Intercompany Transactions in Separate Reporting States

Reprinted from Tax Notes State, April 22, 2024

It’s hard to believe it’s been over five years since the Maryland Court of Special Appeals held in Staples Inc. that an out-of-state parent could be subject to tax in the state by virtue of royalty payments made by in-state related entities despite all intercompany transactions being at arm’s length. That case is one in a line of Maryland cases that purport to permit separate reporting in the state only when related entities have “economic substance as business entities separate from” other members of a unitary group despite being a separate reporting state. I think most would agree that this exception has swallowed the rule in Maryland, and even out-of-state entities with property, payroll, and third-party sales have fallen prey to the requirement that they be discrete business enterprises. But since at least 2006, Maryland has proposed bill after bill studying the fiscal impact that combined reporting might have, coupled with attempts to adopt various iterations of combined reporting. Proposed this February, Maryland H.B. 1007 would require a unitary business to file a combined return on its worldwide taxable income. No such bills have passed thus far.

I’m no fiscal policy expert, so I’m inclined to believe the consensus from those advocating for combined reporting that it typically has the effect of raising revenue in states, although that impact often appears minimal. Only one data point, but the first report of that study mandated by Maryland in 2006 suggested that the state would have collected an additional $109 million to $170 million had it adopted combined reporting. Nonetheless, many state policymakers reasonably prefer separate reporting for its simplicity, not to mention avoiding the technical and constitutional complexities that arise in combined reporting regimes, such as how to apportion disparate streams of income.

Maryland is hardly alone in this struggle between having a legislature stalwartly support a separate reporting framework and the taxing authority aggressively attempting to undermine that statutory framework. As recently as March 11, the governor of South Carolina signed into law S.B. 298, which limits the extent to which the Department of Revenue can force combination among unitary business affiliates. That legislation came after nine years of the DOR asserting that separate reporting is inherently distortive when a unitary business earns income outside South Carolina and that combined reporting would be required in those situations. After the department’s recent win in Tractor Supply, the General Assembly reinforced the requirement that the department look to whether intercompany transactions are at arm’s length, and it imposed numerous conditions that the state must meet in imposing alternative apportionment and requiring combined returns.

Click here to continue reading in Tax Notes State.

A Trap for the Unwary Purchaser of an IRA Credit

Reprinted from Tax Notes State, April 15, 2024

To incentivize investment in clean or renewable energy, the Inflation Reduction Act of 2022 (IRA) created — and in some cases improved on existing — federal income tax credits availablemto investors in eligible clean or renewable energy projects. Some of these credits are popular, at least in part, because they are transferable, meaning that they can be sold by the entity generating the credits. This transferability allows entities that do not expect to use the credits to monetize them by selling all or a portion of the credits to a thirdparty purchaser.

To fuel the market for IRA credits, proposed Treasury regulations provide that the purchaser will not recognize gain on its use of the credit for federal income tax purposes (which is not the case for all credits). However, in the weeds of state tax there is a trap for the unwary: Not all states will follow this federal relief provision, and some states may try to tax gain on the use of a purchased IRA credit.

Click here to continue reading on IRA credits in Tax Notes State.

Florida’s Business Rent Tax Reduction Coming June 1, 2024

On June 1, 2024, Florida’s business rent tax will be automatically slashed from a 4.5% rate to a 2.0% rate due to implementation of its 2021 Wayfair legislation. Florida’s passage of Chapter 2021-2, Laws of Florida adopted economic nexus concepts related to the retail sale of tangible personal property by remote sellers and marketplaces. Part of the legislation included a temporary freeze of Florida’s unemployment tax rates and a diversion of general revenue funds to refill the Unemployment Compensation Trust Fund that was heavily depleted during the pandemic. Once the trust fund matched pre-pandemic levels, the Legislature created an automatic reduction of the state tax rate for the business rent tax to 2.0%.

Florida is the only state in the nation that levies a sales tax on the lease or license to use commercial real property. Beginning January 1, 2018, the Florida legislature started chipping away at the tax rate reducing it from 6.0% to 5.8%. In the following years, the tax was slightly reduced multiple times, yet the rate did not drop below 5.5% until December 1, 2023, due to actions of the 2023 legislature. Now, the rate will be slashed to 2.0% starting June 1, 2024.

This rate reduction only applies to the state sales tax. Any locally levied discretionary sales surtaxes would be in addition to the state tax rate of 2.0%

South Carolina Legislature Reinforces Separate Reporting Regime, Slapping Department on the Wrist

Last week, South Carolina Governor McMaster signed into law Act No. 113 in a much needed reproach to the Department of Revenue’s aggressive attempts to undermine the state’s separate reporting regime for apportioning corporate income. While the law creates a new paradigm for how and in what manner the state or taxpayer may obtain alternative apportionment, the objective was clear: to restrict the Department’s ability to require combined reporting when invoking alternative apportionment. Under the new law, the Department may require combined reporting only if it determines that an affiliated group’s intercompany transactions lack economic substance or are not at fair market value, and it must provide a detailed written statement of its findings justifying combined reporting.  Additionally, and perhaps most importantly, if the Department concludes that a combined return is required in order to fairly represent a taxpayer’s business activity in the state, the Department may not unilaterally exclude unitary members from the combined group.

The Act, which takes effect March 11, 2024, and applies to all open tax periods excluding assessments under judicial review by the South Carolina ALC, Court of Appeals, or Supreme Court, has been a long time coming. Passed unanimously by both the House and Senate, the Act is a clear repudiation of South Carolina Revenue Ruling No. 15-5 (6/12/2015), which has frequently been invoked by the Department to require combined reporting, not where a taxpayer’s transfer pricing studies fail to support the arm’s length nature of intercompany transactions, but simply where a unitary business exists and not all members file in the state. That policy recently came to a head in Tractor Supply Co. v. Dep’t of Rev., Dkt. No. 19-ALJ-17-0416-CC. In that case, the ALJ determined that intercompany transactions were not at arm’s length (despite a transfer pricing study that concluded the opposite) and that combined reporting was a reasonable alternative to the statutory framework to fairly represent the taxpayer’s business activity in the state. While that decision involved a thorough discussion of the facts and evidence in the case, the ALJ was dismissive of the fact that the Department was using executive fiat to undermine the state’s separate reporting regime. In fact, the ALJ specifically said, “I do not find Petitioner established that the Department is using Revenue Ruling #15-5 to systematically target unitary businesses for combined unitary reporting without regard to the factual determination required to impose alternative apportionment.”

Both the South Carolina House and Senate obviously disagreed with the ALJ’s finding in this regard, and for good reason. The assertion that the Department was blindly requiring unitary businesses to file combined tax returns without regard to the facts was not just anecdotal- the Department has systematically targeted unitary businesses operating in the state since it issued Revenue Ruling No. 15-5. The fiscal impact statement all but proves this. It states that the Department reported that approximately $138,000,000 has been generated in the last 3 to 4 years from 53 audits of companies.   

Of course, many entities reporting in South Carolina may be parts of unitary groups that generate only losses. Call us cynics, but we suspect the Department has not required combination of those groups. The Department’s strategy appears to have been to cherry-pick taxpayers for combined reporting; the Department targeted unitary businesses with out-of-state income for combined reporting (some of the largest in the country), but not those unitary businesses with out-of-state losses. This allowed the Department all the revenue benefits of combined reporting, but none of the revenue losses.

More broadly, Act No. 113 may provide some hope to taxpayers confronting similar challenges in other states. Recently, other separate reporting states have aggressively targeted unitary structures in a variety of ways. While South Carolina required combined reporting, others have audited the taxpayer’s transfer pricing studies despite limited audit capabilities in that respect or taken another creative approach to broaden the tax base. Some states may use an “embedded royalty” add back approach, while others may simply say the out-of-state entities lack economic substance. There have been many iterations of this, but the ultimate goal is often the same – to target unitary businesses operating in the state with the goal of undermining the statutory separate reporting paradigm. We’ve seen these issues arise in Alabama, Georgia, Louisiana, Indiana, Maryland, New Jersey and North Carolina.

Many of these states have seen proposed legislation for combined reporting come and go without passing. Taxpayers have reasonably pointed to these failed proposals as evidence that the separate reporting rules should be presumed to fairly reflect a business’s operations in the state, absent reliable evidence to the contrary. The tax departments in these states have often disregarded this argument. South Carolina’s legislation, however, goes a step further and functions as a direct repudiation of the Department’s efforts to target unitary businesses. Maybe the willingness of the South Carolina legislature to pass Act No. 113 will make other state departments think twice before being as aggressive in their audits of intercompany transactions. If not, perhaps Act No. 113 will become model legislation for other similarly situated states. 

Jones Walker SALT Partners Present at TEI Houston Chapter Meeting

Jones Walker SALT Team Partners Jay Adams, Bill Backstrom, and Andre Burvant presented a Louisiana update during the state & local section at the Tax Executives Institute Houston Chapter Meeting. Presentations included updates on state and local taxes and energy tax planning.

We are always excited to speak at TEI Houston and to connect with local clients while discussing important state & local tax issues.

-Jay Adams, Jones Walker State & Local Tax Team Leader

La. Governor Issues Executive Order Regarding ITEP

On February 21, 2024, Governor Jeff Landry issued Executive Order No. JML 24-23 (EO No. 23-24) providing for the conditions for participation in the state’s Industrial Tax Exemption Program (ITEP). The ITEP provides for a property tax exemption for manufacturing facilities. Under the Louisiana Constitutional, art. 7, Section 21(F), subject to terms approved by the Governor, the Board of Commerce and Industry (BCI) may grant an exemption contract to a manufacturing facility for an initial 5 year term and a renewal term of 5 years. The ITEP can be up to a 100% abatement of property taxes for the manufacturer. Under Governor Edwards, the abatement was capped at 80% for most new projects and local government approval was required.

Under EO No. 23-24, Governor Landry has retained the 80% abatement for advance project notifications filed on or after February 21, 2024. EO No. 23-23 specifically does not apply to advance project notifications or ITEP contracts signed before February 21, 2024. EO No. 23-24 contemplates the approval of a “Local ITEP Committee” composed of local elected officials; however, the approval of the Local ITEP Committee will not be dispositive of the ultimate approval of the ITEP by the BCI or the Governor. In addition, under EO No. 23-24, the Louisiana Department of Revenue (DOR) will review each ITEP application and must provide a letter of approval or no objection. EO No. 23-24 does not define the parameters of the LDR’s review of the ITEP Application.

EO No. 23-24 can be found here.

If you have questions on ITEP, contact Jones Walker SALT partner, Jay Adams.

Council on State Taxation Appoints New President and Executive Director

The Board of Directors for the Council On State Taxation (COST) is thrilled to announce that Patrick Reynolds has been appointed as the new President and Executive Director of COST, effective March 1, 2024. He will succeed Doug Lindholm, who has served in this role since 1999. The Board and staff are eager to collaborate with Pat as he navigates COST through the ever-changing state and local tax landscape.

Our Jones Walker SALT Team sends a huge congratulations to Pat and the whole COST family!

Click here to read the full press release from COST.

Equifax Rises from Its Grave; Will the Mississippi Supreme Court Finally Bury this Procedural Monster for Good?

Mississippi Taxpayers should keep a very close eye on the Toolpushers Supply sales tax case just granted certiorari by the Mississippi Supreme Court.  This case addresses important sales tax issues related to wholesale sales and the extent to which a seller must audit its purchaser’s downstream use of the goods on purported resale transactions.  More importantly, perhaps, the case seriously jeopardizes key tax appellate reforms that the Legislature overwhelmingly enacted in 2014 in direct response to the thoroughly criticized 2013Equifax alternative apportionment case.

The substantive sales tax issue in this case is the extent to which a seller can rely on a purchaser’s valid resale permit when deciding whether to treat a sale as a wholesale or retail transaction.  Mississippi’s wholesale sales statute contains a “good faith” requirement that the seller must determine whether the customer was a retailer regularly selling or renting that property.  The case involved sales to an oilfield service provider holding a valid retail sales tax permit, but the Department assessed the seller based on the position that the purchaser later consumed those products instead of reselling them.  The negligible “record” in the case suggested that the seller accepted the permit at face value without any further inquiry (a disputed assertion in the case).  If upheld, the holding suggests that every seller must perform a much more laborious – but undefined – examination of its customer’s planned use of the goods in determining whether the transaction is eligible for wholesale treatment.  While there appear to be substantial factual questions in this case going to that “good faith” requirement, it could require substantial alternation of internal policies and procedures for wholesale sellers going forward.

The more important question in the case, however, may be procedural.  In direct response to widespread criticism and concern about the Equifax decision in 2013, the Mississippi Legislature overwhelmingly approved fundamental changes to the tax appeals statutes to expressly provide for true de novo appeals of tax cases before the chancery court.  In fact, the amended Section 27-77-7 explicitly prohibited application of the more deferential “arbitrary and capricious” standard of review relied upon to such consternation in the Equifax decision.  This express prohibition and statement of intent was necessary after the Supreme Court concluded in Equifax that when the Legislature originally used the term “de novo” under the older version of the appeals statute, it really meant arbitrary and capricious. 

To preclude such a misconstruction of intent in future cases, the Legislature added a new provision mandating that “[t]he chancery court is expressly prohibited from trying any action filed pursuant to this section using the more limited standard of review specified for appeals in Section 27-77-13 of this chapter.”  That cross-referenced code section, governing appeals of permit denials, etc., requires the application of the historic “arbitrary and capricious” standard of review which is more appropriate in those circumstances because an actual evidentiary record is created below to enable a review on that basis.  In the typical sales, use, income and franchise tax context, however, no evidentiary record is created at the Board of Tax Appeals or Review Board, so application of a true de novo standard with a full evidentiary trial is necessary at the chancery court level.

The Court of Appeals in Toolpushers cited the Supreme Court’s analysis in Equifax to again discount the statutory de novo reference and impose the old arbitrary and capricious standard, perhaps unaware of the relationship of that very case to the new statutory standard.  The Court of Appeals never acknowledged, cited, or analyzed the new sentence in Section 27-77-7 expressly prohibiting it from applying the lesser standard of review.

If the Supreme Court upholds the Court of Appeals’ analysis on the standard of review, it could be near impossible for taxpayers to prevail on a judicial appeal under the weaker Equifax standard in the absence of any evidentiary record to review.  This case will be extraordinarily important for both pending and future tax appeals. 

Jones Walker SALT Practice Expands in Florida

Jones Walker LLP announced the firm has reestablished its Tallahassee, Florida, office effective immediately. The new office expansion is the direct result of a successful and long-standing strategic alliance with Florida’s Dean Mead law firm. A total of nine attorneys and government relations professionals have joined Jones Walker, including partner French Brown and special counsel Dan McGinn in the Tax Practice Group, to maximize a larger client delivery platform while continuing to work closely with Dean Mead attorneys, consistent with the strategic partnership that began in 2019.  

French Brown joins Jones Walker after six years at Dean Mead. Over the course of his career as a Florida state and local tax lawyer, and through his work as a lobbyist and government relations advisor before the Florida Legislature, French has been involved in all major tax legislation in the state in recent decades. He offers clients legal advice on the full spectrum of Florida taxes, including sales, corporate income, motor fuels, communications services, property, and documentary stamp taxes. Early in his career, French served as deputy director of the Office of Technical Assistance and Dispute Resolution of the Florida Department of Revenue, where he oversaw more than 50 department attorneys, accountants, and auditors in charge of legal guidance, agency rulemaking, and informal audit protests. He also served as the department’s legislative and cabinet affairs director. In this role, French worked directly with legislators, long-standing legislative staff, the governor, and cabinet offices.

Since returning to private practice, French has been a key contributor to and advocate for significant tax legislation moving through the Florida capitol. As representative for some of the state’s largest trade associations and taxpayers, he has directly worked on and advocated for tax legislation to benefit companies and taxpayers alike. French’s work has contributed to billions of dollars in reduced state and local taxes, including more than a billion dollars in corporate income tax refunds paid in 2020 and 2022. He also was instrumental in promoting Florida’s adoption of remote seller and marketplace facilitator provisions following the US Supreme Court’s 2018 Wayfair decision.

In 2018, French served as counsel to the successful constitutional proposal to permanently preserve the state’s annual 10% cap on commercial property tax increases, which passed with 66.5% of the public vote. In the course of his efforts, he advocated for his clients before the Constitutional Revision Commission to further the development of sound state tax and budget policies. In addition to his legislative work, French assists his clients with Florida tax planning and controversies before the Department of Revenue and local property appraisers.

Dan McGinn returns to Jones Walker after four years at Dean Mead. Dan represents businesses and individuals before Florida’s Department of Revenue and in courts throughout Florida in state and local tax matters. Drawing on his experience and deep knowledge of relevant regulatory frameworks, Dan devises creative solutions for his clients’ concerns and helps them achieve desired outcomes.

He also counsels clients on a broad range of regulatory compliance and legislative advocacy matters, with an emphasis on issues involving Florida’s Division of Alcoholic Beverages and Tobacco, which is tasked with the enforcement of numerous laws and regulations — including Prohibition-era codes — that have failed to keep pace with the demands of innovation-focused industries and businesses. In addition, Dan practices before Florida’s Gaming Control Commission, advocating for sensible gaming regulation and fair application of the prohibitions against illegal gambling.

The Tallahassee office is among the firm’s 16 locations in eight states and the District of Columbia.