installments over 8 years.

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S.B. 1529Oregon – Repeal of Tax Havens

─ In 2013, Oregon required unitary foreign affiliates incorporated in “tax haven” countries to be included in the Oregon consolidated return.

─ Due to the risk of double taxation, S.B. 1529 provides a 2017 tax credit based on taxes paid from Oregon’s tax haven legislation. • Capped at the lesser of:

• The tax attributable to IRC § 965 income; or• The total tax attributable to tax haven addition modifications.

• Any unused credit can be carried forward through 2021.

─ Oregon’s tax haven legislation is repealed beginning in the 2018 tax year.

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Installment Payments

Utah – S.B. 244

─ On March 21, 2018, Utah enacted S.B. 244 which allows installment payments for deferred foreign income described in IRC § 965(h).

Connecticut – OCG-4 (Apr. 6, 2018)

─ A taxpayer must report its IRC § 965 income, in its entirety, on the 2017 Connecticut return. There is no Connecticut election to defer payment of the tax and the tax cannot be paid in installments.

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State Responses to Federal Tax ReformGlobal Intangible Low Taxed Income & Foreign Derived Intangible Income


GILTI – IRC §§ 951A, 250

─ Imposes tax on a US taxpayer’s Global Intangible Low Taxed Income (GILTI), which approximates the taxpayer’s allocable share of amounts earned by CFCs outside the US in excess of routine returns on tangible property.

─ Included in federal taxable income in a manner similar to Subpart F income.

─ A 50% deduction for such income is provided under IRC § 250, generally resulting in a US tax rate of 10.5% for GILTI income

─ Foreign tax credits (FTCs) are available to offset GILTI at the federal level at a rate of 80%.

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Overview


FDII – IRC § 250

─ Permits domestic corporations to deduct 37.5% of their Foreign Derived Intangible Income (FDII) which calculates an amount similar to GILTI and multiplies that amount by the fraction of the income earned in the US that is attributable to property sold or licensed to a non-US person for foreign use or to services provided outside the US.

─ The FDII provision generally results in a reduced effective tax rate of 13.125% on FDII.

─ GILTI and FDII work in tandem – GILTI discourages intangibles in low-tax foreign jurisdictions and FDII encourages intangibles in the US.

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Overview


FDII & GILTI

─ Whether the starting point for calculating a state’s tax base is line 28 or a subsequent line of a corporation’s Form 1120 will play a significant role in determining the state impact of the GILTI tax and FDII deduction.• The GILTI and FDII deductions are in IRC § 250, which is

included in the line 29b "special deductions."─ Because IRC § 951A is a new section, states will not

have a specific exclusion for GILTI.─ States may also not conform to the IRC § 250

deductions or may require the add-back of amounts deducted under IRC § 250.

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SALT Impact


States Decoupling from GILTI

─ Georgia – GILTI Income Not Taxable • On March 27, 2018, Georgia enacted S.B. 328 to exclude IRC §

951A from Georgia taxable income. • The bill treats GILTI as Subpart F income for purposes of the

deduction under OCGA § 48-7-21(b)(8).• The exclusion of GILTI income is consistent with the state's

longtime policy of not taxing foreign income of foreign subsidiaries.

─ Wisconsin – GILTI Income Not Taxable• On April 3, 2018, Wisconsin enacted A.B. 259 which decouples

from IRC § 951A.• Wisconsin was already decoupled from Subpart F income in its entirety.

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New York – Includes GILTI, But Not FDII

GILTI

─ The Budget does not address GILTI. Because of New York’s conformity to the IRC (rolling conformity), both GILTI and the 50% GILTI deduction under IRC § 250 are included in the computation of New York taxable income.

─ In order to avoid a taxpayer double benefit, the Budget amends the subtraction modification related to IRC § 78 gross ups to limit the subtraction modification to dividends that were not included in the IRC § 250 deduction.

FDII

─ The Budget excludes the FDII deduction from the computation of New York taxable business income.

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2018-19 Fiscal Year Budget


Illinois – Included in Income

─ The income inclusion under IRC § 951A and deduction under IRC § 250 is included in determining the Illinois base income.

─ The net amount included will be treated as a foreign dividend eligible for Illinois’ dividend received deduction.

65

2017 Illinois Income Tax Guidance


Idaho – Addback for FDII Deductions

─ Provides for conformity to the IRC as of January 1, 2018, for tax years starting in 2018.

─ GILTI included in federal taxable income under IRC §951A should be included in the Idaho state tax base due to Idaho’s conformity to the IRC.

─ Disallows the IRC § 250 deduction for 50% of the GILTI. However, Idaho’s 85% dividend-received deduction for Subpart F income should apply to GILTI since IRC § 951A is included under Subpart F of the IRC.

─ Disallows the deduction for IRC § 78 gross-up amounts related to GILTI and the federal deduction for 37.5% of FDII, both provided for in IRC § 250.

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H.B. 463


State Responses to Federal Tax ReformOther Provisions


OverviewInterest Deduction Limitation – IRC § 163(j)

─ New IRC § 163(j) limits a taxpayer’s business interest expense deduction to 30% of the taxpayer’s adjusted taxable income plus the taxpayer’s business interest income and floor plan financing interest.

─ States Decoupling from IRC § 163(j):• Georgia: H.B. 918 (2018).• Wisconsin: A.B. 259 (2018).


OverviewFull Expensing for Five Years – IRC § 168(k)

─ Expands bonus depreciation, permitting taxpayers to elect, on an asset-by-asset basis, to fully expense the cost of both new and used “qualified property” acquired and placed in services after September 27, 2017, and before January 1, 2023.

─ State impact may be minimal as most states historically have “decoupled” from bonus depreciation.• For example, New York did not address IRC § 168(k) in its recent

Budget because it already decouples from it.• Pennsylvania: Added back under existing state law. Corp. Tax

Bulletin 2017-02, Penn. Dep’t of Revenue (Dec. 22, 2017).

─ States Decoupling from IRC § 168(k):• Georgia: H.B. 918 (2018).• Florida: H.B. 7093 (2018).• Wisconsin: A.B. 259 (2018).


OverviewForeign-Source DRD – IRC § 245A

─ A 100% DRD is available for dividends received by a domestic corporation that is a US shareholder from a specified 10%-owned foreign corporation.

─ Reduces the basis in stock in foreign corporations to reflect distributions eligible for DRD in calculating losses.

─ Requires recapture of net losses of a foreign branch that is transferred to a foreign corporation – an expansion of existing branch loss recapture rules.

─ State Responses:• Idaho: Added back. H.B. 463 (2018).

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