TWIST - This Week in State Tax

Welcome to TWIST for the week of August 29, 2022, featuring Sarah McGahan from the KPMG Washington National Tax state and local tax practice.

After a few weeks with few developments, this past week there were a plethora of interesting SALT developments. Starting with administrative guidance, the Minnesota Department of Revenue joined Washington State and Pennsylvania in issuing guidance on the taxability of NFTs. The guidance provides that NFTs are subject to sales and use tax when the underlying product is taxable in Minnesota. Under Minnesota law, sales and use tax is imposed on specified digital products, certain other digital products, and digital codes. Non-taxable digital products include access to digital news articles, charts and graphs, digital photos and drawings, and logos and designs.

In legislative news, California Assembly Bill 2280, which authorizes the California Controller to establish an unclaimed property Voluntary Compliance Program, was enrolled and presented to Governor Newsom for signature.  The program will enable voluntary compliance by businesses holding past due unclaimed property that has not been reported to the Controller or that have merged with or acquired businesses that may not be compliant with California’s unclaimed property law.  This development is significant as it would be the first time in nearly twenty years that California has offered a voluntary compliance program for unclaimed property.

In terms of administrative and judicial decisions, we have four to cover this week. In D.C., an ALJ addressed how a financial institution member of a combined group should compute its payroll factor in the tax years after the District moved to single-sales factor apportionment for general corporations. The ALJ, deferring to guidance issued by the Office of Tax and Revenue, concluded that the payroll denominator for financial institutions consisted of the payroll of only the financial institution group members.

In Michigan, the Tax Tribunal released the latest decision in a case with a complex history where the issue was whether a corporate taxpayer had nexus with the City of Detroit.  In this latest decision, the Tribunal determined that Wayfair did not change the original conclusion that the taxpayer did not have Detroit nexus and in any event, any taxation resulting from the application of a new post-Wayfair nexus standard to economic activity occurring prior to the adoption of the new standard would not pass constitutional muster.

Next up, in a detailed 44-page decision, the Oregon Tax Court addressed whether an out-of-state manufacturer, marketer, and distributor of cigarettes and certain other tobacco products was protected from Oregon taxation under P.L. 86-272. The tax court concluded that the taxpayer’s wholesalers were engaging in certain activities on its behalf that exceeded solicitation for orders and were not de minimis.

Finally, under Texas law, only net proceeds from the sale of loans or securities are included in the sales factor. An exception to this general rule applies if a loan or security is treated as inventory of the seller for federal income tax purposes. Recently a Texas appellate court rejected a taxpayer’s position that receipts from holding certain securities should be treated as inventory when the taxpayer used the commodity hedges to manage the cost of the raw materials used to manufacture the food products it ultimately sold. In the court’s view, the U.S. Supreme Court’s decision in Corn Products did not require it to view the commodity hedges as a substitute for the raw materials.

Thank you for listening to TWIST this week. We will be off next week for labor day and hope all of you enjoy the long weekend!

California: Bill Authorizing Creation of Unclaimed Property Voluntary Compliance Program Pending Signature

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On August 23, 2022, Assembly Bill 2280, which authorizes the California Controller to establish an unclaimed property Voluntary Compliance Program (VCP), was enrolled and presented to Governor Newsom for signature.  The VCP will enable voluntary compliance by businesses holding past due unclaimed property that has not been reported to the Controller or that have merged with or acquired businesses that may not be compliant with the California unclaimed property law.  This development is significant as it would be the first time in nearly twenty years that California has offered a voluntary compliance program for unclaimed property.

Under the program, the Controller would be required to waive interest on past due unclaimed property for businesses that participate in and complete the requirements of the VCP. California law currently allows the Controller to assess interest on past due property at a rate of 12 percent per year, and Assembly Bill 2280 finds that an estimated 1.3 million companies file tax returns with California’s Franchise Tax Board (FTB) but do not file unclaimed property reports in the state. With limited remedies for mitigating California’s mandatory interest assessments in the current environment—and with interest assessments that can exceed the actual unclaimed property owed—the new program creates an opportunity for companies to review, confirm, and potentially clean up compliance gaps with the state. This opportunity extends to companies that may have acquired or merged with entities that were not in compliance with California’s unclaimed property law. 

A business would NOT be eligible to participate in the VCP if the business:

• Is currently undergoing a California unclaimed property examination or has been notified that such an examination will occur;
• Is the subject of a civil or criminal prosecution involving unclaimed property compliance; or
• Has been notified by the Controller of an interest assessment within the past five years, and the assessment is unpaid.

The law also states that a business would be ineligible to participate in the program if the business has had interest waived under the VCP in the past five years, unless the past due amounts for which relief is sought are the result of a merger or acquisition with another entity.

The major timeframes and tasks associated with participation in the VCP are outlined in the bill, including that the business would be required to participate in a training program provided by the Controller within three months after the date the Controller notifies the business of its enrollment in the program. Further, a VCP-enrolled business would be required to review its books and records for at least the previous ten years and then make reasonable efforts to notify owners of reportable property no less than thirty days prior to submitting the required unclaimed property report to the Controller.  A business has six months from the date of VCP enrollment to provide an initial unclaimed property report to the Controller.  Thereafter, the business would be required to submit an updated report and remit the property to the Controller within seven months and fifteen days after the initial report was filed.   

KPMG will monitor additional guidance on the VCP and provide updates as they become available. All companies should be aware of other important, upcoming California deadlines including, 1) November 15: the deadline to report unclaimed property compliance status on Corporate Franchise Tax Board forms (click here for more info on this development);  and 2) October 31: the regular deadline for filing unclaimed property Notice Reports with the Controller. For more information, please contact a KPMG professional in our Unclaimed Property Practice:

Will King | +1 (214) 840-6107 | williamking@kpmg.com

Marion Acord | +1 (404) 222-3053 | marionacord@kpmg.com

Jenna Fenelli | +1 (973) 912-4546 | jfenelli@kpmg.com

District of Columbia: Only Payroll of Financial Institution Group Members Included in Payroll Factor

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Recently, an Administrative Law Judge (ALJ) for the D.C. Office of Administrative Hearings (OAH) addressed whether a taxpayer was entitled to a refund of corporate income tax for the 2015-2017 tax years. The taxpayer was a combined group that consisted of two financial institutions and several other corporations that were not financial institutions. Under District law for the relevant tax years, members of a unitary group were required to file combined reports, and general corporations used single-sales factor apportionment while financial institutions used a special industry payroll and gross sales formula. Prior to that time, general corporations used a three-factor double-weighted sales factor formula. On amended returns filed in 2019, the taxpayer included the payroll of all group members (both financials and non-financials) in computing the denominator of the payroll factor.  The Office of Tax and Revenue (OTR) disagreed with the taxpayer’s revised apportionment, and the taxpayer appealed.

The issue before the ALJ was whether, for tax years after the move to single-sales factor apportionment for general corporations, the payroll denominator for financial institutions consisted of the payroll of all members of the combined group or only the payroll of the financial institution group members. (computation of the payroll numerator was clear in the OTR regulation and was not in dispute.) In the taxpayer’s view, the plain language of the applicable statute and regulations supported its position. Alternatively, the taxpayer argued that excluding the payroll of the non-financial affiliates was distortive in violation of the U.S. Constitution.  The ALJ first addressed the plain language argument, which was largely based on a regulation that was promulgated before the move to single sales factor for general corporations. After determining that the statute and regulation relied on by the taxpayer did not directly address the issue at hand, the ALJ noted that the OTR’s administrative guidance, an Apportionment Factor Computation Chart, clearly illustrated how the payroll factor of the financial institution in a mixed combined group was to be calculated. As shown by the chart, the denominator of the payroll factor for the financial institution included only the nationwide payroll of the financial institutions in the combined group and not the payroll of nonfinancial members.  This guidance, the ALJ determined, was entitled to deference when, as here, there was no inconsistency with any statute or non-obsolete regulation. The ALJ next addressed the taxpayer’s distortion argument. Essentially, the taxpayer argued that its interpretation of the law should be applied because the OTR’s interpretation radically distorted the income attributed to the District by increasing the payroll factor by twenty-fold.  The ALJ, however, disagreed that the taxpayer had established constitutional distortion. Rather, the taxpayer had shown that its proposed method of computing the financial institution apportionment formula produced a lower payroll factor and tax than OTR’s method. In the ALJ’s view, however, the taxpayer had not established that the District apportionment formula produced tax on a percentage of the taxpayer’s income that was out of all proportion with the business transacted in the District. Please contact David Meyer with questions on American Express v. Office of Tax & Revenue.

Michigan: Taxpayer Did Not Have City of Detroit Nexus Pre- or Post Wayfair

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The Michigan Tax Tribunal recently concluded that a corporate taxpayer did not have income tax nexus with the City of Detroit under either pre- or post-Wayfair jurisprudence.  The case had a complicated history and dealt with the 2010 and 2012 tax years. The taxpayer, a Delaware corporation, used the mailing address of its parent company to fulfill ministerial duties in Michigan. In 2010, a dividend was paid to the taxpayer which led to the filing a City of Detroit Income Tax return and the payment of a one percent income tax on the dividend income. In 2012, the taxpayer sold its interest in the company, which again resulted in gain and dividends for the taxpayer. The sale was the culmination of a months-long process in which emails were exchanged between the taxpayer’s directors and advisors pertaining to matters such as expenses stemming from the sale. Some of the email correspondence took place in Detroit from the parent company’s office.  In sum, the City of Detroit argued the taxpayer was doing business in Detroit because of these activities and was therefore subject to City income tax for the years at issue.  After carefully examining the facts and Detroit’s income tax ordinances, the Tribunal originally concluded that the officers were acting as “agents” of the taxpayer and the agents’ activities in Detroit were sufficient to establish physical presence nexus. However, although the physical presence test was otherwise met, Detroit’s tax ordinances exempted from the definition of “doing business” the maintenance, by a corporation, of a resident agent in the city, leading the Tribunal to conclude that the taxpayer was not subject to City tax. The City appealed, and in the midst of the appeals, the Michigan Appeals Court ordered the case remanded to the Tribunal to consider the Wayfair decision.

Back before the Tribunal, the issue was whether the Wayfair decision would have changed the result of the Tribunal’s previous determination that was based on the “physical presence” standard enunciated in Quill. In short, the Tribunal concluded that the decision did not change the outcome. When determining whether the taxpayer “availed itself of the substantial privilege of carrying on business” in Detroit, the Tribunal found that the taxpayer’s activities were distinguishable from those in Wayfair. Notably, the taxpayer’s activities as a passive holding company were by design minimal; the taxpayer did not sell any goods or services to customers in the Detroit marketplace; its board of directors did not perform regular activities on their behalf; and the sale of the company that led to the gain took place in a foreign jurisdiction, not Detroit.  Viewed overall, the Tribunal determined that the taxpayer’s connections with the City were substantially different from Wayfair’s pervasive role in South Dakota. Accordingly, the Tribunal determined the taxpayer lacked nexus with Detroit under the Commerce Clause because it was neither physically nor virtually present within Detroit. In addition, as before, the City’s own tax regulation specifically excluded activities of agents. Importantly, the Tribunal also held that even if the taxpayer had been found to have sufficient nexus under a Wayfair analysis, any taxation resulting from the application of a new nexus standard to economic activity occurring prior to the adoption of the new standard would not pass constitutional muster. Please contact Dan De Jong with questions on Apex Laboratories v. City of Detroit.

Minnesota: Department of Revenue Issues Guidance on Taxability of NFTs

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The Minnesota Department of Revenue recently published a revised Sales Tax Fact Sheet 177, which added information on non-fungible tokens (NFT’s) under the scope of digital products. The revised guidance provides that NFTs are subject to sales and use tax when the underlying product (goods or services) is taxable in Minnesota. NFT’s may entitle purchasers to receive products or services including but not limited to:

• Digital products such as music, audio visual works, or video games;
• Admissions to sporting events or concerts;
• Prepared food and beverages; and
• Tangible personal property such as collectibles or memorabilia.

As a reminder, Minnesota imposes sales and use tax on specified digital products, certain other digital products, and digital codes. Specified digital products include (1) digital audio works such as live or recorded music, songs, speeches, audio books, ring tones, or other sound recordings, (2) digital audiovisual works such as movies, music videos, news, and entertainment, or live or recorded events, with the exception of digital photos, and (3) digital books such as novels, biographies, or dictionaries, not including periodicals, magazines, newspapers, blogs, or other news and information products. Other digital products include e-greeting cards and online video or computer gaming.  Examples of non-taxable digital products include access to digital news articles, charts and graphs, digital photos and drawings, and logos and designs. At times taxable and non-taxable digital products are bundled and sold for one lump-sum. The guidance reminds taxpayers that bundled transactions are generally taxable unless the price of the taxable item or service is de minimis. It also notes that sales of digital products are sourced to the address of the customer for purposes of determining the applicable tax rate.

Please stay tuned to TWIST for more updates on the taxability of NFTs.

Oregon: Cigarette Seller Not Protected Under P.L. 86-722

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In a detailed 44-page decision, the Oregon Tax Court addressed whether an out-of-state manufacturer, marketer, and distributor of cigarettes and certain other tobacco products was protected from Oregon taxation under P.L. 86-272. The taxpayer sold products to wholesalers, including Oregon wholesalers, that in turn sold products to retailers, including Oregon retailers. The key issue before the tax court was whether certain aspects of the taxpayer’s agreements with wholesalers caused it to lose P.L. 86-272 protection. Notably, the agreements between the taxpayer and its wholesalers required the Oregon wholesalers to (1) accept returns of taxpayer’s products from Oregon retailers regardless of the reason, and (2) accept and process certain pre-book orders placed by the taxpayer’s Oregon representatives.  With respect to the returns, the key point of disagreement was whether the wholesalers acted on behalf of the taxpayer, and if so, were the return activities outside the scope of making sales or soliciting orders for sales. After determining that the ordinary meaning of “on behalf of,” in 1959, was “in the interest of,” “as representative for,” or “for the benefit of,” the court addressed whether an activity can be “on behalf of” more than one party. In other words, the taxpayer argued that because the return policies benefitted both it and the taxpayer, the activities were not on behalf of the taxpayer for purposes of P.L. 86-272. The tax court disagreed; in its view the wholesalers were obligated under their agreements with the taxpayer to accept the returns on the taxpayer’s behalf. Having reached this conclusion, the court next concluded that the wholesaler’s acting to accept returns for any reason was not an activity ancillary to “making sales” and thus destroyed the taxpayer’s immunity from Oregon corporation excise tax.

The court next addressed whether the taxpayer’s representatives’ acts of following up with certain retailers and sending pre-book orders to the wholesalers likewise caused the loss of P.L. 86-272 protection. The taxpayer “allocated” to the representatives the task of facilitating the placement of orders by retailers who were reluctant to buy product by means of the pre-book order process. In the court’s view, this activity had an independent business purpose outside of soliciting sales and therefore also caused the taxpayer to lose P.L. 86-272 protection. Having concluded on the key issues, the court next held that the taxpayer had not established that either of these activities was de minimis under the Wrigley standard. It did find, however, that the taxpayer’s positions were reasonable and had been disclosed so that no understatement penalty applied. Please contact Rob Passmore with questions on Santa Fe Natural Tobacco Company v. Dep’t of Revenue.

Texas: Securities Held to Manage Risk of Food Costs Not Treated as Inventory

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A Texas Appeals court recently addressed whether a taxpayer that produced packaged food products properly included gross proceeds from sales of securities in its sales factor denominator. To manage the risks associated with potential fluctuation in the price of raw food materials, the taxpayer bought and sold commodity futures contracts and options on commodity futures exchanges. These commodity futures contracts and options met the definition of a “security” under Texas law, which generally provides that only net proceeds from the sale of loans or securities are included in the sales factor. An exception to this general rule applies if a loan or security is treated as inventory of the seller for federal income tax purposes. In that event, the gross proceeds from the sale of the loan or security are considered gross receipts included in the sales factor.   It was undisputed that the taxpayer did not hold the securities as inventory. In a recent case, Citgo, the same court had rejected a taxpayer’s contention that its securities were treated as inventory for federal income tax purposes. The Citgo court concluded held that “[t]he plain language of the statute evidences the legislature’s intent for Texas Tax Code Section 171.106(f) to permit the inclusion of gross proceeds from only those securities that the Internal Revenue Code classifies as inventory of the seller.”  Nevertheless, the taxpayer maintained this case was different and the securities should be treated as inventory because it used the commodity hedges to manage the cost of the raw materials used to manufacture the products it ultimately sold. Therefore, the commodity hedges were “in substance,” a substitute for the raw materials under the U.S. Supreme Court decision in Corn Products.  The Texas court disagreed with the taxpayer’s view of Corn Products. In its view, the inventory hedges were not a substitute for raw materials, and the Corn Products court had noted that the corn futures were not actual inventory. Rather, Corn Products stood for the proposition that the inventory hedges, because they were an integral part of the manufacturing process, were not entitled to capital-asset treatment under the Internal Revenue Code. Further, the court noted that Congress had since supplanted the Corn Products rationale by giving ordinary income treatment to gains and losses from all hedging activities, regardless of whether the constituted inventory hedges. Because the non-inventory securities at issue in this case were not “treated as inventory of the seller” for federal tax purposes, but simply received similar “tax treatment” under a specific, and separate, provision of the Internal Revenue Code, the court upheld the trial court’s determination that the gross proceeds of the sale of those securities could not be considered gross receipts for purposes of Conagra’s apportionment factor. Please contact Jeff Benson with questions on Conagra Brands, Inc. v. Hegar.