TWIST - This Week in State Tax

Welcome to TWIST for the week of January 18th, featuring Sarah McGahan from the Washington National Tax State and Local Tax practice.

The Massachusetts Appellate Tax Board recently concluded that a company that developed computer software was a manufacturing corporation eligible for a local property tax exemption and entitled to use single-sales factor apportionment. In reaching this conclusion, the Board rejected the Commissioner’s position that the taxpayer was not selling software to customers but was using it to provide services. In the Board’s view, the Commissioner’s own factors distinguishing a taxable sale of software from a non-taxable sale of a service— developed in the sales tax context— supported the taxpayer’s position.

In a recent ruling requested by the Virginia Society of CPAs, the Virginia Department of Taxation addressed whether a credit for taxes paid to another state may be claimed by owners of pass-through entities (PTEs) that elect to be taxed at the entity-level in Maryland. The Virginia credit statute provides that tax paid by an electing S-corporation is considered paid by its individual shareholders proportionate to their ownership percentage. The statute is silent regarding the treatment for tax paid by other types of PTEs and a Virginia regulation expressly states that a credit may not be claimed by an individual for tax imposed by another state on a distributing entity except when the entity is an S Corporation. As such, the Commissioner concluded that Virginia resident owners of an electing PTE (other than an S corporation) are not eligible to claim the credit for taxes paid to another state on their individual income tax returns.

In other recent news from state taxing authorities, the Tennessee Department of Revenue issued a Sales Tax Notice addressing the repeal of its drop shipment rule and the Florida Department of Revenue issued information on the automatic corporate income tax refunds Florida taxpayers will receive this spring. 

Thank you for listening to TWIST!

Florida: Guidance Issued on Automatic Corporate Refunds 

Download pdf

The Florida Department of Revenue recently issued a Tax Information Publication providing information on the automatic refunds Florida corporate income/franchise tax taxpayers will receive this spring. Recall, the 2018 legislation conforming Florida to the Tax Cuts and Jobs Act required a downward adjustment of the corporate income tax rate if actual net collections for fiscal years ending June 30 of 2019, 2020, and 2021 exceeded “adjusted forecasted collections” for that year. The legislation also provided for corporate income refunds to taxpayers if collections met certain criteria. Florida’s Revenue Estimating Conference announced in September 2021 that the trigger to issue corporate tax refunds in the spring of 2022 was met.

The automatic refunds are associated with tax years beginning on or after April 1, 2019, and on or before March 31, 2020. Each Florida taxpayer’s share of the refund will be determined by taking the taxpayer’s final tax liability and dividing it by the sum of all the eligible taxpayers’ final tax liability. The Department defines a “final tax liability” as the amount of tax due for the taxable year, as reported on the Florida corporate income/franchise tax return, plus any Florida Tax Credit Scholarship Program credit taken.  The Department notes the partial refund will be first applied to any outstanding tax, penalty, or interest liability. Any remaining amounts of $10 or more will be refunded to the taxpayer by May 1, 2022. Remaining amounts under $10 will appear as a payment credit in the taxpayer’s corporate income tax account. For more information on TIP 22C01-02, please contact Jeremy Dukes or Henry Parcinski. 

Massachusetts: Taxpayer Wins Dispute as to its Manufacturing Corporation Status

Download pdf

The Massachusetts Appellate Tax Board recently addressed whether a company that developed computer software was a manufacturing corporation so that it was eligible for a local property tax exemption and entitled to use single-sales factor apportionment. The taxpayer developed software-based solutions for accelerating, managing, and improving the delivery of web and media content over the Internet. The software components and systems were paired with the taxpayer’s worldwide network of servers. The software solutions were only accessible to customers through the remote server network and were not downloaded to the customer’s computer. Under Massachusetts law, the definition of a manufacturing corporation is “a corporation that is engaged in manufacturing.” Effective January 1, 2006, Massachusetts expanded the definition to specifically include an entity involved in the “development and sale of standardized computer software … without regard to the manner of delivery of the software to the customer.” The issue before the Board was whether the taxpayer was selling standardized, remotely accessed computer software. If it was, then the taxpayer was considered a manufacturer for the tax periods at issue.

The Commissioner argued that the taxpayer did not “sell” its software, but rather it used the software and its worldwide network of servers to provide services to its customers. As such, it should be considered a service provider, not a manufacturing corporation. However, the Board disagreed, noting that the Commissioner’s own factors (developed in the context of sales tax) distinguishing a taxable sale of software from a non-taxable sale of a service provided little support for his position. The factors indicative of a sale of pre-written software included a customer’s ability to: (1) access the pre-written software on the seller’s server, enter the customer’s own information, manipulate it, and/or run reports, and (2) use the software with little or no personal intervention by the seller or the seller’s employees. The Board noted that these factors, which were found in various public written statements issued by the Commissioner, favored the taxpayer’s characterization of its business as involving transfers of standardized software.   The Board dismissed the notion that the wording of a contractual agreement, or indeed the lay meaning of a term used in taxpayer’s marketing campaigns, were indicative of the nature of a transaction. In the Board’s view, marketing descriptions of a product as “software-as-a-service” were not determinative of its taxability. The Commissioner also argued that the taxpayer’s failure to collect sales tax on its software products indicated that it believed it was a service provider. The Board, however, seemed to find it reasonable that the taxpayer did not collect sales tax considering the almost certain challenge to its status as a manufacturer and the potential of having to refund the taxes to customers if it was later determined to be a service provider. In conclusion, the Board determined that the taxpayer was engaged in manufacturing through the development and sale of standardized computer software and was entitled to tax treatment as a manufacturing corporation for all the years at issue. For questions on Akamai Technologies, Inc please contact Nikhil Sequeira. 

Tennessee: Department Issues Notice on Drop Shipment Rule Repeal

Download pdf

The Tennessee Department of Revenue recently issued a Sales Tax Notice addressing the repeal of its drop shipment rule. Under the former rule, in-state suppliers were required to collect state and local sales tax on the sales price of a product sold to an out-of-state dealer, unless the out-of-state dealer provided a state resale certificate or a Streamlined Sales and Use Tax Agreement (SSUTA) Exemption Certificate with a state sales tax ID number. After the repeal of the drop shipment rule, an out-of-state dealer (including an out-of-state marketplace seller) may purchase products for resale that are drop shipped from a Tennessee dealer to the Tennessee dealer’s customer by providing the in-state supplier a resale certificate by another state or a fully completed SSUTA Exemption Certificate including the sales tax ID number issued by another state. The Notice also explains that out-of-state dealers not registered for sales tax in any state may use a SSUTA Exemption Certificate including a tax ID number for another tax type issued by the dealer’s home state. Foreign sellers not registered in any state may use a SSUTA Exemption Certificate including a tax ID number issued by the seller’s home country. Please contact Justin Stringfield with questions on Notice #22-01. 

Virginia: No Credit for Virginia Resident Partners Electing into Maryland SALT Cap Workaround

Download pdf

In a recent ruling requested by the Virginia Society of CPAs (Society), the Virginia Department of Taxation addressed whether credit for taxes paid (CFTP) to another state may be claimed by Virginia residents that are owners of PTEs that elect to be taxed at the entity-level in Maryland. In response to the $10,000 cap on the federal deduction for state and local taxes, Maryland is one of the many states to enact a SALT cap workaround. The Maryland statute allows PTEs to elect to pay tax at the entity-level on the distributive or pro rata shares of all members. A PTE includes an S corporation, a partnership, a limited liability company not taxed as a corporation, and a business or statutory trust not taxed as a corporation. The individual members may then claim their share of the tax paid by the PTE on their individual tax returns.

The issue in the ruling was whether a Virginia resident would be allowed a CFTP on their Virginia income tax return for the tax paid at the entity level in Maryland. Virginia’s CFTP statute allows residents to claim a credit for income taxes paid to another state on their distributive share of state source PTE income. The credit is limited to income taxes, and other types of taxes (e.g., franchise, excise, unincorporated business) do not qualify for the CFTP. Under Virginia law, statutes allowing credits against tax liability, which are considered legislative grants, are strictly construed against the taxpayer in favor of the taxing authority. In this case, the Virginia CFTP statute provides that tax paid by an electing S-corporation is considered paid by its individual shareholders proportionate to their ownership percentage. The statute is silent regarding the treatment for tax paid by other types of PTEs, and a Virginia regulation expressly states that a credit may not be claimed by an individual for tax imposed by another state on a distributing entity except when the entity is an S Corporation. The Society argued the CFTP should be allowed for other types of electing PTEs because the taxes will be owed to Maryland regardless of whether the PTE election is made. In other words, the Society argued that the mechanics of how the taxes are paid remain the same. The Department concluded, however, that it is bound by the literal reading of the Virginia statute that attributes only tax paid by an S corporation to individuals. The Department also pointed to the regulatory language that expressly states the credit is not available for taxes imposed on PTEs other than S Corporations. As such, Virginia resident owners of an electing PTE (other than an S corporation) are not eligible to claim the CFTP to another state on their individual income tax returns. Please contact Diana Smith with questions on this ruling request.