This Week in State Tax

The Department of Revenue has put forth a long-awaited draft rule regarding the sales tax treatment of “mainframe computer access” in the Rocky Mountain State. The draft rule sets forth examples of taxable and nontaxable mainframe access, as well as guidance for sourcing transactions involving access and dealing with mixed transactions. The draft rule will be the subject of a public working group meeting on February 20, 2025.

Colorado law includes the “amount charged for mainframe computer access” within the definition of tangible personal property on which sales tax is imposed. Mainframe computer access is further defined as “access to computer equipment for the purpose of storing or processing data” but does not include access to computer equipment for the purpose of “examining or acquiring data maintained by the vendor.” Access to computer equipment incident to electronic computer software delivery or incident to the use of computer software hosted by an application service provider are further excluded from the definition of mainframe computer access.

The draft rule builds on this framework by providing a general statement that sales of mainframe computer access are considered the lease or rental of computer equipment for the purpose of storing or processing data and are sales of tangible personal property subject to Colorado and state-administered local sales taxes if sourced to a location in the state, unless otherwise exempted. Examples of taxable access provided in the draft include storage of security video footage on a provider’s hardware, storage of a law firm’s electronic documents on a provider’s hardware which can be accessed by the firm’s employees from anywhere, and a data scientist’s payments to a provider for access to ‘the cloud’ to run complex algorithms. Examples of nontaxable access because they involve examining or acquiring data of the vendor include access to real-time and historical market data that allows data base queries, creation of custom reports, and other search and filter options. Likewise, access to an online legal research service that allows queries and downloads from various sources is identified as nontaxable. The rule also provides examples of nontaxable sales of computer software or accessed software services, including use of an online version of word processing software without downloading or installation and a cloud-based subscription to software allowing timekeeping and payroll services.

The sourcing of transactions involving mainframe computer access are governed by the rules for lease transactions, and as such, are generally sourced to the location of the computer equipment that is accessed for the storing or processing data. Finally, the draft rule provides guidance as to the treatment of mixed transactions involving mainframe computer access and either electronic software delivery or software hosted by an application service provider. For further information on Special Rule 46, please contact Steve Metz. 

Download PDF >

On January 9, 2025, an Illinois circuit court judge upheld an Illinois Tax Tribunal decision denying the exclusion of a member of the unitary group as an 80/20 company. Immediately prior to the tax years at issue (2016-2017), the taxpayer, a manufacturer of food and beverage products, underwent a reorganization in which certain foreign activities, including the secondment of expatriate employees to foreign host companies, were centralized under a single disregarded entity. This entity was then placed below the taxpayer’s domestic subsidiary in the organizational structure. After the change, employees of the disregarded entity were treated as foreign employees whose compensation was included in foreign payroll when determining whether the domestic subsidiary would be considered an 80/20 corporation. Under Illinois law, a unitary business group may exclude the income of a member whose business activity outside the U.S. , as measured by its property and payroll factors, exceeds 80 percent of its total business activity. On audit, the Illinois Department of Revenue (Department) disallowed the 80/20 treatment and required the inclusion of the subsidiary in the taxpayer’s unitary group. After the Tax Tribunal upheld the Department’s determination, the taxpayer appealed to the circuit court.

Consistent with the Tax Tribunal, the circuit court held that the payroll of the expatriate personnel which was charged to the disregarded entity should not have been incorporated into the payroll calculations of the domestic subsidiary to determine whether the domestic subsidiary was an 80/20 company. The court further held that the disregarded entity was formed for the purpose of tax benefits and that expatriate compensation charged to the disregarded entity did not reflect substantive foreign business activities conducted by the domestic subsidiary (which derived the bulk of its revenue from the purchase and resale of products in the United States). The taxpayer may appeal the matter within 30 days of the order. Please contact Bradley Wilhelmson with questions about Pepsico, Inc. v. Department of Revenue.

Download PDF >

The Commonwealth Court of Pennsylvania recently held that the allocation of property by Kunj Harrisburg LLC (Kunj), as memorialized by a deed, to its five new associations did not constitute transfers of a beneficial interest in real property subject to the Pennsylvania Realty Transfer Tax. Kunj, a Pennsylvania LLC, converted real property it owned into a condominium consisting of seven units. Kunj subsequently divided itself into six limited liability companies consisting of Kunj and five new associations. Pursuant to the state Entity Transfer Law (ETL), Kunj filed documents with the Department of State explaining it would maintain control of two units, while allocating the remaining five units to its five new associations. After Kunj recorded deeds memorializing the allocations, the Department of Revenue advised Kunj that its recording did not qualify for the claimed transfer tax exemption and issued an assessment. Appeals to the Board of Appeals and the Board of Finance and Revenue were denied, and Kunj then appealed to the Commonwealth Court.

The court began by noting that it has long recognized that not all conveyances of real property are subject to the Realty Transfer Tax, but that the tax is limited only to transfers in which an interest in the property is passing to a person or persons other than the grantor.  It cited to Exton Plaza, in which a general partnership established a limited partnership and recorded a deed to convey a shopping center to the limited partnership. The court in Exton Plaza held that the conveyance was “not a document” within the meaning of Pennsylvania law. It explained the deed “did not effect a meaningful transfer of title” but “merely memorialized the conversion from a general partnership to a limited partnership.”

The court went on to explain that the General Assembly had enshrined the principle of Exton Plaza into law. Under that law, the court determined that Kunj and its five new associations was not a conversion, but a division accomplished under the ETL, which provides that “a domestic entity may divide into … the dividing association and one or more new associations ….” The court noted the ETL allows property allocated to the new associations to vest “without reversion or impairment, and the division shall not constitute a transfer, directly or indirectly, of any property.” The court concluded that Kunj’s deeds did not convey, transfer, demise, vest, confirm, or evidence any transfer or demise of title to real estate; therefore, the deeds were not “documents” subject to Realty Transfer Tax as contemplated by Pennsylvania law. For information on Kunj Harrisburg LLC v. Commonwealth, contact Michelle Dohra or Halie Baker.

Download PDF >

In a recently issued Revenue Ruling, the Tennessee Department of Revenue (Department) clarified that, for purposes of the Tennessee franchise and excise tax, a drop shipment sale delivered to a warehouse in Tennessee is sourced to Tennessee only if the “ultimate recipient” (i.e., the end user) is in Tennessee. The taxpayer was an out-of-state manufacturer that sold its products using both a third-party merchant and a third-party logistics service. Orders were taken from end users by a merchant and transmitted to the taxpayer for review, approval and fulfillment. The taxpayer then delivered the products pre-packaged and pre-labeled to the temperature-controlled facility of the logistics service in Tennessee, where they were held for up to six weeks before being shipped on to end users. The taxpayer retained title to the products for the duration of this process, which culminated with the recording of two sales transactions – taxpayer to merchant and merchant to end user (with flash title conveying to the end user.)

Under Tennessee law, a multistate business must compute its receipts factor by sourcing sales of tangible personal property to the state which the property is delivered or shipped to a purchaser. Regulations specify that property is shipped to a purchaser in Tennessee if the shipment terminates in Tennessee, even though the property is subsequently transferred by the purchaser to another state. Regulations define “purchaser within this state” to include “the ultimate recipient of the property if the taxpayer in this state, at the designation of the purchaser, delivers to or has the property shipped to the ultimate recipient within this state.” The ruling notes that a drop shipment to an ultimate recipient outside Tennessee would not be sourced to Tennessee, even if the actual purchaser is within Tennessee. Applying the facts at hand, the Department determined that the taxpayer’s sales were drop shipment transactions in which the end user of the taxpayer’s products was the “ultimate recipient.” In the Department’s view, the purchaser (the merchant) directed the supplier (the taxpayer) to ship goods directly to the purchaser’s customer (the end user). Accordingly, receipts from the sale should be sourced based on the delivery to the end user. The Department noted that the outcome would be different if the merchant purchased the product and stored it with the logistics service in Tennessee prior to placement of an order by the end user. In that case, the transaction would not be treated as a drop shipment, and the delivery to the logistics service facility in Tennessee would have been delivery to the purchaser. Please contact Taylor Sorrells with questions about Ruling 24-12.

Download PDF >