2017 State Tax Legislative Outlook - Eversheds Sutherland...Federal legislation addressing state sales tax collection is caught up in political wrangling. ... On September 15, 2016,

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2017 State Tax Legislative Outlook

Maria Todorova, Partner, Sutherland Madison Barnett, Counsel, Sutherland Robert Garvey, Principal, PwC TEI San Diego State and Local Tax Seminar September 29, 2016

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Agenda

Sales Tax Nexus Expansion Combined Reporting Market-Based Sourcing Apportionment Ecommerce Platform Collection Taxation of Digital Goods Qui Tam/False Claims Act

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SALES TAX NEXUS EXPANSION

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What Is the Nexus Standard?

The nexus standard set by the U.S. Supreme Court in Quill Corp. v. North Dakota (1992) still applies.

In order for a state to impose a sales and use tax collection obligation on an out-of-state seller, the U.S. Supreme Court has held that a physical presence in the state is required. Quill Corp. v. North Dakota (1992).

The physical presence must be more than de minimis.

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Shifting Nexus Landscape

The U.S. Supreme Court has not accepted a nexus case since Quill.

Federal legislation addressing state sales tax collection is caught up in political wrangling.

States have taken action to overturn Quill. – Aggressive nexus positions

– Anti-Quill legislation

– Anti-Quill legislation that allows for immediate review by state courts

– Use tax reporting

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Direct Marketing Association – Justice Kennedy’s Concurrence

In Direct Mktg. Ass’n v. Brohl, 135 S. Ct. 1124 (2015), Justice Anthony Kennedy went out of his way to invite reconsideration of Quill.

– “Given these changes in technology and consumer sophistication, it is unwise to delay any longer a reconsideration of the Court’s holding in Quill. A case questionable even when decided, Quill now harms States to a degree far greater than could have been anticipated earlier….It should be left in place only if a powerful showing can be made that its rationale is still correct.”

In response, states have taken legislative efforts to force remote vendors to collect sales tax.

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Economic Nexus – Alabama

The Alabama Department of Revenue promulgated regulation 810-6-2-.90.03 imposing sales and use tax reporting and collecting obligations on out-of-state retailers without physical presence in Alabama if such retailer had at least $250,000 in retail sales of tangible personal property the prior calendar year.

Based on commentary from the Alabama Revenue Commissioner, Alabama is willing to litigate the validity of its regulation, even in light of Quill.

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Economic Nexus – Alabama

Once the regulation became effective, the Alabama Department of Revenue asserted that various remote retailers had “substantial economic presence” and had failed to report and collect Alabama sales and use tax.

Newegg Inc. v. Ala. Dep’t of Revenue, ___ (Ala. Tax Tribunal) – On June 8, 2016, Newegg filed suit against the Alabama Department of

Revenue in the Alabama Tax Tribunal. – Newegg contended that the Department’s attempt to apply its regulation

is unconstitutional and violates U.S. Supreme Court precedent. Newegg also argued that the regulation conflicts with Alabama's statutes.

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Economic Nexus – South Dakota

On March 22, 2016, South Dakota enacted S.B. 106, which imposes a South Dakota sales and use tax reporting and collection on out-of-state retailers without physical presence in South Dakota if such retailers have in the current year or had in the prior year either:

– $100,000 of gross revenue from the sale of tangible personal property, electronic products, or services delivered into South Dakota; or

– 200 separate transactions in which tangible personal property, electronic products, or services were delivered into South Dakota.

S.B. 106 permits the state to bring a declaratory judgment action in any South Dakota Circuit Court against “any person [that South Dakota] believes meets the criteria of section 1 of [S.B. 106] to establish that the obligation to remit sales tax is applicable and valid under state and federal law.”

S.B. 106 does not require that the state attempt to collect sales tax from a remote seller before seeking such a judgment. On April 29, 2016, however, taxpayers challenged the constitutionality of S.B. 106. Complaint, Am. Catalog Mailers Ass’n v. Gerlach, No. 32CIV16-___ (6th Cir., S.D.).

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Economic Nexus – South Dakota

South Dakota v. Wayfair Inc., No. 32CIV16-0092 (6th Cir., S.D.) – On April 28, 2016, the South Dakota Department of Revenue filed suit in

state court against several large online retailers (Wayfair Inc., Systemax Inc., Overstock.com Inc., and Newegg.com Inc.) that failed to register to collect and remit sales tax under S.B. 106.

– On May 25, 2016, the retailers filed a Notice of Removal for the case to be transferred to federal court asserting that the case raises an express question of federal law. South Dakota v. Wayfair Inc., No. 3:16-CV-03019-RAL (D.S.D.).

– On July 22, 2016, the Department filed a Motion to Remand asserting that the case should be remanded back to state court because the federal court lacked jurisdiction in declaratory judgment cases. The Department also argued for removal based on federal-state comity grounds, the Tax Injunction Act, and violation of the 11th Amendment.

– On July 22, 2016, the retailers filed a Motion for Summary Judgment asserting the applicability of Quill and the importance of Congress.

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Proposed Economic Nexus

Tennessee: On June 16, 2016, the Tennessee Department of Revenue proposed regulation 1320-05-01-.129 imposing sales and use tax reporting and collecting obligations on out-of-state retailers without physical presence in Tennessee if such retailer had at least $500,000 in retail sales of tangible personal property during the calendar year.

Illinois: On April 15, 2016, the Illinois General Assembly proposed S.B. 1041 to amend Illinois sales tax law to provide that a retailer is also presumed to be “maintaining a place of business in this State” if the retailer's total gross receipts from sales occurring in Illinois in the previous calendar year is $1,000,000 or more.

Minnesota: On April 1, 2016, the Minnesota Legislature proposed H.B. 3787 that would require a remote seller that does not have physical presence in the state to collect and remit Minnesota sales tax if the seller:

– engaged in one of several specified activities that do not require an in-state physical presence; and

– made taxable sales to 20 or more Minnesota purchasers that aggregate to more than $200,000 or makes 200 or more taxable in-state sales.

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COMBINED REPORTING

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Combined Reporting for 2016

Separate Reporting

Combined Reporting

* Based upon general rules.

Not applicable

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Push for Combined Reporting

Pushed in 2016 to no avail: - Alabama - Kentucky - Louisiana - Maryland - Pennsylvania

Success in 2015:

- Connecticut

Pending in 2016: - New Jersey

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Push for Combined Reporting

Indiana: On March 24, 2016, the Indiana General Assembly enacted S.B. 323 calling for a study to be performed by the legislative services agency examining mandatory unitary combined reporting.

- S.B. 323 as initially introduced included provisions that would have instituted mandatory unitary combined reporting.

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MARKET-BASED SOURCING

APPORTIONMENT

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Sales Factor: Weighting for 2016

Three factor, double weighted sales

Three factor, triple weighted sales

Single sales factor (DC)

* Based upon general sourcing rules.

Not applicable, no general corporate income tax

Three factor

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Shift Toward Market-Based Sourcing

Changing economy causing states to shift toward adoption of market-based sourcing 23 states and the District of Columbia have adopted

market-based sourcing for service receipts Since 2014, the following jurisdictions have shifted to

market-based sourcing:

- Connecticut - New York - District of Columbia - Pennsylvania - Louisiana - Rhode Island - Massachusetts - Tennessee - Nebraska

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Recently Enacted Market-Based Sourcing

Connecticut - On June 6, 2016, S.B. 502 was enacted, which adopts market-

based sourcing effective for taxable years beginning on or after January 1, 2016.

Louisiana - On June 28, 2016, H.B. 20 was enacted, which adopts market-

based sourcing effective for taxable years beginning on or after January 1, 2016.

North Carolina - On July 1, 2016, H.B. 1030 was enacted, which adopts proposed

market-based sourcing provisions and requires the North Carolina Department of Revenue to issue related proposed regulations.

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Market-Based Sourcing for 2016

Income producing activity / cost of performance sourcing

Service performed sourcing

Market-based sourcing (DC)

* Based upon general sourcing rules.

Not applicable

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Market-Based Sourcing Final Regulations and Guidance

California - On September 15, 2016, the California Franchise Tax Board filed its

final amendments to 18 CCR § 25136-2 governing market-based sourcing of sales of intangible property, amending its rules governing the sourcing of income from interest, marketable securities, dividends and goodwill. The effective date is January 1, 2017.

Massachusetts - On January 2, 2015, the Massachusetts Department of Revenue

issued its new final regulation, 830 CMR 63.38.1, that provides market-based sourcing rules for apportioning receipts from services and transactions involving intangible property.

Michigan - On October 16, 2015, the Michigan Department of Treasury issued

guidance, Michigan Revenue Administrative Bulletin 2015-20, on how to determine where the recipient of services receives the benefit of those services.

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Market-Based Sourcing Final Regulations and Guidance

Nebraska - On December 27, 2015, the Nebraska Department of Revenue

amended business entity regulations, Neb. Admin. Code 24-301 et seq., on apportionment to incorporate market-based sourcing rules.

Rhode Island - On December 23, 2015, the Rhode Island Division of Taxation

issued its new final regulation, R.I. Regs. § CT 15-04, that provides market-based sourcing rules. The effective date was January 12, 2016.

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Market-Based Sourcing Draft Regulations and Guidance

New York - On October 15, 2015, the New York State Department of Taxation

and Finance issued draft market-based sourcing regulations that describe how to source receipts under the hierarchies described in NY Tax L § 210-A.4 for digital products, and NY Tax L § 210-A.10 for other services and other business activities.

Tennessee - On February 25, 2016, the Tennessee Department of Revenue

issued draft market-based sourcing regulations. Market-based sourcing was enacted during the 2015 session (H.B. 644).

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ECOMMERCE PLATFORM COLLECTION

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Sales Tax Collection

Generally, sales or use tax is either: - Paid by seller; - Collected by seller from customer and remitted to state;

or - Paid by customer. Thus, either the seller or the customer in a retail

transaction is responsible for collecting or paying the sales or use tax.

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Ecommerce Platform Collection

With the expansion of electronic commerce marketplaces, states have looked for opportunities to shift the tax collection obligation to new types of entities. States have focused on:

- Online hotel intermediaries (OTC); - Marketplaces (e.g., Ebay); - Transportation platforms (e.g., transportation network companies); - Financial entities; and - Common carriers.

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Ecommerce Platform Collection

States have attempted to shift the tax collection obligation to these entities through: - Asserting these entities are the seller/vendor/retailer OTCs

- Asserting these entities are agents for the sellers - Enacting legislation to require such entities to collect tax OTCs Short-term rental platforms Transportation platforms

- Proposing legislation to require such entities to collect Credit and debit card processors Marketplaces

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Ecommerce Platform Collection – Marketplaces – New York

New York’s 2015 Budget Bill proposed to create a new class of sales tax payer – a “marketplace provider.”

Marketplace providers would have been responsible and liable for

collecting and remitting New York sales tax on sales by all marketplace sellers with which they have an agreement, irrespective of whether the marketplace seller has nexus in New York.

Marketplace providers would have all the duties, benefits and

entitlements of a person required to collect the sales tax as if such marketplace provider were the vendor, operator or recipient with respect to such sale, occupancy or admission.

This proposal was ultimately removed from the final Budget Bill.

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Ecommerce Platform Collection – Marketplaces – Washington

In Washington, H.B. 2224 proposed legislation that would have created a sales tax collection requirement for marketplace facilitators.

The legislation would have shifted the obligation to collect Washington sales and use tax from the actual seller of the product to the marketplace facilitator.

A marketplace facilitator would have been deemed to be an agent of any marketplace seller selling through the marketplace facilitator’s marketplace.

As such, the marketplace facilitator would have been required to collect Washington sales tax on all retail sales to Washington customers made through the marketplace facilitator’s marketplace – even when the sales are not made by the marketplace facilitator and even when the actual seller has nexus and an independent sales tax collection requirement in Washington.

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Ecommerce Platform Collection – Marketplaces – Other States – 2016

Minnesota - Several bills included language that would have required marketplace

providers that facilitate sales to customers in the state to collect and remit sales tax for the marketplace seller unless the seller is already collecting.

- Bills were never passed. Oklahoma

- H 2531would have required marketplace providers to collect and remit sales and use tax.

- Language was modified before enactment to “allow” marketplace providers to collect.

Rhode Island - H 7375 would have required marketplace providers to collect and remit

sales tax. - Bill was referred to House Committee on Finance.

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TAXATION OF DIGITAL GOODS

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What Are Consumer Digital Goods?

Often digital equivalents to historically tangible items, e.g., books, music, video games and videos (movies, television)

Important distinctions with cloud-based services and B2B services

Influence of the Streamlined Sales and Use Tax Agreement

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Alabama Proposed Regulations – Rental Tax Applies to Streaming Video

The Alabama Department of Revenue (DOR) proposed amendments to the state’s rental tax regulations, which would have applied the tax to “digital transmissions” including on-demand movies and TV, and streaming audio and video. Prop. Ala. Admin. Code r. 810-6-5.09.

After heavy scrutiny during the comment period, and a letter from the Alabama Legislative Council that indicated that the Council would use its administrative review powers to reject enactment of the proposed rule, the Alabama DOR withdrew the proposed amendments.

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California Localities – Communication Users Tax

Specific California localities have explored expanding their Utility User Tax (UUT) to apply to “video services.”

For example, Bencia and City of Indio have issued an administrative ruling indicating that in response to a recent growth of video services using new technologies, the cities are applying/expanding their existing ordinances to tax “video services.”

“Video services” include: - Subscription on-demand

- One-time on-demand

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QUI TAM/FALSE CLAIMS ACT

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Overview

Under-collection

Qui tam/ False Claims Act

risk

Over-collection

Class action risk

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State False Claims Acts

Approximately 30 jurisdictions have False Claims Acts ‒ Some states restrict their False Claims Act provisions to Medicaid and/or

contractor-type “frauds.” ‒ A number of state False Claims Act provisions contain explicit “tax bars” prohibiting

qui tam actions for allegedly false tax claims (e.g., CA, DC, HI, MA, NM, NYC, NC, TN, VA).

‒ Some state False Claims Act provisions impose a tax bar only with respect to income tax matters (e.g., IL, IN, RI).

‒ A number of states do not appear to restrict the action to a particular subject matter (e.g., DE, FL, NV, NH, NJ).

In 2010, New York became the first state to explicitly authorize the application of its False Claims Act to tax claims.

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State False Claims Acts

Extremely high stakes

Generally treble damages plus substantial penalties for each return filed

Extended statute of limitations period

Up to 30% of proceeds are awarded to the whistleblower

Tried in the public domain, often labeled as tax fraud

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Repeat Relators

Illinois has seen hundreds of qui tam actions filed by a Chicago-based class action plaintiffs’ law firm. – The state has intervened for many of these cases to be dismissed.

State of Illinois ex rel. Stephen B. Diamond, PC v. Lush Internet, Inc., No.

13-L-009147 (Ill. Cir. Ct. 2016) – Plaintiff alleged a Lush affiliate underpaid sales and use taxes on online

sales, arguing that the affiliate had sufficient nexus with the state. – Circuit Court of Cook County held that the plaintiff failed to prove by a

preponderance of the evidence that the affiliate (1) had nexus with Illinois; and (2) knowingly failed to collect taxes.

State of New York ex rel. Stephen B. Diamond PC v. My Pillow Inc., No.

100337/14 (N.Y. Sup. Ct. 2016) – Plaintiff alleged that the company failed to collect and remit sales tax on

online and telephone purchase orders. – On July 20, 2016, the company settled the suit agreeing to pay $1.1 million –

$887,200 paid to the state and $221,800 to the relators.

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Continued Fine Tuning

Some states are seeking expansion of their False Claims Act provisions to authorize application to tax claims. – On June 8, 2016, the Michigan Senate proposed S.B. 1020 to allow qui

tam actions for tax law violations if the net income or sales of a company exceed $1 million for the tax year and damages pleaded exceed $350,000.

Illinois has attempted to curb its False Claims Act without success. – On February 20, 2015, the Illinois General Assembly proposed H.B. 2803

and its companion bill S.B. 1828 to provide that no court could have jurisdiction over a qui tam action relating to a tax administered by the Illinois Department of Revenue, unless the action is brought by the Attorney General.

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Questions?

Maria M. Todorova

Sutherland Asbill & Brennan LLP 404.853.8214

[email protected]

Madison Barnett Sutherland Asbill & Brennan LLP

404.853.8191 [email protected]

Robert Garvey

PricewaterhouseCoopers LLP 858.677.2536

[email protected]

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Documents

2017 State Tax Legislative Outlook - Eversheds Sutherland...Federal legislation addressing state sales tax collection is caught up in political wrangling. ... On September 15, 2016,