11th annual domestic tax conference - ey · pdf file4/28/2016 · transmitted or...

Domestic Tax Conference28 April 2016 | New York City

11th Annual

Multistate income tax hot topics

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Views expressed in this presentation are those of the speakers and do not necessarily represent the views of Ernst & Young LLP.

This presentation is provided solely for the purpose of enhancing knowledge on tax matters. It does not provide tax advice to any taxpayer because it does not take into account any specific taxpayer’s facts and circumstances.

These slides are for educational purposes only and are not intended, and should not be relied upon, as accounting advice.

Today’s presenters

Mark McCormick Partner, Ernst & Young LLP

Mike Semes Principal, Ernst & Young LLP

Steve WlodychakPrincipal, Ernst & Young LLP

Smitha HahnSenior Manager, Ernst & Young LLP

Agenda

► Interplay between Nexus and apportionment ► Nexus expansion► Move toward single sales factor apportionment and

market-based sourcing for services and non-tangible property

► Alternative apportionment► Interplay between state and international

► ALAS, transfer pricing and OECD BEPS► State implications of Section 385 regulation proposal► Tax havens

► Other notable developments► Federal pass-through entity audit reform► US Supreme Court’s ruling in Wynne and CSX► Major tax reform► Attempts to apply law change retroactively► MTC apportionment election cases

Nexus expansion

Nexus expansion since 2007Economic nexus – factor presence standards

► Bright-line sales factor presence standards adopted► Alabama – effective 1 January 2015 ► California – effective 1 January 2011 ► Colorado – effective 30 April 2010► Michigan – effective 1 January 2008► Nevada – effective 1 July 2015 (Commerce Tax)► New York – for credit card banks only effective 1 January 2008; expanded to all Article 9-A

taxpayers 1 January 2015 ► New York City – for credit card banks only effective 1 January 2011► Ohio – effective 1 July 2005 (Commercial Activity Tax) ► Tennessee – effective 1 January 2016 (but see J.C. Penney, which requires physical presence)► Washington – effective 1 June 2010 (Business and Occupation Tax)

Nexus expansion since 2007Economic nexus – purposeful direction

► Purposeful direction of business to the state/doing business in the state ► Connecticut – effective 1 January 2010*► New Hampshire – effective 1 July 2007► Oregon – effective 8 May 2008► Rhode Island – effective 12 January 2016► Wisconsin – effective 1 January 2009

Be aware that a challenge to Quill is gathering force as states, including Alabama and South Dakota, have enacted economic nexus provisions for sales and use tax purposes. These new provisions are in direct challenge to Quill and a constitutional challenge to these provisions could make it to the US Supreme Court.

*Does not apply to foreign corporations unless they have effectively connected income – effective 1 January 2011

Move toward single sales factor apportionment and market-based sourcing for services and non-tangible property

2000: states with a 3-factor formula

DC

MD

AK

HI

ME

RI

VTNHMANY

CT

PANJ

DEWV

NC

SC

GA

FL

ILOH

IN

MIWI

KY

TN

ALMS

AR

LATX

OK

MOKS

IA

MN

ND

SD

NE

NMAZ

COUT

WY

MT

WA

ORID

NV

CAVA

*Some additional states were in the process of phasing in to a single sales factor apportionment formula

Key3-factor formulaSingle sales factor formulaNo income tax

2016: states with a 3-factor formulaAs of 6 April 2016

DC

AK

HI

ME

RI

VTNHMANY

CT

PANJ

DEWV

NC**

SC

GA**

FL

ILOHIN

MI WI

KY

TN

ALMS**

AR

LA**TX

OK**

MO*KS

IA

MN

ND

SD

NE

NM**AZ*

COUT**

WY

MT

WA

ORID**

NV

CA**VA*

MD NJ RI

DE*

3-factor formula: equal weighting 3-factor formula: unequal weighting Single sales factor formulaNo income tax

*Single sales factor is either electable or being phased-in**Different apportionment rules apply to certain industries

2000: sourcing of multistate service revenue

RI

DC

DE

AK

HI

ME

VTNHMANY

CT

PANJ

WV

NC

SC

GA

FL

IL OHIN

MIWI

KY

TN

ALMS

AR

LATX

OK

MOKS

IA

MN

ND

SD

NE

NMAZ

COUT

WY

MT

WA

ORID

NV

CAVA

MD

Source to state where greater portion of income producing activity performed (“all or nothing”)

Source to state to the extent services performed in state (“to the extent of” or “direct”)

Source to state where benefit of service received (“benefit” or “market”)

No income tax

2016: sourcing of multistate service revenue As of 6 April 2016

Source to state where greater portion of income producing activity performed (“all or nothing”)Source to state to the extent services performed in state (“to the extent of” or “direct”)Source to state where benefit of service received (“benefit” or “market”)No income tax

AK

HI

ME

MA

VTNHMANY

CT

PANJ

DE

RIWV

NC

SC

GA

FL

IL OHIN

MIWI

KY

TN

ALMS

AR

LATX

OK

MOKS

IA

MN

ND

SD

NE

NMAZ

COUT

WY

MT

WA

ORID

NV

CAVA

MD

DC

Alternative apportionment

When to use alternative apportionment

Proposed method is better


Statutory formula results in distortion


► What is fair/equitable?► What is distortion?► Who bears the burden of proof? ► Same facts may yield different results in different states.► Recent cases:

► Tennessee – Vodafone Americas Holdings (Tenn. S. Ct. 23 March 2016) – Court upheld Commissioner issuance of a variance requiring taxpayer to use an alternative apportionment.

► Indiana – Rent-A-Center East (Ind. Tax Ct. 10 September 2015) – Court disallowed revenue department’s use of forced combination.

► Indiana – Columbia Sportswear USA (Ind. Tax Ct. 18 December 2015) – Court disallowed revenue department’s adjustments to a multistate corporate retailer's Indiana net income.

► Virginia – Corporate Executive Board (Va. Cir. Ct. 25 February 2016) – Court held taxpayer was not allowed to use an alternative apportionment method.

q

ALAS, transfer pricing and OECD Base Erosion and Profit Shifting (BEPS)

Multistate Tax Commission’s (MTC) transfer pricing program

► MTC will run Arm’s-Length Adjustment Services (ALAS) program.► Purpose/vision: The MTC holds multistate transfer pricing audits akin to the income and

sales/use tax audits they currently do.► ALAS staff would work in conjunction with participating states on:

► Training► Transfer pricing analysis► Information exchange, process improvement and case assistance► Case resolution and litigation support services► Optional joint audits

► Minimum commitment of 10 states required for economic viability► 6 states have formally committed (AL, HI, IA, KY, NJ and PA).► 8 states have expressed strong interest (CT, DC, FL, GA, IN, LA, NCand TN).► ALAS hopes to garner support from additional states going forward.

► Training held in 2015, conducted by developer of many IRC § 482 rules – Ednaldo Silva

State transfer pricing activity

► Some states have enacted a statutory provision similar to IRC Section 482, while other states have adopted (explicitly or implicitly) IRC Section 482.► With few exceptions, most states can make transfer pricing-type adjustments.

► Most states without an intangible addback have exercised these powers as a mechanism to force combination (or some settlement) of intangible expense deductions.

► Few states have attempted to perform actual transfer pricing analysis.► Some states are using automated software.► States hiring outside consultants to do transfer pricing audits based on IRC Section

482 standards.► More hired as required in appeals (NY, MN, etc.) Litigation pending in District of Columbia.

► Multiple service firms offering transfer pricing services to states.

What should taxpayers do about transfer pricing?

► Before the audit starts► Make sure transfer pricing is aligned with business

► Value drivers► Substance

► Document arm’s-length nature of transfer prices► Create and follow intercompany agreements

► After the audit starts► If arm’s-length nature of transfer prices are not already documented, do so!► Evaluate whether proposed adjustment is based on transfer pricing principles► Perform cost-benefit analysis on audit defense efforts

OECD BEPS action plan

1) Tax challenges of digital economy –September 2014

2) Hybrid mismatch arrangements –September 2014

3) Controlled foreign company (CFC) rules –September 2015

4) Deductibility of interest and other financial payments – September/December 2015

5) Harmful tax practices – September 2014/September 2015/December 2015

6) Treaty abuse – September 20147) Artificial avoidance of permanent establishment

status – September 20158) Transfer pricing for intangibles –

September 2014/September 2015

9) Transfer pricing for risks and capital –September 2015

10) Transfer pricing for other high-risktransactions – September 2015

11) Development of data on BEPS and actions addressing it – September 2015

12) Disclosure of aggressive tax planning arrangements – September 2015

13) Transfer pricing documentation –September 2014

14) Effectiveness of treaty dispute resolution mechanisms – September 2015

15) Development of a multilateral instrument for amending bilateral tax treaties –September 2014/December 2015

BEPS state tax implications?

► Domestic transfer pricing scrutiny► Buy sell cos and intangibles

► Substance in structuring is critical► Financing structures should align with global treasury function► Potential for state advance pricing agreements (APAs)?► Foreign entities and foreign inbound investment

► Nexus considerations► Tax haven rules► Combined reporting implications► Apportionment trends – Market and single sales factor► Related party transactions ► Non-income based taxes

State implications of Section 385 regulation proposal

Section 385 regulation proposal

► IRC § 385 authorizes the Treasury Department to issue regulations necessary or appropriate to determine whether certain interest in corporations should be treated as stock or indebtedness was enacted in 1969

► There are no regulations currently in effect under § 385► On 4 April 2016 proposed REG-108060-15 under § 385 was introduced ► The proposed regulations would:

► Treat as stock certain related-party interests that otherwise would be treated as indebtedness for federal tax purposes

► Authorize the Commissioner of the IRS to treat certain related-party interests in a corporation as indebtedness in part and stock in part for federal tax purposes

► Establish extensive documentation requirements in order for certain related-party interests in a corporation to be treated as indebtedness for federal tax purposes

State tax considerations of the proposed Section 385 regulation

► Impact on state tax could be significant. Key issues to consider include: ► Debt versus equity characterization► State versus federal application – e.g., federal consolidated returns versus

state combined and separate returns► Timing of state adoption – because it is a regulation, is it automatically

adopted?► Impact on traditional capital structures► Co-obligor arrangements► Implications on ownership percentage for reorganization provisions and

dividend received deductions ► Impact on exceptions to state related party add-back provisions

Tax havens

Tax haven legislation in states

► Under tax haven laws adopted by certain states corporate taxpayers generally must include in their water’s-edge returns the income and apportionment factors of unitary corporate affiliates formed or engaged in business in “tax havens.”► Intent of such laws is to prevent multinational corporations from avoiding state

income taxation by shifting domestically earned income to tax haven affiliates.► There is no single, agreed-upon definition of a tax haven, but a tax haven can

be thought of simply as a country with a low or zero tax rate in which a company reports a significant amount of income (like royalty income) but has insignificant actual operations. ► A good example of a more technical definition comes from the MTC’s Model Statute

for Combined Reporting (adopted in Connecticut, DC, Rhode Island, West Virginia).

Two approaches to identify tax havens

► States generally use one of the following two approaches to identify tax havens:► “Blacklist” approach

► Derived from “old” OECD “tax havens” list► Not only the “usual suspects” (e.g., Cayman Islands, Isle of Man, Bermuda, Luxembourg), but also Ireland,

Switzerland, and the Netherlands, among others

► In June 2015, the European Commission compiled a list of “non-cooperative tax jurisdictions” based on its review of tax haven lists used by European Union Member States.

► Taxpayers argue too rigid (and possibly unconstitutional)

► “Factor” or “criteria” approach► Tax haven is statutorily defined so taxpayers generally must look to specific qualitative criteria to determine

if a jurisdiction qualifies as a tax haven.► For example, jurisdiction’s tax rate is lower than the state’s or has created a tax regime favorable for tax

avoidance, etc.

► Taxpayers argue too vague (and possibly unconstitutional)

States that have enacted tax haven legislation

► Six states and DC have already adopted tax haven laws.► Blacklist approach:

► Montana► Oregon (amended its blacklist in 2015)

► Factor or criteria approach:► Alaska (unique tax rate/intercompany transactions test)► Connecticut (enacted in 2015)► DC (enacted in 2015 but repealed its blacklist on 23 November 2015)► Rhode Island► West Virginia

► Various exemptions from inclusion are included in such laws.► States considering tax haven legislation in 2016: AL, CO, KY, ME, MN, NJ.

Arguments for and against tax haven legislation in states

► Arguments for tax haven legislation► $20b in state tax revenue loss► Belief that multinationals hide profits in “island economies”► Big business does not pay its “fair share”► Small business disadvantaged since unable to use tax haven “loophole”

► Arguments against tax haven legislation► Tax haven “blacklisting” is arbitrary and unmanageable.► No clear evidence that profit shifting to tax havens is eroding the state corporate tax base.► The business share of state and local taxes is actually increasing.► States should not return to a form of worldwide combination. ► States are adopting a go-it-alone approach that is out of sync with the rest of the international

community.

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Federal pass-through entity audit reform

State conformity to IRS partnership audit reform

► P.L. 114-74 (enacted 2 November 2015) – Includes federal partnership audit reform► Applies to partnership taxable years beginning after 31 December 2017► IRS can collect tax due at the entity level for all partnerships – Not just widely-held

partnerships like hedge funds and publicly-traded partnerships – unless the partnership is eligible and elects out

► Designated “tax matters partner” (now known as the “Partnership Representative”) has sole authority to bind the partnership and any tax bill is responsibility of current year partners

► No “joint and several liability” (differs from prior proposals)► Problems?

► Intergenerational partner problems because of IRS assessment at partnership level► Expect significant revisions to partnership agreements and LLC management agreements

State conformity to IRS partnership audit reform

► Will the states conform?► Not automatically –

► Most states conform to the IRC but only for the determination of taxable income, not for its administrative procedures – primarily amends IRC §§6221 to 6241.

► States usually have their own administrative procedures independent of the IRC.► Only one has a partnership audit manual – California FTB – and that only addresses federal

taxation of partnerships.

► Information sharing between IRS and states mean potential for more state audits► But what will the states do with (and are they prepared to deal with) that information?

► Questions for the state

US Supreme Court’s ruling in Wynne and CSX

US Supreme Court (USSC) ruling in Wynne

► Wynne (USSC 18 May 2015) – USSC held that Maryland’s personal income tax scheme, which provides a credit for taxes paid to other states for the state portion of the income tax but not for the county portion, violates the dormant Commerce Clause.

► Internal consistency test played large role.► Complete Auto Transit – Four-Prong Test

1. Applied to an activity with a substantial nexus with the state2. Fairly apportioned3. Does not discriminate against interstate commerce4. Fairly related to the services provided by the state

► Internal consistency test

Implications of Wynne

► Is it now as simple as measuring the rate of tax on interstate commercial activity and if it is higher than that imposed on purely intrastate activity, it’s unconstitutional?

► What about other state schemes? ► States without full credit for taxes paid to localities in other states (e.g., California)?► Credits for taxes paid to foreign countries?► Other tax types?

► A few other states are interpreting their own personal income tax provisions differently for consistency with Wynne.► Iowa: now calculates its out-of-state tax credit before other nonrefundable tax credits and before calculating

school district surtax; must file refund claims for previous tax years.► Kansas: permitting refund claims based on Wynne.

► First Marblehead Corp. (USSC 13 October 2015) – USSC granted certiorari but immediately vacated the judgment and remanded the case to the Massachusetts Supreme Judicial Court for further consideration in light of its 2015 ruling in Wynne.

US Supreme Court ruling in CSX Transportation

► Ala. Dept. of Rev. et al. v. CSX Transportation (USS.C. 4 March 2015) –USSC reversed and remanded 11th Circuit Court of Appeals decision ► Directed lower court to reconsider whether Alabama could justify differential

treatment of railroad operators and their competitors under federal law► Does a state discriminate against a rail carrier in violation of the 4-R Act when it

requires the rail carrier to pay sales/use tax but provides an exemption to the rail carrier’s competitors?

► Decision goes to the breadth of review of discrimination in state tax cases – whether a state may look at the total scope of state taxation in a case to determine if an individual tax discriminates or not

Major tax reform

Major tax reform

► Louisiana ► Expansion of the franchise tax► Cap net operating loss (NOL) deduction; change use of NOL ordering to LIFO► Possible change from graduated tax rate to flat rate but only if voters approve removal of

corporate deduction for federal income taxes paid ► Connecticut

► Mandatory combined reporting, with tax haven provisions ► Adoption of a single sales factor apportionment ► Limit use of NOLs and tax credits

► New York State and City ► Merger of bank franchise tax into corporate franchise tax► Adoption of more traditional mandatory combined reporting► Disconnects between New York State and New York City law (e.g., nexus, apportionment)

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Attempts to apply law change retroactively

Arguments to apply law change retroactively, when it’s not retroactive

► New York – In re Expedia, Inc. (N.Y. Div. Tax App. 5 February 2015) – Out-of-state internet travel company's receipts from reservations are derived from the performance of services and are properly sourced outside of New York because all of the income producing activity was performed outside New York.

► Tax division applied a customer sourcing approach that was not in effect until 2015 and runs contrary to the statutory scheme in place (cost-of-performance) during the years at issue.

► California – Craigslist Inc. (Cal. St. Bd. of Equal. 16 December 2015) – In determining whether online classified ad forum company is taxable in another state for purposes of applying the throw-out rule, company must use nexus rules in effect for tax year at issue.

► Physical presence rule in place for 2007, company argued it had nexus in other states using a factor presence nexus standard, which was adopted by California in 2011.

State tax department Taxpayer

MTC apportionment election cases

Multistate tax compact apportionment election cases

► In Gillette the California Supreme Court held the Multistate Tax Compact equally-weighted apportionment election is unavailable in the state.► Being appealed to the US Supreme Court – case name change to Proctor and Gamble.

► Michigan Supreme Court upheld the use of the Compact election, BUT in response the state enacted legislation retroactively repealing the Compact. ► Michigan Court of Appeals (COA) upheld the constitutionality of the Compact repeal legislation; taxpayers are appealing

this ruling. ► COA held Compact election available for Single Business Tax, retroactive repeal not applicable.

► Minnesota Tax Court rejected Kimberly-Clark’s use of the Compact election, upheld state’s repeal of the provision. ► Minnesota Supreme Court heard arguments in the case on 11 January 2016.

► In Health Net, the Oregon Tax Court granted state’s motion for summary judgment upholding the legislation disabling the Compact election.► Decision has been appealed.

► Texas Court of Appeals denied Graphic Packaging’s use of the Compact election, holding the revised franchise (Margin) tax is not an income tax.► Decision has been appealed.

Domestic Tax Conference28 April 2016 | New York City

11th Annual

11th annual domestic tax conference - ey · pdf file4/28/2016 · transmitted or...

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