John Fletcher, a partner on the State and Local Tax team, conducted two joint presentations with officials with the Mississippi Department of Revenue at the Mississippi Tax Institute on December 7, 2017 in Jackson, Mississippi. John’s sessions updated attendees in the areas of multi-state taxation of pass-through entities, potential Mississippi consequences of the recent federal income tax changes, and Mississippi sales and use tax regulatory developments.
Louisiana Governor John Bel Edwards (D) recently met with leaders from the Louisiana Legislature to discuss his draft 2018 Tax & Budget Priorities, including recommendations for how the State should address the long-term issue of its current taxing and spending structure, as well as the short-term issue of the $1 billion “fiscal cliff” looming in the upcoming fiscal year.
The Governor has explained that his draft plan is “not calling for net new tax revenue,” but rather is meant to replace the temporary revenue measures enacted in 2015 and 2016.
Currently, it is anticipated that Governor Edwards will indeed call a special legislative session in February 2018 to solve the fiscal cliff and again discuss long-term tax reform. The Governor cautioned, however, that he would not call a special session unless he felt that these issues could (and would) be resolved.
The 2018 regular session of the legislature is a non-fiscal session; thus, tax legislation is not germane. As a result, the Governor would need to call a special session either before or after the regular session if any new tax bills are to be entertained by the legislature in 2018. If no special session is called, then the legislature would be forced to address the upcoming fiscal cliff solely with budget cuts.
The fiscal cliff in next year’s budget results from the scheduled roll-off of incoming revenue from the additional 1% “clean penny” state-level sales tax, as well as the sunset of several temporary haircuts to various exemptions and credits. These measures, which were put in place during the 2015 and 2016 legislative sessions, were considered “temporary” while the legislature worked toward longer-term taxing and spending reform.
The Governor has explained that he is not in favor of merely extending the “clean penny” sales tax increase past its current 2018 expiration date, unless it is a “bridge” to a more permanent solution.
This story may sound familiar, because it is.
Numerous long-term tax reform measures were proposed by the Governor’s administration during the legislature’s 2017 regular session. Ultimately, however, much of that proposed legislation was largely rejected by the legislature, leaving questions unanswered as to how the state would address its short-term and long-term fiscal issues.
As was the case during the 2017 regular session, in his new draft 2018 Tax & Budget Priorities, the Governor has again proposed taxing measures consistent with those previously recommended by the legislative Task Force on Structural Changes in Budget and Tax Policy.
The Governor’s self-described “aggressive but balanced approach” to address the upcoming fiscal cliff and enact long-term tax reform includes:
- Making permanent reductions to tax credits, deductions and rebates (Act 109, Act 123, and Act 126, of the 2015 regular session).
- Compressing individual income tax brackets and reducing the excess itemized deduction to 50%.
- Cleaning all four pennies of the state-level sales tax based on the currently available “clean penny” exemptions.
- Taxing business utilities at 4% (full state-level permanent sales tax rate) and industrial utilities at 2% (50% state-level rate).
- Expanding the sales tax to certain services.
The Governor has explained that his draft plan is “not calling for net new tax revenue,” but rather is meant to replace the temporary revenue measures enacted in 2015 and 2016.
Specifically, the Governor’s draft 2018 Tax & Budget Priorities propose the following:
Make Permanent Reductions to Tax Credits, Deductions, and Rebates
- Act 109 of the 2015 regular session provided limitations on the credit for taxes paid to other states to those states that provide a similar tax credit for Louisiana income taxes paid on certain sources of income. These limitations would be made permanent.
- Act 123 of the 2015 regular session temporarily reduced the value of several corporate income tax exclusions and deductions, including depletion and dividend income. These would be made permanent.
- Act 126 of the 2015 regular session temporarily reduced the value of the following rebate programs: Quality Jobs Program, Corporate Headquarters Relocation Program, and the Competitive Projects Payroll Incentive Program. These reductions would be made permanent.
Compress Individual Income Tax Brackets and Reduce Excess Itemized Deductions to 50%
- Current law allows and individual income tax deduction for 100% of excess federal itemized personal deductions. Excess federal itemized personal deductions are defined as the amount by which the federal itemized personal deductions exceed the amount of the federal standard deduction.
- The Governor’s proposal would reduce the amount of the deduction from 100% to 50%. The proposal would also compress individual income tax brackets.
Clean All Four Pennies of State-Level Permanent Sales Tax Based on Currently Available “Clean Penny” Exemptions
- The Governor’s proposal would expand the sales tax base on the permanent 4% state-level sales tax (the “permanent pennies”) by mirroring the current sales tax base of the temporary additional 1% “clean penny” state-level sales tax.
Tax Business Utilities at 4% and Industrial Utilities at 2%
- Under Act 25 of the 2016 first special session, business utilities are currently subject to state-level sales tax at the rate of 3% through June 30, 2018 and 1% through March 31, 2019.
- Business utilities are subject to the 1% “clean penny” state-level sales tax through June 30, 2018, pursuant to Act 26 of the 2016 first special session. The total state-level sales tax rate for business utilities through June 30, 2018 is 4% and then 1% through March 31, 2019.
- The proposal will tax business utilities at 4% and create a “special rate” for industrial users at 2%.
Expand Sales Tax to Services
- The Governor’s plan would expand the sales tax base (likely the state and local sales tax base) to include services such as:
- Debt collection services
- Insurance services
- Data processing services (similar to Texas)
- Information services (similar to Texas)
- Cable and satellite services
- Repairs to real property (immovables)
As we move closer to a 2019 gubernatorial election year in Louisiana, budget issues, tax reform, and the raising of taxes will surely continue to be infused with a heavy dose of politics from all sides.
The Louisiana and multistate business community should continue to carefully follow the upcoming special session (if ultimately called) and be prepared to provide input or otherwise act with regard to any new legislation proposed this year by the legislature.
The Jones Walker SALT Team will continue to closely follow – and report on – these legislative developments as they occur.
On December 15, the House and Senate conference committee released a conference report that reconciled the differences in each chamber’s tax reform bills. Both the House and Senate are expected to vote on the reconciled bill this week. Both have indicated that they have the necessary votes to pass the bill and the President has indicated that he will sign the bill into law.
Summaries of the key provisions are below:
Individuals: The top individual rate would be reduced from 39.6% to 37% for individuals earning at least $500,000 and joint filers earning at least $600,000. There would be 7 tax brackets in total (10%, 12%, 22%, 24%, 32%, 35%, and 37%). The standard deduction would nearly double to $12,000 for individuals and $24,000 for a couple filing jointly. The rates and standard deduction expansion expire in 2026.
Corporate Rate: The top corporate rate would be reduced to 21% starting January 1, 2018.
Pass-through Taxation: Pass-through entity owners that meet certain conditions would be eligible for a 20% deduction on their business income. Pass-through owners who file jointly with taxable income of at least $315,000 are subject to a phased-in limitation on the deduction. The restriction is based on how much the pass-through pays in wages or invests in equipment and machinery. Owners of pass-through service businesses, such as law, medical, and accounting firms, are eligible for the deduction if the owners are under the taxable income threshold, and the deduction is phased out completely if the taxable income of an owner who filed jointly is at least $415,000. The deduction would expire in 2026.
Estate, Gift, and Generation-Skipping Transfer Tax: The lifetime estate, gift, and generation-skipping transfer tax exemptions would be doubled to $11 million for individuals and $22 million for married couples, indexed annually for inflation. The exemption amounts would revert to current levels after 2025.
State and Local Tax Deduction: Individual taxpayers could deduct up to an aggregate of $10,000 of state and local property, income, and sales taxes.
Interest Deductibility: Interest deductions would be limited to 30% of a company’s earnings before interest, tax, depreciation, and amortization (EBITDA) for 4 years. After that, the bill would limit the deduction to 30% of earnings before interest and taxes (EBIT). However, this limitation does not apply to businesses with average annual gross receipts not exceeding $25 million.
Business Expensing: Full expensing of new and used capital investments would be permitted for 5 years. Section 179 expensing will also be made permanent.
Tax Credits: The bill does not materially modify the Low Income Housing or New Markets Tax Credit programs. For buildings owned or leased after January 1, 2018, Historic Tax Credits must be claimed over a 5 year period (currently, the full amount of the credit may be claimed in the year the credit is earned). The 5-year modification will generally not apply to buildings that were owned or leased prior to January 1, 2018.
Private Activity Bonds: Interest on private activity bonds remains tax-exempt.
International Tax: The international taxation regime would move toward a territorial system, and would include a base erosion and anti-abuse tax, which requires U.S. multinationals that make excessive deductible payments to their foreign affiliates to pay a 10% tax on their income without such deductions, after a one-year 5% transition rate. A new tax on global intangible low-taxed income would be imposed. Overseas profits would be taxed automatically at a 15.5% rate for cash assets and 8% rate for illiquid assets.
Alternative Minimum Tax: The individual AMT would be increased to apply to individuals earning more than $500,000 or joint filers earning $1 million. The corporate AMT would be repealed.
Mortgage Interest Deduction: The bill would preserve the deduction for existing mortgages and add a cap of $750,000 for newly purchased homes starting January 1, 2018. However, the deduction for interest on home equity loans would be suspended.
Child Tax Credit: The child tax credit would be increased to $2,000 per child with up to $1,400 of it being refundable and a higher income phased out would apply.
College Endowments: A 1.4% excise tax is imposed on the net investment income of private university and college endowments. The tax applies to schools with assets of more than $500,000 per student.
We will provide a more detailed analysis of the key provisions after (and if) the bill is signed into law.
“Substantial economic presence” nexus standard formally embodied in regulation.
As expected after recently having filed an economic impact statement, the Mississippi Department of Revenue on November 1 filed its final remote seller use tax regulation with the Secretary of State. The new regulation will be effective December 1, 2017, and contains numerous changes from the original proposal issued in January (see prior Jones Walker coverage here, here, here, and here). The notice contains no public hearing or comment period, so it is unlikely there will be any further revisions prior to the effective date.
“Substantial economic presence” standard finalized.
The final regulation retains the original $250,000 annual sales standard, providing that anyone having that level of sales into the state over the prior twelve months has “substantial economic presence” and has use tax nexus if those sales are coupled with purposeful and systematic exploitation of the market.
The original proposal based the testing period on the previous calendar year’s sales, whereas the final version applies it on a rolling twelve-month basis. Under both versions, the collection requirement is triggered prospectively once that threshold is met, and does not apply retroactively to the sales occurring during that test period.
As written, however, the new rolling standard could result in a seller temporarily having substantial economic presence based on a brief spike in sales, only to have them fall below that standard a few months later. It is unclear whether the Department will allow a seller in that circumstance to cancel its use tax registration until it again had a sales spike and exceeded the threshold over that rolling test period.
What constitutes “purposefully or systematically” exploiting the market?
The Mississippi use tax statutes do not make any reference to “substantial economic presence” or contain the $250,000 standard, but they do purport to require a foreign seller to collect and remit use tax if that seller “purposefully or systematically” exploits the consumer market. The final regulation provides the following examples the Department considers to meet this standard:
- Television or Radio advertising on a Mississippi station;
- Telemarketing to Mississippi customers;
- Advertising on any type of billboard, wallscape, bus bench, interiors and exteriors of buses or other signage located in Mississippi;
- Advertising in Mississippi newspapers, magazines or other print media;
- Emails, texts, tweets and any form of messaging directed to a Mississippi customer;
- Online banner, text or pop up advertising directed toward Mississippi customers;
- Advertising to Mississippi customers through applications “apps” or other electronic means on customer’s phones or other devices; or
- Direct mail marketing to Mississippi customers.
In the context of electronic commerce, the final regulation does not disclose any specific criteria the Department will use to determine whether any of these enumerated activities are “directed toward a Mississippi customer” as opposed to the online market generally. For example, a seller could sponsor an online banner or pop-up advertisement on a national news website or social media site targeted to the public generally, but not specifically to Mississippi. If a Mississippi resident stumbles upon that website, can the seller be deemed to have specifically targeted that customer or the Mississippi consumer market in particular? Likewise, will the Department rely on cookies, phone or credit card billing addresses, actual internet access points (i.e., tower locations, wifi hotspots, etc.), or some other criteria to determine whether Mississippi was the targeted market for a seller’s texts, emails, tweets, and “any form or messaging”?
These distinctions could be very important not only in determining if the seller meets the regulation’s criteria, but also from a constitutional perspective. The lack of clarity on these points raises substantial vagueness questions and may render the regulation constitutionally suspect on due process grounds even if Quill’s physical presence standard is eventually overturned.
Is $250,000 nexus threshold limited solely to tangible personal property sales?
In what may be a critical nuance, the final regulation removed the reference to “retail sales of tangible personal property” when enacting the $250,000 sales threshold. Under the original proposal, it appeared clear that only tangible personal property sales would be considering when applying that standard.
By removing that reference in these final provisions, however, the Department may be signaling that it intends to make the initial nexus determination based on all sales activities, potentially including wholesale transactions, services and sales of intangible property. Although the regulation only requires the addition of the use tax to sales of tangible personal property, this new distinction could be a trap for the unwary and may require sellers to modify their data collection processes to encompass a broader range of activities when calculating that $250,000 trigger.
No voluntary compliance safe harbor in final regulation.
The original proposal provided that sellers who voluntarily registered by July 1, 2017, would be subject to the regulation strictly on a prospective basis, but that the Department would apply the regulation retroactively and without any statute of limitations to those who did not. That language was removed from the final version.
Uncertainty regarding effective date.
The final regulation states that the regulation applies to all transactions on or after December 1, 2017. It does not specify, however, whether that means the rolling twelve-month test period will be measured by transactions beginning on that date or if the collection requirement begins on that date based on the preceding twelve months’ sales.
Jones Walker will continue to monitor these developments and provide updates as these issues arise and are clarified.
On October 21, 2017, Louisiana voters resoundingly voted in favor of a Constitutional Amendment to the Louisiana Constitution (Act 428 of the 2017 Regular Session of the Louisiana Legislature). The Amendment clarifies a long standing practice that construction materials delivered to a construction site are exempt from ad valorem tax during the pendency of the construction project.
More specifically, the Amendment exempts all equipment and materials delivered to a construction site from ad valorem tax if the equipment and materials are intended to be incorporated into any tract of land, building, or other construction as a component part under the Louisiana Civil Code. The Amendment includes property that may be deemed a component part once placed on an immovable for its service and improvement.
The Amendment exempts the equipment and materials until the construction project for which the property has been delivered is “complete.” For purposes of the Amendment, complete means that construction is finished to the extent that the project can be used or occupied for its intended purpose. A project is not complete during the inspection, testing, or commissioning stages, as defined by reasonable industry standards.
Taxpayers should take note that the Amendment does not apply to:
- any portion of a construction project that is complete, available for its intended use, or operational on the date the property is assessed;
- for projects constructed in two or more distinct phases, any phase of the construction project that is complete, available for its intended use, or operation on the date the property is assessed; and
- public service properties (public service properties may be exempt from ad valorem tax under other provisions of the Louisiana Constitution).
The Amendment is especially important for taxpayers who are constructing large manufacturing projects because it cements a benefit historically enjoyed by these taxpayers. The added level of certainty is particularly welcoming considering the limitations and requirements imposed by Executive Order No. JBE 2016-16 to Louisiana’s Industrial Tax Exemption Program (“ITEP”) (e.g., requirements for creation or retention of jobs, applications for miscellaneous capital additions and tax exemptions for maintenance capital, required environmental capital upgrades, and the elimination of the exemption for replacements of existing machinery).
The Louisiana Department of Revenue has now issued formal guidance regarding the new requirement that taxpayers receive a Louisiana state tax clearance in order to obtain: (i) a new or renew an existing Louisiana state sales tax resale certificates; and (ii) approval of certain Louisiana state procurement contracts.
Specifically, the Department has issued the following new Revenue Information Bulletins (RIBs):
- Revenue Information Bulletin No. 17-020 (October 17, 2017) (Tax Clearance Required for All Taxes for Sales Tax Resale Certificate); and
- Revenue Information Bulletin No. 17-021 (October 17, 2017) (Tax Clearance Required for Approval of Certain Procurement Contracts).
Tax Clearance Required for State Sales Tax Resale Certificates – RIB 17-020:
Effective June 14, 2017, Act 211 (HB 307) of the 2017 Regular Session of the Louisiana Legislature enacted La. R.S. 47:1678 to require an applicant applying for issuance or renewal of a Louisiana state sales tax resale certificate to be current in filing all tax returns and reports and in payment of all taxes, interest, penalties, and fees owed to the state and collected by the Department.
As of October 1, 2017, the Department will not issue or renew a state resale certificate for any taxpayer unless the taxpayer has obtained a tax clearance, which is achieved when the taxpayer has:
- filed all tax returns and reports due, and
- paid all taxes, interest, penalties, and fees owed to the state.
Excluded are items under formal appeal pursuant to applicable statutes or being paid in compliance with the terms of an installment agreement with the Department.
This tax clearance requirement applies to all state taxes, including sales, income, withholding, excise, severance, tobacco, and automobile rental tax.
Tax Clearance Required for State Procurement Contracts – RIB 17-021:
Effective June 14, 2017, Act 211 (HB 307) of the 2017 Regular Session of the Louisiana Legislature enacted R.S. 39:1624(A)(10) and 47:1678 to require a tax clearance for approval of certain state contracts.
As of October 1, 2017, all state contracts that require the review and approval of the central purchasing agency of the Louisiana Office of State Procurement (the “Procurement Office”) for the procurement of personal, professional, consulting, or social services will be approved only after the Procurement Office has obtained a tax clearance from the Department on behalf of the contracting taxpayer.
A tax clearance will only be granted by the Department if the proposed contractor is current in filing all tax returns and reports and payment of all taxes, interest, penalties, and fees owed to the state and collected by the Department.
Excluded are items under formal appeal pursuant to applicable statutes or being paid in compliance with the terms of an installment agreement with the Department.
A tax clearance is not required in order to bid on or solicit a procurement contract.
If a proposed contractor is subject to a final assessment that is collectible by distraint and sale, the proposed contractor cannot be approved for a procurement contract until the contractor has filed all returns and reports due, paid, or made arrangements with the Department to pay the delinquent tax liability, and the Department has notified the Procurement Office of the payment or arrangement to pay.
Files Questionable Economic Impact Statement with Secretary of State
On Tuesday, the Mississippi Department of Revenue filed an economic impact statement with the Secretary of State addressing its proposed regulation adopting use tax economic nexus standards and remote seller collection obligations. Readers may recall the Department issued the proposed regulation in January and held a public hearing in February, only to have a similar legislative proposal die after Lieutenant Governor Tate Reeves publicly stated that he considered the proposal unconstitutional. See prior detailed coverage of these proposals and events on the blog here and here and here.
To recap, the proposed regulation would define “substantial economic presence” to exist when sales into the state exceed $250,000 per year based on the previous calendar year’s sales. Out-of-state sellers who lack a Mississippi physical presence but who are making retail sales of tangible personal property into the state and have a substantial economic presence for sales and use tax purposes would be required under the proposal to register for a license with the Department in order to collect and remit use tax. The Department would apply the regulation prospectively to those who voluntarily register to collect use tax on their sales into Mississippi by July 1, 2017, but would assess those who have not voluntarily registered to comply with the regulation retroactively. No statute of limitations will be used in determining the total tax liability for such non-registering taxpayers under the proposal.
The economic impact statement contains several interesting claims that reveal the Department’s reasoning and view of the regulations’ impact on multistate sellers:
- In summarizing the benefits of the regulation, the Department states that it will provide “greater clarity and guidance concerning the taxability of out-of-state sales and an increase in tax revenue and uniformly applied laws.” No mention is made of the almost certain unenforceability of its provisions, even though the Commissioner was quoted in a February 2017 Associated Press news story acknowledging that the regulation directly contradicts Quill and is likely unconstitutional, stating, “What we’re doing is probably unconstitutional, but we’ve got to do it to get another hearing.”
- The Department claims the state is losing an estimated $150,000,000 in use tax revenue due to out-of-state vendors who do not collect the tax. These figures reportedly are based on an estimate of lost revenue provided by 21st Century Retail (www.efairness.org), which was created from data using the National Conference of State Legislators 2015 data.
- The Department claims “the law does not provide any other methods to collect and remit tax.” Interestingly, there is no mention of the fact that, under existing law, local consumers are required to self-report these taxable interstate transactions, or that the Department actively enforces the use tax laws against Mississippi businesses.
- In defining the need for the regulation, the Department states that it “sees a need to properly define ‘purposefully and systematically exploiting the consumer market’ in order to have clear meaning.” The statement does not explain how the regulation’s unqualified $250,000 sales threshold equates to “purposefully” or “systematically” exploiting the local market, especially considering the Department previously acknowledged that a single unsolicited transaction could meet this requirement.
- Instead, the explanation for the regulation focuses solely on purported lost revenue. “Sales originating from out of state have steadily increased over the years attributing to the erosion of the tax base for sales and use taxes for the State of Mississippi resulting in lower sales and use tax collections. This provides an unfair advantage to out-of-state businesses selling from outside Mississippi. The DOR is attempting to ensure that the laws of the state are uniformly applied to persons doing business in this state.”
- The Department estimates it will not cost the agency or other state entities anything to implement the proposed regulation. Litigation costs apparently did not enter this equation. Similarly, the Department reports “minimal” estimated costs and/or economic benefits to persons directly affected by the proposed rule.
- The statement also purports the regulation to have “minimal” estimated impact on small businesses, but the explanation clearly states that the Department had no data upon which to base that statement. “The DOR could not determine with any accuracy or reliability the total number of businesses in the U.S. that have gross sales or revenue less than $10,000,000 or how many of those businesses are making sales of $250,000 or more in this state.” It goes further to state that compliance costs will have “minimal impact” on small businesses because “many companies already have filing requirements in other states and already have the necessary recordkeeping and reporting mechanisms in place.” No mention is made of the complete lack of uniformity across the country’s thousands of sales and use tax jurisdictions on issues such as nexus, sales tax base, rates, exemptions, exclusions, procedure, etc., all of which undeniably create substantial burdens on interstate sellers and especially those small businesses lacking the extensive internal resources of many larger organizations.
- The statement claims the benefits of adopting the rule are “substantially more than” that compared to not adopting the rule. It is unclear whether the Department was referring to costs/benefits to the State itself or to the impacted taxpayers. It also claimed there are no “less costly or less intrusive methods” for achieving the purpose of the proposed rule.
Interested parties may submit written comments to the economic impact statement at any time prior to October 30, 2017, but no public hearing appears to have been scheduled at this time.
Taxpayers should keep a close eye on Mississippi’s proposed regulation, especially considering the Department claims it has authority (and, presumably intent) to move forward with the regulation even in the absence of any further legislative support.
In October 2016, the Mississippi Supreme Court issued its long-awaited decision in Mississippi Department of Revenue v. AT&T Corporation, concluding the state’s dividend exclusion statute violated the Commerce Clause of the United States Constitution. The statute, Miss. Code Ann. Section 27-7-15(4)(i), unconstitutionally discriminated against interstate commerce by excluding from Mississippi gross income any dividends received from subsidiaries doing business and filing income tax returns in the state, while taxing identical dividends received from “non-nexus” subsidiaries having no Mississippi presence.
Following the AT&T decision, effectively no dividends remain taxable for Mississippi corporate income tax purposes. Longstanding Department of Revenue regulations classify dividends from foreign subsidiaries as non-business income, so the Court’s decision expanding the Section 27-7-15(4)(i) exclusion to encompass non-nexus dividends now renders virtually all domestic dividends exempt.
That practically universal dividend exclusion, however, has produced several important downstream consequences over the past year that could reduce the benefit from that decision, in many recent cases having resulted in material income and franchise tax audit adjustments.
- Income Tax Apportionment – On its corporate audit schedules, the Department now routinely includes all dividends – domestic and foreign – in nonbusiness income. In computing the sales factor, all nonbusiness income is removed from gross receipts when calculating both the numerator and denominator of that ratio. Because very few multistate corporate taxpayers would have had any dividends sourced to Mississippi, this removal serves almost exclusively to reduce the denominator, thereby inflating the sales factor. In some egregious cases, this could double or even triple a company’s Mississippi sales factor. In a single sales factor scenario this could materially reduce the benefit received from the exclusion of those dividends from gross income.
- Franchise Tax Apportionment – Several years ago, the Mississippi Legislature amended the franchise tax statutes to provide that the gross receipts for franchise tax apportionment purposes would be the same as those calculated for income tax. Mississippi’s franchise tax apportionment ratio consists of a modified two-factor formula that adds together the in-state tangible real and personal property (often narrower than the income tax property factor) to the Mississippi gross receipts, and then divides that total by the similarly computed worldwide combined factors. In other words, there is one combined numerator divided by a single combined denominator, rather than two separately calculated factors added together and divided by two. The removal of these “non-business” domestic dividends from the income tax sales denominator will have a similar – and often more material – impact on the franchise tax side. This can be a significant adjustment for companies having large amounts of passive income but not meeting the rigid statutory requirements of the franchise tax holding company exemption. Because the franchise tax statutes contain no direct alternative apportionment authority as do the income tax laws, defending this “flow-over” adjustment is often more challenging.
- Interest Expense – Acquisition Debt. Mississippi does not permit the deduction of “interest upon indebtedness for the purchase of . . . stocks, the dividends from which are nontaxable under the provisions of this article.” Miss. Code Ann. Section 27-7-17(1)(b). There is no business purpose exception to this disallowance as there is for interest on debt used to purchase treasury stock or pay dividends. Since all dividends are now considered “nontaxable under the provisions of [the income tax] article” the Department recently has begun to look more closely at the origin of corporate obligations and has been aggressively disallowing the interest expense deduction if there is any reference within the company’s annual reports, press releases, or other sources to suggest third-party debt was used to purchase another corporation’s stock. It should be noted that acquisitions of entities other than corporations, such as partnerships and limited liability companies, do not appear to fall within this disallowance since those types of earnings are not statutorily exempt like dividends. This position is still in its infancy, and it is yet to be seen whether or to what extent the auditors will grant taxpayers any leeway in cases where debt was used for acquisitions as well multiple other non-acquisition purposes. There may be multiple ways, however, to address these issues depending on a company’s particular facts and circumstances.
- Interest Expense – Nonbusiness Asset Ratio. Mississippi utilizes a “non-business asset ratio” to calculate that portion of a company’s overall interest expense purportedly attributable to the generation of non-business income, and the Department has been very aggressive on audit in using that formula to disallow otherwise ordinary and necessary interest deductions. Historically, investments in foreign subsidiaries have been included in the numerator of that ratio since the income tax regulations classify foreign dividends as nonbusiness income (queue a Foreign Commerce Clause challenge). Unitary domestic dividends, however, technically do not constitute nonbusiness income, so the investments in those domestic subsidiaries arguably should not enter that equation. The authors have seen domestic investments included in that formula on a few preliminary audit workpapers, so taxpayers should diligently review any proposed adjustments to determine if that inclusion is being made.
- Could Some Dividends Remain Taxable? The Court relied on the internal consistency test from Maryland v. Wynne to isolate and quantify the discriminatory effect of the exclusion statute in double taxing a non-nexus subsidiary’s earnings. In theory, however, a subsidiary could earn 100% of its income in a state not imposing an income tax, in which case Mississippi’s taxation of those domestic dividends would not result in the double taxation of the non-nexus subsidiary’s earnings found offensive by the Court since no state would have taxed those earnings at the operational level. In that rare case, application of the statute may not produce an unconstitutional result, although it still would be constitutionally suspect under a facial discrimination analysis, which the Court did not reach in AT&T. The authors have not seen this hypothetical fact pattern arise in any cases so far, and are unaware of the Department making such inquiries on audit given the rarity of such a scenario.
The Department was very concerned about the fiscal impact of the AT&T decision, especially given Mississippi’s already dubious budget situation, and unsuccessful attempts were made earlier this year to amend the statute in a way that many taxpayers and observers feared was a surreptitious attempt to legislatively negate the ruling. It is equally clear that the Department intends to aggressively audit companies and assert these and potentially other novel positions in an attempt to minimize the impact of that newly expanded exemption to corporate taxpayers. Taxpayers should review closely their facts and circumstances in light of these new positions when preparing returns or defending an audit.
In response to the impact of Hurricanes Harvey and Irma, parts of the United States have been declared as major disaster areas by the federal government. As a result, numerous states have enacted delayed filing and payment periods for individuals and businesses located in these major disaster areas. Louisiana has joined this growing list with the Department of Revenue’s release of Revenue Information Bulletin No. 17-015.
The Bulletin provides that the Department will grant filing extensions to taxpayers whose homes, principal places of business, or critical tax records are located in any of the disaster areas declared as disaster areas by the president as a result of Hurricane Harvey. The due date for qualifying tax returns has been extended to January 31, 2018 for individual income, corporate income and franchise, fiduciary, partnership, and partnership composite taxes with original or extended due dates on or after August 23, 2017, and on or before December 31, 2017. Taxpayers requesting such relief should identify their returns by writing “Hurricane Harvey” in black ink on top of the form.
Other pertinent state relief:
- Alabama Department of Revenue, Press Releases: August 29, August 31, September 12, 2017
- Alabama taxpayers residing in Texas or Florida counties designated as disaster areas by the federal government have until Jan. 31, 2018, to file tax returns due on or after Sept. 1 (Sept. 15 for Hurricane Irma victims), 2017, and before Jan. 31, 2018.
- Penalty relief will be provided during the extension period.
- Taxpayers seeking this tax relief should write “Texas Flood 2017” or “Irma Relief – 2017” in red ink on any state paper return/report which relies on this filing extension relief.
- The relief applies to individual income tax, corporate income tax, pass-through entities, sales and use tax, withholding tax, and business excise tax.
- IRP/IFTA requirements for vehicles are temporarily suspended for vehicles engaged in disaster relief efforts.
- Florida Department of Revenue, Current Topics – Hurricane Tax Relief
- The Florida Department of Revenue will follow the tax relief granted by Internal Revenue Service regarding postponement of return due dates.
- Florida corporate income tax returns, as well as Florida corporate income tax installment payments, with original due dates or extended due dates between Sept. 4, 2017 and Jan. 31, 2018 will now be due Feb. 15, 2018.
- Sales and use tax returns filed by 5:00 p.m. on Sept. 28, 2017 will be deemed timely filed.
- Taxes on fuel trucks entering the state are waived to expedite fuel delivery.
- Penalties for the sale of dyed diesel field are waived to any person who sells or uses dyed diesel fuel for highway use.
- Georgia Department of Revenue, Press Releases: September 5, September 12, September 14, 2017
- The Department is postponing until January 31, 2018, certain deadlines for individuals who reside, and businesses whose principal place of business is located, in the disaster areas specified by the IRS.
- This extension now applies to all counties in Georgia as a result of Hurricane Irma
- The postponement also includes return filing, tax payment, and other time-sensitive acts related to Georgia tax types such as Georgia sales and use tax but does not apply to International Fuel Tax Agreement interest. This includes monthly sales tax returns originally due September 20, 2017, October 20, 2017, November 20, 2017, December 20, 2017, and January 22, 2018. It also includes quarterly sales tax returns due October 20, 2017, and January 22, 2018, as well as annual sales tax returns due January 22, 2018.
- Affected taxpayers filing paper returns should write: “2017 Texas, Hurricane Harvey” or “2017 Hurricane Irma” across the top of any forms submitted to the Department.
- IRP/IFTA requirements for vehicles engaged in disaster relief efforts are temporarily suspended.
- Mississippi Department of Revenue, Notice 80-17-002 (September 25, 2017)
- Taxpayers who reside in the counties designated as federally declared disaster areas have until January 31, 2018 to file individual income, corporate income and pass-through entity tax returns due on or after August 23, 2017, for Hurricane Harvey and September 4, 2017, for Hurricane Irma and before January 31, 2018.
- The Department of Revenue automatically provides interest and penalty relief on original or extended filing and payment due dates, including extended filing or payment due dates, that fall within the postponed period.
- Texas Comptroller, Declared Natural Disasters and Emergencies Tax Help
- Taxpayers in declared disaster areas affected by Hurricane Harvey can contact the Comptroller’s office and request up to a 30-day extension to file and pay certain monthly and quarterly state taxes.
- For the 2017 franchise tax reports with valid extensions to Nov. 15, the Comptroller’s office is granting an automatic extension to Jan. 5, 2018, to businesses located in the federally declared disaster area in Texas. Businesses located in these counties do not need to request an extension for their franchise tax reports. Service providers who file franchise tax reports on behalf of other taxpayers can request a franchise tax extension if the provider is affected by Hurricane Harvey.
- The Comptroller’s office is granting businesses located in the federally declared disaster areas in Texas that are not required to file electronically, an automatic 30‐day extension to complete August monthly reports due Sept. 20 and quarterly reports due Oct. 20.
- In addition to allowing the Comptroller to extend tax-filing deadlines, Texas law exempts certain recovery-related expenses from sales tax, including:
- (i) the cost of labor to repair storm-damaged, nonresidential property, including office buildings and stores. Labor charges must be separately stated on the repair bill. Texas also does not impose sales tax on labor for residential repairs;
- (ii) services used to restore storm-damaged tangible personal property, including dry cleaning of clothing and draperies, rug and carpet cleaning, and appliance repairs regardless of whether the property is residential or nonresidential.
- All laws authorizing or requiring the collection of state or local hotel or motel occupancy taxes from the victims of Hurricane Harvey or personnel participating in relief operations are suspended beginning August 23, 2017, and ending October 23, 2017.
- Temporary waiver of the International Fuel Tax Agreement (IFTA), which will suspend requirements that trucking firms track and pay tax on the amount of fuel used in Texas when delivering needed relief supplies and fuel into the state.
As hurricane season continues to bring devastation to parts of the U.S., states will continue to extend relief to these declared disaster areas.
In order to help track these developments, the Jones Walker SALT team has compiled and summarized the provided relief of all participating states in the J.W. Disaster Prep and Recovery blog post, State Tax Relief for Hurricane Victims. Our team will continue to monitor for further state and local tax related disaster relief announcements and update the linked post accordingly.
Department of Revenue Now Authorized to Hire Auditors and Expert Witnesses on Contingency Fees
$1,000,000 Appropriation to Fund Contingency Contracts
RFPs Quickly Issued for Transfer Pricing Audits and Underreported Cash Sales
The Mississippi Legislature recently authorized the Department of Revenue to hire third party tax auditors and expert witnesses and to pay them contingency fees based on revenue generated from audits they identify and bring to the Department. This new authority was not included in the original Senate Bill 2973 passed by the Senate or the amended bill passed by the House of Representatives, but appears to have been slipped in quietly during the conference committee process before final passage. While it is possible many legislators voting on the final appropriations bill were unaware of this new authority to hire contingent-fee auditors, the bill appropriated up to $1,000,000 to fund those contingency contracts for the current fiscal year. The Legislature’s website contains copies of the final bill and the conference report reflecting the insertion of this contingent fee authority.
The Governor signed the bill on April 18, and the new provisions became effective on July 1, 2017. Wasting no time, in May the Department issued requests for proposals targeting transfer pricing and underreported cash sales audits. The Department reissued the transfer pricing RFP in August in substantially the same form, and while the contract was supposed to have been awarded on August 31, the Department does not appear to have awarded it at this point. The Department appears to have abandoned the underreported cash sales initiative, at least for now.
The original Transfer Pricing Analysis request (RFP 2017-02) was reissued in August in substantially the same form as RFP 2017-05, and specifies that the contractor “will provide Intercompany Transfer Pricing Analysis and Transfer Pricing Analysis Reports prepared consistent with the provisions of the Internal Revenue Code Section 482 and the regulations promulgated thereunder.” The Department claims to need these reports to identify profit shifting via intercompany transactions, and the contract will require the vendor to provide training to the Department’s staff and any expert witnesses for Board of Tax Appeal hearings and litigation in the event of a lawsuit. The RFP further defines the scope of those services as follows:
- To “provide audit leads” and rank those targets from highest to lowest based on the size of the recommended Section 482 adjustments;
- To perform audit and legal analysis, which will include the initial basis for the potential adjustments for those taxpayers selected from the target list;
- Drafting information document requests to be issued to the targeted taxpayers and analyzing information received in response;
- Preparation of formal transfer pricing reports, to be in a form sufficient for submission as evidence in administrative and judicial proceedings;
- Providing expert witnesses at the Board of Tax Appeals and court, and providing other audit and litigation support (all within the scope of the contingency fee); and
- Training Department employees on transfer pricing methods and providing support in responding to taxpayers’ studies and reports.
At least one group is believed to have submitted questions seeking clarification of the scope and terms of the original RFP, but it is unknown if they or any others ultimately submitted proposals to that first RFP. This development suggests the Department is investing heavily in the transfer pricing arena, and adds a new dynamic to recent reports of Mississippi’s active participation in the Multistate Tax Commission’s transfer pricing initiatives.
The state’s new use of contingent fee auditors – and especially contingent fee expert witnesses – could significantly alter the nature of audits and the Department’s litigation of any intercompany pricing adjustments. The authors have seen a noticeable increase in the number and complexity of Mississippi transfer pricing audits, and the Legislature’s blessing and funding of these contingent fee arrangements suggest this trend is likely to increase in the near future.
Underreported Cash Sales
The Department verbally stated that the Department decided not to proceed with the underreported cash sales request (RFP 2017-01), and the authors have been unable to obtain a copy of that proposal so the exact scope and terms of the request are currently unknown. Based on questions submitted by unidentified potential bidders, however, these arrangements also would have been contingency-based and likely were similar to the transfer pricing contracts described above.
The questions submitted suggest that the Department was seeking a “turnkey solution” and that the contractor would have been responsible for targeting unregistered taxpayers and underreported transactions, but also stated that the Department did not expect the contractor to perform actual audits or site visits. Rather, it sought “information that will lead to the recovery of unpaid taxes” which the Department staff would then presumably handle through field audits, investigations and other normal processes. The project would have included information matching as the questions specifically referenced federal Forms 1099K which taxpayers use to report payment card and third party network transactions (i.e., prepaid cards such as gift cards).
Considering the Department’s recent activities directed toward remote internet sellers, it is plausible that the Department intended this project to target non-resident sellers who might fall within the Department’s recently proposed economic nexus standards. Although this initiative appears to be on hold at least temporarily, we will continue to monitor this area in the event a revised RFP is issued.
Jones Walker will continue to monitor and report on these developments, and welcomes any questions or comments as well as any taxpayer’s experiences with these new contingent fee audits.