TWIST - This Week in State Tax

Welcome to TWIST for the week of December 20th, featuring Sarah McGahan from the Washington National Tax State and Local Tax practice.

The first development we are covering today is a case from the Louisiana Supreme Court holding that legislation narrowing the sales and use tax “further processing exclusion” was invalidly enacted because it did not receive a supermajority vote in each house of the legislature. The “Tax Limitation Clause” of the Louisiana Constitution requires any legislation levying a new tax or increasing an existing tax to receive a 2/3 approval of each house of the legislature. In the court’s view, the amendments to the further processing exclusion constituted a “new tax” or an “increase to an existing tax” because the bill’s enactment caused something that was not taxable— in this case the taxpayer’s purchases of Limestone—to be rendered taxable.

In Washington State, an appeals court ruled in favor of the Department of Revenue in a case involving the application of the state’s B&O sourcing rules, which looks to where a taxpayer’s customer receives the benefit of a service.

In corporate income tax news, the Wisconsin Tax Appeals Commission concluded that income from selling certain vehicle-related environmental credits was apportionable operational or unitary income.  The income was operational in nature because the credits were inextricably tied to the taxpayer’s automaking operations. The income was also unitary in nature as the taxpayer’s regulatory compliance division was unitary with the vehicle manufacturing entities, and the sale of the credits was not a “discrete business enterprise” as envisioned by the U.S. Supreme Court in the Exxon Mobil case.

Finally, in Massachusetts, changes have been made to the law requiring certain vendors to make a sales tax advance payment. Recall that, as of April 1, 2021, Massachusetts requires vendors to make an advance payment, not later than the 25^th day of the month, of the tax collected for any taxable sale made during the first 21 days of the month. The new legislation provides a safe harbor for vendors under which the advance payment requirement is satisfied if the vendor remits, rather than the actual tax collected during the first 21 days of the month, an amount that is “not less than 80 percent of the tax collected on the gross receipts from taxable sales during the immediately preceding filing period.”

Thank you for listening to TWIST and stay well. We will be on break until 2022, so I want to wish everyone happy holidays and happy new year. 

Louisiana: Law Limiting Sales Tax Exclusion Not Validly Enacted 

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The Louisiana Supreme Court recently held that a law that narrowed a sales tax exclusion was invalidly enacted because it was not passed with a 2/3 supermajority vote.  The taxpayer at issue owned and operated an electrical power generating facility in Louisiana that was used to produce electricity, steam, and ash.  Limestone was used in the production process for the dual purpose of inhibiting the taxpayer’s sulfur emissions and producing saleable ash generated by the chemical reaction of the limestone and sulfur. Some portion of the resulting ash was sold to another company at a cost that was less than the taxpayer’s cost of the limestone. For a number of years, the taxpayer purchased its limestone exempt under the “further processing exclusion.”  In a suit that also ended up before the state supreme court, the taxpayer successfully argued that it qualified for the further processing exclusion for its limestone purchases.   Before that litigation was final, the Legislature enacted Act 3 in which it narrowed the further processing exclusion so that it did not apply to materials further processed into a “byproduct,” defined as an incidental product sold for a sales price less than the cost of the materials. After the amendments, a local parish again sued the taxpayer for tax owed on its limestone purchases. After separate litigation confirmed that the ash was a “byproduct” as required under the Act 3 amendment, the court of appeal determined that Act 3 was not validly enacted because it did not obtain the required 2/3 vote of each house of the Legislature. The parish appealed.

The “Tax Limitation Clause” of the Louisiana Constitution requires that any legislation levying a new tax or increasing an existing tax receive a 2/3 approval of each house of the legislature.  Act 3 was not enacted with a supermajority vote in each house. Thus, the issue was whether the amendments to the further processing exclusion constituted a “new tax” or an “increase to an existing tax.” In the court’s view, the test for whether a bill implicates the Tax Limitation Clause was whether its enactment caused something that was not taxable to be rendered taxable.   By narrowing the further processing exclusion to exclude purchases of materials that are further processed into a byproduct (rather than simply tangible personal property as under prior law), Act 3 subjected the taxpayer’s purchases of limestone, which were “beyond the reach of tax” before Act 3, to a new tax. Accordingly, because Act 3 was not properly enacted with supermajority support, the court concluded it was invalid. The decision was not unanimous. One justice dissented on the basis that he did not believe the taxpayer qualified for the exclusion for purchases of limestone that were consumed in the fuel production process. In the dissenting justice’s view, the exclusion would apply only to the portion of limestone that was processed into saleable ash. As such, the adoption of Act 3 was merely to clarify the prior law and did not create a new tax. Please contact Randy Serpas with questions on Calcasieu Parish School Board Sales and Use Department, et al. v. Nelson Industrial Steam Company.  

Massachusetts: New Safe Harbor for Advance Payment Requirement 

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On December 13, 2021, the Massachusetts governor approved (in part) House bill 4269, aimed primarily at addressing the allocation of federal assistance provided to the Commonwealth under the American Rescue Plan Act of 2021. The new law includes a provision amending the Commonwealth’s advance payment requirement for vendors filing returns for sales/use tax, meals tax, room occupancy tax, and marijuana retail tax. Recall that, as of April 1, 2021, Massachusetts requires such vendors to make an advance payment, not later than the 25^th day of the month, of the tax collected for any taxable sale made during the first 21 days of the month. The tax collected for any taxable sale made during the remaining days of the month is required to be remitted with the return by the 30^th day of the following month. The advance payment requirement does not apply to vendors whose cumulative sales tax or room occupancy tax liability for the preceding calendar year is less than $150,000.

The new legislation provides a safe harbor for vendors under which the advance payment requirement is satisfied if the vendor remits, rather than the actual tax collected during the first 21 days of the month, an amount that is “not less than 80 percent of the tax collected on the gross receipts from taxable sales during the immediately preceding filing period.” In addition, the legislation provides that a vendor’s advance payment “shall be credited against the actual tax liability due on the return required for the filing period.” For questions regarding the Massachusetts advance payment requirement, please contact Jonathan Benson.

Washington State: Appeals Court Upholds Department’s Benefits Received Sourcing Interpretation 

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A recent decision from an appeals court in Washington State illustrates the challenges of applying market-based sourcing rules, even when the state has issued comprehensive regulations.  The taxpayer at issue was a Seattle-based industrial design firm that offered design services to an aircraft manufacturer. When a particular airline purchased a plane, the taxpayer’s design team worked with the airline to customize the planes design to that airline’s specifications.  However, the taxpayer generally invoiced the aircraft manufacturer for these customization services, although there were times the taxpayer contracted directly with the airline for more specialized services.   The taxpayer filed a B&O tax refund on the basis that it over-apportioned its service receipts to Washington State. The Department granted the taxpayer’s refund request for taxes imposed on income received from the taxpayer’s direct contracts with airlines. However, the refund was denied with respect to the taxes paid on receipts from customization contracts with the Washington State based aircraft manufacturer. After a trial court upheld the Department’s position, the case was appealed.

Under Washington B&O tax law, service receipts are attributed to Washington if a “customer received the benefit of the taxpayer’s service” in the state. A “customer" means a "person or entity to whom the taxpayer makes a sale or renders services or from whom the taxpayer otherwise receives gross income of the business.”  When a business provides services that relate to tangible personal property, Rule 19402(303) provides that the benefit is received where the tangible personal property is located or intended expected to be located.  If the tangible personal property will be created or delivered in the future, the principal place of use is where it is expected to be used or delivered.  Relying in large part on the rule and the guidance specific to services related to tangible personal property, the taxpayer’s position was that the income should be apportioned to the location where the airline companies would use the aircraft interiors. The Department, in contrast, argued that the aircraft manufacturer was the taxpayer’s customer, and the benefit of the design service was received at the location where the planes were manufactured.  Rejecting the taxpayer’s arguments, the appeals court held that it was “clear” that the manufacturer was the taxpayer’s customer and that the manufacturer received the benefit of the services in Washington where the design services would be used during the manufacturing process.  One justice dissented on the basis that the statutory and regularity provisions were ambiguous as applied to the design services at issue, and therefore the ambiguity should be resolved in the taxpayer’s favor. The dissenting justice stressed that the rule for when services relate to tangible personal property was silent with regard to where the “customer’s” place of use occurs. Rather, the rule simply requires sourcing receipts to where the tangible personal property will be used or delivered. Please contact Michele Baisler with questions on Walter Dorwin Teague Associates, Inc. v. Department of Revenue. 

Wisconsin: Income from Sales of Credits is Apportionable Income

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Recently, the Wisconsin Tax Appeals Commission addressed whether income from selling certain vehicle-related environmental credits was apportionable income.  The taxpayer, a car manufacturer based in California, earned federal environmental credits because it manufactured fuel-efficient vehicles that emitted less pollution than required by federal standards. At times, the credits were sold to other car manufacturers. All the activities associated with the credit sales occurred in California at the company’s headquarters.  For federal purposes, the income from the sale of the credits was treated as capital gains. The taxpayer did not treat the income as apportionable income on its Wisconsin unitary combined return. On audit, the Department of Revenue took the position that proceeds from the sale of the credits should be included in Wisconsin apportionable income. The taxpayer protested, and the matter came before the Tax Appeals Commission.

The Commission noted at the outset that the income from sale of credits did not “fall neatly” into any of the 24 statutory examples of apportionable income. However, the examples were not exhaustive, and income is presumed to be apportionable if it is unitary income, operational income, or other income with a taxable presence in the state. Applying these criteria, the Commission first determined that the income from the sale of credits did not have its own taxable presence in Wisconsin. As such, the next question was whether it was unitary or operational income. The Commission concluded it was both. The income was operational in nature because the credits were inextricably tied to the taxpayer’s automaking operations. Further, the taxpayer did not purchase or invest in the credits in anticipation of appreciation, as an investment is commonly understood. The credits were also not sold as investments; the purpose of selling the credits to other automakers was to help those companies offset their noncompliance with federal environmental regulations. The income was also unitary in nature as the taxpayer’s regulatory compliance division was unitary with the vehicle manufacturing entities, and the sale of the credits was not a  “discrete business enterprise” as envisioned by the U.S. Supreme Court in the Exxon Mobil case.  Please contact Brad Wilhelmson with questions on American Honda Motor Co., Inc. v. Wisconsin Department of Revenue.