Welcome to TWIST for the week of January 23, 2023, featuring Sarah McGahan from the KPMG Washington National Tax state and local tax practice.
First up today, on January 20th, the Texas Comptroller proposed amendments to its Margin Tax apportionment rule. Importantly, the revised rule removes the “receipts-producing, end-product act” test that was invalidated by the Texas Supreme Court in the Sirius XM litigation. In its place, language is added providing that a service is performed at the location or locations where the taxable entity's personnel or property are doing the work that the customer hired the taxable entity to perform. A few other amendments have been made to address where a service is performed and determining fair value if a service is performed both within and without Texas. The revised rule retains the customer-based sourcing rules for Internet hosting services and the audience-based rules for advertising services. The Comptroller will be accepting comments on the proposed changes for 30 days following the date of publication in the Texas Register.
In other news, we have two administrative decisions that illustrate the importance of following required state procedures. In the first, the Florida Division of Administrative Hearings determined that although a vendor over collected sales tax on sales of electronically delivered software and computer hardware, it was not entitled to a refund. Under Florida law, a vendor has no right to a refund of erroneously remitted or overpaid sales tax until the vendor has refunded the tax its customer or assigned the right to seek a refund to its customer. Here, the vendor did neither and the Division denied its sales tax refund request.
In Virginia, the Tax Commissioner found that a taxpayer failed to property elect to forego an NOL carryback for the tax year at issue. As such, the NOL was carried back fully utilized in an earlier tax year and the taxpayer’s corporate tax assessment for the later tax year was upheld.
Recently, the Florida Division of Administrative Hearings denied a vendor’s sales tax refund because the vendor did not first refund the sales tax to its customer. The vendor, a computer software and technology company, sold electronically delivered software and computer hardware to a Florida customer. Electronically delivered software is not subject to tax in Florida, but the vendor erroneously collected sales tax from the customer. With regard to the computer hardware, Florida law provides that only the first $5,000 of the purchase price of tangible personal property is subject to a local option sales tax (also called a discretionary sales surtax). The vendor erroneously collected the local option sales tax from its customer based on the full purchase price of the computer hardware. The customer later identified these errors, contacted the vendor, and requested that the vendor assign its refund rights to the customer. The vendor declined to assign its refund rights (for unspecified reasons), however, and instead filed a refund claim directly with the Department of Revenue. Additionally, the vendor chose to not refund the overpaid sales tax to the customer prior to filing the refund claim. The vendor’s rationale was that it did not have assurance from the Department that the refund claim would be approved. The Department denied the vendor’s refund claim, explaining that Florida law requires a vendor to first refund the sales tax to its customer, and that this rule operates to protect the Department from exposure to potential liability. In response to the refund claim denial, the vendor filed a request for a formal hearing before the Division of Administrative Hearings.
In its decision, the Division found that the vendor had met its burden by a preponderance of the evidence that the electronically delivered software sold to the customer was not subject to tax, and that the vendor had collected the local option sales tax on the full amount of computer hardware to the customer, rather than limiting the tax to the first $5,000 in price. The Division agreed with the Department, however, that under Florida law, a vendor has no right to a refund of erroneously remitted or overpaid sales tax until the vendor has refunded the tax its customer. Alternatively, a vendor can assign the right to seek a refund directly to its customer. The Division found that the Department’s interpretation of the Florida statutes and rules were based on their plain and unambiguous meaning. Here, the vendor chose not to assign the right to the refund, nor to refund its customer the overpaid sales tax. In addition, although the vendor claimed that it was contractually obligated to pay any sales tax refund that it received to its customer, the Division found that the parties’ contract did not address the parties’ rights and responsibilities regarding refunds of improperly collected taxes. Therefore, the Division affirmed the Department’s denial of the vendor’s refund claim request. While this is not a particularly surprising outcome, it is a good reminder that a Florida vendor must assign the right to a refund to a customer or pay the sales tax refund to the customer before requesting a refund directly with the Department. Please contact Ben Cella with questions on Oracle America Inc. v. Dep’t of Revenue.
On January 20, 2023, the Texas Comptroller proposed amendments to 34 TAC §3.591 in the Texas Register. Recall, 34 TAC §3.591 is the rule addressing apportionment for purposes of the Margin (Franchise) Tax. Importantly, the revised rule removes the “receipts-producing, end-product act” test that was invalidated by the Texas Supreme Court in the Sirius XM decision. In its place, language is added providing that a service is performed at the location or locations where the taxable entity's personnel or property are doing the work that the customer hired the taxable entity to perform. This language was added to incorporate the court’s determination that the most natural reading of “service performed in this state” supports locating the performance of the service at the place where the taxpayer's personnel or equipment is physically doing useful work for the customer.
The rule then provides that “activities that are not directly used to provide a service are not relevant when determining the location where a taxable entity performs a service.” Scant guidance is offered on how taxpayers should determine the fair value of services performed in Texas if services are performed both within and without Texas. However, the amended regulation notes that if costs are considered, costs should be limited to the direct costs of doing the work that the customer hired the taxable entity to perform and should not include costs that are not directly used to provide a service to the customer. There are no changes to other parts of 34 TAC §3.591, including the section adopting customer-based sourcing provisions for Internet hosting services. Internet hosting services are broadly defined to include video gaming, data processing, streaming, and marketplace provider services. The rule also retains the audience-based rules for advertising services. The Comptroller will accept comments on the proposed changes for 30 days following the date of publication. Please contact Jeff Benson or Karey Barton with questions.
The Virginia Tax Commissioner recently responded to a protest regarding the election required to waive a net operating loss carryback. The taxpayer filed a consolidated federal income tax return and a separate Virginia corporate income tax return for the disputed tax years. On its 2015 Virginia return, the taxpayer claimed a net operating loss deduction against its 2015 federal taxable income based on a loss incurred in 2014. The Department of Taxation determined that in 2014 the taxpayer failed to elect to waive the two-year carryback that was allowed for the tax years at issue. After the Department carried back the loss, an assessment was issued for the 2015 tax year because the net operating loss deduction was fully utilized in 2013.
Under a Virginia regulation, taxpayers that do not want to carry back an NOL are required to file a statement so indicating with the original Virginia return for the tax year in which the NOL was incurred. The taxpayer argued that the election required to waive the two-year carryback of net operating losses did not apply to corporations filing separate returns in Virginia because the regulation was located in the administrative code under a section with the heading “Consolidated and Combined; Carryovers.” The taxpayer also appeared to assert that because the Department’s tax return instructions did not address the election, it was not required. The Commissioner disagreed with both arguments. The regulation, although under a heading referencing consolidated and combined returns, specifically stated that the election statement must be filed by a “corporation or an affiliated group of corporations.” In addition, in the Commissioner’s view, tax return instructions are not intended to be a comprehensive explanation covering all nuances of the tax code, but rather a source of helpful guidance for taxpayers.
The Commissioner also highlighted that Treasury likewise required a similar election statement to waive a federal net operating loss carryback. A corporation that files separately for federal purposes does not need to not include the election statement with its return, but instead may check the box on Schedule K to waive the loss carryback for federal tax purposes. Virginia has routinely allowed corporations that checked the box on Schedule K to waive the state’s net operating loss carryback. The taxpayer, however, did not check this box on Schedule K included with the separate federal pro forma return filed for the 2014 tax year. Accordingly, the Department’s position was upheld. Please contact Diana Smith with questions on PD 22-149.