State and local tax advisor: August 2022

The states covered in this issue of our monthly tax advisor include: 

• All states
• Alabama
• Arkansas
• Illinois
• Michigan
• Mississippi
• New Jersey
• Tennessee
• Texas
• Virginia
• Wisconsin

All states

Corporate income, sales, and use taxes: MTC holds annual meeting

The Multistate Tax Commission held annual meetings last week in Anchorage, Alaska. Among the topics discussed were:

• Cryptocurrency
• Partnership taxation
• Sales tax on digital products
• A uniform power of attorney draft

What cryptocurrency issues were discussed?

The Nexus Committee began the discussion of cryptocurrencies by providing a brief overview of related tax issues. That was followed up by a presentation from Norm Hannawa, director (tax strategy) of Chainanalysis, Inc., regarding the use of technology tools in cryptocurrency tax audits.

On the third day of the conference, a presentation entitled, “Decoding Crypto,” was given in order to provide attendees with information regarding best practices for taxing crypto.

What partnership taxation developments occurred?

The Uniformity Committee updated the MTC on its work developing partnership taxation proposals. The workgroup intends to continue working on taxation of partnership issues; the group started with investment partnerships and once that portion is complete it will move on to another partnership topic. The work group has produced a draft model on taxation of investment partnerships and is awaiting comments from the states.

What developments occurred regarding digital products?

Next, the Uniformity Committee heard a presentation regarding sales taxation of digital products. The chair of the sales tax on digital products project gave a status report and presented the “Discussion Draft of Detailed Outline of a White Paper on Sales Taxation of Digital Products.” The purpose of the project is to help states develop a simpler and more adaptable approach to the taxation of digital products.

What is the status of the uniform power of attorney draft?

There was also an update on the development of a uniform power of attorney. Work is continuing on the draft and a further update is expected at the November committee meetings.

Finally, the MTC passed a resolution recommending states that adopt the statement of information concerning practices of the MTC and supporting states under P.L. 86-272 also adopt the model factor presence nexus standard for business activity taxes.

Multistate Tax Commission, Annual Meeting Week, Aug. 1, 2022.

Alabama

Corporate income tax: Interest expenses not subject to addback

A corporate taxpayer who paid interest to a related affiliate in Ireland and deducted those expenses for Alabama income tax purposes wasn’t required to add those expenses back to its taxable income pursuant to Alabama’s addback statute. The transaction met the requirements for the subject-to-tax exception to the addback statute.

The taxpayer argued that its interest payment to the affiliate should be excepted from addback because the payment was subject to a tax on the affiliate’s net income in Ireland. The question was whether that interest payment by the taxpayer was attributed to Ireland despite being deducted by the affiliate on its own return after the affiliate paid the interest to Luxembourg affiliates.

The exception applies if the interest paid was in the same tax year subject to a tax based on or measured by the related affiliate's net income. If the tax was imposed by a foreign nation, the foreign nation must have in force an income tax treaty with the United States, and the recipient must be taxed as a resident of the foreign nation.

The Department of Revenue didn’t dispute that the related affiliate was a resident of Ireland during the year at issue, pursuant to an income tax treaty that was in force between Ireland and the United States. The dispute concerned whether the interest expense paid to the affiliate was “subject to a tax based on or measured by [the affiliate’s] net income” in Ireland.

The interest payment was attributed to Ireland according to that nation’s sourcing methodology for purposes of its net income tax. Thus, the interest income that the affiliate received from the taxpayer was considered “subject to a tax” even if no actual taxes were paid on the item of income in the taxing jurisdiction by reason of deductions or otherwise.

Pfizer, Inc. v. Alabama Department of Revenue, Alabama Tax Tribunal, No. BIT. 18-236-JP, July 28, 2022.

Arkansas

Sales and use tax: Taxpayer not entitled to manufacturing machinery and equipment exemption

A taxpayer’s purchase of certain items to upgrade and replace equipment in its plant didn’t qualify for the Arkansas manufacturing exemption from sales and use tax because the items weren’t used directly in the manufacturing process and weren’t substantial replacements. In this matter, the taxpayer requested a refund claiming entitlement to the manufacturing machinery and equipment exemption as the purchases were associated with either the substantial replacement of existing machinery or plant expansion.

The Department of Finance and Administration (department) rejected the application, stating that the items didn’t directly act upon the finished product and weren’t substantial replacements. Further, these replacements didn’t result in either the creation of new products or an increase in production. Upon review, the Office of Hearings and Appeals agreed with the department and noted that the taxpayer had not established entitlement to the claimed exemption by a preponderance of the evidence. Accordingly, the refund claim was denied.

Docket No. 22-539, Arkansas Department of Finance and Administration, Office of Hearings and Appeals, May 25, 2022.

Illinois

Multiple taxes: EDGE credit, NOL, and energy assistance charge regulations amended

Illinois amended regulations to:

• Clarify corporate and personal income tax credit recapture provisions under the Economic Development for a Growing Economy (EDGE) Program.
• Reflect the limitation on net operating loss (NOL) deductions by corporations for tax years 2021 through 2024.
• Incorporate the rate changes in the public utility energy assistance charge beginning with the 2022 tax year.

86 Ill. Adm. Code Secs. 100.2198, 100.2330, 516.120, 516.130, 516.140, Illinois Department of Revenue, effective July 12, 2022.

Michigan

Sales and use tax: Recycling machines did not qualify for industrial processing exemption

A taxpayer that sold container-recycling machines didn’t qualify for Michigan’s industrial processing sales tax exemption, as the machines didn’t perform any of the statutorily enumerated industrial processing activities. The machines accept and sort aluminum cans, and glass and plastic bottles for recycling. The aluminum cans are crushed, and the bottles are sorted by color.

The machines didn’t perform “inspection, quality control, or testing” because the returned containers aren’t materials or products, but raw materials that are later turned into different products. They also didn’t perform remanufacturing or production material handling, as they simply facilitated the collection of raw materials. The machines didn’t engage in “recycling of used materials for ultimate sale at retail” because the returned containers are destroyed, not sold at retail.

The negligence penalty was upheld, as the taxpayer failed to maintain consistent documents and its own accounting records showed a greater amount of gross sales than its tax returns.

Tomra of North America, Inc. v. Department of Treasury, Michigan Court of Appeals, No. 356950, July 21, 2022.

Personal income tax: Out-of-state holding company not subject to Detroit income tax

A taxpayer didn’t have nexus with the City of Detroit under either a pre- or post-Wayfair analysis to justify the imposition of Detroit income taxes on its dividends and gains. The Michigan Tax Tribunal reached this decision on remand of the case from the Court of Appeals.

The taxpayer was a Delaware company created merely to hold stock in a Canadian company. The taxpayer had a Delaware mailing address, but on an annual report filed in Delaware, it listed a principal place of business in Detroit. The taxpayer received dividends from the Canadian company and later sold its interest in the company. The city assessed income taxes on the dividends and gain. The taxpayer stated that it had no office, property, or employees, made no sales, and hand no market in Detroit. It said that one of its shareholders accepted mail on its behalf at an office in Detroit for administrative convenience.

The city asserted that the taxpayer’s commercial domicile was in the city, because that was where it managed its business and had a business office. Alternatively, the city argued that even if the taxpayer was domiciled out of state, it had agents in the city conducting activities on its behalf, and their physical presence created nexus with the city. The city further contended that nexus was established because the taxpayer was part of its parent’s Detroit unitary business.

According to the Tribunal, although the taxpayer was “doing business” under the broad statutory definition, the taxpayer lacked nexus with the city because it had no physical presence or minimum connection with the city, nor did it substantially avail itself of the Detroit marketplace. The taxpayer’s only contact with the city was through its officers and directors. Under the city’s own regulations, the activities and presence of these agents were excluded from the “doing business” determination. In addition, the Tribunal rejected the city’s reliance on the commercial domicile concept, as that term didn’t appear in the City Income Tax Act and was otherwise irrelevant to the determination of whether the taxpayer was doing business in the city. The Tribunal also found that the city’s reliance on the unitary business concept was misplaced, because the City Income Tax Act didn’t include that concept, nor was there any language that would allow a unitary business to create a nexus link to a corporation.

Apex Laboratories International Inc. v. City of Detroit, Michigan Tax Tribunal, No. 16-000724-R, August 19, 2022.

Mississippi

Corporate income tax: Guidance issued on pass-through entity election

The Mississippi Department of Revenue has issued guidance on the pass-through entity election, effective for tax years beginning on or after Jan. 1, 2022. The election allows any partnership, S corporation or similar pass-through entity to elect to be taxed as an “electing pass-through entity” for state income tax purposes and to pay income tax at the entity level. Each owner, member, partner, or shareholder of an electing pass-through entity must report their pro rata or distributive share of the income from the electing pass-through entity and is allowed a credit against income taxes in an amount equal to his or her pro rata or distributive share of income tax paid by the electing pass-through entity for the corresponding taxable year.

Eligibility

Any partnership, S corporation or similar pass-through entity desiring to be taxed as an electing pass-through entity must have a vote by or written consent of the members of the governing body of the entity, as well as a vote by or written consent of the owners, members, partners, or shareholders holding greater than 50% of the voting control of the entity in order to make the election. Fiduciaries aren’t eligible to make a pass-through entity election.

Making or revoking an election

Both the election to become an electing pass-through entity and the revocation of that election is made by submitting Form 84-381, Pass-Through Entity Election Form, to the department on or before the 15th day of the third month following the close of the taxable year for which the entity elects to be taxed as an electing pass-through entity, or for which the entity elects to no longer be taxed as an electing pass-through entity.

Return filing

An electing PTE must file Form 84-105, Pass-Through Entity Tax Return, and check the “Electing Pass-Through Entity” box in order to be taxed at the entity level. A copy of Form 84-132, Pass-Through Entity Election Form, should also be attached to the return. The Mississippi Schedule K-1s for each owner, member, partner, or shareholder of the electing PTE are also required to be attached to the return. The K-1s should have the “Electing Pass-Through Entity” check box checked with the amount of tax paid by the electing PTE for each partner provided on the K-1s. The Pass-Through Entity Tax Return is due on or before the 15th day of the third month following the close of the taxable year.

Estimated tax payments

Electing PTEs that have an annual income tax liability in excess of $200 are required to make estimated tax payments. Payments are due on or before the 15th day of the fourth, sixth, ninth, and 12th months of the income year, and should be submitted using Form 84-300, Pass-Through Entity Income Tax Voucher. Estimated tax payments must not be less than 90% of the annual income tax liability.

Penalty and interest may be imposed for taxpayers who fail to file and pay estimated taxes, or who underestimate the required amounts. However, any electing PTE that receives a penalty notice for underestimate on the 2022 first and second quarter estimated payments are advised to contact the department to receive abatement.

Composite returns

A pass-through entity can elect to file the Pass-Through Entity Tax Return as an electing PTE or as a composite pass-through entity, but not both. Composite returns can only be filed on behalf of nonresident partners with no other activity in Mississippi other than that from the pass-through entity. Once an entity begins to file a composite return, it must continue to file in that manner unless permission to change has been granted by the department or until an election to file as an electing PTE has been made.

Credit for taxes paid on the electing pass-through entity return

Each owner, member, partner, or shareholder of an electing PTE must report their pro rata or distributive share of the income of the electing PTE on their separate income tax returns. The amount of credit for taxes paid on the electing PTE will be calculated by the entity and provided to the partner on the Mississippi K-1. A copy of the K-1(s) received from the electing PTE must be attached to the partner’s separate return. The amount of credit allowed will be limited to the partner’s income tax due and any excess credit can’t be refunded or carried forward.

Notice 80-22-001, Mississippi Department of Revenue, July 28, 2022.

New Jersey

Unemployment compensation: Payroll tax doesn’t discriminate against interstate commerce

The New Jersey Supreme Court affirmed an appeals court decision upholding the imposition of payroll tax on Jersey City businesses (taxpayers) because the tax doesn’t discriminate against interstate commerce or violate the commerce clause of the U.S. Constitution. In this matter, the taxpayers challenged a Jersey City ordinance that imposes a 1% payroll tax on employers for the purpose of funding public education but exempts employers from paying the tax for employees who are residents of Jersey City, allegedly in violation of the commerce clause of the U.S. Constitution. The trial court granted the Department of Revenue’s motion to dismiss the complaint, concluding that the ordinance was a valid constitutional exercise of Jersey City’s authority. Subsequently, the appeals court affirmed the trial court’s ruling except as it pertained to the taxation of employees who work out of state but are supervised by someone in Jersey City. The appeals court noted that: (1) the “residency exemption” applies without respect to whether the employer is a resident of this state or another; and (2) there was no evidence that the payroll tax as enacted was either intended to, or did, burden out-of-state residents, or that employers were or would be inhibited from hiring them. Finally, the appeals court stated that the taxation of services of employees who work out of state but whose supervisor is based in Jersey City was internally inconsistent and violated the commerce clause. Accordingly, the supreme court affirmed the appeals court’s decision.

Mack-Cali Realty Corp. v. State of New Jersey, Supreme Court of New Jersey, No. 085465, May 31, 2022, released July 2022.

Corporate, personal income taxes: Tax credit purchase program regulations adopted

New Jersey has adopted regulations to implement the income tax credit purchase program that applies to credits issued under the:

• Historic Property Reinvestment Act
• Brownfield Redevelopment Incentive Program Act
• New Jersey Innovation Evergreen Act
• Food Desert Relief Act
• New Jersey Community-Anchored Development Act
• New Jersey Aspire Program Act
• Emerge Program Act
• Grow New Jersey Assistance Program
• Offshore Wind Economic Development Tax Credit Program
• State Economic Redevelopment and Growth Grant Program
• Film and Digital Media Tax Credit Program

What is the tax credit purchase program?

Under the program, a taxpayer with a tax credit from an eligible program can submit an application to have New Jersey purchase the credit. Taxpayers are eligible for the program if:

• The taxpayer has made a good faith effort to utilize or transfer the tax credit, and the taxpayer can establish those efforts by certification.
• The taxpayer is in tax compliance with New Jersey.
• The taxpayer is registered and in compliance pertaining to business registration with the Division of Revenue and Enterprise Services.

However, New Jersey won’t purchase credit if it has previously purchased tax credits from the taxpayer within two years from the filing date of the taxpayer’s previous application.

How much will New Jersey pay for a credit?

A New Jersey tax credit presented:

• More than three years before its expiration is eligible for purchase at a value not to exceed 20% of the value of the credit.
• More than two years before its expiration, but less than three years before its expiration, is eligible for purchase at a value not to exceed 40% of the value of the credit.
• More than one year before its expiration, but less than two years before its expiration, is eligible for purchase at a value not to exceed 60% of the value of the credit.
• Less than one year before its expiration, but at least 90 days before its expiration, is eligible for purchase at a value not to exceed 75% of the value of the credit.

Emerge Program Act and Community-Anchored Development Program credits that are presented for purchase must not be presented less than two years after issuance and will be reimbursed at 90% of the value of the credit.

N.J.A.C. 18:34, New Jersey Division of Taxation, effective Aug. 15, 2022.

Tennessee

Franchise tax: Taxpayer not required to add back short-term intercompany trade payable

A corporation (taxpayer) wasn’t required to add back a short-term intercompany trade payable owed by its U.S. branch to its affiliates for Tennessee franchise tax purposes. In this matter, the taxpayer conducted operations within the United States through its U.S. branch. The U.S. branch purchased inventory from affiliated plants to serve customers, which created a short-term intercompany trade payable that was settled on a monthly basis.

The taxpayer requested a ruling on whether, under the applicable statute, it was required to add back the short-term intercompany trade payable owed by its U.S. branch to the affiliates for purposes of calculating its tax liability. The Department of Revenue (department) noted that the trade payable owed by the U.S. branch to the affiliates was settled on a monthly basis; therefore, the taxpayer appropriately classified it as a current liability for financial reporting purposes. Under the department’s position, trade payables that are current liabilities aren’t treated as affiliated debt, and therefore the addback provision didn’t apply in this case.

Letter Ruling No. #22-03, Tennessee Department of Revenue, May 4, 2022, released July 2022.

Sales and use tax: Seller and service fees made by a delivery network company were not subject to tax

Seller and service fees charged by a delivery network company that elected to register with the Tennessee Department of Revenue as a marketplace facilitator weren’t subject to sales and use tax.

Seller and service fees

The taxpayer charged the fees to third-party sellers and service providers for the service of connecting them to purchasers and for processing payments. Both the sellers and service providers were also provided access to the taxpayer’s web-based interface and app.

True object of the transactions

The taxpayer’s nontaxable lead generation and payment processing services were the true object of the transactions covered by these fees. The taxable web-based interface and app were merely incidental to that true object. The software that provided the sellers and service providers access to the platform merely facilitated lead generation and payment processing. Without connecting to purchasers who pay for items and have them delivered, the software would be of little to no use to the sellers and service providers.

Letter Ruling No. 22-02, Tennessee Department of Revenue, April 11, 2022, released July 2022.

Texas

Corporate income tax: Research and development activities credit rule amended

Texas amended its franchise tax research and development activities credit rule to:

• Amend the definition of the Internal Revenue Code to include federal regulations adopted after Dec. 31, 2011, if a taxable entity could have applied the regulations to the 2011 federal income tax year.
• Explain how to determine the credit carryforward when the membership of a combined group changes.
• Clarify that the conveyance, assignment, or transfer of an ownership interest in a taxable entity isn’t a conveyance, assignment, or transfer of the credit by the taxable entity.

Application of federal regulations adopted after Dec. 31, 2011

Examples of federal regulations adopted after Dec. 31, 2011, that a taxable entity could have applied to the 2011 federal income tax year include:

• Treasury Reg. Sections 1.174-2 (definition of research and experimental expenditures), revised as of July 21, 2014.
• Treasury Reg. Sec. 1.41-4 (qualified research for expenditures paid or incurred in taxable years ending on or after Dec. 31, 2003), revised as of Nov. 3, 2016, except for paragraph (c)(6) (internal use software), for which a taxpayer may elect to follow two different versions.

Determining credit carryforward when membership of a combined group changes

When the membership of a combined group changes, the credit carryforward will be determined as follows:

• The credit carryforward attributable to a member of a combined group for each prior report year is determined by multiplying the total credit carryforward available for that report year by a fraction, the numerator of which is the qualified research expenses paid or incurred by the member during that report year, and the denominator of which is the total qualified research expenses paid or incurred by the combined group during that report year.
• If a combined group loses a member, the credit carryforward will be attributed to each member of the combined group that was included on the report for the report year to which the carryforward relates, and each member of the combined group that has a credit carryforward attributed to it, including the member that leaves the combined group, may continue to use that carryforward on its future franchise tax reports.
• If a taxable entity that wasn’t part of a combined group when it created a credit carryforward later joins a combined group, any credit carryforward it had previously established may be claimed on the combined group’s future franchise tax reports.
• If a taxable entity, including a member of a combined group, is a nonsurviving entity in a merger transaction, any credit carryforward established by the nonsurviving entity may be claimed on the surviving entity’s future franchise tax reports.
• Except in the merger scenario described above, if a taxable entity, including a member of a combined group, is terminated, dissolved, or otherwise loses its status as a legal entity, the credit carryforward attributable to that taxable entity may not be claimed on any future franchise tax report.
• If all of the assets of a member of a combined group are conveyed, assigned, or transferred in the merger scenario described above, the carryforward attributed to that member may be conveyed, assigned, or transferred as part of that transaction.
• A combined group may use a credit carryforward attributable to a member under these provisions only if that member is part of the combined group on the last day of the accounting period on which that report is based.

34 TAC 3.599, Texas Comptroller of Public Accounts, effective Aug. 4, 2022.

Virginia

Sales and use tax: Remote seller’s nexus discussed

In a letter ruling, the Virginia Tax Commissioner (commissioner) determined whether a remote seller’s use of banner advertisements for sales promotion, or its relationship to its parent company, triggered sales and use tax nexus requirements.

In this matter, the taxpayer requested for a ruling on (1) whether its use of digital banner ads constituted in-state solicitation for nexus purposes; and (2) if its parent created nexus for it in the state.

Under Virginia law, the term “dealer” includes every person who, “sells at retail, or who offers for sale at retail, or has in his possession for sale at retail, of for use, consumption, or distribution, or for storage to be used or consumed in this Commonwealth, tangible personal property.” The commissioner noted that the taxpayer qualified as a “dealer” as it was selling tangible personal property for use and consumption in Virginia.

Moreover, the banner advertisements didn’t meet nexus requirements, and a dealer engaging solely in such activity in Virginia wasn’t required to collect and remit sales and use tax. Also, the taxpayer didn’t provide sufficient details of the parent’s activities in Virginia, or the taxpayer’s relationship to the parent, for the commissioner to definitively rule on nexus.

Ruling of Commissioner, P.D. 22-55, Virginia Department of Taxation, March 30, 2022, released July 2022.

Wisconsin

Corporate income tax: Out-of-state travel services provider properly subject to tax

A Florida corporation that sold travel services through independent travel consultants (ITCs) in Wisconsin was properly subject to corporate income tax assessment as the taxpayer’s services weren’t covered under the ambit of the federal law that barred Wisconsin from imposing a net income tax on the income from foreign corporations engaged in interstate commerce.

In this matter, the Wisconsin Department of Revenue (department) issued an assessment against the taxpayer as the taxpayer didn’t pay the tax for the tax years at issue. The taxpayer protested against the assessment and asserted that the federal law barred Wisconsin from imposing a net income tax on the income from foreign corporations engaged in interstate commerce and that it was in the business of selling Software as a Service (SaaS).

Upon review, the tax appeal commission noted that the travel services weren’t tangible personal property protected by the federal law and that the taxpayer didn’t sell software or SaaS. Moreover, the taxpayer had nexus with Wisconsin as the taxpayer had contracts with ITCs located in Wisconsin which received commissions from the taxpayer for sales of travel services in Wisconsin. Accordingly, the taxpayer was properly subject to Wisconsin corporate income tax.

ASAP Cruises, Inc. v. Wisconsin Department of Revenue, Wisconsin Tax Appeals Commission, No. 19-I-258, May 23, 2022, released July 2022.