This Week in State Tax

The Massachusetts Department of Revenue recently issued a working draft regulation that it describes as “intended to clarify the statutory rules as they apply to sales and use tax imposed upon the purchase of software in light of changes in commercial practices and the analyses in recent cases.” The Department generally explains in the working draft regulation that standardized computer software is tangible personal property, regardless of the method of delivery or access of such software, and sales or use tax is imposed on the sale or use of such software in Massachusetts. A taxable sale of software will include the value of any services that are a required component of the software transaction, regardless of whether the charges are separately stated on a customer invoice. Software is not taxable if it is an inconsequential element of a professional, insurance, or personal service transaction for which no separate charge for the software is stated, and the working draft provides several examples to demonstrate the application of this provision.

To govern the apportionment of tax on software to be used for business purposes in Massachusetts and one or more other states, as provided for in current law, the draft regulation puts forth a new registration and certification process that the Department indicates is the sole process by which a taxpayer may apportion the tax due on such purchases. A taxpayer must first pre-register with the Commissioner of Revenue by providing information concerning its tax registration, general business operations, location of its employees, and the details of its Massachusetts operations. Upon registration, the taxpayer will receive a Software Apportionment Certificate which must be renewed every three years. If a taxpayer seeks to apportion the tax due at the time of purchase, the taxpayer must provide its vendor with a copy of its certificate and a written Apportionment Statement on a form to be prescribed by the Commissioner. In the apportionment statement, the taxpayer will certify to the vendor a reasonable estimate of the expected proportion of the usage of the software in the Commonwealth; the reasonable estimate must be supported by the taxpayer’s books and records as well as any other appropriate records. If the vendor accepts the certificate and the apportionment statement in good faith, they are relieved of further collection obligations for that transaction. Otherwise, the vendor is responsible for collection on the full sales price of the software. The draft regulation provides several examples of methods of apportionment, depending on the type of software.

The draft regulation also provides a process for a purchaser to apportion its tax after the time of sale, either by requesting that the vendor file amended returns, or by directly seeking an abatement of tax from the Commissioner, after securing an assignment from the vendor. Post-transaction claims are to be based on actual use of the software, and they must also be accompanied by the taxpayer’s certificate and apportionment statement. The working draft regulation is open for public comment through January 31, 2025. For questions on the working draft, please contact Ryanne Tannenbaum.

A tobacco manufacturing company has asked the U.S. Supreme Court to review an Oregon decision interpreting the scope of the protections offered by Public Law 86-272. In June, the Oregon Supreme Court upheld a Tax Court ruling that a tobacco manufacturer was not protected by P.L. 86-272 because when its salespeople participated in the “prebook order” process, they went beyond the mere solicitation of sales. Public Law 86-272 prohibits a state from imposing a net income tax on a taxpayer when the taxpayer’s only business activities in the state include (1) the solicitation of orders sent outside the state for approval and fulfillment; or (2) the solicitation of orders on behalf of a prospective customer, if that customer will fill the orders by purchasing items from the taxpayer, and the customer’s order will be sent outside the state for approval and fulfillment. In interpreting P.L. 86-272, the Supreme Court has recognized that the law protects activities that “facilitate the requesting of sales,” but not necessarily those activities that directly facilitate the sales themselves.

In this case, the taxpayer argued that its employees’ activities were protected by the second clause, because they solicited orders from retail tobacco sellers on behalf of wholesalers (who would fulfill these orders by making qualified purchases from the taxpayer). In the Oregon court’s opinion, some of the activities of the taxpayer’s salespeople (which it refers to as “sell sheet orders”) fell within this protection. However, a second category of activities, “prebook orders,” did not. The key distinction relied on by the court was that sell sheet orders formed only an initial contact between the retailer and the wholesaler, and either party had the option of ultimately rejecting the transaction, causing them to fall within the scope of “solicitation.” By contrast, prebook orders were described as “guaranteed orders,” and a wholesaler that ultimately rejected a prebook order entered into by the manufacturer’s salesperson would be contractually subject to the loss of rebate payments from the manufacturer (including repayment of prior rebates). The court noted that the first clause of P.L. 86-272 clearly distinguishes between the acceptance of orders (which must occur outside the state) and the solicitation of the order (which may occur within the state). With the financial penalties imposed on a wholesaler that rejected a prebook order, the act of making a prebook order was effectively accepting an order within the state, which exceeded mere solicitation. Furthermore, because the guarantee promised by a prebook order was not advertised to retail purchasers to entice them to make a purchase, it could not be considered part of the solicitation. Instead, the prebook order process effectively gave the taxpayer control over its products stored within the state, which the court ruled exceeds the scope of P.L. 86-272.

In its cert petition, the taxpayer rejects the Oregon court’s characterization of its prebook orders. In the taxpayer’s opinion, the Oregon court incorrectly attributes the activities of its wholesale customers to the taxpayer, which contradicts Supreme Court precedent. Focusing solely on the activities performed in Oregon by the taxpayer’s salespeople, it argues that the only Oregon-based distinction between sell sheet orders and prebook orders is whether the retailer or the salesperson physically transmits an order to the wholesaler. The taxpayer further argues that, to the extent that elements of the prebook arrangements exceed solicitation, these activities occur exclusively outside Oregon. Contact Nisha Mathew for more information on Santa Fe Natural Tobacco Co. v. Department of Revenue.

The Pennsylvania Supreme Court has held that taxpayers who were subject to an unconstitutional limitation on net operating losses (NOLs) are not entitled to refunds for taxes paid under the now-overturned regime. In doing so, the court rejected its previous decision in General Motors Corp. v. Commonwealth, which held that the prohibition on flat NOL caps applied retroactively.

Starting in 2007, Pennsylvania law generally capped the amount of NOLs that a corporation could use at 12.5 percent of its taxable income or $3 million, whichever was larger. Nextel Communications successfully argued that this scheme unfairly favored a taxpayer with a lower income (which could offset its entire taxable income up to the $3 million cap) over one with a higher income (which could never offset more than 12.5 percent of its taxable income) in violation of the Pennsylvania Constitution’s Uniformity Clause. After reviewing potential remedies for the unequal treatment, the Pennsylvania supreme court ruled in Nextel (2017) that eliminating the $3 million minimum cap (and thereby limiting NOLs for all taxpayers to 12.5 percent of taxable income) was the approach that best preserved the intention of the legislature which had consistently favored some limitation on the use of NOLs. In a subsequent case, General Motors challenged a pre-2007 NOL limitation, which subjected all taxpayers to a flat $2 million cap on NOL usage, as a violation of the Uniformity Clause. The parties agreed that the flat cap was unconstitutional, but the case made its way to the Pennsylvania supreme court on the question of whether the prohibition on flat NOL caps as established in Nextel should apply retroactively.  In addressing the question, the General Motors court focused on the question of whether Nextel established a new principle of law. The court ruled that it had not done so, but rather had applied longstanding principles related to the Uniformity Clause, meaning the prohibition should apply retroactively and that General Motors was entitled to a refund.

The current case concerned taxes paid for tax year 2014. Like the years at issue in Nextel (and unlike the years at issue in General Motors), the NOL limitation in 2014 included both a percentage cap and a flat minimum cap. Under the rule laid down in Nextel, there was no question that flat cap should be invalidated. The taxpayer further argued that, under the General Motors decision on retroactivity, Pennsylvania was required also to remedy the disparate treatment of those affected by the percentage cap. Since it could not practically or legally require additional payments from taxpayers who benefited from the now-invalidated flat cap, the Commonwealth must instead provide relief to taxpayers that were subjected to the percentage-based limitation and allow a full NOL deduction for past years.

In a split decision, the state supreme court rejected this argument, and in doing so, repudiated its previous ruling on retroactivity in General Motors. The current court ruled that the General Motors court misapplied the Chevron test to determine retroactivity when it focused on only one of its three factors—whether the decision being applied established a new principle of law—and erred as well when it ruled that Nextel had not done so. On the “new principle of law” factor, the court ruled that the decisions relied on in Nextel were sufficiently distinguishable (as applying to other than corporate income taxes) to require a finding that the decision was a novel one. On the second factor (whether retroactive application would forward the operation of the decision) the court noted that many taxpayers would be ineligible for relief due to statutes of limitations having expired; remedying disparate treatment in a way that was available only to some affected taxpayers would not further the uniformity principle advanced in Nextel. On the third prong, the court ruled that equities did not favor retrospective application because of the “potentially devastating repercussion” a refund requirement would have on the public fisc. As all three Chevron prongs militated against retroactive application of Nextel, the taxpayer was not entitled to a refund. Contact Mark Achord for more information on Alcatel-Lucent USA Inc. v. Commonwealth.

The Texas Comptroller recently released a pair of letter rulings explaining the requirements of both physical and electronic marketplace providers.

In the first ruling, the Comptroller determined that a dealer of construction and mining equipment selling manufacturer warranties at its dealership was a marketplace provider responsible for collecting and remitting Texas sales tax on taxable sales. The manufacturer warranties, called “customer value agreements,” were offered by a subsidiary of the manufacturer; they provided protection for equipment and parts sold by the dealer. The Comptroller first noted that the sale of extended warranties or service policies are taxable in Texas. Next, the Comptroller reasoned that Texas’s definition of a “marketplace” includes both electronic and physical mediums; therefore, the dealership’s physical location served as a physical marketplace. Because the dealer was also processing payment for the warranties, the Comptroller concluded the dealer fit the definition of a “marketplace provider,” and as such has the rights and duties of a retailer, including collection of tax on warranties sold at its location.

In the second ruling, the Comptroller found a software and event planning company was a marketplace provider. The taxpayer provided three service offerings that enabled restaurants to offer food at external locations: popup, catering, and delivery.

•       For popups, the taxpayer would arrange for one or multiple restaurants to sell food at a client-designated location using a taxpayer-provided POS software platform. The taxpayer charged the restaurants a fee for the popup and for use of the POS platform.

•       For catering, the taxpayer coordinated and managed catering services between clients and a restaurant including ordering, scheduling, tracking, and payment. The taxpayer’s POS platform allowed restaurants to upload catering menus and prices and view order information. Customers booked their catering and made payment via the taxpayer’s website. The taxpayer charged the restaurants a fee for delivering the catering to the customer location, a fee for use of the platform, and a percentage fee based on the total order.

•       For delivery, restaurants accepted orders placed via the taxpayer’s mobile application, and the taxpayer coordinated with a driver to pick up and deliver the food. The taxpayer charged restaurants a percentage fee based on the charge for the food delivered.

The Comptroller determined that the taxpayer was a marketplace provider in all scenarios described above. The taxpayer was determined to be providing an electronic marketplace in all instances involving the taxpayer’s POS platform or mobile application. Additionally, the popup events were considered physical marketplaces at which restaurants could make sales of tangible personal property. Further, the fees charged by the taxpayer to the restaurants were all considered taxable sales of data processing. In both rulings, the Comptroller explained that a marketplace provider must certify to the marketplace seller that the marketplace provider is collecting and remitting sales tax on sales occurring on the marketplace. For questions on Private Letter Ruling No. 202410006L and Private Letter Ruling No. 202410007L, please contact Karey Barton.