Tennessee issues guidance regarding nexus and apportionment

Tennessee's 2015 franchise and excise tax guide provides additional information that companies operating inside and outside Tennessee should review and plan accordingly in advance of 2016.

1. Economic nexus standard - expanding criteria under which an out-of-state vendor may incur nexus
2. Apportionment formula - changed apportionment formula by triple-weighting the sales factor
3. Market-based sourcing - additional information and clarification regarding application of market-based sourcing for sales other than tangible personal property
4. Distribution apportionment incentive - special elective apportionment rule for taxpayers who sell very large volumes of product to regional distribution

Economic Nexus Standard

For tax years beginning on or after January 1, 2016, out-of-state businesses not already subject to Tennessee taxes will be subject to franchise and excise taxes to the fullest extent allowed by the Constitution. Such nexus includes, but is not limited to, any of the following:

• The taxpayer is organized or commercially domiciled in Tennessee;
• The taxpayer owns or uses its capital in Tennessee;
• The taxpayer has a systematic and continuous business activity in Tennessee that has produced gross receipts attributable to customers in Tennessee; or
• The taxpayer has a bright-line presence in the state. A person has a bright-line presence in this state for a tax period if any of the following applies:
  • Receipts: > $ 500,000 or 25% of total receipts from sales in TN
  • Property: > $ 50,000 or 25% of total property by value in TN
  • Payroll: > $ 50,000 or 25% 

Triple-Weighting of Sales Factor

For tax years beginning on or after July 1, 2016. the apportionment formula consists of the property factor, plus the payroll factor, plus three times the receipts factor, and the denominator is five (5).

Market-Based Sourcing

For tax years beginning prior to July 1, 2016, sales of other than tangible personal property are allocable to Tennessee if a greater proportion of the earnings-producing activities are performed in Tennessee. Effective for all tax years beginning on or after July 1, 2016, sales, other than sales of tangible personal property, are in Tennessee if the taxpayer’s market for the sale is in Tennessee. (see page 52 of the guide for details on when the taxpayer's market is in Tennessee)

Distribution Incentive

Effective January 1, 2016, a taxpayer that meets the gross sales threshold and the receipts factor threshold (one billion dollars or the taxpayer's receipts factor exceeds 10%) during the tax period qualifies for the application of a new distribution incentive and may elect the incentive by filing an election form with the Department on or before the due date of the tax return for the period for which such election is to take effect. The election remains in effect until revoked by the taxpayer or until the taxpayer no longer qualifies for the election.

"Certified distribution sales" means sales of tangible personal property made in Tennessee by the taxpayer to any distributor, whether or not affiliated with the taxpayer, that is resold for ultimate use or consumption outside the state; provided, that the distributor has certified that such property has been resold for ultimate use or consumption outside Tennessee. (see page 53 of guide for details on when the incentive applies)

market-based sourcing to be analyzed by MTC special subcommittee

The Multistate Tax Commission (MTC) has formed a Special Subcommittee to review market-based sourcing regulations in the context of separate-entity filing and related party transactions. The first meeting will be held Friday, August 28, 2015 at 3:30 pm EST via teleconference. The meetings will be held every Friday at 3:30 pm until further notice.

According to media reports, the special subcommittee was formed to examine concerns about the possible impact on taxpayers filing separate-entity income tax returns. The MTC is concerned that taxpayers may manipulate market-based sourcing methodology through the use of related party transactions, distorting the result. 

The taxpayer and tax professional community must accept that market-based sourcing is here to stay and will eventually be adopted by all states. Therefore, we must be proactive in how the rules are crafted and implemented. The majority of the economy in the U.S. is derived of service providing companies, or companies that provide services along with selling tangible goods. Technology allows companies to provide several types of services across the U.S. without physically delivering the service into each state (i.e., services are performed in one state, while customers are in multiple states). Consequently, market-based sourcing in-conjunction with "factor-presence" nexus or "economic" nexus (a subject for another day) will create greater tax liability and/or compliance burdens for companies.

Be prepared. Be involved.

For more information, check out my previous posts on market-based sourcing.

Bloomberg BNA releases its 2015 state tax survey

Taxpayers are always trying to obtain certainty regarding their tax issues. Unfortunately, it is not possible to achieve 100% certainty when the facts are complex and the state's rules are grey. Consequently, the taxpayer and adviser generally review all binding authority (statutes, regulations, cases, etc.) and unbinding authority (informal guidance, etc.) to develop support for a tax position. This is why we have the lovely 'levels of assurance' such as the 'realistic possibility of success' (33%), 'substantial authority' (40%), or 'more likely than not' (> 50%).

Depending on the situation, taxpayers are commonly balancing risk and the amount of dollars to spend to chase down this elusive certainty.  Accordingly, taxpayers are trying to attain the most cost-effective and practical solution that reduces risk to an acceptable level. Thus, other factors (business, legal, financial) may determine how much effort is taken to support a specific tax position, resulting in some taxpayers choosing to default to paying more tax to avoid risk.

Bloomberg BNA released its 2015 Survey of State Tax Departments this week, which according to BBNA, clarifies each state’s position on the gray areas of corporate income tax and sales and use tax administration, with an emphasis on nexus policies. 

BBNA has added new sections addressing income and sales tax nexus for registration with state agencies, as well as sales tax nexus for drop shipment transactions. The survey also has a new focus on each state’s rules for sourcing sales factor receipts for income tax purposes. 

As I have stated in previous posts, surveys like this provide great insight into how a state will treat certain issues and fact patterns. The problem is that many answers provided by the state may not be based on actual statutes and regulations or court rulings. The answers may be based on internal policy or simply be an interpretation of a grey area (right or wrong). Regardless of the basis, the states' answers help a company formulate a conclusion.

You can download the report for FREE, just go here.

retroactively changing state tax legislation creates uncertainty

COST or (Council on State Taxation) recently urged the U.S. Supreme Court to hear a court case involving the state's ability to retroactively change legislation enacted eight years earlier (Hambleton v. State of Washington). The case involves Washington's estate tax, but has implications for other tax types (income tax and sales tax).

what are the limits?

COST's amicus brief discusses the history of the courts allowing retroactive changes to legislation and the limits imposed. According to COST, some courts have found as little as 16 months excessive and other courts have found more than ten years permissible. COST mentions that the Court has held that retroactive changes are allowed to carry out the intent of legislation enacted slightly more than one year before. The broad range and lack of uniformity among the states not only creates compliance concerns for taxpayers, but also carries the potential for violating the Due Process Clause of the U.S. Constitution.

uncertainty creates burden

Taxpayers generally take positions based on their own risk tolerance. Taxpayers who have a high risk tolerance may be willing to take positions based on their interpretation that a grey area of tax law is not constitutional or vague. These types of taxpayers run the risk of a state not only assessing additional tax, interest and penalties, but also are exposed to a state's ability to retroactively change its law in its favor.

Taxpayers with a lower risk tolerance may choose to take a conservative position and follow the grey are of tax law despite how obvious it may be that the law is unconstitutional or vague. These types of taxpayers may choose to file amended returns claiming a refund of the tax paid. In this case, the taxpayer is protected from being assessed additional taxes, interest and penalties. However, the taxpayer is still exposed to a state's ability to retroactively change its law in its favor resulting in the disallowance of the taxpayer's refund claim. 

In both situations, taxpayers may incur compliance costs, consulting fees, attorney fees, court costs, etc. before the issue is resolved. Additionally, while the issue is being litigated or considered, the uncertainty creates additional exposure for current tax years. 

I agree with COST, and urge the U.S. Supreme Court to consider this case not only for the reasons asserted by COST in their amicus brief, but also because states have an obligation to create a stable and reasonable compliance environment that doesn't keep taxpayers guessing.

market-based sourcing uniformity project continues

The Multistate Tax Commission (MTC) UDITPA Section 17 Work Group recently released its Working Draft Model for Market-Sourcing Regulations. 

States who have recently adopted market-based sourcing have similar guidelines. The goal is to develop uniformity for current and future states that enact market-based sourcing for determining the sourcing of sales of services, intangible property and other non-tangible personal property for multistate income tax apportionment purposes. 

The Working Draft provides insight into where the MTC is going and how complicated market-based sourcing really is. The support for switching to market-based sourcing from the costs-of-performance method is partially based on the claim that it is easier to implement. I think the 44-page document speaks for itself.

Check out the Working Draft and my previous posts regarding market-based sourcing for more information.

2015 state tax amnesty programs - should your company apply?

Is amnesty the way forward? Does your company have past liabilities that need paid without paying penalties or interest? Should your company participate in a state's amnesty program or utilize the state's Voluntary Disclosure Program?

These questions plague companies when faced with identified compliance exposure and failures for multiple tax years. Some states offer one-time, short time-frame amnesty periods allowing companies to come forward, file prior year tax returns, and pay tax with the promise of future compliance. Depending on the specifics of the state's amnesty program, penalties and/or interest may be abated.

Key to remember: if your company has exposure and does not come forward, then the state may assess more significant penalties and interest when it finds your company later.

The Council on State Taxation (COST) has put together a great matrix of 2015 state tax amnesty programs. Check it out here.

Also, if you would like to read more about amnesty, check out my previous posts here.

Specifically, you may like: Amnesty and Voluntary Disclosure Agreements: What, When, Why?