TWIST - This Week in State Tax

Welcome to TWIST for the week of September 26, 2022, featuring Sarah McGahan from the KPMG Washington National Tax state and local tax practice.

First up today, the Colorado Department of Revenue recently announced that it is accepting cryptocurrency as an additional payment option for several types of taxes. This option allows for cryptocurrency payment through the PayPal Cryptocurrencies Hub, where taxpayers will be able to select their desired cryptocurrency to use for the payment. The guidance confirms that while taxpayers can pay their tax obligation using cryptocurrency, tax refunds will not be issued in cryptocurrency. The CDOR has drafted a FAQs document with additional information.

Next, a taxpayer challenged the imposition of late payment penalties on the basis that it acted in good faith and exercised ordinary business care and prudence when it determined that an affiliate was an 80/20 company excluded a from the Illinois unitary group. The Illinois Tax Tribunal concluded that the taxpayer was not entitled to an abatement. In the Tribunal’s view, the anticipated tax savings meant the structure should have been scrutinized at length and the taxpayer failed to provide any documentation or analysis to support its 80/20 determination.

Finally, In Louisiana, the Board of Tax Appeals ruled in a taxpayer’s favor that it was entitled to use the formula applicable to manufacturing entities to allocate its taxable capital to Louisiana. The taxpayer at issue developed software that customers accessed over the Internet. The Board concluded that the taxpayer’s software was tangible personal property that the taxpayer transformed from raw materials into a finished product. As such, the taxpayer was a manufacturer entitled to use the manufacturing allocation formula.

Colorado: Department will Accept Cryptocurrency for Tax Payments

Download PDF

The Colorado Department of Revenue (CDOR) recently announced that, as of September 1, 2022, it is accepting cryptocurrency as an additional payment option for individual income, business income, sales and use, withholding, severance, and excise tax obligations. This option allows for cryptocurrency payment through the PayPal Cryptocurrencies Hub, where taxpayers will be able to select their desired cryptocurrency to use for the payment. When taxpayers make payments in cryptocurrency, the CDOR will convert the taxpayers' cryptocurrency into dollars and attach a service fee of $1.00 plus 1.83 percent to the payment price. In addition, the CDOR instructs taxpayers to have the entire value of their tax obligation in a single cryptocurrency in their PayPal Cryptocurrency Hub. PayPal purchase fees or miner/gas fees may apply when transferring cryptocurrencies from an external wallet to your PayPal Cryptocurrencies Hub. Taxpayers may only use PayPal personal accounts to pay their tax obligations as PayPal does not allow the purchase or use of cryptocurrency with a PayPal business account. Finally, note that while taxpayers can pay their tax obligation using cryptocurrency, tax refunds will not be issued in cryptocurrency. The CDOR has drafted a FAQs document with additional information. Please stay tuned to TWIST for additional crypto developments.

Illinois: Tax Tribunal Upholds Late Penalty in 80/20 Company Dispute

Download PDF

Under Illinois law, a unitary business group does not include the income of those members whose business activity outside of the United States makes up 80 percent or more of the member’s total business activity, generally measured by means of property and payroll factors. On May 4, 2021, applying a substance over form analysis, the Illinois Independent Tax Tribunal concluded that an LLC was not the true employer of certain expatriated employees and as such the corporate owner of the LLC did not meet the test for being an excluded 80/20 company. As such, the corporation’s income was added to the Illinois unitary group’s income for the tax years at issue. Along with the additional tax owed, the Department assessed approximately $2.1 million in late penalties. The taxpayer challenged the imposition of the late payment penalties on the basis that it acted in good faith and exercised ordinary business care and prudence, it had a strong history of tax compliance, and it relied on tax professionals and tax authority when it made its 80/20 determination.

The Tribunal noted at the outset that assessed penalties are presumed to be correct and the taxpayer has the burden to prove by clear and convincing evidence that the penalties should be abated. After reviewing the taxpayer’s compliance history, the Tribunal concluded that, overall, there had been no issues out of the ordinary, considering that the taxpayer was a large multinational company with complex filings. However, the Tribunal noted that, in determining whether to abate penalties based on the “reasonable cause” standard, the primary factor to consider is whether the taxpayer made a good faith effort to pay the proper tax liability by exercising ordinary business care and prudence. In the Tribunal’s view, the taxpayer in this instance did not. The Tribunal observed that the anticipated tax savings “should have set off alarm bells in the tax department” and that the structure should have been “scrutinized in-depth to insure it was a viable strategy.” Furthermore, the Tribunal noted that no internal memorandum or document was produced that could support a finding that the taxpayer prepared a legal analysis of the 80/20 company position. There was also no opinion or memorandum provided in support of the taxpayer’s position that had been prepared by an outside law firm or accounting firm. Having determined that the taxpayer did not exercise ordinary business care and prudence, the Tribunal upheld the Department’s deficiency notices. Please contact Brad Wilhelmson with questions on Pepsico Inc. v. Illinois Dep’t of Rev.

Louisiana: Web-Based Software Developer Entitled to Use Manufacturing Allocation Formula

Download PDF

The Louisiana Board of Tax Appeals recently concluded that a taxpayer properly used the formula applicable to manufacturing entities to allocate its taxable capital to Louisiana. The taxpayer at issue developed software products for use in the healthcare industry. The software was generally provided to customers through the Internet; many customers had a subscription service to access the software. The taxpayer filed its Louisiana corporate income and franchise tax returns allocating its taxable capital to the state using the formula applicable to manufacturers under La. R.S. 47:606(A)(3)(b).  The Department protested the use of this formula arguing that the taxpayer failed to demonstrate that its software was “canned” software and not custom software that is excluded from the definition of tangible personal property for sales tax purposes. Alternatively, the Department argued that the taxpayer failed to demonstrate that it manufactured tangible personal property by the use of raw materials.

With respect to whether the software at issue was tangible personal property, the Board relied on the Louisiana Supreme Court’s decision in South Central Bell Telephone Co. v. Barthelemy. In the 1994 Bell case, which involved local use tax, the court held that all software—regardless of its classification as canned or custom—was tangible personal property.  Following that decision, the legislature amended the law to exempt custom computer software from sales tax.  However, in the Board’s view, the Bell decision applied to the case at hand and there was no need for the taxpayer to establish that it produced “canned” software.  In other words, although canned and custom software is treated differently for sales tax purposes, the distinction did not apply to the issue before the Board. As such, the Board determined the question was whether the taxpayer’s software was fundamentally different than the software in Bell. Although the Department argued that the taxpayer’s software was distinguishable because it was delivered over the Internet, the Board determined that position was not persuasive. A component of the software in Bell was delivered via phone line, an analogous precursor to the modern Internet. The Department also argued that the taxpayer’s software did not become inseparable from a physical object like a disc. Noting that this was a “closer question,” the Board nevertheless concluded that the software was tangible property even if it was not delivered to or stored on customers’ computers. “The uses to which customers can put Taxpayer's software show the manner in which it causes a computer to perform physically perceptible operations.” Finally, the Board addressed whether the taxpayer transformed raw materials into tangible personal property. The taxpayer stated that it created software by having employees write sets of instructions that were physically manifested on a media through the arrangement of electrons in binary form that told electronic hardware, e.g. computers, what to do. After determining that the baseline arrangement of electrons was the relevant raw materials, the Board concluded that by rearranging electrons from something like a blank file into a useful form, like a program, the taxpayer transformed raw material into finished tangible personal property for sale. Accordingly, the taxpayer was in the business of manufacturing and was entitled to use the allocation formula applicable to manufacturers. Please contact Christie Rao with questions on Chervey, LLC. V. Secretary of Revenue.