TWIST - This Week in State Tax

New Jersey: Guidance Released on Retroactive Convenience of the Employer Rule

The New Jersey Division of Taxation recently posted guidance on its website addressing the state’s new convenience of the employer rule, which is effective retroactive to January 1, 2023. Under the convenience of the employer rule, a nonresident taxpayer’s employee compensation from a New Jersey employer for the performance of personal services is sourced to the employer’s location (New Jersey) if the employee is working from an out-of-state location (e.g., at home in their resident state) for their own convenience rather than for the necessity of their employer. The New Jersey rule applies only to employees who are residents of states that also impose a similar test (e.g., Connecticut, Delaware, Nebraska, New York, and Pennsylvania). Although Pennsylvania has such a rule, the new law does not apply to Pennsylvania residents who work in New Jersey, as there is a Reciprocal Agreement in place with the Commonwealth. Further, the convenience of employer sourcing rule also does not apply to Connecticut residents who work in New Jersey, based on New Jersey’s understanding that the similar Connecticut convenience rule does not apply to New Jersey residents who work in Connecticut. The Division intends to coordinate with the Connecticut Department of Revenue Services and issue further guidance for clarification.

In its recent guidance, the Division reminds taxpayers that the rule is retroactive and advises that affected taxpayers must begin withholdings and/or making estimated payments for Tax Year 2023 as soon as possible. Taxpayers are required to have proper tax paid in by April 15, 2024. Employers should consider adjusting withholdings to ensure that employees are not underpaid. The Division will not impose penalty and interest if the taxpayer begins complying with the new law as of September 15, 2023. Please contact John Montgomery with questions on the rule.

New York: Corporate Franchise Tax Regulations Officially Proposed

On August 9, 2023, the New York Department of Taxation and Finance (Department) published the comprehensive Article 9-A corporate franchise tax regulations in the New York State Register. In doing so, the Department has started the process under the State Administrative Procedure Act (SAPA) of formally adopting these regulations, which have been in draft form for over a year. The 417 pages of regulatory text can be accessed here. These regulations implement New York’s substantially reformed corporate and bank tax laws that have generally been in effect since tax years beginning on or after January 1, 2015 (the enactment of a zero percent tax rate on entire net income for Qualified New York Manufacturers was effective for the 2014 tax year). It is likely that almost every New York business taxpayer will be affected by some aspect of the revised regulations. Most of the significant changes are in Parts 1 through 9 of Subchapter A of Chapter I of Title 20 of the Codes, Rules and Regulations of the State of New York, which will be repealed and replaced with entirely new language.

The expectation is that the Department will likely apply these regulations back to the inception of New York State corporate tax reform. Below is a summary of what is covered in Parts 1 through 9 of the proposed regulations.

Part 1 addresses which corporations are subject to New York tax and incorporates the state’s post-reform economic nexus standard whereby a corporation or combined group will be subject to New York tax if it derives receipts from activity in New York that equals or exceeds $1 million (adjusted periodically for inflation and set at $1.138 million for the 2022 tax year).

This part also provides examples of activities that are, and are not, protected under P.L. 86-272.  These examples cover situations where a foreign corporation will be subject to New York tax, and the regulations incorporate aspects of the Multistate Tax Commission’s revised Statement on P.L. 86-272. Notably, a business that provides post-sales assistance to customers via email or chat will not be protected under P.L. 86-272 because these activities are not entirely ancillary to solicitation of orders for sales of tangible personal property. Other activities that exceed the scope of P.L. 86-272 protection include a corporation receiving branded credit card applications over its website and allowing prospective employees to submit an electronic application over a website for non-sales positions. The regulations also incorporate the MTC’s guidance on the use of cookies by Internet sellers. Cookies placed on customer devises to gather information that will be used to adjust production schedules and inventory amounts, develop new products, or identify new items to offer customers are not protected activities under P.L. 86-272.

Part 2 addresses accounting periods and methods and is largely unchanged from its predecessor regulations.

Part 3 provides guidelines for the computation of tax on the business income base, capital base and the fixed dollar minimum tax. This part is substantially revised and, in addition to capturing the New York tax reform related changes to computing the business income tax base, the regulation also addresses certain federal tax reform items, such as 163(j). Post-reform, New York NOLs are computed on an apportioned basis and are no longer limited to the allowed federal NOL amount. The regulation addresses the post reform NOL computation, and provides guidance on computing the prior net operating loss conversion subtraction used to convert pre-reform NOLs into a new subtraction to be used in post-reform years.

Part 4: New York’s tax reform bills significantly overhauled the state’s apportionment rules, including generally adopting customer-based sourcing rules for service receipts in lieu of sourcing service receipts to the location where services were performed. Under the sourcing rules, there is a hierarchy that must be applied to determine a customer’s location. The first step in the hierarchy is to look to the location where the customer receives the benefit of the service.

While the general rule sources service receipts to customer location, specific statutory provisions address various types of service receipts. In fact, per the Department’s summary of the changes to the Article 9-A regulations, post-reform, there are over 50 categories of receipts and income addressed in the statutory apportionment provisions. The regulation does not address each and every category but, per the Department, provides guidance “where needed.”  For each category of receipts addressed in the regulation, there are numerous illustrative examples.

The statute was silent with respect to sourcing asset management fees. Of interest to those in the asset management industry, the regulation provides a hierarchy to determine where the benefit of a service is received if services are provided to a “passive investment customer” as opposed to an individual customer or a business customer. The benefit of management, distribution, and administration services provided to a passive investment customer is presumed to be received at the location of the investors in such passive investment customer unless the investor is holding the interest in the passive investment customer for a beneficial owner. If the investor is holding the interest in the passive investment customer for a beneficial owner, the benefit of the services is presumed to be received at the beneficial owner’s location. The location of an individual investor or beneficial owner is its billing address; the location of a non-individual is its principal place of business. Management, distribution and administration services provided to a passive investment customer are apportioned to New York in proportion to the average value of the interests in the passive investment customer held by the passive investment customer’s investors and beneficial owners located in New York. To calculate the average value of the interests in, taxpayers are instructed to add the percentage of the value of the interests held by investors and beneficial owners located in New York at the beginning of the taxable year to the percentage of the value of the interests held by investors and beneficial owners located in New York at the end of the taxable year and divide by two. If a corporation cannot determine the location under the general rule, the benefit of management, distribution, and administration services provided to a passive investment customer is presumed to be received at the location where the contract for such services is managed by the passive investment customer.

Another point to note is that the regulation recognizes the increasing use of intermediaries to facilitate sales and adopts specific rules for “intermediary transactions.” An intermediary transaction means a transaction where the business customer derives value from a product or service (digital or otherwise) at the location of the consumer rather than the location of the business customer itself. Various examples illustrate what, in the Department’s view, is and is not considered an intermediary transaction.

Part 5 addresses tax credits and makes minimal changes to its predecessor regulations.

Part 6 provides guidance on New York’s reporting requirements. Importantly, Subpart 6-2 implements the tax change to mandatory unitary combined reporting by defining terms, providing explicit guidance, and presenting illustrative examples of the application of the new combined reporting rules in specific circumstances.

Part 7 relates to the payment of tax and estimated tax, as well as collection.  It is largely unchanged.

Part 8 is dedicated to the computation of the Metropolitan Transportation Business Tax Surcharge and Part 9 provides definitions of terms and rules pertaining to the following special entities: qualified New York manufacturers, corporate partners, New York S corporations, real estate investment trusts and regulated investment companies, and domestic international sales corporations.

Next Steps and Contacts: Although comments were accepted on the regulations while in draft form, SAPA procedures require that the proposed regulations will be subject to a 60-day public comment period. This period will end October 10, 2023. Please contact Russ Levitt or Aaron Balken with questions.

South Carolina: Administrative Law Court Approves Combined Reporting Alternative Apportionment Method

Recently, the South Carolina Administrative Law Court upheld the Department of Revenue’s assertion that a group of subsidiaries were required to file a combined return to properly reflect business activity in South Carolina. The overall business consisted of almost 1,600 rural lifestyle retail stores in 49 states and an e-commerce website. The named taxpayer in the case, TSC, operated retail stores in every state but Texas, Michigan, Utah, and Alaska, and provided services to the group from its headquarters in Tennessee. The other two subsidiaries, Michigan and Texas, operated stores in those states. The Michigan entity leased all its employees from TSC, and the Texas entity held the group’s intangibles, but did not charge the entities for their use. As part of a 2001 restructuring, Texas was assigned the role of providing the procurement function for TSC and Michigan. TSC had previously performed this function. During the audit years, TSC filed its South Carolina corporate income tax returns using separate entity reporting. Texas and Michigan did not file in South Carolina. During an audit, the Department concluded that separate entity reporting did not fairly represent TSC’s business activity in South Carolina and allowed TSC to minimize its taxes by shifting income from its retail sales (including its South Carolina retail sales) to Texas through a 9.7 percent markup on inventory Texas charged pursuant to the parties’ Procurement Agreement. As such, the Department asserted that under its authority to apply an alternative apportionment formula, TSC should file a combined return with Michigan and Texas. The taxpayer protested and the matter eventually came before the Administrative Law Court.

In a 65-page opinion, the court first determined that combined reporting was an alternative method of apportionment because reporting methods fell under the umbrella of “apportionment.”  Therefore, the Department had the authority to modify both South Carolina net income and the sales factor to fairly reflect the business activity of TSC. The taxpayer also argued that the Department could not impose combined reporting (or combined entity apportionment, as it was referred to in the decision) because the term “taxpayer” was used in the statutes in the singular. Citing to the Media General South Carolina Supreme Court case, the court concluded that the use of the term taxpayer in the singular did not bar the Department from requiring unitary combined reporting. Having concluded that the Department was permitted to require combined reporting as an alternative apportionment method, the court next addressed whether the Department had proven (1) that the statutory formula did not fairly represent TSC’s business activity in South Carolina and (2) that the proposed alternative formula was reasonable. Interestingly, the court recognized that the reporting method was not the true problem in this case- it was the transfer pricing. But none of the experts involved had produced a corrected transfer price, which in the court’s view meant it could not fix the issue by adjusting the transfer pricing.   The court concluded that it was constrained by the evidence before it and without a corrected transfer price, the application of separate entity reporting resulted in a taxable base that did not fairly reflect TSC’s business activity in South Carolina. The taxpayer next made several arguments that combined reporting was not a reasonable alternative method. In the court’s view, combined unitary reporting, by the very nature of how it is applied, reasonably carved out and fairly represented the income associated with TSC’s business activity in South Carolina, which were its retail sales. While no method of apportionment is perfect, the court determined that combined unitary reporting had the benefit of removing the unreliable transfer price while recognizing the value flowing between the entities and carving out only the income from retail sales associated with South Carolina. Please contact Jeana Parker with questions on Tractor Supply Company v. South Carolina Department of Revenue.