Source: http://taxexecutive.org/2016-state-tax-bellwethers-some-cautionary-notes/
Timestamp: 2019-04-19 02:53:49+00:00

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In 2016 several states have used a variety of tools in an attempt to manage challenges that plague all states. From contesting established United States Supreme Court precedents to making broad-sweeping statutory interpretations of state laws, the landscape of state and local tax is shifting to address the evolution of commerce. In this article, we evaluate significant state tax trends and explore the possible consequences and challenges associated with them.
States have exuberantly taken note of Justice Kennedy’s call for reevaluation of Quill and have increased their attempts to challenge, overturn, or circumvent Quill. Some of these attempts directly challenge Quill by providing an economic nexus standard, whereas other states have argued that the Internet marketplace already meets the physical presence requirements of Quill.
Out-of-state retailers, especially large online retailers that have not met the traditional physical presence standard, will continue to be swept into the controversy until an “appropriate” case is brought before the U.S. Supreme Court or Congress intervenes.
In September 2015, the Alabama Department of Revenue announced a regulation7 requiring remote sellers with significant sales in Alabama to collect and remit sales and use tax. The regulation requires collection and remittance if an out-of-state seller that lacks a physical presence in Alabama had in-state sales exceeding $250,000 in the prior calendar year.8 The regulation directly contradicts Quill, and based on commentary from the commissioner and the deputy co-commissioner of the Alabama Department of Revenue, the Department of Revenue acknowledges that its regulation is inconsistent with Quill and that it is willing to litigate the validity of its regulation in light of Quill, which it argues should be overturned.
Soon after, in October 2015, the Alabama legislature swiftly passed the Simplified Sellers Use Tax Remittance Act,9 which allows sellers without physical presence in the state to collect and remit sales and use tax at a flat 8 percent rate, rather than the combined state and local tax rate, which can be more than 8 percent.
Once the regulation became effective, the Department of Revenue asserted that various remote retailers had “substantial economic presence” and had failed to collect and remit Alabama sales and use tax. Newegg Inc. was one of those remote retailers. This past June, Newegg filed suit in the Alabama Tax Tribunal.10 Newegg contends that its lack of an Alabama physical presence renders the Department of Revenue’s attempt to apply its regulation against it unconstitutional and a violation of U.S. Supreme Court precedent. Newegg also argues that the regulation conflicts with Alabama’s sales and use tax statutes and that the Alabama Code does not authorize the Department of Revenue to impose collection and remittance requirements on an out-of-state retailer with no physical presence in Alabama.
Remote sellers also responded immediately to the new law by filing suit against the Department of Revenue. On the same day the Department of Revenue’s suit was filed, American Catalog Mailers Association (ACMA) and NetChoice, trade associations representing catalog marketers and e-commerce retailers, respectively, sought a declaratory judgment in South Dakota Circuit Court designating the new law as unconstitutional.19 ACMA and NetChoice argue that the new law violates the Commerce Clause of the United States Constitution and guarantees for due process. As of early August, no decision has been made yet.
After Alabama and South Dakota, other states have followed suit. In June the Tennessee Department of Revenue proposed an economic nexus regulation,20 similar to Alabama’s new regulation, that would require a remote seller with more than $500,000 in in-state sales during the calendar year to collect and remit sales tax.
Quill is the Supreme Court’s landmark decision upholding the principle that only a company with physical presence in a state, such as having employees or a store, can be obligated by that state to collect and remit sales and use tax.
An increasing number of states have done away with apportioning income on a costs-of-performance sourcing basis in favor of market-based sourcing rules. Generally, the costs-of-performance method apportions revenue to the state where the taxpayer incurs costs to perform an income-producing activity, whereas the market-based sourcing method apportions revenue to the state where a customer is located or where the benefit of a service is received.
In addition to legislative amendments adopting market-based sourcing, some states with statutory provisions that are commonly interpreted as costs-of-performance sourcing have sought to apply their provisions in a manner that mimics market-based sourcing results.
In Vodafone Americas Holdings Inc. v. Roberts,35 the Tennessee Supreme Court upheld the Tennessee Department of Revenue’s use of its variance authority, which allows the state to require application of an apportionment method that differs from the statutory apportionment formula. The Department applied a variance to a telecommunications company and required it to use market-based sourcing to calculate its sales factor rather than the state’s costs-of-performance provisions.
Similar to Vodafone, in Equifax Inc. v. Mississippi Department of Revenue,39 the Mississippi Supreme Court upheld the Mississippi Department of Revenue’s use of alternative apportionment requiring application of market-based sourcing, despite the taxpayer’s use of costs-of-performance sourcing in compliance with the governing statute. The Mississippi Supreme Court deferred to the Department of Revenue’s decision to use alternative apportionment. The court also held that the taxpayer bears the burden of proving that the Department of Revenue’s use of an alternative apportionment method is arbitrary and unreasonable. The decision appeared to grant the Department of Revenue sweeping power to impose alternative apportionment methods.
Typically, a state tax controversy arises between two parties: the taxpayer and the state. Through some states’ False Claims Act provisions, third parties—private citizen whistleblowers and relators—have been acting on behalf of the state, suing taxpayers for allegedly making false statements material to an obligation to pay state taxes. Though most states have False Claims Act provisions, many of these states explicitly bar qui tam actions related to most state taxes. However, there are a few states that either bar only income tax claims or do not appear to restrict any subject matter, including tax, from qui tam actions.
The impact of these qui tam actions on tax claims is still developing. It is unclear how whistleblowers and states intend to use their respective False Claims Act provisions in tax matters, and many cases exist under court-ordered seals before any public disclosure occurs. Nonetheless, it is evident that taxpayers dealing with these actions face costly litigation or settlement even when the tax positions at issue are taken in good faith in light of legal uncertainty. With such large awards given to successful whistleblowers, it is no wonder that the state tax arena has seen states with liberal False Claims Act provisions, especially New York and Illinois, inundated with these suits.
New York recently expanded its False Claims Act to allow whistleblowers to bring qui tam actions against taxpayers for tax fraud matters. Two taxpayers, Sprint and Vanguard, have been ensnared in high-stakes qui tam actions in New York that demonstrate the challenges associated with these actions.
In People ex rel. Schneiderman v. Sprint Nextel Corp.,45 Empire State Ventures LLC filed a qui tam action against Sprint under New York’s False Claims Act, alleging that the company failed to collect or pay New York sales tax on a portion of flat-rate monthly access charges for wireless voice services, which Sprint treated as unbundled charges for interstate and international calls. The state attorney general filed a superseding complaint, converting the qui tam action into a civil enforcement action and alleged that the company knowingly failed to collect sales tax.46 Sprint subsequently filed a motion to dismiss for failure to state a cause of action.
The New York Court of Appeals denied the company’s motion to dismiss and as a result, Sprint will have to continue to face the suit, which with treble damages and penalties amounts to well over $400 million.47 The court found that New York law imposes tax on interstate voice services that are bundled with other services and sold by mobile providers for a fixed monthly charge. The court also rejected the company’s argument that federal legislation—the Mobile Telecommunications Sourcing Act—preempts New York’s law and that the retroactive application of New York’s False Claims Act violates the U.S. Constitution’s ex post facto clause. The court found that the state had specified a cause of action, and, though the state had a high burden to prove that Sprint acted fraudulently, it was still entitled to discovery.
Though Sprint Nextel is moving forward, with the New York attorney general’s office vigorously fighting to support the action, the attorney general’s office has declined to pursue numerous qui tam actions that were ultimately dismissed by the courts. For example, in Danon v. Vanguard Group, Inc.,48 a former in-house tax counsel accused Vanguard of knowingly violating its tax obligations and evading billions in taxes by avoiding payroll withholding obligations and offering services at cost to related entities when it failed to charge arm’s-length prices. Vanguard moved to dismiss the case, arguing that the whistleblower should be punished for violating attorney ethics for using confidential client information to sue his former client. The court ruled in favor of Vanguard, focusing on the attorney’s ethics violation.
States have exuberantly taken note of Justice Kennedy’s call for reevaluation of Quill and have increased their attempts to challenge, overturn, or circumvent Quill.
In other states, False Claims Act provisions have been used to attack tax positions taken in good faith in light of unclear law. Illinois has seen hundreds of qui tam actions filed by a Chicago-based class action plaintiffs’ law firm. The firm has blanketed Cook County Circuit Court with hundreds of qui tam actions against various out-of-state retailers after conducting its own inquiry and concluding that the retailers did not properly collect or remit sales, use, or excise tax. The firm has alleged that these retailers have fraudulently failed to collect tax in areas of tax law that are unsettled, such as establishing nexus through in-state affiliates. The state has intervened for many of these actions to be dismissed. Recently, the Cook County Circuit Court dismissed hundreds of the firm’s qui tam actions after the state intervened and asked for these actions to be dismissed.
Legislative attempts to address this abusive use of Illinois’ False Claims Act have not gained traction. Concurrent bills51 in the House and the Senate of the Illinois General Assembly were introduced last February to limit use of the state’s False Claims Act. The bills would have removed any tax administered by the Illinois Department of Revenue from the scope of qui tam actions brought under Illinois’ False Claims Act. Neither bill moved out of committee.
States and localities have been struggling with how to address streaming services, as demonstrated by how widely states and localities have differed on whether and how these services should be taxed. Moreover, in states that have not specifically addressed the taxability of streaming services, additional caution is needed to evaluate whether streaming services could be interpreted as a type of taxable technology. As recent developments illustrate, the taxability of streaming services is developing, and taxpayers should consider conflicting determinations (or the lack thereof) across the states.
It is unclear how whistleblowers and states intend to use their respective False Claims Act provisions in tax matters, and many cases exist under court-ordered seals before any public disclosure occurs.
The Alabama Department of Revenue proposed an amendment55 to Administrative Rule 810-6-5-.09, which would have extended Alabama’s rental tax on tangible personal property to include streaming services. Due to pressures exerted by state legislators and businesses, the Department of Revenue withdrew its proposed amendment.56 The Department of Revenue subsequently revoked its earlier revenue rulings addressing technology. Without this guidance, it is unclear what the Department of Revenue’s positions are and signals the Department of Revenue’s continued attempt to classify various technologies as taxable tangible personal property. Earlier this year, Alabama legislators considered a bill57 that would have broadened the definition of tangible personal property to include digital goods and services; however, the bill was rejected in committee.
Some localities are also attempting to reach the growing streaming services revenue. In June 2015, the City of Chicago issued a ruling58 that, under the authority of the local amusement tax ordinance, streaming services would be subject to the city’s 9 percent amusement tax. Soon after, taxpayers challenged the ruling in Labell v. City of Chicago,59 arguing that the ruling exceeded the ordinance’s authority, violated the federal Internet Tax Freedom Act, and violated the Illinois and federal constitutions.60 Previous expansions of Chicago’s amusement tax have been subject to numerous challenges,61 and it is not surprising that the recent expansion to streaming services would be challenged as well.
States continue to face challenges associated with legislative processes that lag behind new technologies and businesses. Recent trends indicate that states will attempt to pull in more revenue by trying to overturn the physical presence standard provided by Quill and by using discretionary variances. It is uncertain how states intend to use some of the means available to them, such as qui tam actions through False Claims Act provisions. And even when states are able to address these new technologies, the landscape across states will continue to be patchy. These trends make the state tax arena more unpredictable, providing more compliance hurdles for taxpayers.
Jeffrey Friedman is a partner and Stephanie Do is an associate with Sutherland Asbill & Brennan LLP.
Direct Marketing Association v. Brohl, 135 S.Ct. 1124 (2015).
National Bellas Hess Inc. v. Dept of Revenue of Illinois, 386 U.S. 753 (1967).
Direct Marketing Association, 135 S.Ct. at 1134-1135.
Alabama Reg. 810-6-2-.90-.03 (effective January 1, 2016).
Alabama Legislative Act No. 2015-448 (effective October 1, 2015).
Statement of Newegg Inc. in Support of Its Notice of Appeal to the Alabama Tax Tribunal (June 8, 2016), Newegg Inc. v. Ala. Dept. of Revenue, ___ (Alabama Tax Tribunal).
SB 106 (South Dakota 2016) (effective April 1, 2016).
South Dakota v. Wayfair Inc., No. 32CIV16-000002 (6th Cir., S.D.).
Defendants’ Notice of Removal, South Dakota v. Wayfair Inc., No. 3:16-CV-03019-RAL (D.S.D.).
Plaintiff’s Memorandum of Law in Support of Motion to Remand, South Dakota v. Wayfair Inc., No. 3:16-CV-03019-RAL (D.S.D.).
Am. Catalog Mailers Assoc. v. Gerlach, No. 32CIV16—000096 (6th Cir., S.D.).
Tennessee Comp. R. & Regs. 1320-05-01-.129 (proposed June 16, 2016).
Those activities are: (1) sending, transmitting, or broadcasting of flyers, newsletters, telephone calls, targeted email, text messages, social media messages, or targeted mailings; (2) collecting, analyzing, and utilizing individual data on purchasers or potential purchasers in the states; (3) using information or software, including cached files, cached software, cookies, or other data-tracking tools, that is stored in or distributed within the state; or (4) conducting any other actions that use persons, tangible property, intangibles, digital files or information, or software in the state in an effort to enhance the probability that a person’s contact with a customer in the state will result in a sale to that customer. HB 3787 (Minnesota 2016).
“Direct response marketing” is defined as the same four activities adopted by Minnesota’s bill.
Crutchfield Inc. v. Testa, Case No. 15-0386 (Ohio, filed March 6, 2015); Newegg Inc. v. Testa, Case No. 15- 0483 (Ohio, filed March 25, 2015); Mason Cos. Inc. v. Testa, Case No. 15-0794 (Ohio, filed May 19, 2015).
Ohio Rev. Code § 5751.01(H)(3).
Ohio Rev. Code § 5751.01(I)(3).
Merit Brief of Appellant Crutchfield Corp. (August 31, 2015), Crutchfield Inc. v. Testa, Case No. 15-0386 (Ohio, filed March 6, 2015); Merit Brief of Appellant Newegg Inc. (August 31, 2015), Newegg Inc. v. Testa, Case No. 15-0483 (Ohio, filed March 25, 2015); Merit Brief of Appellant Mason Companies Inc. (August 31, 2015), Mason Cos. Inc. v. Testa, Case No. 15-0794 (Ohio, filed May 19, 2015).
Appellee Tax Commissioner’s Merit Brief (October 20, 2015), Crutchfield Inc. v. Testa, Case No. 15-0386 (Ohio, filed March 6, 2015); Appellee Tax Commissioner’s Merit Brief (October 20, 2015), Newegg Inc. v. Testa, Case No. 15-0483 (Ohio, filed March 25, 2015); Appellee Tax Commissioner’s Merit Brief (October 20, 2015), Mason Cos. Inc. v. Testa, Case No. 15-0794 (Ohio, filed May 19, 2015).
Dish DBS Corp. v. S.C. Dept. of Revenue, No. 14-ALJ-17-0285-CC (S.C. Admin. Law Ct. 2015).
Uniform Division of Income for Tax Purposes Act § 17; S.C. Code Ann. §§ 12-6-2290, 12-6-2295(A)(5).
Dish DBS Corp., No. 14-ALJ-17-0285-CC at 10 n. 22.
Vodafone Americas Holdings Inc. v. Roberts, 486 S.W.3d 496 (Tennessee 2016).
After this lawsuit was filed, the Tennessee legislature amended the sourcing rules, and market-based sourcing became effective on July 1, 2016. HB 644 (Tennessee 2015).
Vodafone, 486 S.W.3d at 527.
Equifax Inc. v. Miss. Dept. of Revenue, 125 So.3d 36 (Mississippi 2013).
See, e.g., N.Y. Fin. Law §§ 189(1), -(3); 740 Ill. Comp. Stat. §§ 175/3(a)(1), -(2).
See, e.g., N.Y. Fin. Law § 190(6); 740 Ill. Comp. Stat. § 175/4(d).
See, e.g., N.Y. Fin. Law § 192(1); N.Y. Tax Law §1147(b).
People ex rel. Schneiderman v. Sprint Nextel Corp., 26 N.Y.3d 98 (N.Y. 2015).
Superseding Complaint (June 14, 2012), New York v. Sprint Nextel Corp., No. 1039172011 (New York, filed April 19, 2012).
Sprint petitioned a writ of certiorari to the U.S. Supreme Court, which was recently denied. Sprint Nextel Corp. v. New York, 136 S.Ct. 2387 (2016).
Danon v. Vanguard Group, Inc., No. 100711/13 (N.Y. Sup. Ct. 2015).
Danon v. Vanguard Group Inc., No. 15-6864 (E.D. Pa. 2016).
David Sawyer, Vanguard Whistleblower Finds Success With Texas Payday, State Tax Notes, November 30, 2015, at 654.
SB 1828 (Illinois 2015); HB 2803 (Illinois 2015).
S.C. Revenue Ruling No. 16-5 (July 6, 2016); Connecticut Legal Ruling No. 2015-5 (November 3, 2015).
S.C. Revenue Ruling No. 16-5 (July 6, 2016).
Connecticut Legal Ruling No. 2015-5 (November 3, 2015).
Alabama Admin. Code 810-6-5-.09 (proposed June 11, 2015).
Letter from Julie Magee, Commissioner, Alabama Dept. of Revenue, to Paul Sanford, Chairman, Alabama Legislative Council (July 7, 2015).
City of Chicago Dept. of Finance Amusement Tax Ruling 5 (June 9, 2015) (effective July 1, 2015).
Labell v. City of Chicago, 2015 CH 13399 (Ill. Cir. Ct.).
First Amended Complaint for Declaratory and Injunctive Relief (December 17, 2015), Labell v. City of Chicago, 2015 CH 13399 (Ill. Cir. Ct.).
See Communications & Cable of Chicago, Inc. v. City of Chicago, 668 N.E.2d 1032 (Ill. App. Ct. 1996) (cable companies unsuccessfully challenged the amusement tax’s expansion to paid television).

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