Welcome to TWIST for the week of February 28th, featuring Sarah McGahan from the Washington National Tax State and Local Tax practice.
At this time of year, states with a fixed-date connection to the Internal Revenue Code generally adopt legislation updating their conformity. In Virginia, House Bill 971 advances the Commonwealth’s conformity to the Internal Revenue Code as of December 31, 2021. West Virginia Senate Bill 451 provides that for corporate net income tax purposes, all amendments made to the laws of the United States after December 31, 2020, but prior to January 1, 2022, shall be given effect to the same extent those changes are allowed for federal income tax purposes. Finally, Idaho House Bill 472 adopts the Internal Revenue Code as in effect on January 1, 2022.
In other corporate income tax news, the Pennsylvania Department of Revenue issued Corporation Tax Bulletin 2022-01 addressing the proper apportionment of income by a taxpayer involved in activities subject to both special apportionment formulas and the standard single sales factor formula. The Bulletin sets forth the steps for applying the Department’s split apportionment methodology and provides examples how apportionment is computed for taxpayers involved in activities subject to special apportionment and activities subject to the standard apportionment rules.
Finally, the New York Tax Appeals Tribunal affirmed a decision holding that an IT security services company was providing taxable protective services. The services at issue enabled customers to prevent, detect, respond to, and predict cyberattacks. The Tribunal rejected the taxpayer’s argument that its services were not taxable because they did not attempt to prevent unauthorized access to a customer’s computer network, or try to identify the individuals attempting the unauthorized access.
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The New York Tax Appeals Tribunal recently affirmed an Administrative Law Judge (ALJ) determination concluding that a taxpayer was providing taxable protective services. Under New York tax law § 1105(c)(8) protective and detective services are specifically enumerated taxable services. These services include “alarm or protective systems of every nature, including . . . protection against burglary, theft . . . or any other malfunction of or damage to property or injury to persons…”. The taxpayer at issue was an IT security services provider that offered various managed and monitored security services enabling customers to prevent, detect, respond to, and predict cyberattacks. As a result of these services, customers were made aware of potential threats in critical areas of their IT infrastructure. After a rather contentious audit, the taxpayer was ultimately assessed sales tax based on customers whose devices had New York IP addresses. The taxpayer protested the assessment, and the matter went before an ALJ who concluded that the taxpayer’s services were protective services subject to tax. The taxpayer appealed.
Before the Tribunal, the taxpayer generally argued that its services were not taxable because they did not attempt to prevent unauthorized access to a customer’s computer network, nor did the services try to identify the individuals attempting the unauthorized access. In other words, the taxpayer’s services identified potential threats, but did not take actions to directly stop those threats or identify the parties involved. The taxpayer further claimed that under a prior Tribunal decision, AlliedBarton, a service must directly guard or protect persons or property to be deemed a taxable protective service under Tax Law § 1105(c)(8).
At the outset, the Tribunal observed that the law broadly defined the types of services included in the scope of protective services. In addressing the specific categories of services, the Tribunal noted that when it provided device management services, the taxpayer used its industry experience and information collected from other customers to configure devices to prevent connections from outside threats. The taxpayer argued that it was not actively or directly guarding customers’ IT infrastructures and therefore the device management services were similar to the reception services found to be nontaxable in AlliedBarton. The Tribunal disagreed. While it may not have been taking overt action to block attempted threats the moment they occurred, the taxpayer was nevertheless actively protecting its customers’ networks from threats. Next addressing the taxpayer’s monitoring services, the Tribunal found them to be analogous to an alarm system because the taxpayer reviewed network events to notify customers of potential threats. The Tribunal agreed that the taxpayer’s vulnerability scanning services and targeted threat hunting services were integrated services because they involved providing protective services along with an information component. When a service is integrated, determining whether it is subject to tax requires assessing the primary function of the service. In the Tribunal’s view, the primary function of both services was to protect its clients' networks from malicious activity. The information services provided to customers were incidental to the taxable protective services. With respect to the taxpayer’s incident response service that helped clients analyze and contain breaches, the Tribunal noted that these services prevented a breach from spreading further and were also taxable protective services. Please contact Judy Cheng at 202-872-3530 with questions on Matter of Secureworks, Inc.
The Pennsylvania Department of Revenue recently issued Corporation Tax Bulletin 2022-01 addressing the proper apportionment of income by a taxpayer involved in activities subject to both special apportionment formulas and the standard single sales factor formula. Under Pennsylvania law, taxpayers that engage certain activities – including railroad, truck, bus, airline or qualified air freight forwarding companies, pipeline or natural gas companies, water transportation companies, and satellite television service providers – are subject to special apportionment formulas. In Buckeye Pipeline v. Commonwealth, the Commonwealth Court adopted a split apportionment methodology under which a taxpayer was treated as a pipeline company for 1.4 percent of its gross receipts and was subject to the general apportionment rules for the remaining 98.6 percent of its gross receipts. Since the 1997 decision, the Department has consistently applied the split factor methodology adopted in Buckeye Pipeline. Applying this method involves twelve-steps that are set out in the Bulletin and the Bulletin contains three examples demonstrating the application of the framework. The examples calculate apportionment for a taxpayer that is involved in: (1) one activity subject to special apportionment and one or more activities subject to standard apportionment; (2) two different activities subject to special apportionment and one or more activities subject to standard apportionment; and (3) one activity subject to special apportionment and one or more activities subject to standard apportionment and that is in a loss position for the year. Please contact Mark Balistrieri at 412-232-1556 with questions.
Virginia House Bill 971, which was signed into law on February 23, 2022, advances the Commonwealth’s Internal Revenue Code conformity to the Code as of December 31, 2021. Previously, Virginia was coupled to the Code as of December 31, 2020 and therefore did not conform to any of the provisions in the American Rescue Plan Act. The Virginia Department of Taxation recently issued a Bulletin addressing the Commonwealth’s updated conformity. Per the Bulletin, Virginia generally conforms to the federal tax treatment of COVID-19 business assistance programs for the 2021 and after. As a result, no adjustment will generally be required on 2021 Virginia income tax returns for taxpayers that have business expenses funded with forgiven PPP loan proceeds, EIDL program funding, and Restaurant Revitalization grants during the 2021 tax year. Recall, for the 2020 tax year, businesses were allowed a deduction for $100,000 of expenses paid with forgiven PPP loans. The General Assembly retroactively extended to taxable year 2019 the deduction for up to $100,000 in business expenses funded by forgiven PPP loan proceeds and the Virginia-specific subtraction of up to $100,000 for Rebuild Virginia grant recipients. This allows fiscal year filers to benefit from the deduction and subtraction for such expenses and income received during 2020 that was reflected on their 2019 returns.
In other conformity news, West Virginia Senate Bill 451 was signed on February 21, 2022. This bill provides that for corporate net income tax purposes, all amendments made to the laws of the United States after December 31, 2020, but prior to January 1, 2022, shall be given effect to the same extent those changes are allowed for federal income tax purposes, whether the changes are retroactive or prospective, but no amendment to the laws of the United States made on or after January 1, 2022, shall be given any effect.
Finally, Idaho House Bill 472, which was signed into law on February 23, 2022, adopts the Internal Revenue Code as in effect on January 1, 2022. Please stay tuned to TWIST for additional conformity updates.