COST - Key State Tax Developments

Northeast Region

November 2015

Page 2 Key State Tax Developments – Northeast Region

Today’s agenda

► Key State Tax Developments – Northeast Region► Connecticut► Massachusetts► New Jersey► Pennsylvania/Philadelphia► District of Columbia► Maryland

November 2015

Page 3

Today’s presenters

Jon G. Spisto Ernst & Young LLP

New York, NY

Deane R. EastwoodErnst & Young LLP

McLean, VA

Matt J. ShetzlineErnst & Young LLP

Philadelphia, PA

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Connecticut

November 2015

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Connecticut budget bill and budget implementer bill

► PA 15-244 (budget bill, enacted 30 June 2015) contains significant corporate, personal income and sales/use tax law changes

► SB 1502 (budget implementer bill, enacted 30 June 2015) contains several notable changes to the FY 2016-17 budget bill PA 15-244

► To understand what Connecticut did, you have to read BOTH acts and realize the second changes provisions of the first … really confusing!

► Collectively, we’ll refer to the two bills as the Act► Plus recent comments from the State

November 2015

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Connecticut budget bill and budget implementer bill

► Key provisions of the Act: ► Adopt mandatory unitary combined reporting for corporations► Limit use of net operating losses (NOLs) and credits► Extend the corporate tax surcharge ► Expand the scope of computer data processing services subject to sales

tax ► Increase the luxury sales and use tax rate ► Eliminate the sales and use tax exemptions for certain clothing and

footwear ► Increase the top individual income tax rate and impose a new, higher rate

on high wage earners (6.99%)► Delay the expiration of the moratorium on the issuance of new film tax

credits► Delay various benefits (e.g., increased deduction, property tax credits) for

individual income tax filers

November 2015

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Corporate income tax changes Mandatory combined reporting

► Effective for taxable years commencing on and after 1 January 2016, Connecticut adopts mandatory unitary combined reporting

► Similar to the current law, corporations calculate their Connecticut tax liability on the basis of both net income and capital base

► The Act repeals the current preference tax applicable to elective combined return filers, since the filing method is now mandatory

November 2015

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Corporate income tax changes Defining the combined group

► A combined group includes all unitary members with 50% or more voting control owned by common owner(s)

► The combined group can include taxable (nexus) and nontaxable (non-nexus) members, and it only needs one taxable member

► The combined group’s net income, additional tax base and the apportionment factors are determined on a water’s edge basis (if no worldwide or affiliate group election is made), and includes any taxable or nontaxable member that: (1) Is incorporated in the US, or formed under the laws of the US, unless

80% or more of both its property and payroll are located outside the US;

(2) Is incorporated or formed anywhere if 20% or more of both its property and payroll are located outside of the US; or

(3) Is incorporated in a jurisdiction that is determined by the commissioner to be a tax haven

November 2015

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Corporate income tax changesDefining the combined group – tax havens

► What’s a “tax haven”?► The Act defines “tax haven” to include jurisdictions:

► Lacking transparence, ► Favorable for tax avoidance and ► With laws preventing effective exchange of information with other

governments for tax purposes► The Commissioner is required to publish a list of tax haven

jurisdictions no later than 30 September 2016

November 2015

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Corporate income tax changes Combined group income

► The combined group income is the aggregate net income or loss of every taxable member and non-taxable member of the combined group derived from a unitary business

► Include the direct and indirect distributive share of a pass-through entity’s unitary income

► Eliminate intercompany dividends► Treat deferred intercompany transactions in a manner

similar to the federal consolidated return regulations

November 2015

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Corporate income tax changes Apportionment

► Each member of the combined group calculates its own apportionment based on the formula applicable to that member. Combined denominators are used when calculating each member’s apportionment, regardless of whether a member utilizes that factor in its own apportionment formula, and it includes taxable and non-taxable member data

► The receipts factor numerator includes the receipts assignable to Connecticut from all taxable members

► The receipts assignable to Connecticut from non-taxable members are distributed proportionately among the taxable members and are included in the receipts numerator. Intercompany transactions are eliminated from both the numerator and denominator

► Sales factor sourcing rules have not been modified

► Each member of the combined group calculates its apportioned net income or loss by applying its apportionment percentage to the combined group net income

November 2015

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Corporate income tax changes Combined group NOLs

► A taxable member may carry over its post-apportioned NOLs

► For NOLs incurred by a taxable member after 1 January 2016, the NOL may be shared with other entities that were members of the combined group in the year that the loss occurred

► Pre-1 January 2016 losses of a taxable member may be shared among other entities that were a member of the same elective combined group (either consolidated nexus or unitary)

► Effective for income years beginning on or after 1 January 2015, the NOL carryforward is limited to the lesser of

1) 50% of apportioned net income, or

2) The excess of NOL over the net operating loss being carried forward from prior income years

November 2015

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ConnecticutSales and use tax items

► PA 15-244 as amended by SB 1502 (enacted 30 June 2015)► Expand the scope of computer data processing services subject to

sales and use tax to include the creation, development, hosting, and maintenance of a web site, effective 1 October 2015

► Increase the luxury sales and use tax rate to 7.75% (from 7%), effective 1 July 2015

November 2015

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Massachusetts

November 2015

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MassachusettsRecent developments

► FAS 109 deduction► HB 4001 (enacted 11 July 2014) – Delays the FAS 109 deduction

related to the adoption of combined reporting until 2016 and amends combined reporting administrative provisions

► 17 July 2015 compromise agreement between Governor and legislative leaders will delay the FAS 109 deduction related to the adoption of combined reporting, which was scheduled to take effect in 2016, for an additional five years and extend the period to claim the deduction from seven years to 30 years

► Market based sourcing► 839 CMR 63.38.1 (adopted 2 January 2015) – DOR adopted final

market-based sourcing regulations for sales factor and changes the apportionment regulations for certain special industries

November 2015

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MassachusettsJudicial developments

► The First Marblehead Corp. (Mass. Sup. Jud. Ct., 28 January 2015) – DOR properly treated the loan portfolios of an out-of-state holding company's property as being located wholly in Massachusetts and, therefore, included in the numerator of the company's property factor

► Staples, Inc. v. Mass. Comr. of Rev. (Mass. App. Tax Bd. Sept. 4, 2015) – Intercompany transfers associated with a cash management system (CMS) did not give rise to bona fide debt either for purposes of the net income portion or the net worth portion of the corporate excise; therefore, the parent company of wholly owned office supply retail subsidiaries could not reduce its corporate excise tax by deducting the transfers as interest expenses

November 2015

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New Jersey

November 2015

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New JerseyRecent developments

► Related party add-back► Morgan Stanley & Co. (N.J. Tax Ct. 29 October 2014) – A financial

services company was entitled to a deduction for interest paid on loans to related parties under the unreasonable exception to the related party interest and expense add-back provisions► Division of Taxation "acted unreasonably" by not examining the facts cited by

the company to determine if they supported the unreasonable exception

► Throwback and throwout rules► Toyota Motor Credit Corp. (N.J. Tax Ct. 1 August 2014) – Division of

Taxation erred in applying the throw-out rule to company’s receipts sourced to Nevada, South Dakota and Wyoming, because for the years at issue the company had sufficient presence in these states

► Single sales factor phase-in► Phase in 2012-2014

November 2015

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New JerseyRecent developments (cont.)

► Intangible expense / intercompany transactions► Spring Licensing Group Dkt. No. 01001-2010 (N.J. Tax Ct.

September 23, 2015) – An out-of-state company with economic nexus (i.e., royalty income) with the state could not avoid filing a Corporation Business Tax (CBT) tax return under the New Jersey Supreme Court’s Lanco precedent if its related party did not deduct the corresponding royalty expense

November 2015

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New JerseyJudicial developments

► PPL Electric Utilities Corp. (N.J. Tax Ct. 2 October 2014) – A corporation is not required to add-back the PA Gross Receipts Tax and PA Capital Stock Tax in computing its NJ Corporate Business Tax (CBT), because those taxes are not based on or measured by income, profits, business presence or business activity, but rather are each an excise tax and property tax, respectively

► Duke Energy Corp. (N.J. Tax Ct. 2 December 2014) – An energy company is not required to add-back utilities taxes paid to North Carolina and South Carolina in computing its CBT, because those taxes are not based on or measured by income, profits, business presence or business activity

► Toyota Motor Credit Corp. (N.J. Tax Ct. 1 August 2014) – A vehicle leasing company that benefited from bonus depreciation for federal income tax, but not for CBT, purposes is allowed to adjust its federal basis when determining gain from the sale of property for CBT purposes

► MCI Communication Services (N.J. Tax Ct. 20 July 2015) (not for publication) – Taxpayer is not entitled to adjust its entire net income to reverse the effect of a reduction in its tax attributes required by IRC §108(b) as modified by the federal consolidated return regulations

November 2015

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Pennsylvania / Philadelphia

November 2015

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Pennsylvania / PhiladelphiaRecent developments

► Market-based sourcing► Notice 2014-01 (12 December 2014) – Provides guidance on sourcing

revenues from the sales of services for sales factor apportionment purposes under the new market-based sourcing provisions that apply starting in 2014► Receipts from the sale of other items that are not TPP (and are not services)

will continue to be sourced under the "costs of performance" method under "Section 17."

► Intangible expense and cost add back► Act 52 of 2013 closes the “Delaware Loophole” by requiring companies to

add back intangible expenses and costs, including the interest expense associated with the intangible expense and cost, effective for tax years beginning after December 31, 2014.► The adjustment would not apply to a transaction that did not have as “the”

principal purpose the avoidance of tax “and was done at arm’s-length rates and terms.”

November 2015

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Pennsylvania / PhiladelphiaRecent developments

► Pennsylvania capital stock/foreign franchise tax► Phase out of tax rate for tax years after 12/31/2015.

► Philadelphia wage/earnings tax rates to go down effective July 1, 2015► Philadelphia Department of Revenue website (June 2015) - The

City of Philadelphia Department of Revenue announced that the Philadelphia wage tax rates will be reduced effective July 1, 2015. The rate as of July 1, 2015 for residents of Philadelphia will decrease from 3.92% to 3.9102%, and the rate for nonresidents of Philadelphia will decrease from 3.4915% to 3.4828%.

► Philadelphia BIRT - single sales factor phase-in for 2015

November 2015

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Maryland

November 2015

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MarylandRecent Developments

► US Supreme Court: Comptroller v. Wynne - Court held that Maryland’s personal income tax scheme, which provides a credit for taxes paid to other states for the state portion of the income tax but not for the county portion, violates the dormant Commerce Clause

► Refunds … when can Maryland taxpayers expect them?► Maryland HB 72 (became law without governor’s signature, 29 May

2015)► Maryland Attorney General certified Court’s ruling triggers refunds ► Comptroller will process refund claims in the order in which they were

received

► Implications for other jurisidictions?

November 2015

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MarylandJudicial developments

► Staples Inc. (Md. Tax Ct. 28 May 2015) – “Enterprise dependency” existed and that the out-of-state corporations were not separate business entities from in-state affiliated companies, were part of a unitary business, and thus had nexus with Maryland

► ConAgra (Md. Tax Ct. 24 February 2015) – Out-of-state intangible holding co. lacking economic substance apart from parent has nexus in MD based on parent’s activities (decision recently affirmed by Anne Arundel County District Court)

► In both cases Revenue Administration Division’s use of blended apportionment formula to determine holding company’s income upheld

November 2015

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District of Columbia

November 2015

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District of ColumbiaRecent developments

► Income tax changes - L20-0155; A20-424; B20-750 (Law date 26 February 2015) ► Reduce the unincorporated and incorporated business franchise

tax rate from 9.975% to 9.4% on 1 January 2015, and in subsequent years reduces the rate to 9.2%, 9%, 8.75%, 8.5% or 8.25%, depending on funding availability

► Adopt a single sales factor apportionment formula with market-based sourcing for services

► Income tax changes generally effective for taxable years beginning after 31 December 2014

November 2015

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District of ColumbiaJudicial developments

► Use of Chainbridge to perform transfer pricing analysis► Microsoft decision (not appealed) rebuking Chainbridge analysis

► ALJ ruled that DC’s analysis did not distinguish between controlled and uncontrolled transactions in its CPM methodology

► ALJ held that methodology did not comport with 482 principles► Shell Oil Co., Hess Corp. and Exxon Mobil Oil Corp. – Non-mutual

offensive collateral estoppel precludes the Office of Tax & Revenue (OTR) from relitigating the validity of assessments based on transfer pricing analysis prepared by an OTR contractor

► “Oil companies” assessment struck down by ALJ, citing Microsoft► DC is appealing, arguing Microsoft not precedential

November 2015