Earlier this year, the California Franchise Tax Board (the “FTB”) issued Chief Counsel Ruling 2017-01 (the “2017 Ruling”), which addresses the application of the state’s market-based sourcing rules to non-marketing services under California Revenue and Taxation Code (“Code”) section 25136 and California Code of Regulations (“Regulation”) section 25136-2. The 2017 Ruling concludes that receipts from non-marketing services should be sourced to California to the extent that a taxpayer’s direct customers (and not its customer’s customer) receive the benefit of the service in California. The 2017 Ruling reaffirms an earlier ruling, Chief Counsel Ruling 2015-03 (the “2015 Ruling”), where the FTB reached the same conclusion regarding receipts from non-marketing services. The 2015 and 2017 Rulings seem to foster a common theme developing under California’s market-based sourcing regime that the appropriate market is the location of a taxpayer’s direct customer (and not its customer’s customer).
Less than a year after a similar minimum tax proposal was soundly defeated at the polls, a gross receipts minimum tax measure is again being proposed by way of voter initiative in Oregon. A draft ballot title for Initiative Petition 2018-027 (“IP 27”) was received by the Oregon Secretary of State Elections Division from the Attorney General on July 13, 2017 for the November 6, 2018 general election. While the specifics of IP 27 are yet to be revealed, the summary provided in the draft ballot indicates that it is in ways even more aggressive than the one rejected by voters last November (“Measure 97”). Although the fate of this latest tax proposal is still very much in question, companies doing business in Oregon should take notice of the continued interest in gross receipts taxes (another proposal, H.B. 2830, which would have imposed a tax similar to Ohio’s Commercial Activity Tax, was narrowly defeated in the state legislature earlier this year), especially in light of the state’s recent move to market-based sourcing.
Currently, corporations doing business in Oregon pay the greater of the state’s corporate excise (income) tax and the minimum tax. The excise tax is based on net income, and is imposed at a rate of 6.6 percent on corporate “income” (i.e., revenues less deductible expenses) less than $1 million and 7.6 percent on corporate income greater than $1 million. The current minimum tax is a tiered structure based on “Oregon sales” that ranges from $150 for corporations with $0 to $500,000 of Oregon sales and is capped at $100,000 for corporations with $100,000,000 or more of Oregon sales. “Oregon sales,” for minimum tax purposes, are the same as Oregon-sourced sales for excise tax apportionment purposes, and are generally equivalent to gross receipts—not income—although certain gross receipts are excluded from the definition of “sales” for apportionment purposes.
As we previously reported in Oregon Proposes “Gross” New Tax, the much talked about 2016 proposal, Measure 97, would have modified Oregon’s minimum tax structure, most notably by removing the tax’s cap for larger businesses. Specifically, for C corporations (S corporations, limited liability companies, and partnerships were not covered by the tax) with more than $25 million in Oregon sales, Measure 97 proposed a minimum tax ($30,001) plus a 2.5 percent tax on all Oregon sales in excess of $25 million. Because “sales” for minimum tax purposes are generally equivalent to gross receipts and not income, any corporation with more than $25 million in Oregon-sourced sales would have potentially paid tax on their gross receipts, with no deduction for business expenses.
The summary in IP 27 reveals that the newly-proposed gross receipts tax would again be implemented by way of the state’s existing minimum tax. Under IP 27, the minimum tax on corporations with Oregon sales over $5,000,000 would be $4,001 plus 0.95% of sales above $5,000,000. Furthermore, unlike Measure 97, S corporations are included within the scope of IP 27. Thus, under IP 27, the floor and rate of the gross receipts tax would be lower—the floor would be set at $4,001 down from $30,001 and the rate would be 0.95% rather than the 2.5% proposed in Measure 97—but the sales threshold of $5 million and the inclusion of S corporations threatens to impact many more taxpayers. Furthermore, like Measure 97, there does not appear to be any cap on minimum tax liability. Therefore, any business with more than $5 million in Oregon-sourced sales could potentially pay an uncapped tax based on gross receipts.
Imposing an uncapped gross receipts tax based on Oregon sales could have an even greater impact now, given that the Oregon legislature recently passed a bill moving the state from costs of performance sourcing to market-based sourcing for sales factor apportionment purposes. Under current law, for apportionment purposes, sales of tangible property are sourced based on the destination and those sales that are not taxable in another state are “thrown back” to Oregon and treated as Oregon sales. Sales of “other than tangible personal property” are Oregon sales if the income-producing activity is performed in Oregon or the income-producing activity is performed both in and out of Oregon and a greater proportion of the income-producing activity is performed in Oregon, based on costs of performance. On July 6, 2017, Governor Kate Brown signed legislation that replaces costs of performance sourcing with market-based sourcing effective January 1, 2018. Under the new market-based sourcing statute, sales of other than tangible personal property (i.e., services and intangibles) will be sourced to Oregon if the “taxpayer’s market for sales” is in Oregon. For sales of services a taxpayer’s market is in Oregon if the service is delivered to a location in the state.
The combination of market-based sourcing and an uncapped gross receipts tax based on Oregon sales has the potential to drastically impact the tax liability of service providers who are making sales to Oregon customers. The move from costs of performance sourcing to market-based sourcing alone may increase the tax liabilities for companies with out-of-state operations. If IP 27 (or a similar measure) is enacted, not only would companies be paying tax to Oregon based on the presence of customers in Oregon, but their tax base (i.e., gross receipts) would not allow for the deduction of many expenses that are deductible for federal and state income tax purposes.
At the moment, neither the Oregon legislature nor the governor seem particularly inclined to support a move towards a gross receipts tax. While Governor Brown supported Measure 97 last year, she, along with Oregon House Speaker Tina Kotek and Senate President Peter Courtney, announced that, after the failure of H.B. 2830 to pass both chambers, any legislative plans to implement a gross receipts tax were being shelved until 2019. However, this statement did not stop interested citizens from putting forth their own measure in the form of IP 27. Whether IP 27 will garner the support that Measure 97 lacked remains to be seen. Nevertheless, companies doing business in Oregon are well-advised to consider the implications of both market-based sourcing and a possible move to taxation of gross receipts (in some form) in the coming months.
On May 3, 2017, in Romantix Holdings Inc. v. the Iowa Dept. of Revenue, the Court of Appeals of Iowa affirmed the Iowa Department of Revenue’s (the “Department”) determination that (1) a parent holding corporation was ineligible to join its Iowa subsidiaries’ consolidated Iowa income tax returns because the holding company was not subject to Iowa income tax; and (2) the holding company’s Iowa subsidiaries could not deduct certain expenses incurred and paid directly by the holding corporation but ratably allocated to the subsidiaries based on a percentage of revenue approach. While the Court ruled against the taxpayer on both issues, this case more broadly holds that an in-state operating subsidiary’s use of an out-of-state holding company’s intangible property, including a business trademark, does not necessarily create nexus for the out-of-state holding company with Iowa. The Court’s ruling potentially conflicts with determinations from other state courts under similar facts where intangible holding companies were held to have nexus based on the activities of in-state operating subsidiaries involving the out-of-state entities’ intangible personal property. See our prior coverage, Colorado District Court Holds Economic Nexus Exists for a Minnesota Intangible Holding Company and Agrees to a Modified Alternative Apportionment Method, June 19, 2017. Read more…
After months of bitter fighting, the United States Supreme Court vacancy left by the death of Justice Antonin Scalia has finally been filled with the confirmation of Justice Neil Gorsuch on April 7, 2017. What this means for state tax issues that are ripe for Supreme Court review—retroactivity, the death of Quill, etc.—will certainly be the subject of much debate and prognostication. One thing that seems quite clear, based on his record in the Tenth Circuit, is that when given the chance, Justice Gorsuch will likely conclude that the deference standard that currently applies to judicial review of agency regulations is too lenient, and that the power of the administrative state should be curtailed.