This Week in State Tax

Governor Gavin Newsom vetoed Assembly Bill 52 that would have provided a state income tax credit to offset that portion of the sales and use tax imposed on the purchase of manufacturing machinery and equipment, as well as certain research and development purchases, that is not currently exempted. Recall, under current law, purchases of qualified manufacturing and research equipment are exempted from the 3.975 percent state sales and use tax, but remain subject to city, county, and district sales and use taxes. AB 52 would have provided a state income tax credit for the local tax imposed on such qualified purchases to become effective in 2025, provided that the state budget specifically provided funding to administer the credit. In his September 20 veto message, the Governor indicated he agreed with the intent of the bill, but said the impact on the state general fund was significant and should be considered as a regular part of the budget process. See our earlier TWIST on Assembly Bill 52 here. Assembly Bill 2854, which would require public disclosure of certain local sales tax sharing agreements, is still before the Governor. He must act on it by September 30. For further information, please contact Jim Kuhl.

The Massachusetts Department of Revenue (Department) has released additional information regarding administration of the recently authorized tax amnesty program. Recall, the FY 2025 Commonwealth budget authorized the Department to establish a 60-day amnesty program to be conducted prior to June 30, 2025. The amnesty is to provide eligible taxpayers with a waiver of all penalties associated with most returns and payments due prior to December 31, 2024.

Highlighting the guidance is that the program will run from November 1, 2024, through December 30, 2024.  To avail themselves of the program, taxpayers must apply, file any required returns, and remit necessary payments of tax and interest within that window.  Applications to participate may be made only on MassTaxConnect, the Department’s filing portal.  Taxpayers with an existing liability will automatically receive an Amnesty Eligibility Letter from the Department with the amount owed and instructions for participation. Those filing amended returns with additional liability, or new returns, will need to determine the amount owed, file an Amnesty Application with payment for the amount owed, and file required returns prior to December 30 to be eligible. Beyond the penalty waivers, first time filers will receive a 3-year limited lookback, unless they were previously contacted by the Department, have collected but not remitted trustee taxes (e.g., sales tax), or are filing estate tax returns. 

Taxpayers eligible for the amnesty include those with unfiled returns, underreported tax, or other unpaid assessments; a current audit that will result in assessment of penalties; and matters Pending Resolution, Appellate Tax Board, and Collection cases. Tax types eligible for amnesty include corporate excise, partnership income, personal income, sales, meals, and room occupancy, among others.  Taxpayers are not eligible to participate if they are: recipients of prior amnesty relief in 2015 or 2016 for the same tax type and period; seeking waiver of penalties related to tax that was already paid; seeking a refund of tax or a credit for an overpayment; under tax-related criminal investigation or prosecution; in active bankruptcy; or the subject of a tax-related criminal investigation or prosecution, currently or previously, for fraudulent filing. A Tax Amnesty 2024 Frequently Asked Questions document provides additional details. For further information on the Massachusetts Tax Amnesty, please contact Ryanne Tannenbaum or Nikhil Sequeira. 

The Oregon Tax Court recently addressed the sales factor treatment of repatriation income under Internal Revenue Code section 965 that was included in Microsoft’s Oregon taxable income.  Recall, the Tax Cuts and Jobs Act of 2017 (TCJA) required the shareholders of certain controlled foreign corporations (CFCs) to include the accumulated earnings and profits of the CFCs from 1986 through 2017 on their 2017 federal tax return (repatriation amount) and subjected it to a 10 percent federal tax. On its Oregon return, Microsoft deducted 80 percent of the federal repatriation amount pursuant to Oregon’s “dividends-received” subtraction and included the remaining 20 percent in its pre-apportionment taxable income. On its original return, Microsoft excluded any repatriation income from its sales factor, based on a 2018 Oregon Department of Revenue Bulletin. Microsoft subsequently filed an amended return, including the 20 percent repatriation amount in its sales factor denominator. The Department denied the resulting refund request, and Microsoft appealed, arguing that inclusion of the 20 percent repatriation amount in the sales factor was appropriate under the Tax Court’s previous decision in Oracle II. Microsoft also argued on appeal that it is entitled to another form of factor representation because the statutory apportionment method failed to fairly represent the extent of Microsoft’s business activity in Oregon and was unconstitutional. 

In its decision, the court agreed with Microsoft that it was entitled to include the 20 percent repatriation amount in its sales factor denominator. Under the law for the relevant tax year, the sales factor “excludes gross receipts arising from the … holding of intangible assets … unless those receipts are derived from the taxpayer’s primary business activity.” In Oracle II, the court interpreted this language to mean that Subpart F income should be included in the sales factor so long as the water’s edge group was engaged in a unitary business with the CFC that generated the income. In the court’s view, many of Microsoft’s CFCs were engaged in similar “primary” business activities abroad as the Microsoft water’s edge group engaged in domestically. The court further determined that there was sharing and exchange of value among all the corporations, and the only reason the earnings and profits of the CFCs were not included in federal taxable income prior to the enactment of IRC  section 965 was because Congress had not required the amounts to be included as Subpart F income and the directors of the CFCs had not chosen to pay the amounts as dividends to the shareholders.

Note that the court’s conclusion to allow for the inclusion of the 20 percent repatriation amount in the sales factor did not result in a refund of the full amount claimed by Microsoft as part of its appeal. Microsoft had also argued that it was entitled to deviate from Oregon’s statutory apportionment formula under an alternative apportionment theory. In filings, the taxpayer had articulated three possible methods of providing alternative factor representation to better reflect the activities of the entities giving rise to the included repatriation income: including 20 percent of all CFC sales in the sales factor denominator; including 100 percent of the deemed repatriation in the sales factor denominator; or use of separate accounting. The court ultimately rejected Microsoft’s factor representation argument finding that the taxpayer failed to meet its burden of proof to demonstrate that the Oregon apportionment did not fairly represent its business activities and that the statutory method was unconstitutional.  In the court’s view, Microsoft failed to show that including the 20 percent repatriation amount did not provide sufficient factor representation considering the 80 percent dividends received deduction and the portion of the repatriation amount included in the denominator of the sales factor. The court also rejected Microsoft’s argument that the statutory formula violated the Commerce Clause and the Due Process Clause. Please contact Nisha Mathew for questions about Microsoft Corp. v. Oregon Department of Revenue.

The Washington Department of Revenue recently ruled that a taxpayer’s electronic signature and document workflow services were subject to the Washington retail sales tax and retailing business and occupation (B&O) tax. The determination held that the taxpayer’s offering constituted digital automated services and that certain services offered to customers were provided exclusively in connection with digital automated services, thus making them taxable. The seller offered services allowing buyers to send, sign, and manage legal documents in the cloud, with their electronic signature product accounting for ninety percent of their revenue. Additionally, the seller provided telephone support, data processing, data services, and training and seminars, which were separately itemized on invoices and reported under the wholesaling B&O tax classification.

On audit, the Department reclassified these receipts to the retailing B&O classification and assessed retail sales tax on the support and training services, concluding they were associated exclusively with the sale of digital automated services. The taxpayers appealed, asserting the receipts for telephone support and training and seminars were stand-alone services not subject to retailing B&O tax and retail sales tax. Washington imposes retail sales tax on each retail sale in the state, and income derived from making retail sales is subject to retailing B&O tax. Digital automated services, defined as services transferred electronically using one or more software applications, are classified as retail sales. The retail sale of digital automated services is defined to include any service provided by the seller exclusively in connection with digital automated services, regardless of whether a separate charge is made for such services.

The Department determined that the taxpayer’s telephone support and training and seminar services were connected exclusively to their signature and document workflow service because a customer could not access these support services without purchasing the signature and document workflow service. At hearing, the taxpayers conceded that the telephone support and seminars were not useful for those not purchasing the signature and document workflow services; they also failed to provide evidence that these services were offered in connection with other products. Consequently, the Department concluded that the services were part of the retail sale of digital automated services and subject to retailing B&O tax and retail sales tax. For information on Determination No. 21-0196 (issued September 9, 2024), please contact Michele Baisler.