A Grain of SALT: April State Focus – South Dakota

On April 17, the United States Supreme Court will hear oral argument in South Dakota’s case challenging the Court’s physical presence requirement for sales tax nexus. South Dakota v. Wayfair, Docket 17-494.

50 years ago, in National Bellas Hess v. Department of Revenue, 386 U.S. 753 (1967), the Supreme Court held that the Due Process and Commerce Clauses of the United States Constitution barred states from requiring remote retailers with no physical presence in a State to collect and remit sales tax. In 1992, the Court affirmed its prior ruling under the Commerce Clause. Quill v. North Dakota, 504 U.S. 298 (1992).

Quill has been at the center of state tax nexus controversy since the time of its issuance, as states have worked to restrict, and taxpayers have worked to expand the scope of the ruling. States and taxpayers have been continually tied up in disputes regarding the meaning of “physical presence” sufficient to trigger nexus. Concerned about the rapid growth of digital commerce, states have advanced increasingly aggressive theories of “physical presence” in an attempt to stem the loss of sales tax revenues from internet sales. Taxpayers, on the other hand, repeatedly have sought to apply the physical presence nexus standard to other types of taxes, principally income tax. Until South Dakota v. Wayfair, the Supreme Court declined to accept review of any case seeking further guidance with respect to the physical presence nexus standard.

In 2015, in a concurrence issued in Direct Marketing Association v. Brohl, 135 S.Ct. 1124 (2015), Justice Kennedy strongly signaled that the Court was ready to reconsider the physical presence nexus standard. In his concurrence, Justice Kennedy stated that given changes in technology and consumer sophistication, it would be “unwise” to delay any longer a reconsideration of the Court’s holding in Quill. Justice Kennedy went on to characterize Quill as “[a] case questionable even when decided,” and suggested that the decision “now harms States to a degree far greater than could have been anticipated earlier.” According to Justice Kennedy, Quill “should be left in place only if a powerful showing can be made that its rationale is still correct.”

Not surprisingly, states responded aggressively to Justice Kennedy’s remarks by enacting laws or adopting regulations that directly challenge the physical presence nexus requirement. In South Dakota, the state legislature amended its sales tax nexus statute, on a going-forward basis, to incorporate an economic nexus standard triggered by at least 200 South Dakota sales or $100,000 in South Dakota sales revenue in a calendar year. When Wayfair successfully challenged the constitutionality of the new nexus statute before the South Dakota Supreme Court, the stage was set for United States Supreme Court review.

As of the date of this publication, 38 amicus briefs have been filed in connection with the South Dakota v. Wayfair appeal. In addition to considering the physical presence nexus standard, the Court may address the issue of retroactivity in its ruling, in response to concerns expressed that states other than South Dakota might seek to give retroactive effect to any ruling that rejects the physical presence nexus standard. The international tax community is also watching the appeal with interest, given the United States government’s active involvement. If the United States argues that states have the power to tax sales to state residents by out-of-state retailers, what does this mean for the international front, as non-US countries attempt to tax digital sales income?

COST, Bloomberg Tax and McDermott will host a moderated roundtable discussion at 12:00 pm (EST) at McDermott’s DC office immediately following the South Dakota v. Wayfair oral argument. The roundtable discussion will explore the issues before the Court and opinions regarding the many possible outcomes from the case. To join the live stream, contact mdubinets@mwe.com.

Top March Hits You May Have Missed

Overview of Minnesota’s Response to Federal Tax Reform

More States Respond to Federal Tax Reform

Illinois Confirms Treatment of Deemed Repatriated Foreign Earnings Provisions

Looking Forward to April

April 17, 2018: Stephen Kranz and Diann Smith will be speaking and moderating at the South Dakota v. Wayfair Oral Argument Roundtable, hosted in McDermott’s DC office immediately following the oral argument itself. Please email Maria Dubinets at mdubinets@mwe.com to RSVP for this event.

April 17, 2018: Alysse McLoughlin is speaking at the Financial Services session at the Council On State Taxation’s 2018 Spring Audit Session – Income Tax Conference in Boston, MA.

April 18, 2018: Alysse McLoughlin is presenting “The State Taxation of Foreign Source Income: Planning, Compliance and Constitutional Challenges Post-Federal Tax Reform” at the Council On State Taxation’s 2018 Spring Audit Session – Income Tax Conference in Boston, MA.

April 24, 2018: Cate Battin, Jane May and Diann Smith will be presenting “State Tax After Reform” at McDermott’s Inaugural Tax Symposium in the Chicago, IL office.

April 25, 2018: Stephen Kranz is presenting “E-Fairness and Nexus: The Online Sales Tax Battle” and “Handling Tax Controversy to Win” at the 35th Annual President’s Seminar of the Minnesota Chapter of Tax Executives Institute (TEI) in Minneapolis MN. Steve will discuss the nexus wars and latest developments in Wayfair vs. South Dakota and Congress. He will also discuss an approach to solving tax problems holistically, understanding the offensive and defensive tools available and the avenues for relief when interacting with the government, planning and building the team to effectively work all avenues the government offers, tools available including FOIA, policy solutions and litigation.

Earlier this month, the New Mexico Administrative Hearings Office issued an opinion that addressed the questions on the minds of many state tax professionals in the wake of federal tax reform: under what circumstances can a state constitutionally impose tax on a domestic company’s income from foreign subsidiaries, including Subpart F income, and when is factor representation required? These issues have recently received renewed attention in the state tax world due to the new federal laws providing additions to income for foreign earnings deemed repatriated under Internal Revenue Code (IRC) section 965 and for global intangible low-taxed income (GILTI). Since many state income taxes are based on federal taxable income, inclusion of these new categories of income at the federal level can potentially result in inclusion of this same income at the state level, triggering significant constitutional issues.

In Matter of General Electric Company & Subsidiaries, a New Mexico Hearing Officer determined that the inclusion of dividends and Subpart F income from foreign subsidiaries in General Electric’s state tax base did not violate the Foreign Commerce Clause, even though dividends from domestic affiliates were excluded from the state tax base, because General Electric filed on a consolidated group basis with its domestic affiliates.

The Hearing Officer distinguished the facts in General Electric from the facts of a 1997 New Mexico Supreme Court case, Conoco Inc. v. New Mexico Taxation and Revenue Department, 1997-NMSC-005 (NM Sup. Ct. 1997), in which the court determined that the inclusion of dividends from foreign corporations in the state tax base of a taxpayer that filed its New Mexico returns on a separate entity basis is unconstitutional, even if the factors of the foreign corporations are represented in the taxpayer’s apportionment formula. The Hearing Officer determined that a different result was required for a taxpayer that reports its income on a consolidated basis with its domestic affiliates because, unlike with a separate entity filer, the earnings of the domestic affiliates are included in the state tax base through the consolidated filing, even if domestic dividends are ultimately deducted. The Hearing Officer, relying on holdings of other state courts, reasoned that inclusion in the tax base of the dividends and Subpart F income from foreign corporations is permissible when the taxpayer files a consolidated New Mexico return because, while foreign income and domestic income may not be taxed in the exact same manner, “there is a tax symmetry” under the consolidated group method that renders the state’s taxation of foreign dividends constitutional.

Another important issue that arises with respect to the inclusion of dividends and Subpart F income received from foreign corporations is whether the factors, or a portion of the factors, of the foreign corporations need to be included in the taxpayer’s apportionment formula. In this case, such issue did not need to be addressed because the Department had computed the taxpayer’s proposed tax liability by including the foreign corporations’ factors in General Electric’s New Mexico apportionment factor. Noting the importance of this issue, however, the Hearing Officer did state that “[f]ormula factor relief, is certainly relevant to the question of disparate treatment between foreign and domestic dividends, even if it by itself it’s not dispositive of the question.”

As the issue concerning inclusion of traditional Subpart F income in the state tax base has constitutional implications, so does the issue concerning inclusion of deemed repatriated foreign earnings and GILTI. Thus, taxpayers should consider these issues as they assess the state tax implications resulting from federal tax reform.

Since the Tax Cuts and Jobs Act (TCJA) passed in December 2017, over 100 bills were proposed by state legislatures responding to the federal legislation. Thus far in 2018, nearly half of states have passed legislation responding to the TCJA. With some exceptions, in this year’s legislative cycles the state legislatures were primarily focused on the treatment of foreign earnings deemed repatriated and included in federal income under IRC § 965 (965 Income).

The STAR Partnership has been very involved in helping the business community navigate the state legislative, executive and regulatory reaction to federal tax reform, and IRC § 965 in particular. The STAR Partnership’s message to states has been clear: decouple from IRC § 965 or provide a 100 percent deduction for 965 income. The STAR Partnership emphasized that excluding 965 Income from the state tax base is consistent with historic state tax policy of not taxing worldwide income and avoids significant apportionment complexity and constitutional issues. 

Most of the states that enacted legislation in response to the TCJA ultimately conformed to the recommendation of the STAR Partnership and did not tax a material portion of 965 Income. Of the states that enacted legislation in response to the TCJA, only one state explicitly decided to tax more than 20 percent of 965 Income. Below is a map prepared by the STAR Partnership illustrating the states’ responses to IRC § 965.

2018 STAR Partnership Success Stories Related to IRC § 965

Connecticut: Connecticut provides a dividends-received deduction for deemed dividends that, based on guidance from the Connecticut Department of Revenue Services, applies to 965 Income. A bill proposed by the Connecticut legislature would have deemed 10 percent of the dividend income to be a non-deductible expense attributable to such income. Due, in part, to advocacy efforts of the STAR Partnership and its members, the legislation that was ultimately adopted contained an expense attribution percentage of only 5 percent.

Hawaii: The STAR Partnership prepared policy and technical talking points and worked with local advocates to support Hawaii’s decoupling from IRC § 965. When legislation was passed, Hawaii did decouple from IRC § 965.

Indiana: The STAR Partnership prepared policy and technical talking points and worked with local advocates to support Indiana’s exclusion of 965 Income from the tax base. Indiana did enact legislation providing a 100 percent deduction for 965 Income, provided the taxpayer owns at least 80 percent of the foreign subsidiary.

Iowa: The STAR Partnership prepared policy and technical talking points and worked with local advocates to support Indiana’s decoupling from IRC § 965. Iowa did enact legislation effectively decoupling from IRC § 965.

Kentucky: The STAR Partnership prepared policy and technical talking points and worked with local advocates to support Kentucky’s decoupling from IRC § 965. Kentucky did enact legislation effectively decoupling from IRC § 965, at least with respect to taxpayers with calendar year CFCs.

Missouri: The STAR Partnership requested guidance from the Missouri Department of Revenue providing that 965 Income will be treated as a dividend and excluded from the state tax base under Missouri’s law, regardless of whether the taxpayer uses a three-factor or single-factor apportionment formula. The Department of Revenue issued the guidance that the STAR Partnership requested and, thus, pursuant to that guidance 965 Income is excluded from the Missouri state tax base for corporate taxpayers.

New Jersey: The New Jersey legislature proposed a special dividends tax on 965 Income, which would have resulted in tax being imposed on approximately 3 percent of total 965 Income. The STAR Partnership prepared talking points in opposition to the “special dividends tax” and sent a letter to the New Jersey legislature explaining that such tax was unconstitutional. Due to these efforts and the efforts of the STAR Partnership members, the legislature did not adopt the “special dividends tax.”

North Carolina: The STAR Partnership prepared policy and technical talking points and worked with local advocates to support North Carolina’s decoupling from IRC § 965. The legislature ultimately enacted legislation providing a 100 percent deduction for 965 Income.

Oklahoma: Due in part to the advocacy efforts of the STAR Partnership, the Oklahoma Tax Commission has stated that it will issue regulations that would effectively exclude 965 Income from the Oklahoma apportionable tax base for most taxpayers.

South Carolina: The STAR Partnership prepared policy and technical talking points and worked with local advocates to support South Carolina’s decoupling from IRC § 965. The legislature did pass a statute decoupling from IRC § 965.

While the state treatment of global intangible low-taxed income (GILTI) was on the mind of many taxpayers, most state legislatures that enacted legislation in 2018 focused on the state treatment of foreign earnings deemed repatriated under IRC § 965, leaving the state treatment of GILTI unclear in many states. That said, of the states that enacted legislation addressing GILTI, very few have decided to tax a material portion of GILTI.

In states that did not address global intangible low-taxed income through legislation, a lack of clarity in the state laws created an opportunity for the STAR Partnership to seek favorable administrative guidance on the treatment of GILTI. The STAR Partnership pursued that opportunity in a number of states, as discussed in more detail below.

Set forth below is a map illustrating the states’ 2018 legislative responses to GILTI.

The STAR Partnership expects GILTI to be a very important issue in the 2019 legislative cycles, and plans to continue to advocate for the exclusion of GILTI from the state tax bases either through legislation or administrative guidance.

2018 STAR Partnership Success Stories Related to GILTI

Connecticut: Connecticut provides a dividends-received deduction for deemed dividends that, based on guidance from the Connecticut Department of Revenue Services, applies to GILTI. A bill proposed by the Connecticut legislature would have deemed 10 percent of the dividend income to be a non-deductible expense attributable to such income. The STAR Partnership prepared policy and technical talking points and worked with local advocates to support the legislation that was ultimately adopted and contained an expense attribution percentage of only 5 percent.

Hawaii: The STAR Partnership prepared policy and technical talking points and worked with local advocates to support Hawaii’s decoupling from the GILTI provisions in IRC § 951A. When legislation was passed, Hawaii did decouple from IRC § 951A.

Indiana: The STAR Partnership prepared policy and technical talking points and worked with local advocates to support Indiana’s exclusion of GILTI from the tax base. Indiana did enact legislation providing a 100 percent deduction for GILTI, provided the taxpayer owns at least 80 percent of the foreign subsidiary.

Kentucky: The Kentucky legislature passed legislation in response to federal tax reform under which it was unclear whether the state’s dividends-received deduction applied to GILTI. The STAR Partnership requested a Technical Advice Memorandum from the Kentucky Department of Revenue providing that GILTI would be treated as dividend income and eligible for Kentucky’s dividends-received deduction. The Department agreed with the STAR Partnership’s arguments that GILTI should be treated as a dividend and issued the guidance requested by the STAR Partnership in August 2018.

Massachusetts: The STAR Partnership advocated for decoupling from the GILTI provisions in IRC § 951A or providing a deduction for GILTI. The Massachusetts legislature did enact legislation providing a 95 percent deduction for GILTI.

North Carolina: The STAR Partnership prepared policy and technical talking points and worked with local advocates to support North Carolina’s decoupling from the GILTI provisions in IRC § 951A. The North Carolina legislature did enact legislation providing a 100 percent deduction for GILTI.

Oklahoma: Due in part to the advocacy efforts of the STAR Partnership, the Oklahoma Tax Commission stated it will issue regulations that would provide that GILTI is treated as dividend income and allocated to the taxpayer’s state of commercial domicile.

South Carolina: The STAR Partnership prepared policy and technical talking points and worked with local advocates to support South Carolina’s decoupling from the GILTI provisions in IRC § 951A. The legislature did pass a statute decoupling from IRC § 951A.

A bill (AB 447) was introduced on March 25th in the Nevada Assembly that would create a broad new excise tax on the retail sale of “specified digital products” to Nevada customers. Instead of expanding the scope of Nevada’s sales and use tax, the bill would enact an entirely new chapter of the Revenue and Taxation Title imposing this new excise tax. Currently, sales of digital products, including electronic transfers of computer software, are not subject to the sales and use tax. Thus, the new proposal represents a major policy departure from the status quo. The introduced bill also would create inconsistencies with the Streamlined Sales and Use Tax Agreement (SSUTA)—to which Nevada is a member state—and contains many potential violations of federal law under the Permanent Internet Tax Freedom Act (PITFA) that do not appear to have been carefully considered.

Broad New Tax

Specifically, the bill would impose the new excise tax “upon the retail sale of specified digital products to an end user in this State . . . [and] applies whether the purchaser obtains permanent use or less than permanent use of the specified digital product, whether the sale is conditioned or not conditioned upon continued payment from the purchaser and whether the sale is on a subscription basis or is not on a subscription basis.” Based on this broad imposition, subscription-based services and leases or rentals of “specified digital products” would be covered by the new tax. “Specified digital products” is defined as “electronically transferred: (a) Digital audio works; (b) Digital audio-visual works; (c) Digital books; (d) Digital code; and (e) Other digital products.” Except for “other digital products,” these terms are defined consistently with the definitions in the SSUTA (of which Nevada is a member). The bill defines the term “other digital products” as “greeting cards, images, video or electronic games or entertainment, news or information products and computer software applications.”

Consistent with SSUTA?

The definition of “tangible personal property” for purposes of the Sales and Use Tax Act will continue to include “prewritten computer software . . . [but] does not include any products that are transferred electronically to a purchaser.” Nev. Rev. Stat. Ann. § 360B.485. While the term “computer software applications” is not defined in AB 447, the inclusion of electronically transferred computer software applications in the new excise tax on specified digital products leaves open the possibility for “computer software applications” to be broadly interpreted to capture electronically delivered prewritten computer software and all three cloud computing service models (SaaS, PaaS and IaaS). However, such an approach would conflict with Section 333 of SSUTA, which states that computer software shall be excluded from the imposition on digital products transferred electronically. While the reference to administration consistent with the SSUTA in the bill should prevail, as introduced, AB 447 would create a potential grey area that could lead to dispute if aggressively enforced. Furthermore, the broad nature of the proposed specified digital products imposition, including applicability to subscriptions and purchasers with less than permanent use of the specified digital products, means the proposal may be aimed at remotely accessed digital products such as subscription audio, video and gaming services.

The amount of the new tax would mirror the sales and use tax rate on sales of tangible personal property, which would be multiplied by the gross receipts of the retailer. Gross receipts, sales, retailer and other non-digital terms of art are defined almost exactly the same as they are currently in the Sales and Use Tax Act. Likewise, nearly all of the administrative requirements of the Sales and Use Tax Act would apply to the proposed new specified digital products tax chapter. However, in a departure from the SSUTA, AB 447 provides different sourcing rules applicable to specified digital products. The SSUTA provides a five-tiered sourcing rule while AB 447 only has two tiers. While the bill’s two-tiered sourcing rule is adapted from the third and fourth tiers of the SSUTA rule, it omits the other three. This sourcing inconsistency appears to be a violation of the SSUTA. See SSUTA Section 309(A) (stating that “[e]ach member state shall agree to require sellers to source the retail sale of a product in accordance with Section 310 or Section 310.1. Except as provided in Section 310.1, the provisions of Section 310 apply to all sales regardless of the characterization of a product as tangible personal property, a digital good, or a service.” If enacted, this, among other provisions of the bill, would put Nevada out of compliance with the SSUTA and expose it to sanctions from the SSUTA’s governing board.

PITFA Concerns Galore

The bill also creates possible violations of the PITFA, which bans multiple or discriminatory taxes on electronic commerce. PITFA prohibits states from imposing tax on an online version of something if the similar offline version is not subject to tax. It also prohibits a state from imposing different rates or obligations to collect on online service providers. As introduced, the bill imposes tax on numerous categories of products delivered electronically, while the non-electronic versions are not subject to tax. For instance, the bill would subject electronically transferred “news” to the tax, while newspapers are exempt from the sales and use tax. The bill would subject “video or electronic games” to tax while there is no tax on playing pin-ball machines or video games at an arcade. The new tax extends to electronically transferred “entertainment.” While Nevada has a separate tax on live entertainment, there is still the possibility for different tax treatment and obligations based on whether the entertainment is provided by an online service provider due to the application of the non-uniform sourcing rules that would be created. Therefore, simply taxing both online providers and providers of similar services delivered through other means may not be sufficient to prevent a PITFA violation if the application of the tax obligations is incongruent. Potential PITFA violations do not seem to have been carefully considered in the introduced bill, making the treatment of certain digital goods and services ripe for litigation if AB 447 is enacted as introduced.

Practice Note

As introduced, AB 447 would take effect “upon passage and approval for the purposes of adopting regulations and taking such other actions as are necessary to carry out the provisions of this act and [sic] on January 1, 2020.” While slightly ambiguous, the introduced bill appears to take effect on January 1, 2020, for purposes of enforcement, but upon passage and approval for purposes of taking the necessary actions (such as adopting regulations) to begin implementing in 2020. The Assembly Committee on Taxation is scheduled to take up AB 447 at a public hearing next Thursday, April 4 at 4:00 pm in Room 4401 of the Grant Sawyer State Office Building. As introduced, the bill would require a two-thirds majority vote of each chamber to be enacted.

On May 8, Governor Bill Lee (R) signed SB 558, which provides for the exclusion of 95% of Global Intangible Low-Taxed Income (GILTI) and foreign earnings deemed repatriated under IRC section 965 (965 Income) from the tax base for tax years beginning on or after January 1, 2018. By enacting this bill, Tennessee joins about 20 other states that explicitly exclude at least 95% of GILTI from the tax base and joins about 25 other states that explicitly exclude at least 95% of 965 Income from the tax base.

Despite this win for taxpayers, many may be wondering, “what about 965 Income included in 2017?” With respect to 2017, the Tennessee Department of Revenue issued guidance providing that 965 Income should not be included in the Tennessee tax base because such income was not reported on Line 28 of the Federal 1120 (the federal form changed for 2018 and 965 Income is included on Line 28 of the 2018 Form 1120). We understand that SB 558 has not impacted the department’s guidance in any way and that it remains the department’s position that 100% of 965 Income should be excluded from the tax base for 2017.

SB 558 does not address whether or how the 5% of GILTI and 965 Income that is taxed will be represented in the apportionment formula. Some states that have opted to tax 5% of GILTI and 965 Income consider the taxed amount to be a disallowed expense related to the GILTI and 965 Income that is excluded from the base. Tennessee does not frame its 5% tax as an expense disallowance so such taxed amounts should be represented in the apportionment formula. However, at least for now, there is no guidance from the legislature or Department of Revenue on this issue.

Legislators in Frankfort added a new “video streaming service” tax to the omnibus tax bill (HB 354) as part of a closed-door conference committee process before the bill was hastily passed in the House and Senate. Notably, the new video streaming service tax was not previously raised or discussed as part of HB 354 (or any other Kentucky legislation) before it was included in the final conference committee report that passed the General Assembly in March.

Specifically, as passed by the General Assembly, HB 354 will add “video streaming services” to the definition of “multichannel video programming service” subject to the telecom excise tax.  This is the same tax imposition that the Department of Revenue argued applied to video streaming services in the Netflix litigation—an argument that was rejected by the courts in Kentucky and then subsequently settled on appeal. Under existing law, Kentucky taxes “digital property” under the sales and use tax. The term is broadly defined and applies to audio streaming services, but expressly carves out “digital audio-visual works” (i.e., downloaded movies, TV shows and video; defined consistently with the SSUTA) from the scope of the sales and use tax imposition. HB 354 would not modify the treatment of digital goods and services under the sales and use tax, and changes that would be implemented are limited to the telecom excise tax imposed on the retail purchase of a multichannel video programming service.

As amended by HB 354, the definition of “multichannel video programming service” for purposes of the telecom excise tax would be expanded to mean “live, scheduled, or on-demand programming provided by or generally considered comparable to or in competition with programming provided by a television broadcast station and shall include but not be limited to: (a) Cable service; (b) Satellite broadcast and wireless cable service; and (c) Internet protocol television provided through wireline facilities without regard to delivery technology; and (d) video streaming services.” The legislation defines “video streaming services” as “programming that streams live events, movies, syndicated and television programming, or other audio-visual content over the Internet for viewing on a television or other electronic device with or without regard to a particular viewing schedule.” Thus, the “video streaming services” language in HB 354 would clearly subject over-the-top video streaming service providers to the excise tax on the retail purchase of a multichannel video programming service. As passed by the General Assembly, the new video streaming services excise tax in HB 354 would “apply to transactions occurring on or after July 1, 2019.”

Governor Matt Bevin signed HB 354 into law on March 26, 2019. The General Assembly subsequently passed a “cleanup bill” (HB 458) that was enacted into law last month, but it did not make any changes to the part of HB 354 that expanded the scope of the tax on multichannel video programming services to include video streaming services.

Kentucky is a member of the Streamlined Sales and Use Tax Governing Board. Taxation of electronically transferred audio-visual works is something specifically dealt with in the Streamlined Sales and Use Tax Agreement (SSUTA). The SSUTA also prohibit the enactment of so-called “replacement taxes” that have the effect of avoiding the provisions of the SSUTA.  Kentucky’s inclusion of streamed movies in its tax on multichannel video programming services, a regime outside the sales and use tax, could run afoul of the SSUTA’s prohibition on replacement taxes, potentially putting the state out of compliance with the SSUTA and exposing it to the risk of sanctions by the Governing Board.

Practice Note:  From an administrability and compliance point of view, enacting a new tax on digital goods and services as part of excise or gross receipts taxes outside the generally applicable sales and use tax poses significant problems. Many businesses that are not telecom providers simply do not have the compliance infrastructure to allow them to collect and remit taxes other than sales and use taxes. In addition, by taxing certain digital goods and services under a tax other than what is applicable to similar content sold via a tangible medium (such as a physical movie rental or viewing a movie in theater), the federal Permanent Internet Tax Freedom Act enacted by Congress may be implicated and pose a litigation risk to the state. Both the compliance nightmare and litigation risk could be easily avoided by imposing the tax under the sales and use tax (as opposed to miscellaneous excise or gross receipts taxes). We will continue to monitor the digital tax climate in Kentucky, and encourage companies impacted by this new imposition to contact the authors to discuss this issue in more detail.

The Illinois General Assembly enacted a number of new tax measures in a flurry of activity at the end of its legislative session. Some of the changes are taxpayer friendly and others are not. Unlike the no-deal chaos of past years, all of the measures have been or are expected to be signed by the state’s new Democratic governor, J.B. Pritzker.

This blog post summarizes the income-tax and franchise tax-related changes approved by the General Assembly. Subsequent posts will address sales/use, property and other tax changes.

Graduated Income Tax

The General Assembly approved, by a three-fifths vote in each Chamber, a referendum to appear on the November 2020 ballot in which Illinois taxpayers will be asked whether the Illinois Constitution should be amended to permit the imposition of a graduated income tax. Article IX, Section 3 of the current Constitution provides that any tax on or measured by income “shall be at a non-graduated rate,” and that only one such tax shall be imposed at one time. The same section also provides that any corporate income tax shall have a rate that does not exceed the rate imposed on individuals by more than a ratio of 8 to 5. The referendum to appear will ask taxpayers whether the Constitution should be amended to delete the prohibition against a graduated tax rate and to provide that the highest corporate income tax rate cannot exceed the highest personal income tax rate by more than a ratio of 8 to 5.

Article XIV, Section 3 of the Constitution provides that in order to take effect, the referendum must be approved by either three-fifths of those voting on the question or a majority of those voting in the election.

The General Assembly also enacted a companion bill, SB 687, signed by the governor as Public Act 101-0008, which establishes the graduated rate system that would take effect if the referendum is approved. The Bill provides for the following rates, effective in 2021:

Non-Joint Filers

$0 – $10,000 – 4.75%

$10,001 – $100,000 – 4.9%

$100,001 – $250,000 – 4.95%

$250,001 – $350,000 – 7.75%

$350,001 – $750,000 – 7.85%

If income exceeds $750,000 then 7.99% of all income

Joint Filers

$0 – $10,000 – 4.75%

$10,001 – $100,000 – 4.9%

$100,001 – $250,000 – 4.95%

$250,001 – $350,000 – 7.75%

$350,001 – $1,000,000 – 7.85%

If income exceeds $1,000,000 then 7.99% of all income

SB 687 also would increase the corporate income tax rate from 7% to 7.99% (10.49% with the personal property tax replacement income tax), effective in 2021.

TCJA Conformity/Decoupling

SB 689, signed by the governor as Public Act 101-0009, included legislation that will add-back the TCJA’s deduction for foreign-derived intangible income (FDII). The decoupling is effective for tax years beginning after December 31, 2018. The FDII deduction enacted in sub-part (a)(1)A of IRC section 250 provides US corporate taxpayers a deduction in the amount of 37.5% of income earned from the sale of property to a person outside the US for use outside of the US or the provision of services to a person outside the US or with respect to property not located in the US. See new IITA § 203(b)(2)(E-18). Starting in 2026, the deduction is reduced to 21.875%.

SB 689 also approved a deduction for trusts and estates equal to the amount of “excess business loss” disallowed by Internal Revenue Code § 461(1)(B). The amount disallowed under IRC § 461 is deemed a net operating loss carryover to the following taxable years(s). However, in the case of a trust or estate, because Illinois decouples from the federal net operating loss provisions, absent this amendment, an excess business loss would have been permanently disallowed to a trust or estate. See new IITA § 203(c)(2)(Z).

New/Expanded Income Tax Credits

SB 689 included the “Blue Collar Jobs Act,” which provides for an EDGE-type income tax credit (Economic Development for a Growing Economy) in the form of a credit for incremental income tax withholding on construction jobs for High Impact businesses, businesses in Enterprise Zones and River Edge areas. The credit is enhanced if the construction jobs are in an “underserved” area. The amendment uses the same definition of “underserved” found in the current EDGE Tax Credit Act (see 35 ILCS 10/5-1 et seq.). The credits are equal to up to 50% (or in some instances, 75% if the project is in an underserved area) of income tax withheld from construction project contractor and subcontractor employees. Unused credits can carry forward five years; credits earned by pass-through entities flow through to the owners.

Withholding Requirements

SB 1515 requires Illinois income tax withholding for non-resident employees that spend more than 30 working days in Illinois starting in 2020. The Bill also provides that Illinois residents will receive a credit for taxes paid to other states if they are based in Illinois but pay income taxes on days spent in other states.

Franchise Tax

At long last, the Illinois Franchise Tax has been repealed (see SB 689). Sections 15.35 and 15.65 of the Business Corporation Act were amended to exempt the first $X in liability from the Franchise Tax, as follows:

2020:   $30

2021:   $1,000

2022:   $10,000

2023:   $100,000

2024 and thereafter:   No tax due

Amnesty Programs

Amnesty for Taxes administered by Illinois Department of Revenue

The Legislature adopted a new amnesty program for all taxes administered by the Illinois Department of Revenue (see SB 689). The program will run from October 1, through November 15, 2019. Taxes due for any taxable period ending after June 30, 2011, and prior to July 1, 2018, are eligible. Interest and penalties are waived with payment. Unlike previous Illinois amnesties, there is no penalty interest imposed on taxpayers eligible for amnesty who do not participate in the program. See 35 ILCS 745/10.

Franchise Tax Amnesty Program

The Legislature also adopted a new amnesty program for franchise taxes and license fees imposed by Article XV of the Business Corporation Act (see SB 689). The program will run from October 1, through November 15, 2019. Taxes due for any taxable period ending after March 15, 2008, and on or before June 30, 2019, are eligible. Interest and penalties are waived with payment. See 805 ILCS 8/5-10.

This has been an eventful and exciting week for those interested in the states’ taxation of global intangible low-taxed income (GILTI). On Monday, taxpayers received the good news that New York Governor Cuomo signed S. 6615—a bill that excludes 95% of GILTI from the New York State corporate income tax base. By passing this bill, New York joins many other states—including neighboring states Massachusetts, Connecticut and Pennsylvania—that chose not to tax a material portion of GILTI. The New York law instructs taxpayers that have GILTI to include the 5% of GILTI that is taxed in the denominator of the apportionment formula (no portion of GILTI is included in the numerator of the apportionment formula).

Perhaps not surprisingly, after the New York news broke, the Florida legislature presented its GILTI exclusion bill (HB 7127) to Governor DeSantis. HB 7127 passed the legislature back in May but had not been transmitted to the governor until yesterday. Those on the ground in Florida believe that the transmittal to the governor now, on the heels of the New York legislation, suggests that the governor will sign the bill. The governor has 15 days to sign or veto the bill (if he does neither, the bill becomes law after the 15-day period).

There was also GILTI action on the west coast. On Monday, the Oregon legislature passed a bill (SB 851) that allows taxpayers to deduct 80% of GILTI under the state’s dividend-received deduction. While, under this legislation, Oregon would tax a larger portion of GILTI than many other states, the willingness of the legislature to extend the 80% deduction to GILTI is consistent with the trend among states to not tax this new category of income from foreign operations. The bill has not yet been signed by Oregon Governor Kate Brown.

On June 24, 2019, Wisconsin Governor Tony Evers (D), signed into law AB 10, entitled “2019 Wisconsin Act 7.” This Act either bars a deduction for, or requires that amounts deducted be added back to, Wisconsin taxable income “for moving expenses” deducted on federal income tax returns if the expenses are associated with a move of a business either out of the state or out of the country. This requirement would not apply to expenses incurred by a taxpayer in moving a business to a different location within the state of Wisconsin. The provisions apply regardless of the form of ownership of a business, either as a sole proprietorship, a corporation, or a pass through entity such as a partnership, limited liability corporation or subchapter S corporation. 

Under federal tax law, a taxpayer generally may deduct the costs associated with moving its business operations from one location to another as ordinary and necessary business expenses.  The Wisconsin income tax “piggybacks” on federal taxable income for purposes of determining the state income tax. Under the provision, a taxpayer would have to add back to its Wisconsin taxable income any expenses associated with a move that had been deducted on the federal return.

The fiscal note accompanying the bill notes no data exists that would permit an estimate of how much revenue the measure would raise, but anticipates the amount would not be large. The fiscal note provides an example of a business that spent $500,000 in moving either out of the state or out of the country. Assuming an apportionment factor of 14.7% (the average for all Wisconsin businesses in 2016), it would pay an additional $5,807 in income tax. If 100 similar businesses moved out of the state, the revenue increase to the state (or cost to business in increased income taxes) would be $580,700.

The low revenue score for the measure suggests the purpose is political rather than revenue raising. Indeed, Governor Evers, in his Twitter feed, stated “I signed AB 10 into law to make sure businesses don’t get an unfair tax advantage for moving their business out of Wisconsin.”  Governor Evers was backed by the head of the Wisconsin chapter of the AFL-CIO, who praised him for calling out the “unjust practice of rewarding companies with tax breaks for moving jobs out of WI.”

Discriminatory?

The Act blatantly discriminates against interstate and international commerce and is unconstitutional under the Commerce Clause of the US Constitution, which grants to Congress the power to regulate commerce with foreign nations, and among the several states. The Supreme Court has long held the Commerce Clause “prohibits state laws that unduly restrict interstate commerce” and “prevents States from adopting protectionist measures.[1] In addition, the Court has held that “a State “may not tax a transaction or incident more heavily when it crosses state lines than when it occurs entirely within the State.” See Armco Inc. v. Hardesty, 467 U. S. 638, 642 (1984).

In evaluating state taxes under the Commerce Clause, the Courts look to the four-part test enunciated in Complete Auto Transit, Inc. v. Brady, which asks whether a “tax is applied to an activity with a substantial nexus with the taxing State, is fairly apportioned, does not discriminate against interstate commerce, and is fairly related to the services provided by the State.” 430 U.S. 274 (1977). Because the Act would impose a higher tax burden on a business moving from Wisconsin to another state or country than it would impose on a business moving from one location in the state to another, it discriminates against interstate commerce and would fail the “does not discriminate against interstate commerce” prong of the Complete Auto four-part test.

The Act also likely infringes on the constitutional right of free travel between the states (Art. IV, Sec. 2). The right of a citizen of one state to pass through, or to reside in any other state has long been recognized as a right protected by various provisions of the Constitution. One line of cases grounds the right in the Privileges and Immunities Clause.[2] Another line of cases rests on the Privileges and Immunities Clause of the Fourteenth Amendment.[3] Other cases find the right in the Commerce Clause.[4] To the extent the Act restricts travel outside the United States, it might infringe the Due Process Clause of the Fifth Amendment.[5] Whatever the source of the right to travel, the placement by a state of a tax on the right of egress of a citizen from a state is abhorrent and likely unconstitutional.

What can be done about it?

Challenging the provision through a traditional tax dispute is a problematic and likely lengthy process. A taxpayer seeking to litigate the issue of the constitutionality of the provision could claim deductions (or fail to add them back to its Wisconsin taxable income) and wait to see if the moving expense issue is challenged on audit and then work the issue through the typical administrative review process and through the courts. However, as noted above, the financial impact of the moving expense issue on a taxpayer’s liability likely is minimal. There would not be enough money in the issue to justify the challenge. The same would be true if a taxpayer were to not claim a deduction or add the moving expenses back to income and then file a claim for refund. The juice would not likely be worth the squeeze.

Another possible avenue of attack on the constitutionality of the Act would be through a declaratory judgment action. Wisconsin has adopted the Uniform Declaratory Judgments Act.[6]  Under this procedure, one would not have to wait for the usual administrative tax dispute process to play out. A taxpayer could bring an action asking that a court enter a declaration that the Act is unconstitutional on a number of grounds. Such a decision would be precedential and available for use by other taxpayers in challenging the denial of deductions or refusal to add moving expense back to Wisconsin taxable income. But, once again, the juice likely is not worth the squeeze as the costs of litigation likely would exceed the amount of any deduction for tax refund.

One other possible angle of attack would be for a trade association representing business interests to bring such a declaratory judgment action on behalf of its members. In Wisconsin, it appears associations have standing to bring declaratory judgment actions on behalf of their members.[7] For instance, a trade association representing business located in Wisconsin could allege that the constitutional rights of its member companies is being chilled by the infringement on such members rights to freedom of travel between the states by the Act’s imposition of higher taxes on business that move out of state as compared to Wisconsin businesses who move to a different location in the state. The Act also works immediate harm on Wisconsin businesses because it discriminates against interstate commerce by virtue of more favorable taxes on those who move from one location in Wisconsin to another as compared to those who chose to move to another state or country. Making a showing of standing by a business trade association with members in Wisconsin should not be a problem.

Where does it stop?

Wisconsin is the first state to pull a political stunt like enacting a tax on exiting businesses, but if Wisconsin is not stopped in its tracks, its unconstitutional approach is likely to proliferate and mutate. Wisconsin started with a small item like moving expenses. Other states are sure to scour their, and the federal, tax codes for other deductions or tax benefits to tweak so they don’t apply to businesses moving out of the state that will hurt more than moving expenses. A better approach for Wisconsin would be for it to review its corporate income tax policies to make sure they are pro-job and pro-growth. Then perhaps no one would move out…

Special thanks to Marisa Poncia in our DC office for contributing to this piece.

[1] See Philadelphia v. New Jersey, 437 U. S. 617, 623–624 (1978), Willson v. Black Bird Creek Marsh Co., 2 Pet. 245, 252 (1829), New Energy Co. of Ind. v. Limbach, 486 U. S. 269, 273 (1988), Comptroller of Treasury of Md. v. Wynne, 575 U. S. ___ (2015), Tennessee Wine and Spirits Ass. V. Thomas, _ U.S. _ (June 26, 2019) (slip op. p. 6).

[2] See e.g., Corfield v. Coryell, 6 F. Cas. 546, 550 (C.C.E.D.Pa. 1823), Paul v. Virginia, 8 Wall. 168, 180 (1869), and Ward v. Maryland, 12 Wall. 418, 430 (1871).

[3] Edwards v. California, 314 U.S. 160, 181, 183-185 (1941) (Douglas and Jackson, JJ., concurring), and Twining v. New Jersey, 211 U.S. 78, 97 (1908).

[4] Edwards v. California, supra, and the Passenger Cases, 7 How. 283 (1849)

[5] Kent v. Dulles, 357 U.S. 116, 125 (1958), Aptheker v. Secretary of State, 378 U.S. 500, 505-506 (1964); Zemel v. Rusk, 381 U.S. 1, 14 (1965),

[6] Wisc. St. Sec. 806.04.

[7] Wisconsin’s Environmental Decade, Inc., v. Public Service Commission of Wisconsin, 69 Wis. 2d 1

230 N.W.2d 243 (1975), Metropolitan Builders Association f Greater Milwaukee, v. Village of Germantown, 282 Wis. 2d 458, 2005 WI App 103, 698 N.W.2d 301(2005).

Recently passed budget legislation in both Connecticut and Rhode Island included tax increases on sales of digital goods and services. The Connecticut bill has been signed into law. The Rhode Island bill passed late last night awaits executive action. Below are brief summaries of the impacts of these bills on the sales taxation of digital goods and services (assuming the Rhode Island governor signs the bill) beginning October 1, 2019.

Connecticut

Governor Ned Lamont (D) signed the Connecticut budget bill (HB 7424) into law in early June. The bill contains language increasing the sales and use tax rate on most digital goods and services from the current 1% rate to the full 6.35% rate beginning October 1, 2019. See Sections 319-322 (starting on page 460 of the Public Act). Specifically, these provisions expand the definition of “tangible personal property” for sales and use tax purposes so they include: (1) “digital goods” and (2) “canned or prewritten software that is electronically accessed or transferred, other than when purchased by a business for use by such business, and any additional content related to such software.” Note, there is a statutory carve-out for electronically accessed or transferred software transactions in the B2B context. As enacted, “digital goods” means audio works, visual works, audio-visual works, reading materials or ring tones that are electronically accessed or transferred. The bill also creates explicit statutory sale for resale standards for the sale of canned or prewritten software, “digital goods” and “computer and data processing services.” To the extent your company offers or purchases “digital goods” or electronically delivered or cloud-based software to consumers, the authors encourage careful review of these new provisions.

Effective October 1, 2019, the tax rate for sales of digital goods and B2C SaaS and other cloud-based services will increase from 1% to 6.35%.

Rhode Island

Late last night (June 27), the Rhode Island Senate concurred with changes made by the House late last week (via substitute) to the budget bill (H. 5151). The amended substitute that cleared the General Assembly contains a proposal increasing the sales and use tax base so that it includes “specified digital products.” This proposal was first raised in January as part of the governor’s executive budget proposal. These provisions (Article 5, Section 9, beginning on page 161 of the amended bill) would include “[t]he sale, storage, use, or other consumption of specified digital products” in the sales tax base starting October 1, 2019. The bill defines “specified digital products” consistent with the SSUTA and includes electronically transferred digital audio-visual works, digital audio works and digital books. Because the bill does not specify otherwise and Rhode Island is a SST state, the base increase will be limited to downloads (i.e., right of permanent use required and must not be conditioned upon continued payment). Thus, if signed by the governor, the “specified digital products” base expansion that passed yesterday would not cover subscription-based offerings or streamed audio/video offerings where the right to use the specified digital product is only temporary.

Next, the budget bill with the new “specified digital products” tax will be delivered to Governor Gina Raimondo (D) for consideration.

Practice Note

State legislatures were active in 2019 in the digital goods and services tax space. For example, another New England state (Vermont) considered a bill (S. 96) that would have repealed the cloud tax exemption it enacted a few years ago. While the provision was ultimately stricken from the bill prior to passage, legislative leaders in Vermont indicated that they expect the proposal to be considered again during the 2020 session. Companies interested in staying on top of these developments for advocacy and compliance purposes are encouraged to contact the authors.

Many New Jersey taxpayers have a reason to celebrate today as the Division of Taxation withdrew Technical Bulletin-85, providing for a special apportionment regime for global intangible low-taxed income (GILTI) and income used to compute the foreign-derived intangible income (FDII) deduction that many felt was unfair and potentially unconstitutional.

In December 2018, the New Jersey Division of Taxation issued Technical Bulletin-85 providing for a special apportionment regime for GILTI and income used to compute the FDII deduction. Under Technical Bulletin-85, GILTI and income used to compute the FDII deduction were apportioned to New Jersey separately from other business income based on the New Jersey Gross Domestic Product (GDP) relative to the GDP in all states where the taxpayer had nexus. This regime was unfair and likely unconstitutional as applied to many taxpayers because the apportionment formula was in no way related to where GILTI and income used to compute the FDII deduction were earned.

Today, thanks to the efforts of the business community in New Jersey and advocacy groups such as the STAR Partnership, the Division withdrew Technical Bulletin 85. The Division provided instead that GILTI and income used to compute the FDII deduction should be apportioned to New Jersey with the rest of the taxpayer’s business income, with GILTI (net of the federal deduction for GILTI) included in the denominator of the apportionment formula and income used to compute the FDII deduction (net of the FDII deduction) included in the denominator of the apportionment formula and the numerator to the extent such income is sourced to New Jersey. The Division is expected to release a new Technical Bulletin memorializing this guidance and providing more detail later this week. The Division’s current guidance is available at: https://www.state.nj.us/treasury/taxation/pdf/pubs/tb/tb85.pdf. Stay tuned for more!

Taxpayers may have celebrated too soon when the New Jersey Division of Taxation announced that it was withdrawing TB-85 and the GDP-based apportionment regime for global intangible low-taxed income (GILTI) and foreign-derived intangible income (FDII) in favor of a more fair apportionment regime. Read our first post on T8-85 here.

Yesterday, the Division issued a new Technical Bulletin (TB-92) on the state’s treatment of GILTI and FDII that is quite troubling. The guidance provides that GILTI and FDII should be included in the general business income apportionment factor and sourced as “other business receipts” to New Jersey. The guidance then provides that “to compute the New Jersey allocation factor on Schedule J, the net amount of GILTI and the net FDII income amounts are included in the numerator (if applicable) and the denominator. This is to help prevent distortion to the allocation factor and arrive at a reasonable and equitable determination of New Jersey tax.” 

As an initial matter, the Division considers FDII a new category of income, which is not the case – FDII is income from certain non-US sales that has always been included in income. The Tax Cuts and Jobs Act created the FDII deduction, which is based on such sales but FDII is not a new type of income. Thus, it seems particularly unreasonable that FDII would be subject to special apportionment rules and included on a net basis (really a net, net basis because instead of including gross receipts the guidance would include income net of a deduction) when other sales are included on a gross basis. This seems to be a blatant violation of the foreign commerce clause. It also seems unreasonable that FDII would be sourced as “other business receipts” and not based on the property or service actually sold by the taxpayer.

Furthermore, there Division provided no guidance on how GILTI and FDII should be included in the numerator of the apportionment formula. The Bulletin provides only that the taxpayer cannot look through to the underlying sales of the CFC (unless they are members of the combined group) when allocating GILTI and FDII. This is troubling because, in certain circumstances, other business receipts are sourced to the commercial domicile of the taxpayer. This would harm NJ-based companies and was likely not the intention of the Division.

Importantly, this guidance from the Division is merely the Division’s interpretation of the relevant New Jersey statutes and, to the extent that the guidance is inconsistent with the statutes or the US Constitution, the guidance is invalid. Accordingly, New Jersey taxpayers should consult with counsel to determine whether an appropriate tax return filing position exists to include the factors of the CFCs generating the GILTI in the New Jersey apportionment formula, thereby reducing the amount of income taxable in New Jersey, and/or whether they should file protective refund claims if they have already paid tax computed using the Division’s apportionment method.

On January 14, LB 989 was introduced in the Nebraska Legislature, which would impose sales and use tax on “the retail sale of digital advertisements.” The bill defines “digital advertisement” as “an advertising message delivered over the Internet that markets or promotes a particular good, service, or political candidate or message” (see pages 5-6 of the bill). The definition is a sweeping one, but the exact scope is unclear as the terms used are not further defined. It is also unclear how a taxable digital advertising transaction would be sourced if the proposed legislation is enacted.

The digital advertising tax proposed in the bill would have an effective date of October 1, 2020. Nebraska’s state sales tax rate is 5.5%, with local sales taxes up to an additional 2%.

Similar to Maryland’s SB 2 proposal, because Nebraska would tax digital advertising but not tax non-digital advertising, the proposed tax raises a series of legal concerns (above and beyond the obvious policy concerns).  For example, the tax would be a “discriminatory tax” prohibited by the Permanent Internet Tax Freedom Act (PITFA). The proposal also raises serious First Amendment (singling out digital commercial speech for tax) and Equal Protection (lack of rational basis for tax only on digital advertising) issues.

Practice Note: If enacted, LB 989 would create an uncharted and sweeping tax on digital platforms and advertisers. While this bill will have an uphill battle in 2020 (for example, Nebraska has a short, 60-day legislative session this year and Nebraska has a filibuster rule) the repeated introduction of digital advertising tax bills early in 2020 state legislative sessions may be the start of an alarming trend of legally suspect tax proposals that we are keeping a close eye on.  Businesses impacted by the Maryland and Nebraska digital advertising tax proposals are encouraged to contact the authors to discuss these legislative developments further.

On January 16, a bill (H. 756) was introduced in the Vermont Assembly that would repeal the sales and use tax exemption for remotely accessed prewritten computer software. If enacted as introduced, the exemption would no longer protect Vermont taxpayers from this legally suspect tax beginning July 1, 2020.

This is not the first time the Vermont Legislature has considered the issue of taxing cloud software. After the Department of Taxes administratively issued guidance interpreting the sales tax to apply to all prewritten software (including cloud-based software) in 2010, legislative actions were taken to curtail this administrative overreach—including a 2012 temporary moratorium and the aforementioned 2015 exemption—to preclude the imposition of sales tax on the mere accessing of prewritten computer software.

Practice Note: With the introduction of H. 756, Vermont is at risk of reverting back to the dark ages of cloud tax uncertainty that existed throughout the first half of the past decade. As noted below, there are substantial policy and legal flaws with this proposal that counsel against repeal of the exemption. Vermont Legislative Counsel estimates that repealing the sales tax exemption for cloud software would generate six to seven million dollars of revenue in FY 2021—hardly enough to justify the additional administrative complexities and disputes that will arise on audit (and potential litigation arising therefrom). Specifically, even if the cloud tax exemption is repealed, substantial uncertainty remains under Vermont law as to whether there is sufficient authority to impose sales or use tax on cloud service providers. Disturbing the existing certainty created under current law will take Vermont from one of the most favorable jurisdictions to do business in United States to one of the worst from a cloud service provider point of view. In a world where relocation can be accomplished at the click of a button, Vermont would be putting itself at a disadvantage over its neighboring states and incentivize new and relocating businesses to avoid consumption in Vermont in favor of states with more favorable (and more certain) tax laws.

Currently, Vermont sales tax applies to the retail sale of tangible personal property, unless an exemption applies. 32 V.S.A.§ 9771(1). In 2015, an exemption enacted prohibiting the taxation of “charges for the right to access remotely prewritten software shall not be considered charges for tangible personal property.” 2015 Acts and Resolves No. 51, Sec. G. 8. This amendment sought to eliminate confusion for customers and businesses of prewritten computer software that stemmed from administrative positions taken by the Department in the first half of last decade. If the 2015 exemption is repealed, it would precipitate uncertainty once again, in addition to numerous potential disputes and litigation.

Assuming the 2015 exemption is repealed as proposed, a few legal issues will inevitably arise. Most notably, the Permanent Internet Tax Freedom Act (PITFA) bans discriminatory taxes on electronic commerce; states are prohibited from imposing a sales tax on the online version of something that is tax exempt offline. Vermont generally does not tax offline services, and thus a sales tax on remotely accessing cloud software runs the risk of a legal conflict with PITFA’s congressional mandate. For example, consider the use of an internet-based tax return preparation service: if H. 756 is passed, this software service would be subjected to a sales tax, even though offline tax return preparation in Vermont is not taxed. This inconsistency opens the door for audit disputes and costly litigation, which will harm state coffers and not result in the revenue generation that is being projected.

Prior to moving forward with the proposed cloud tax exemption repeal, Vermont legislators should carefully consider the potential externalities that may arise from this action and whether it would result in one step forward and two steps back.

On January 21, A. 9112 was introduced in the New York Assembly. An identical Senate companion bill, S. 6102, has been referred to the Senate Budget & Revenues Committee after being introduced in May 2019. The bills would impose an additional 5% tax on the gross income of “every corporation which derives income from the data individuals of this state share with such corporations.” The bills do not provide further detail or limitation on the scope of the proposed new imposition language.

The bills would also establish a six-member Data Fund Board, to invest the tax revenue collected and distribute net earnings “to each taxpayer of the state” in a manner determined by the Board. If enacted without amendment, the bills would take effect 180 days after being signed into law.

As written, the proposed New York tax would unconstitutionally apply to all income worldwide earned by a company deriving income from data from New Yorkers. A state tax on a multistate business must “be fairly apportioned to reflect the business conducted in the State.”

The tax as written is so broad it would apply to essentially every business. Every business collects data and uses it to market or complete a sale, and any corporation with data-derived income from New York customers would be subject to the new tax on their total revenue. “Data” is a broad term. If a company collects zip codes or phone numbers at checkout, asks for email address to join a mailing list, counts customers coming in or out of the store, collects website click or open data, or asks for information from customers, such as their size or shipping address, before making a sale, it apparently would be subject to this tax. For many such businesses, a gross receipts tax at a 5% rate would wipe out all profits, equivalent to an over 100% corporate income tax. At that point, a tax for engaging in data collection might become so punitive it violates the Due Process Clause. Another obvious due process problem is that the lack of definitions and the broad sweep of this proposal could invalidate it on void for vagueness grounds.

Any meaningful attempts to address these constitutional issues, such as by specifically applying the tax only on big tech companies, would add new problems under the Permanent Internet Tax Freedom Act (PITFA). A tax on digital use of data while the non-digital use of data is not similarly taxed would run afoul of PITFA’s ban on tax discrimination against electronic commerce.

First Maryland, then Nebraska, now New York. The repeated introduction of targeted taxes on digital companies early in 2020 seems to be the start of an alarming trend of legally suspect tax proposals that we are keeping a close eye on.

Most states have historically not subjected foreign-source income to state income tax. Consequently, since the passage of TCJA, the vast majority of states have opted not to tax GILTI (with most states explicitly decoupling from GILTI or excluding at least 95% of GILTI from the state tax base) or repatriation income (only five states have failed to decouple or provide significant relief).

Unfortunately, the Nebraska Department of Revenue (DOR), despite for years consistently holding that foreign source (Subpart F) income is deductible as dividends received, ruled last year that GILTI and repatriation income are not deductible. The DOR ruling would start taxing foreign source income, a significant departure from Nebraska’s tax policies as established by the Legislature.

The Nebraska Legislature may decide the question, with today’s introduction of LB 1203. The bill would clarify the state’s policy that GILTI and repatriation income are deductible, as foreign dividends received or deemed to be received. The bill frames the policy as a clarification, and therefore applicable to tax filings prior to the bill’s effective date.

The STAR Partnership expects GILTI to be a continued important issue in the 2020 legislative cycle, and plans to continue to advocate for the exclusion of GILTI from the state tax bases either through legislation or administrative guidance.

On March 18, 2020, Maryland legislature sent a massive new tax on digital advertising services to Governor Hogan for consideration. The tax imposes a rate of up to 10% on annual gross revenue in the state derived from digital advertising services. This tax is on a sliding scale based on companies’ global revenues and would take effect with tax year 2021. There are many legal problems with the legislation, including the violations of the Internet Tax Freedom Act, the Commerce Clause and the First Amendment. Other states have considered and are considering similar proposals. It is imperative that companies know how broadly this new tax will apply.

Click below to watch our recent webinar on this new tax. We discuss the legal challenges that can be made and how to protect your company from the unlawful reach of such laws.

Illinois has announced the following tax-related relief measures related to COVID-19. Taxpayers who file quarterly estimated returns should note that unlike the federal government, Illinois has not extended the April 15, 2020 due date for first quarter estimated tax payments.

I. Extension of Filing and Payment Deadlines for Illinois Income Tax Returns

The 2019 income tax filing and payment deadlines for all taxpayers who file and pay their Illinois income taxes on April 15, 2020, have been automatically extended until July 15, 2020. This relief applies to all individual returns, trusts and corporations. The relief is automatic; taxpayers do not need to file any additional forms or call the Illinois Department of Revenue (IDOR) to qualify. For additional details, click here for the guidance issued by IDOR on March 25, 2020.

Penalties and interest will begin to accrue on any remaining unpaid balances as of July 16, 2020.

Even though the deadline has been extended, IDOR has encouraged taxpayers expecting a refund to file as soon as they can. Taxpayers who have already filed a return can check the status of their return by using the Where’s My Refund? link located at mytax.illinois.gov

Note: This extension does NOT impact the first and second installments of estimated payments of 2020 taxes that are due on April 15 and June 15. Although the federal government has extended the date for the payment of first quarter estimated tax payments to June 15, 2020, Illinois has not followed this practice. Illinois taxpayers are still required to estimate their tax liability for 2020 and make four equal installment payments to IDOR, starting on April 15, 2020.

II. Sales Tax Deferral for Bars and Restaurants

To help alleviate some of the unprecedented challenges facing bars and restaurants due to COVID-19, Governor Pritzker has directed IDOR to defer sales tax payments for eating and drinking establishments that incurred less than $75,000 in sales tax liabilities last year. Qualifying businesses are still required to timely file their sales tax returns, but will not be charged penalties or interest on their late payments due in March, April or May 2020. The IDOR estimates this will give relief to nearly 80% of the bars and restaurants in Illinois.

Taxpayers taking advantage of this relief will be required to pay their sales tax liabilities due in March, April and May in four installments, starting on May 20 and extending through August 20. For more information, please view IDOR’s informational bulletin available at tax.illinois.gov.

III. Small Business Loans

The US Small Business Administration has approved the state’s eligibility for disaster assistance loans for small businesses facing financial hardship in all 102 Illinois counties due to COVID-19. Eligible businesses can apply for up to $2 million in low-interest loans here.