Current Multistate Tax Issues – Policy
Developments and Trends
New Mexico Tax Research Institute
Annual Tax Policy Conference
May 2011
Douglas L. Lindholm
President & Executive Director
Council On State Taxation (COST)
Agenda
• Fiscal State of the States
• Transfer Pricing Audits
• Recent Trends in Tax Legislation
• Federal Legislation on State Tax Issues
• Combined Reporting Update
• Other Current State Tax Trends
• How Does New Mexico Compare?
State of the States
State Revenues – Total Taxes
Year over year change on a monthly basis – September 2000 through December 2010
20
15
10
5
0
-5
-10
-15
-20
Source: Federation of Tax Administrators
3
Breaking It Down by Source
Year over year change on a monthly basis – January 2003 through December 2010
50
40
30
20
10
0
-10
-20
-30
Ind. Income
Sales
Corp. Income
Source: Federation of Tax Administrators
4
Retail Sales and Recessions
Nominal Retail Sales in 36 Months Following Onset of Recession
120
110
100
90
80
Jan-80
Jul-90
Mar-01
Dec-07
Source: Bureau of Census, St. Louis Federal Reserve
5
Three-Year Impact
Change in Tax Revenues for 12 Months Ending December 2010 versus December 2007
Alaska -18.1%
Hawaii -7.2%
D.C. -14.1%
> 0% (6)
0% to -10% (23)
-10% to -15% (13)
More than -15% (9)
Source: Census Bureau
6
Budget Deficits Likely to Persist
• Deficits expected to run at roughly $120 billion per year or more
through FY 2013
• Reasons:
o One-time revenues and temporary tax increases must be backfilled with
ongoing revenues
o Federal stimulus has run its course
o Normal lag in revenues of 3–4 years between beginning of recession and
recovery is likely extended to 4-5 years
o Retail sales and housing continue to lag
o Unemployment remains inordinately high
7
State Budget Deficits
2009
• Total gap of $110 billion filled; 15 percent of general
fund budget
2010
• Deficit of $190 billion; about 35 percent offset with
stimulus funds
• Amounts to over 28 percent of budget
2011–2012
• Center on Budget and Policy Priorities puts gap at
up to $130 billion in 2011 and $125 billion in 2012
• Federal stimulus offsets about 45 percent in 2011,
but less than 1 percent in 2012
• FY 2012 deficit is about 20 percent of total budget
2013
Source: Center on Budget and Policy Priorities, Feb. 2011

Budgets expected to begin stabilization
8
Projected Return to Peak Revenues
2011
• New Hampshire, Oregon, Texas
2012
• Delaware, Hawaii, Kentucky, Nebraska,
Vermont, Washington, West Virginia,
Wisconsin
2013
• Connecticut, Iowa, Kansas, Maryland,
Minnesota, Mississippi, Tennessee, Virginia
2014
• Florida, Georgia, Idaho, North Carolina
2015
• Arizona, Maine, Montana, New Mexico
2016
• California
Source: National Conference of State
Legislatures, October 2010
9
The Worst of the Worst
•
Seven states have projected FY 2012 budget deficits amounting to 25
percent or more of the total budget (data accumulated by Center on Budget
and Policy Priorities)
o Illinois (52.3 percent),
o New Jersey (37.5 percent),
o Nevada (36.7 percent),
o Mississippi (27.6 percent),
o South Carolina (26.1 percent),
o California (25.7 percent), and
o Minnesota (25.0 percent)
10
Gubernatorial Proposals
States proposing to raise revenues significantly along with expenditure reductions
California (extend current sales and income rates), Connecticut (services, upper income
brackets, combined reporting), Hawaii (income and sales tax), Illinois (income tax increases
passed), Minnesota (upper income households,) North Carolina (extend sales tax), Rhode
Island (services and other exempt goods)
States proposing to reduce expenditures AND reduce revenues significantly
Arizona (reduce corporate rate, SSF, property tax passed), Florida (phase-out corporate tax,
reduce property tax), Maine (repeal AMT, reduce individual rate, larger estate exemption),
Michigan (repeal MBT, adopt corporate income tax, shift to individual), New Jersey (reduce
corporate minimum tax, increase estate exemption), North Carolina (reduce corporate rate),
North Dakota (reduce income tax rates, reduce property tax, increase state share), Idaho
(2013 – adopt flat personal and corporate income tax)
Others focused largely on expenditure reductions with many proposing targeted
corporate tax incentives
11
TRANSFER PRICING AUDITS
• What IS an Analytical Transfer Pricing Audit?
• Who Is Conducting Them?
• Are they Coming Soon to a State Near You?
• Taxpayer Challenges
Analytical Transfer Pricing Audits –
New Trend or Flash in the Pan?
What’s an Analytical Transfer Pricing Audit?
– Computer Modeling based on public documents
– Comparison of company profit level among industry peer average
– Assumption that Transfer Pricing is occurring between related
corporations resulting in tax avoidance
– Assessment based on below-average ETR
Who is Conducting Analytical Transfer Pricing Audits?
– Outsourced to ACS, corporate provider of state gov’t services
– Subcontracted to Chainbridge Software, developer of patented
methodology
– Contracts are awarded/paid on a contingent fee basis
Transfer Pricing Contract Status
• District of Columbia
-- Currently underway: 16% contingent fee, capped at $9 million
-- Several assessments; contentious litigation
-- Potentially $50 million+ in assessments, per DOR
-- Amount realized to date: $0
• Kentucky: contract recently signed
• AL, NJ: contract signed, little activity (many settlements)
• IN, MN: efforts to pass authorizing litigation
• CA: FTB contacted; authorization exists
• Other states/localities (?)
-- AZ this session passed prohibition on contingent-fee audits
Challenges to Analytical
Transfer Pricing Audits
• Legal:
-- Potential violations of taxpayer confidentiality statutes
-- Unlawful delegation of authority
-- Prohibitions on tax collection based on amounts collected
• Practical/Ethical:
-- Burden shifts to taxpayer to prove a negative
-- Contingent fee raises bias and conflict of interest issues
-- No disclosure of methodology behind assessment
-- Refunds available?
Recent Trends in Tax Legislation
Recent General State Revenue Actions
• Amnesties
o More than 12 amnesties
• Scheduled in MI & WA in 2011
o Increasing use of post-amnesty penalties
• Other one-time measures
o Accelerating tax payments
o Deferral or trimming of tax attributes
o Sale-leaseback or leasing of state assets
• Sin and excises
o Nearly 20 cigarette tax increases and 5 alcohol tax increases
o Expanded gambling
o New “sins”
17
Revenue Actions: Corporate Tax
• Statutory economic nexus standards
• CA (2011), CO (regulation), CT, NYS/NYC (Credit Card Banks), WA
(2010), WI
• Continued consideration/adoption of combined reporting
• “Tax Haven” language contentious
• Continued tightening of expense disallowance statutes
• Significant activity with captive REITs
18
Revenue Actions: Corporate Tax, cont.
• Continued movement to single-sales factor
o CA (elective in 2011), CO (accelerated), NYC (phased), PA (greater
weighting), UT (2011 – certain sectors), VA (phase-in begins 2011), WA
(when apportionment is required)
• Market sourcing of services and intangibles
o CA (2011 if single sales factor is elected), OK (7/11/2010),
WA (2010), WI (2009)
• Other actions
o Limit or suspend NOLs (CA 2010–2011, CO 2011–2013)
o Decouple from federal provisions
o Strict liability penalties -- New California regime for tax shelter
transactions
19
Revenue Actions: Sales and Use Tax
•
Click-through nexus (Amazon)
o Paying commissions to unrelated in-state entity
o In-state entity, directly or indirectly, refers sales to out-of-state entity, including
through a Web link
o Rebuttable presumption
o New York (2008), North Carolina, and Rhode Island (2009)
o Arkansas and Illinois (2011) – No rebuttable presumption in Illinois
o Bills considered in CA, HI, VT, AZ and elsewhere
20
Revenue Actions: Sales and Use Tax
•
Amazon.com, LLC v. N.Y. State Dep’t of Taxation & Fin. (N.Y. App. Div. 2010)
• Amazon.com originally filed suit seeking declaratory and injunctive relief after
New York revised its law in 2008 to adopt click-through nexus provisions.
• Appeals court rejected Amazon.com’s facial Due Process, Commerce Clause,
and as-applied Equal Protection challenges.
• The appeals court remanded the case on as-applied Due Process and
Commerce Clause challenges.
•
The evidentiary record was not developed enough to determine whether the
statute violated the Due Process and Commerce Clauses, as applied to the
taxpayers.
21
Revenue Actions: Sales and Use Tax
•
Affiliate nexus – Related to a party in the state
o Related party in same line of business – New York (2009), Oklahoma (2010)
o Being a retailer in a controlled group that also has another retailer with nexus in the
state (Oklahoma and Colorado – 2010) (South Dakota – 2011)
o Illinois (2011) – Same line of business, trademarks, etc. and provides consideration
to in-state entity
o South Dakota (2011)
o
Has substantial ownership interest in a retailer doing business in state and in same
line of business/line of products, trademarks, etc.
o
Substantial ownership interest in or substantially owned by an entity with an in-state
distribution facility
o Arkansas (2011)
o
Establishes rebuttable nexus presumption if affiliated person engages in certain
activities in the state. Activities include selling similar line of products, use of instate personnel to assist sales, use of marks similar to seller’s marks, or has instate distribution facility.
22
Revenue Actions: Sales and Use Tax
•
Obligations imposed on non-collecting Colorado retailers
o Must notify Colorado purchasers of potential use tax liability at the time of sale
o
$5 penalty for each failure to notify
o By January 31 annually, must notify each Colorado purchaser of total amount of
goods purchased the preceding calendar year
o
Notice must notify of duty to file sales and use tax return
o
Must be sent first class-mail
o
Must be labeled “Important Tax Document Enclosed”
o
$10 fine per failure to provide notice (unless reasonable cause)
o By March 31 annually, must notify Colorado DOR of purchases by residents with
volume of purchases and general types of purchases
o $100,000 de minimis threshold
o South Dakota and Oklahoma have adopted first notice provision
23
Legal Action on Reporting Requirements
Direct Mktg. Ass’n v. Huber (D. Colo. Jan. 26, 2011)
Department enjoined from enforcing information reporting requirements
enacted in 2010
DMA case based on variety of arguments
 Burden
on interstate commerce/lack of substantial nexus
 Discrimination
 Consumer
 Certain
against interstate commerce
right to privacy
federal laws
DMA found to have a substantial likelihood to prevail and would face
irreparable harm without the injunction
MTC is Proposing Model Legislation Similar to CO law despite injunction
24
Revenue Actions: Sales and Use Tax
• Vendor Compensation
o Reduced or eliminated – NY, OK, PA, UT, VA
• Digital Goods
o WY
• Impose Tax on Candy and/or Soft Drinks: New “Sin” Taxes
o Proposals in AL, AZ, CA, CO (enacted), CT, HI, KS, MS, NH, NM, NY,
RI, SC, TN, VT, WA (enacted, but later repealed by voters)
• “Bag Tax/Fee”
o CA, CO (enacted), DC (enacted), HI, MD, MN, NJ, NM, VA, WV
25
Revenue Actions: Sales and Use Tax
•
Taxation of digital products and services
o Growing number of states explicitly taxing digital goods
o Some still taxing digital transfers as part of TPP
o Others use such statutes such as ‘data processing,’ ‘computer services,’ or
‘communication services,’ or ‘information services’
o Some look to equivalent to TPP, i.e., electronic credit report taxable if
tangible report was formerly taxable
o Taxation of electronic delivery varies
o Taxation of hosted software is growing issue
•
Constructive possession concept
•
Sometimes lack of transfer controls
•
Confusion with information services and data processing
•
Some still try to divine ‘true object’
26
Revenue Actions: Sales and Use Tax
•
Issues compound with growth of ‘cloud computing’
o Remote computing via telecommunications and Internet
o Significant difficulty defining the nature of the transaction – what is being
purchased
•
Software, computing facilities, data processing, information services or
“software as a service”
o Also questions of nexus and characterization for tax purposes
•
Basic watchword:
o Growing area of risk and concern
o Worthy of investigation from seller and purchaser perspective
27
Proposed Federal Legislation
• Business Activity Tax Simplification Act of 2011, H.R. 1439
• Mobile Workforce State Income Tax Simplification Act, H.R 1864
• Main Street Fairness Act (pending introduction)
• Wireless Tax Fairness Act, H.R. 1002/S. 543
• Other
– Video Tax Fairness Act
– Digital Goods & Services Tax Fairness Act
– Pipelines & Rental Cars
BATSA
• Business Activity Tax Simplification Act of 2011, H.R.
1439
• Physical Presence for nexus with 14-day de minimis
• Update/modify PL 86-272 to include services and
intangibles
• Applies to all direct business activity taxes
• Uniform rule for treatment of agents
• Prohibits Finnigan Apportionment
Mobile Workforce (Nonresident
Withholding) Legislation
• Mobile Workforce State Income Tax Simplification Act,
H.R. 1865 (Introduced May 12 by Howard Coble (R-NC) and Hank
Johnson (D-GA)
• Addresses problem of nonresident withholding and
liability of traveling employees
• 30-day safe harbor before state rules apply
• N/A for athletes, entertainers and other prominent
persons
• MTC working on state-level effort w/ 20-day threshold
Main Street Fairness Act
• HR 5660, The Main Street Fairness Act (formerly Sales
Tax Fairness and Simplification Act) (111th Congress)
• What the Bill does –
Would allow states and local jurisdictions to require remote sellers (entities with
no nexus or physical presence) to collect sales and use taxes provided they
have met the minimum simplification requirements set forth in the Act.
•What the Bill does not do It does not take away any existing state and local tax revenue currently
collected, and would significantly enhance tax collections by state and local
governments.
• Contentious Issues Remain: Compensation, Small
Business Exception, Communications Taxes
Digital Goods & Services
Tax Fairness Act
Digital Goods & Services Tax Fairness Act
• Precludes any new, discriminatory state and/or local taxes
from being imposed on wireless consumers, services or
providers for 5 years.
• Does not take away any existing state and local tax
revenues currently collected.
• Does not preclude any state or local jurisdiction from
raising revenues by applying or increasing broadly
applicable taxes (e.g., sales taxes) to wireless customers,
services and/or providers.
Wireless Tax Fairness Act
Wireless Tax Fairness Act – H.R. 1002 / S. 543
• Precludes any new, discriminatory state and/or local taxes
from being imposed on wireless consumers, services or
providers for 5 years.
• Does not take away any existing state and local tax
revenues currently collected.
• Does not preclude any state or local jurisdiction from
raising revenues by applying or increasing broadly
applicable taxes (e.g., sales taxes) to wireless customers,
services and/or providers.
Combined Reporting:
2010 Proposed Legislation
WA
MT
ME
ND
OR
VT
MN
ID
NH
WI
SD
MI
NY
WY
CT
NV
PA
IA
NE
IL
UT
CA
NJ
OH
IN
WV
CO
KS
VA
MO
KY
NC
TN
AZ
OK
NM
AR
SC
MS
AK
TX
HI
Key
States that rejected combined reporting legislation
AL
GA
LA
FL
DE
MD
DC
MA
RI
Combined Reporting
Legislation: Status 2011
WA
MT
ME
ND
OR
VT
MN
ID
NH
WI
SD
MI
NY
WY
RI
NV
PA
IA
NE
IL
UT
CA
NJ
OH
IN
WV
CO
KS
VA
MO
KY
NC
TN
AZ
MA
CT
OK
NM
AR
SC
MS
AK
TX
HI
Key
Warning state/district – likely
Caution state – less likely
Very unlikely (watch out, however, for special sessions)
AL
GA
LA
FL
DE
MD
DC
Other Trends: Economic Substance
• States may take position of conformity to federal economic
substance statute by virtue of overall Internal Revenue Code
conformity
o Unlikely that mere IRC conformity is sufficient
o However, states have been applying economic
substance doctrine and other judicial doctrines for years
to add back deductions, include income, reach nonnexus entities, etc.
• HMN Financial, Inc. v. Comm’r casts some doubt on
states’ ability to apply economic substance doctrine
absent statutory authority
36
Other Trends: Discretionary Powers
• Departments of Revenue are using discretionary authority to disregard:
• Filing methodologies
• Related-party transactions
• Apportionment computations
• There appears to be no consistent standard for invoking these
discretionary powers
• Wal-Mart Stores East v. Hinton, 676 S.E.2d 634 (N.C. App. 2009)
• Carmax West v. Dep’t of Revenue, No. 09-ALJ-17-0160-CC (S.C.
Admin. Ct. Apr. 22, 2010)
• Bellsouth Adver. & Publ’g Corp. v. Chumley, 2009 Tenn. App. LEXIS
576 (Tenn. App. Aug. 26, 2009)
37
How Does New Mexico Compare?
• 2010 COST / E&Y “Total State and Local Business Taxes”
• 2010 COST “Best & Worst of State Tax Administration”
• 2011 COST / E&Y Study: “Competitiveness of State and
Local Business Taxes on New Investment”
How Does New Mexico Compare?
• 2010 COST / E&Y “Total State and Local Business Taxes”
• 50-state study, measures total business tax burden, FY 2009
• Considers all taxes paid by businesses in the state
• Comparison relative to: 1) economic activity (private sector
GSP), and 2) government services benefiting business
• New Mexico ranks 25th (national avg) on benefits comparison
(midpoint estimate), but 42d worst on tax burden as % of private
sector GSP (8th highest – 5.9% vs. national avg of 4.7%)
How Does New Mexico Compare?
• 2010 COST “Best & Worst of State Tax Administration”
• Evaluates statutory provisions of tax administration
• Procedural Issues and Independence of Tax Appeals System
• New Mexico one of 8 states with “D” Grade
• No Independent dispute system; must pay to get to District Court for de
novo review
• Only 30 Days to protest an assessment
• Lack of CIT regulations fosters uncertainty and ambiguity
• Short time period for reporting federal changes on amended return
How Does New Mexico Compare?
• 2011 COST / E&Y Study: “Competitiveness of State and
Local Business Taxes on New Investment”
• Compares tax liabilities on new investment in states, considering 5
types of mobile capital investments
• Computes effective tax rate on such investments
• Need to understand limitations of study
• New Mexico ranks 51 out of 51 at 16.9% Why?
• Three-factor apportionment
• High gross receipts tax on business activity
• Property taxes on real and tangible personal property
Contact Information
Doug Lindholm
Council On State Taxation (COST)
Ph: 202.484.5212
[email protected]
42