For 2016, the trend of states continuing to pursue aggressive nexus and apportionment policies will continue. Bloomberg BNA’s 2016 Survey of State Tax Departments indicates that 35 states apply an economic presence test for income and franchise tax purposes. The test purportedly allows states to assert the jurisdiction to tax or “nexus” solely on the basis that a company has sales or otherwise derives an economic benefit from activities within their borders. Accompanying this idea is a rejection of the physical presence standard applied more than 20 years ago by the US Supreme Court in the Quill sales tax case. Quill suggests that having persons or property within a state is required under the US Constitution to impose tax on nonresident businesses. This year only five states indicated they apply Quill in making income tax nexus determinations. These states are Delaware, Hawaii, Massachusetts, Pennsylvania, and Texas. Tennessee expressed it stopped applying Quill in 2016.
The BNA survey found only five states responded that they do not apply an economic presence standard: Delaware, Louisiana, Rhode Island, Texas, and Vermont. The survey results also highlighted the uncertainty businesses face on nexus issues. Hawaii, Michigan, Nebraska, New Mexico, Oklahoma, and Tennessee indicated their “policy is based on economic presence” and physical presence (which may or may not involve the Quill test of “de minimis” contact). These contradictory approaches are usually poorly laid out in state tax codes and involve a high degree of discretion on the part of state tax officials. In some cases, there are no published interpretations of nexus. Wisconsin, for example, asserts a “30-day” contact standard which can benefit out-of-state companies. It has no basis in state statutes or administrative rules. On the downside, the standard has been used with punishing effect to enforce the state’s sales throwback rule and deny businesses the right to apportion their income outside Wisconsin.
Another area of uncertainty concerned states’ nexus treatment of information technology activities. Forty jurisdictions (including the District of Columbia and New York City) responded that owning a web server located within their borders establishes taxable presence. Twenty-nine of these states also indicated that sharing space on a third-party service provider’s server network also establishes nexus. One can only imagine a corporate tax manager combing through all of the company’s server locations (owned and/or) leased and attempting to determine for a given state whether nexus is created by: ownership of the server, exclusive rental of the server, or shared rental space on the server.
Web-hosting presents another conundrum. Twenty-two states responded to the BNA survey that paying service charges for web-hosting on a third-party server located inside their borders creates nexus. In such an arrangement, the only presence in a state that a company can have is electronic in nature. One has to ask the question as to whether any or all of these states believe web-hosting presence overcomes the nexus standards required for companies that sell tangible personal property under federal Public Law 86-272.
States keep migrating away from a cost-of-performance sales factor method for businesses that render services and derive income from sources other than the sale of goods. They are increasingly moving to a market-based sourcing method which assigns sales to where customers derive the benefit of the services or other value received rather than where the work is performed. Approximately 22 states have enacted laws that provide for the apportionment of receipts from services under a market-based sourcing approach. Beginning in 2015, the District of Columbia, New York, and Rhode Island apply market sourcing. Tennessee and Indiana came out with rulings that required market sourcing for taxpayers that rendered services even though their statutory schemes require the use of cost of performance. See, for example, Indiana Letter of Findings No. 02-201230402, IN DOR Feb. 25, 2015. Although market-based sourcing continues to gain widespread acceptance, the implementation of this method varies greatly among market-based sourcing states and takes into consideration a number of different factors when determining the location of the market. Implementation of this approach may also vary among different categories of receipts within a single state. The market sourcing trend has significant tax implications for service firms, software companies, franchisors, and other types of businesses.
States also continue to establish sufficient nexus without a physical presence requirement by adopting “bright-line” nexus requirements. Under bright-line nexus standards, an out-of-state entity has nexus with a state so long as it meets a minimum-dollar threshold for property, payroll, or sales in the state, regardless of physical presence. Under the Multistate Tax Commission (MTC) model statute, nexus is triggered for each type of contact only if the following thresholds are exceeded during the tax period:
- $50,000 of property,
- $50,000 of payroll,
- $500,000 of sales, or
- 25 percent of total property, total payroll, or total sales.
Currently, about nine states, including California, Connecticut, Michigan, New York, Ohio, and Washington, have bright-line tests. Tennessee recently enacted a nexus provision that substantially conforms to the MTC model statute.
Forty-four states currently impose corporate income taxes and 24 of those states plus the District of Columbia have adopted combined reporting.
During the 2015 legislative session, 21 total bills (excluding legislative drafts) attempting either to implement a new mandatory combined reporting scheme or amend an existing unitary reporting system were introduced in Alabama, Illinois, Louisiana, Maryland, Massachusetts, Michigan, Missouri, New Jersey, New Mexico, and Pennsylvania.
Most recently, New York implemented mandatory combined reporting for corporate taxpayers for tax years beginning after Jan. 1, 2015. Rhode Island and Connecticut also switched to combined reporting in 2014 and 2015, respectively. The effective date of Connecticut’s change to mandatory combined reporting was delayed until Jan. 1, 2016.
US-foreign tax minimization by multinational companies has caught the attention of state revenue agencies. The MTC is developing a state transfer pricing program for those states unwilling to wait for the federal government to act on what has become known as “base erosion and profit shifting” (BEPS) in the international tax world. The question is, Will corporations with overseas activities soon face state IRC section 482 adjustments that are difficult even for the IRS to make fairly? The MTC Executive Committee approved the concept in its recently released Design for an MTC Arm’s-Length Adjustment Service. The idea is to provide training to state revenue officials with the goal of beginning transfer pricing audits in the relatively near future. In a proposal dispersed to the states, the MTC solicited commitments and support for the program. Despite opposition from the multinational businesses and state tax practitioners, the MTC proposed and approved the Arm’s-Length Adjustment Services (ALAS) program in May 2015 with a targeted implementation date of July 1, 2015. Shortly after approving the ALAS program, the MTC implemented a four-year charter period for the participating states. Currently, six states are charter members of the ALAS program: Alabama, Iowa, Kentucky, New Jersey, North Carolina, and Pennsylvania. Initially, MTC envisioned a 10-state participation charter, but many states question the cost relative to the potential revenue. The MTC has yet to announce a new implementation date.
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