This Week in State Tax

The Board of Tax Appeals (Board) recently affirmed a decision of the Ohio Tax Commissioner (Commissioner) denying a bank’s claims for a refund of the state Financial Institutions Tax (FIT) based on an alternative apportionment formula proposed by the bank. Before the Commissioner, the taxpayer argued that the FIT violated several provisions of the Constitution, and that the alternative apportionment was required to alleviate those infirmities. The Commissioner denied the refund on the basis that (1) the desired apportionment remedy could not be “uncoupled” from the several constitutional questions the taxpayer raised, and (2) she lacked authority to adjudicate constitutional questions. The taxpayer appealed to the Board.

The FIT is a privilege tax imposed on certain financial institutions that conduct business in the state or otherwise have nexus with Ohio. The tax is imposed on total equity capital of the institution apportioned by the ratio of gross receipts sitused in Ohio to gross receipts everywhere. The tax then applies a “regressive” rate structure with a rate of 0.8 percent on the first $200 million in apportioned equity capital, declining to a rate of 0.25 percent on Ohio equity capital over $1.3 billion. The taxpayer in the case was based in Pennsylvania and did not have greater than $200 million in Ohio equity capital in any of the relevant years (2016-2020).

Before the Board, the taxpayer argued the FIT violated the Due Process, Equal Protection, Commerce, and Supremacy clauses of the Constitution. It specifically argued the tax was incompatible with the internal consistency test as applied by the Supreme Court in Wynne. The Board did not discuss the particular elements of the constitutional issues. Instead, it first found that the taxpayer had not waived its right to argue for statutory alternative apportionment when it agreed to an expedited hearing before the Commissioner that was “confined to the issues related to the FIT rate issue and its constitutionality.” Despite the Commissioner’s contentions before the Board, it held the evidence was not clear that the argument was waived, and the taxpayer had always sought that remedy. It went on to find, however, that remedy sought could not be separated from the harm alleged which was attributable to the constitutional questions raised. Further, the proposed remedy would rewrite the statutory rate structure which is beyond the purview of the alternative apportionment statute. Accordingly, it affirmed the refund denial on the basis that it could not deal with the alternative apportionment without implicitly adjudicating the constitutional questions which are, by law, beyond its authority. For questions on Dollar Bank FSB v. Harris, contact Brandon Erwine.

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The Pennsylvania Board of Finance and Revenue (BFR) ruled that a taxpayer was required to both include a deemed royalty payment in its Pennsylvania net income and recharacterize a portion of its cost of goods sold as disallowed related party intangible expenses. The taxpayer (Parent) engaged in a restructuring termed an F reorganization under the Internal Revenue Code by transferring stock in a domestic subsidiary to a wholly owned foreign subsidiary (IP Holder) then converting the domestic subsidiary into an LLC. Although I.R.C. § 367(d) required Parent to include a deemed royalty payment from IP Holder on its federal return, it excluded this amount from its Pennsylvania return. In a related (but separate) transaction, Parent began purchasing finished goods for from a second foreign subsidiary (Manufacturer) for U.S. distribution. Manufacturer paid royalties to IP Holder for use of intellectual property in the manufacturing process. Parent deducted its payments to Manufacturer as cost of goods sold from both its federal and state returns. On audit, the Pennsylvania Department of Revenue (Department) determined both that Parent was required to include the 367(d) deemed royalty in its Pennsylvania net income, and that a portion of the deduction for payments to Manufacturer should be disallowed as (in effect) an intercompany intangible expense.

On appeal, Parent argued that inclusion of the deemed royalty on a state tax return would violate the foreign commerce clause under the U.S. Supreme Court’s holding in Kraft General Foods v. Iowa Department of Revenue because the lack of a combined reporting regime or a foreign tax credit mechanism in Pennsylvania meant that more state tax was imposed on a transfer to a foreign subsidiary than would be imposed on an equivalent transfer to a domestic subsidiary. The taxpayer also argued that inclusion of the deemed royalties in Pennsylvania net income was distortive because the transfer to a foreign entity of a California-based corporation lacked a connection to business done in Pennsylvania.

On the cost-of-goods-sold adjustment, Parent argued that all relevant transactions (Parent/Manufacturer and Manufacturer/IP Holder) were conducted at arm’s length pursuant to transfer pricing studies. Further, it alleged that its principal purpose for engaging in the relevant transactions was not to avoid tax because the F reorganization was conducted to centralize ownership of intellectual property and reduce the number of legal entities in its corporate structure, and the purchase of finished goods from Manufacturer was intended to take advantage of both Manufacturer’s production expertise and Parent’s sales expertise.

The BFR rejected Parent’s arguments. For the deemed royalty, the BFR simply stated that “Petitioner has not proven it was entitled to this deduction or that the royalties lacked any connection to Pennsylvania.” It also noted that it lacked authority to consider Parent’s constitutional argument. For the cost of goods sold deduction, the BFR ruled that Parent “has not sufficiently proven the types of transactions [it] engaged in served an economic purpose” or that “tax avoidance was not the principal purpose of its arrangements.” It is unknown whether Parent will attempt to appeal further. For questions about Decision No. 2403677, contact Mark Achord.

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The increasing popularity of fuel-efficient vehicles adversely affects fuel tax revenue flows that most states rely on to maintain roads, bridges, and tunnels. Several states have implemented or are considering a retail delivery fee (RDF) to help offset the impact. Generally speaking, an RDF is a charge imposed on the delivery by a motor vehicle of products purchased at retail to consumers in the state. Here is where RDFs stand in the states.

Colorado: Colorado imposes a $0.29 RDF on all retail deliveries made by retailers with $500,000 or more and marketplace facilitators (MPFs) with  $100,000 or more in retail sales of tangible personal property, commodities, or services to purchasers located in Colorado in the previous calendar year. The fee, implemented in 2022, is imposed on deliveries containing at least one item of tangible personal property subject to the state sales tax.

Minnesota: Minnesota imposes a $0.50 RDF on each transaction made by retailers with $1 million or more and MPFs with $100,000 or more in retail sales in Minnesota in the previous calendar year. Minnesota’s RDF, implemented in 2024, applies to transactions of $100 or more, comprising tangible personal property subject to Minnesota sales tax and clothing (not subject to sales tax), but sales of certain items (e.g., food, drugs, medical devices, and certain baby products) are not considered in computing the $100 threshold. The Minnesota legislature is considering two bills dealing with the RDF - H.F. 5 would repeal the fee, and H.F. 1104 would apply the fee to all deliveries of tangible personal property subject to the sales tax.

Hawaii: Hawaii’s S.B.1124, as introduced, proposes a retail delivery safety fee of $0.50 on retailers for each non-food retail delivery. Retailers may collect the fee from purchasers, and if the fee is separately stated on the invoice or bill of sale, the fee shall be excluded from the sales price for purposes of the general excise tax.

Mississippi: Mississippi’s H.B. 530 proposes a delivery fee of $0.30 on each commercial transaction involving retail delivery of taxable tangible personal property and clothing (except cloth diapers) and provides retailers with the discretion to collect the fee from the purchaser. If the delivery fee is stated separately on the receipt, invoice, or bill of sale, it shall be excluded from the sales price for sales tax purposes.

Maryland: Maryland’s  S.B. 321 and H.B. 352 propose a $0.75 RDF per delivery transaction beginning June 1, 2025, on deliveries of retail sales of taxable tangible personal property to persons in Maryland. The fee will apply only to vendors with $500,000 or more in retail sales and MPFs that facilitated retail sales of marketplace sellers totaling $100,000 or more in the previous or current calendar year.

Vermont: Vermont’s S. 75 proposes a retail delivery fee of $0.30 on all retail deliveries by persons required to collect sales tax. Vendors may elect to collect the fee from purchasers if the fee is separately stated on the invoice. The fee shall not be included in the sales price of the items for sales tax purposes when separately stated.

Note that in all states, each transaction is subject to only a single delivery fee, even if more than one delivery is needed to complete the transaction. Please contact Jeff Cook for more information on retail delivery fees.

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As some legislative sessions begin to wind down, several states have adopted (or are moving toward adoption of) IRC conformity updates:

• Arizona: H.B. 2688 updates state conformity to the IRC as in effect January 1, 2025, applicable to all tax years beginning on or after December 31, 2024. The bill has been passed by both houses of the state legislature and is currently awaiting action by Governor Hobbs.
• Idaho: Governor Little has signed H.B. 3, which updates the IRC conformity to January 1, 2025.
• Ohio: H.B. 14 updates the IRC conformity for several taxes to March 15, 2023. The bill has been passed by both houses of the legislature and is currently before Governor DeWine.
• South Dakota: Governor Rhoden has signed H.B. 1028, which updates the IRC conformity for the bank franchise tax to January 1, 2025.
• West Virginia: Governor Morrisey has signed H.B. 2025, which updates  IRC conformity for the corporation net income tax to December 31, 2024.
• Virginia: H.B. 1600, the Commonwealth Budget as sent to the Governor, places a two-year hold on  the modified rolling IRC conformity measure adopted in 2023. Recall, Virginia adopted legislation in 2023 to switch from static to rolling conformity for tax years beginning on or after January 1, 2023, except for federal amendments with a state revenue effect of greater than $15 million. Under the Budget passed this year, Virginia will not conform to any federal amendment passed between January 1, 2025 and January 1, 2027 that would increase or decrease state revenue by any amount. This limitation does not apply to federal tax extenders, defined as amendments extending the expiration of measures to which the Commonwealth conforms. The bill has been passed by both houses of the General Assembly and is awaiting action by Governor Youngkin. 

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