RSM Resources

California

FTB to appeal new decision on LLC fee
In a recent ruling, the San Francisco superior court released a tentative decision that California’s limited liability company (LLC) fee is unconstitutional and cannot be reformed. In Ventas Finance I, LLC v. California Franchise Tax Board, the court ruled that the LLC fee is a tax and is unconstitutional because it isn’t fairly apportioned. The court further ruled that because the California Legislature considered and rejected an apportionment scheme, the Franchise Tax Board’s (FTB) suggestion to add an apportionment mechanism would be counter to the Legislature’s expressed intent.

The FTB indicated that it will appeal this decision. The FTB also indicated that it will hold meetings in the near future to discuss potential taxpayer remedies in the event its appeal is unsuccessful. This decision follows a similar decision by the San Francisco superior court in Northwest Energetic Services, LLC v. California Franchise Tax Board. Ventas Finance I LLC v. California Franchise Tax Board, tentative decision, Nov. 6, 2006 and telephone call with FTB on Dec. 21, 2006

State supreme court denies two sales factor cases, returns two others
The California Supreme Court denied petitions in Microsoft Corp. v. Franchise Tax Board and General Motors Corp. v. Franchise Tax Board. These cases involve apportionment of short-term marketable securities by multistate unitary businesses. In Microsoft the court ruled that receipts from redemption of marketable securities are includible in the sales factor. It also found the FTB successfully established that the company should use an alternate formula that excludes return of principal. In General Motors the court ruled that only the interest produced by repurchase agreements should be included as gross receipts in the sales factor.

In light of its decisions in Microsoft and General Motors, the California Supreme Court returned Toys “R” Us, Inc. v. Franchise Tax Board and The Limited Stores, Inc. v. Franchise Tax Board to the appellate courts. These cases relate to returns of principal from short–term investments and the appellate courts are instructed to vacate their decisions and reconsider the cases in light of the rulings in Microsoft and General Motors. Toys “R” Us, Inc. v. Franchise Tax Board and The Limited Stores, Inc. v. Franchise Tax Board, denied and returned Nov. 15, 2006

Illinois

Taxpayer did not elect to forego right to carry back NOL
A corporate taxpayer was allowed to carry back losses it had previously carried forward to offset new liabilities despite the state’s contrary position. The dispute in this case began when the Illinois Department of Revenue audited the taxpayer and determined that it should exclude losses from its Wisconsin subsidiaries. Before the audit was completed, however, the taxpayer filed for bankruptcy and reorganized.

Following the taxpayer’s reorganization, the department issued a claim for additional taxes determined in the audit. In bankruptcy court the taxpayer argued that it had non-Wisconsin subsidiary operating losses and should be allowed to carry them back against its new Illinois liabilities. The department disagreed with the taxpayer’s position, but lost the issue in bankruptcy court.

On appeal to the federal district court, the department argued that the taxpayer was precluded from using available carryback losses because it filed an Illinois income tax return that carried those losses forward. The department viewed a carryforward election as an irrevocable election to waive the right to carryback losses. Alternatively, the department argued that the common law duty of consistency prevented the taxpayer from changing its position to its advantage.

The federal district court held that the taxpayer was not prevented from carrying back its losses under the duty of consistency. The court stated that this duty did not bar the taxpayer from using carryback losses because the duty is imposed to preclude taxpayers from “gaming the system by flip-flopping positions after the statute of limitations expires to gain an advantage.” Here, the taxpayer merely carried its net operating losses forward because it had no taxable income. Later, when taxable income resulted from disallowed losses, it carried back other losses.

The court also disagreed with the department’s interpretation that a carryforward election irrevocably waives the right to carry those losses back. It held that the department’s regulation on this matter is silent on how a taxpayer makes an election to forego carryback periods. Since it’s silent, the court looked at the unambiguous language of the statutes and regulations and held that neither precluded the taxpayer from carrying back net operating losses against its new liability. The Illinois carryback provisions apply to tax years ending prior to Dec. 31, 2003. Illinois Department of Revenue v. Envirodyne Industries, Inc., Oct. 31, 2006

Indiana

Out-of-state property management services not “doing business” in Indiana
A recent Indiana letter ruling determined an Ohio company that provided management services to a partnership with an Indiana apartment building wasn’t doing business in Indiana for gross and adjusted gross income tax purposes. The management company had no employees in Indiana, but it collected rent from Indiana property on behalf of the partnership. On audit, the department determined the taxpayer wasn’t in a true agency relationship with the partnership because the department construed the management agreement to read that the property management company was allowed to keep certain late fees and similar charges. The department also determined that a payroll reimbursement clause in the management contract indicated the management company had employees in Indiana.

This letter ruling determined that the management company’s agreement with the partnership did not allow it to keep late fees. It also indicated that the management agreement explicitly stated the Indiana employees were employees of the partnership, not the management company. Consequently, the management company was in a true agency relationship with the partnership and did not have income-generating activity in Indiana. Letter of Findings No. 03-0407, Sept. 20, 2006

New Jersey

No physical presence required for income tax nexus
In a per curiam decision of national importance, the New Jersey Supreme Court held that the state can impose corporate business tax on Lanco, Inc. despite its lack of physical presence in the state. Lanco is a Delaware corporation that licenses trademarks, trade names and service marks to Lane Bryant, a clothing retailer. Lanco has no real or personal property or personnel in New Jersey, but it derives income through its licensing agreement with a company with operations in the state.

The New Jersey court affirmed the appellate court decision to impose income tax without physical presence. The court also added that it interprets the U.S. Supreme Court ruling in Quill Corp. v. North Dakota as limited to sales and use taxes. The court believes the Supreme Court didn’t intend to create a universal physical presence requirement for all state taxation in Quill.

New Jersey’s Supreme Court is the second state high court to use an economic nexus approach to allow taxation of a corporation with no physical presence. South Carolina’s Supreme Court issued the first such opinion in Geoffrey, Inc v. South Carolina. West Virginia’s Supreme Court also adopted economic nexus in a recent decision. In other states, lower courts have ruled for and against taxpayers on the issue of physical presence requirements for taxation. New Jersey’s Supreme Court referred to this “split of authority” among the states and affirmed that it sided with those states that interpret Quill’s application to only sales tax. Lanco, Inc. v. Director, Division of Taxation, Oct. 12, 2006

New York

Unrelated business income tax applies to employee trusts
On Nov. 9, 2006, the New York Department of Taxation and Finance issued a bulletin on the application of unrelated business income tax (UBIT) to employee trusts. Employee trusts as described in IRC section 401(a) must file and pay New York UBIT on unrelated trade or business in the state beginning Jan. 1, 2006.

Until this bulletin, New York didn’t subject employee trusts to UBIT based on a 2003 tax appeals tribunal decision that held that the Employee Retirement Income Security Act (ERISA) prohibited taxation of such trusts. In early 2006, however, the United States Court of Appeals for the Second Circuit determined in Hattem v. Schwarzenegger that ERISA doesn’t prohibit California from taxing an employee trust as described in IRC section 401(a). Since New York’s UBIT is substantially similar to California’s, the issue before that court was the same as the issue before the tax appeals tribunal. Further, since New York is part of the federal second circuit, the department determined that the federal appeals court decision supersedes that of the tax tribunal. The bulletin also notes that the federal appeals court decision specifically mentioned the tax tribunal’s decision and rejected its reasoning. TSB-M-06(6)C, Nov. 9, 2006

North Carolina

Carryover of unused business investment credits not always available
A partner who received more than $50,000 in qualified business investment tax credits from two partnerships was unable to carry over unused credits on his North Carolina individual income tax return. The partner, who filed jointly with his spouse, cited a North Carolina statute permitting carryover of unused credits and argued that it allowed him to carry over unused qualified business investment credits in excess of the $50,000 limit.

The North Carolina Department of Revenue, however, determined that the maximum credit a pass-though entity owner can claim for investments in qualified businesses is limited to $50,000. This limit applies regardless of the amount or number of investments in qualified businesses in a single year. The department indicated that the carryover provision cited by the taxpayers applied to unused credits resulting from other limitations on claiming the credit, such as limitations due to other allowable credits or the amount of income tax imposed. Because the taxpayers used their available $50,000 credit, they had no unused credit available to carry over to succeeding years. Secretary of Revenue Decision No. 2006-2, June 26, 2006 (released Oct. 31, 2006)

Texas

Margin tax developments
The Texas Comptroller of Public Accounts Office recently provided additional guidance regarding Texas’ upcoming revised franchise tax, also known as the margin tax. Texas’ margin tax is effective for tax years ending on or after Dec. 31, 2007.

• Dormant and inactive companies must file returns
  A taxable entity with a computed tax liability less than $1,000 or total revenue from its entire business less than $300,000 does not owe Texas margin tax, but it must file a short form report. This filing requirement applies to dormant and inactive companies. Texas Comptroller of Public Accounts Letter No. 200608778L, Aug. 23, 2006
  
  
• Compensation deduction limited to $300,000 per person; does not include 1099 employees
  Taxable margin will be calculated as the lesser of revenue less cost of goods sold or compensation, not to exceed 70 percent of total revenue. For purposes of the margin tax, the compensation amount is limited to $300,000 per person but does not include compensation paid to workers receiving a Federal Form 1099 or to undocumented workers. Texas Comptroller of Public Accounts Letter Nos. 200608757L and 200609761L, Aug. 24, 2006 and Sept. 6, 2006

West Virginia

State supreme court affirms economic nexus
In the latest case involving economic nexus, the West Virginia Supreme Court recently ruled that a Delaware-domiciled bank with no physical presence in the state was subject to West Virginia business franchise and corporation net income tax. The court held that the bank’s continuous and systematic direct mail, telephone solicitation and promotion in West Virginia, along with its significant gross receipts in the state, indicated a significant economic presence sufficient to meet the substantial nexus prong of Complete Auto Transit, Inc. v. Brady.

Similar to the New Jersey Supreme Court, the court here also held that the physical presence standards adopted in National Bellas Hess, Inc. v. Illinois Revenue Department and Quill Corp. v. North Dakota apply only to sales and use taxes. In support of its position, the court first noted that it agreed with a lower court’s holding that the U.S. Supreme Court’s decision in Quill is based primarily on stare decisis. The court further examined the Supreme Court’s language in Quill and determined that a reasonable construction implies that Quill applies only to sales and use taxes. In its third point, the court noted that the Bellas Hess and Quill courts based their decisions in part on the undue collection burden of sales and use taxes. As a final point, the court also stated its opinion that the development and proliferation of communication technology now makes it possible for an entity to have a significant economic presence in a state without a physical presence.

The bank argued that a greater nexus requirement should be applied to direct taxes such as income and franchise taxes because they are more burdensome due to a compliance duty and direct payment obligation. The court rejected this argument by stating that the Bellas Hess and Quill courts placed significant weight on the compliance burdens of collecting sales and use taxes. The court also rejected the bank’s argument that adopting a substantial nexus requirement less than physical nexus is applying only a Due Process minimum contacts standard and not a Commerce Clause standard. The court summarized its position by stating that although a substantial economic presence standard is more elastic than a bright-line test, a greater nexus is required under it than under the minimum contacts standard. Tax Commissioner v. MBNA America Bank, N.A., Nov. 21, 2006