TWIST - This Week in State Tax

California: Motion for Summary Judgment Denied in Case Challenging P.L. 86-272 Guidance

Recently, a California superior court denied a motion for summary judgment in a case filed by the American Catalog Mailer’s Association (ACMA) challenging the Franchise Tax Board’s revised guidance on the application of P.L. 86-272 to Internet sellers.  The ACMA is not an Internet seller itself but is a non-profit that advocates for the interests of catalog, online, direct mail and other remote sellers. Recall, California was the first state to publicly adopt aspects of the Multistate Tax Commission’s (MTC) revised “Model Statement of Information Concerning Practices of Multistate Commission and Supporting States Under P.L. 86-272. In TAM 2022-01, the FTB addressed whether the protections of P.L 86-272 apply to fact patterns that are common in the current economy due to “technological advancements.” 

The general rule stated in the TAM and the MTC’s revised statement is that when a business interacts with a person or entity in the state via the business’s website or app, the business engages in an activity within the state.  If that activity goes beyond solicitation of sales, then the business is not protected under P.L. 86-272. Examples of activities conducted by a seller of tangible personal property over the Internet that would appear to cause the loss of P.L. 86-272 protection include, but are not limited to, providing post-sales assistance over the Internet and leaving cookies on customer devices that gather marketing information. The guidance in the TAM 2022-01 was later incorporated into FTB Publication 1050.

In the instant matter, the ACMA moved for summary judgement that the TAM and FTB Publication 1050 were invalid because they contradicted P.L. 86-272 and the U.S. Constitution.  The FTB raised a host of objections to ACMA’s claims, including that the ACMA lacked standing and was not an interested person who might seek a declaratory declaration as to the validity of a regulation, the TAM and Publication 1050 were not regulations to which ACMA could seek declaratory relief, and there was no controversy ripe for consideration by the court. The court found that none of these objections were persuasive. In the court’s view, ACMA had associational standing through its members. Further, in light of the dilemma in which ACMA’s members found themselves due to the uncertainty as to whether they would be protected under P.L. 86-272, the court determined that the facial challenge was ripe for adjudication. The court also agreed that the TAM and Publication 1050 were “regulations,” despite not being adopted in accordance with the state’s Administrative Procedure Act, and therefore they could be the subject of a declaratory action.  Although the court agreed with the ACMA regarding the procedural challenges, the court nevertheless concluded that the ACMA had not provided adequate support for its position that the FTB’s examples of non-protected activities involving post-sale assistance or internet cookies contradicted P.L. 86-272 on its face such that the TAM and Publication 1050 should be invalidated. As such, the case will presumably continue to trial.  Please contact Shirley Sicilian with questions on American Catalog Mailers Association v. Franchise Tax Board.

Florida: Telecom Company Entitled to Refund on Electronically Delivered Software

Recently, a Florida circuit court held that a taxpayer's sales of electronically delivered software to an affiliate was not subject to sales tax. The taxpayer acted as a procurement company making centralized purchases of equipment, software, and services for its operating affiliates. The software at issue was electronically delivered to the purchasing company and stored on servers located at a virtual warehouse dedicated to the operating entity. It was then electronically delivered to an individual cell site owned by the operating affiliate. The taxpayer (purchasing company) collected sales tax on the sale of the electronically delivered software and remitted such tax to the Department of Revenue. The taxpayer later filed a refund claim for overpayment. The claim was initially approved in email communication from the Department, and the taxpayer refunded the sales tax back to the operating affiliate that paid the sales tax, as required under Florida law.

Florida does not tax sales of electronically delivered software as it is not considered a sale of tangible personal property or a taxable service. While it was undisputed that electronically delivered software is not taxable, the Department argued that the software was subject to sales tax because it was a service sold with tangible personal property. The circuit court disagreed for two reasons: (1) electronically delivered software is an intangible, not a service, and (2) the software at issue was not sold with tangible personal property. First, the court reviewed numerous authorities from Florida and other states and concluded that electronically delivered software is intangible property that is not subject to sales tax. The Department, the court noted, erroneously relied on a rule providing that customized software is a service for sales tax purposes. This was not customized software. Second, the court determined that even if the software was a service, the taxpayer had established that it did not sell any tangible personal property to its affiliate along with the software. The Department also argued that the taxpayer did not produce sufficient documentation to support the refund claim; it appeared to be arguing that the court’s review should be limited to evidence presented during the Department’s audit of the refund claim and the court should not consider the documents and testimony provided at trial. The court disagreed, noting that as a finder of fact, it must base its decision on the evidence received at trial. That evidence, which included SAP sales tax reconciliation reports and other documentation, sufficiently supported the refund claim, which the court granted. Please contact Amanda Ribeiro with questions on T-Mobile Resources, LLC v. Florida Dept. of Revenue.

Massachusetts: Corporate Excise and Individual Tax Changes Enacted

After weeks of negotiations, the Massachusetts House and Senate agreed to a tax compromise plan that includes components of earlier House and Senate tax proposals. The legislation, H. 4104, was quickly passed by both chambers and was signed by Governor Healey on October 4, 2023.

The final agreement incorporates changes to the corporate excise tax law that were included in the earlier House tax bill and reduces the tax rate on short-term capital gains. The legislation also includes many provisions aimed at providing tax relief for individuals, including but not limited to, an expanded tax credit for children, disabled adults, and seniors, an expanded estate tax exemption, and tax breaks for renters and senior citizens.

General Corporation Apportionment Changes: Under current law, the income of a corporation is apportioned to the Commonwealth by multiplying net income by a fraction, the numerator of which is the property factor plus the payroll factor plus twice the sales factor, and the denominator of which is four. Certain entities- manufacturing corporations, mutual fund service providers, and defense corporations- use single sales factor apportionment. Effective January 1, 2025, all corporations will apportion net income to the Commonwealth by use of the sales factor only. Oddly, the effective date does not address the specific “tax years” to which the move to single-sales factor apportionment applies.

The bill also makes changes to reflect that all corporations will now be using single sales factor apportionment.

Financial Institution Apportionment Changes: Currently, financial institutions apportion receipts to Massachusetts using an evenly weighted three factor property, payroll, and receipts factor formula. Effective January 1, 2025, financial institutions will apportion net income to the Commonwealth using the receipts factor only. The bill also revises the provisions addressing how financial institutions source interest, dividends, net gains and other income from investment assets and activities and from trading assets and activities under Mass. G.L. c. 63 § 2A(d)(xii).  Currently, this amount is determined by multiplying various categories of income from such assets and activities by a fraction, the numerator of which is the average value of the assets assigned to a regular place of business of the taxpayer within the Commonwealth and the denominator of which is the average value of all such assets of the institution.

Effective January 1, 2025, the amount of such receipts included in the Massachusetts numerator will be determined by multiplying all income from such assets and activities by a fraction. The numerator of the fraction is the total receipts included in the numerator pursuant to Mass. G.L. c. 63 § 2A(d)(i) through (x), which are the statutory sourcing rules for various types of income of a financial institution, and paragraph (xii). The denominator of the fraction is all total receipts of the taxpayer included in the denominator other than interest, dividends, net gains, but not less than zero, and other income from investment assets and activities and trading assets and activities. While the intent of the law appears to be to source interest, dividends, net gains, and other income from investment assets and activities and from trading assets and activities based on a financial institution’s other Massachusetts receipts, the reference to including receipts from paragraph (xii) in the numerator is somewhat circular; paragraph (xii) informs a financial institution how such receipts should be attributed to the Commonwealth.

The bill strikes language in the statute that addresses the computation of the property and payroll factors for a financial institution.

Individual Tax Changes: Currently, individuals are taxed on their short-term capital gains at a rate of 12 percent. H. 4101 reduces the rate on the gain from the sale or exchange of capital assets held for one year or less to 8.5 percent effective for tax years beginning on or after January 1, 2023.  In addition, the individual income tax code has been revised to require married persons to file a joint tax return if they file a joint federal tax return. The purpose of this change is to ensure that married couples cannot avoid the new so-called Millionaire’s Tax, which was approved by voters last November. Under the revised law, effective for tax years beginning on or after January 1, 2023, the flat individual income tax rate was increased from 5 percent to 9 percent on income above $1 million. It should be noted that a working draft TIR was recently issued in Massachusetts that indicates a nonresident’s income would be subject to the 4 percent surtax on income over $1 million if the nonresident’s Massachusetts source income exceeded the threshold. This provides clarity as there was concern that a proportional amount of Massachusetts income might be subject to the surtax if the nonresident’s federal income exceeded $1 million.

Another change affecting individuals involves the so-called “Chapter 62F refunds.” Under Massachusetts law, when tax revenues exceed a certain amount in a given fiscal year, the excess revenue is refunded to individual taxpayers. Historically, a taxpayer’s refund was based on a percentage of their personal income tax liability for the given year. Effective for tax years beginning on or after January 1, 2023, the refund will be provided based on the number of personal income taxpayers filing an income tax return in the previous taxable year. In other words, each personal income taxpayer will receive the same refund amount, regardless of their personal income tax liability. Persons that are married filing jointly count as two taxpayers.

Contacts: Please contact George Burns or Jamie Posterro with questions on H. 4101.

Tennessee: Carriage Rides Subject to Amusement Taxes

The Tennessee Court of Appeals recently upheld a chancery court's sales and use tax assessment on a horse-drawn carriage company. The taxpayer offered horse or mule drawn carriage rides, including narrated historical rides, in the downtown Nashville Entertainment District. Customers were charged based on ride duration, not distance traveled, and were let off when the agreed upon ride time was over, regardless of the location.  Under Tennessee law, tax is levied on the sales price of each sale at retail of sales of tickets, fees or other charges made for admission to or voluntary contributions made to places of amusement. Following an audit, the Tennessee Department of Revenue assessed sales and use tax on the basis that the taxpayer was subject to taxation as a place of amusement. The taxpayer disagreed, and after a chancery court upheld the assessment, this appeal followed.

On appeal, the taxpayer first argued that the lower court erred when it concluded that the amusement tax statute "does not require a permanent, physical location as the 'places' of amusement." In short, the taxpayer argued that its carriage rides could not be "places" of amusement because they were not permanent buildings or localities. However, the Department of Revenue's Rule 117 and Sales & Use Tax Notice #16-09 evidenced that the statute applies to a broad range of amusement and recreational activities, including those that were not housed in permanent buildings or locations. The court noted that while there were no Tennessee cases on point, the Missouri Supreme Court had addressed the taxability of carriage rides under a similar statute and held that when a business "controls the locality of amusement or entertainment, it was liable for sales tax." Applying that reasoning, the court concluded that the taxpayer's carriage rides fell within the broad range of amusement or entertainment activities encompassed by Tenn. Code Ann. § 67-6-212(a)(2) because the driver controlled the location of amusement - the carriage. The appeals court also determined that the taxpayer's carriage rides were primarily for amusement, not transportation. Notably, the taxpayer was restricted as to where it could transport passengers as its carriages could only travel in a small area of downtown Nashville. In addition, the cost of the rides was high, compared to taxis, buses or Uber, making them impractical for transportation purposes. Additionally, the taxpayer did not guarantee its passengers would be dropped at their desired location, which further detracted from the taxpayer's position that it offered a transportation service. Therefore, the fees for the taxpayer's carriage rides were subject to taxation as a place of amusement. The appeals court also agreed with the lower court that the taxpayer had not proven that it was entitled to summary judgement on its claim that there was an equal protection violation because the Department selectively enforced the law against it and had not assessed other carriage ride companies. Please contact Justin Stringfield with questions on Sugar Creek Carriages v. Gerregano.