This Week in State Tax

The Commonwealth Court of Appeals recently held that although certain of a taxpayer’s products were “prepared foods” under Kentucky law, they were exempt from sales tax as they met an exception to the imposition of tax for prepared food sold by a manufacturer. The taxpayer operated a deli, café, and grocery in one building, producing items like sandwiches, soups, and meatballs, In the back of the building, the taxpayer operated a commercial kitchen and bakery in which it produced about 200 products, including bulk quantities of “salads and spreads” such as chicken salad, pasta salad, quiches, pizzas, etc., which were sold in individual containers in the grocery and deli. A second building was used for making fresh and dry pasta. On audit, the Department of Revenue (Department) assessed additional sales tax on about 20 items (mainly salads and spreads) that it considered taxable "prepared food." After an unsuccessful protest to the Board of Tax Appeals, the taxpayer appealed to the Circuit Court, which reversed the assessment, prompting the Department's appeal to the Court of Appeals.

Kentucky exempts sales of food and food ingredients for human consumption, excluding "prepared food," from the retail sales tax. For the purposes of this case, prepared food is defined generally as items with two or more ingredients combined by the retailer for sale as a single item, with the exception of prepared food sold without utensils provided by a seller that is properly classified under the North American Industrial Classification System (NAICS) as a manufacturer in sector 311. The Department argued the taxpayer's products were prepared food, while the taxpayer contended its products were made in bulk and repackaged, not intended for sale as single items. The appellate court found the statutory definition of "prepared food" was ambiguous and relied on Kentucky case law to narrowly construe tax exemptions against taxpayers. It determined that the taxpayer’s salads and spreads were mixed or combined for sale as a single item, and accordingly, were properly considered prepared foods. [Here, it rejected a circuit court finding that they were not prepared foods.] It went on, however, to determine the taxpayer was primarily engaged in food manufacturing and therefore was properly considered a business that primarily manufactured perishable prepared foods under NAICS. The court noted that most of the taxpayer’s facilities and employees were involved in food manufacturing, and it therefore constituted a plurality of the taxpayer’s business. Thus, the taxpayer was deemed primarily engaged in perishable prepare food manufacturing, and its identified prepared food items were exempt from sales and use tax. Please contact Dave Perry for questions on Department of Revenue v. Hale Inc. d/b/a/ Lotsa Pasta [2023-CA-1192-MR].

Download PDF >

A New Hampshire Superior Court judge recently ruled that a capital loss carryback generated by one member of a combined group could be used to offset capital gains earned by a different group member. One member of the taxpayer’s combined group reported a net capital gain on the group’s original 2017 New Hampshire Business Profits tax return. After a different member showed a capital loss on a subsequent return, the taxpayer amended the 2017 return to use the loss carryback to offset the reported gain. The Department of Revenue Administration (DRA) denied the resulting refund, and the taxpayer appealed.

New Hampshire law requires certain taxpayers to file a combined return “containing the combined net income of the water’s edge combined group … as though the entire combined net income of the water’s edge combined group was that of one business organization or … in such other manner as the commissioner shall determine to be equitable ….” A DRA regulation interprets this statute to require each group member to compute its net income separately, with the net income of all group members summed to reach the combined group’s total. The taxpayer offered numerous arguments, most notably that this approach contradicted the plain meaning of the statute (because it did not tax the combined group “as though [it was] one business organization”) as well as certain state and federal constitutional provisions.

The court found that the text of the statute was ambiguous, but that the clear underlying purpose of the statute was to treat the combined group as one business organization. Accordingly, it agreed with the taxpayer that the statute authorized the sharing of capital loss carrybacks between members of the combined group. Under this understanding, the DRA regulation was invalid because it treats combined group members as separate entities until the final summation. Having found for the taxpayer on the state law question, the court declined to consider the state and federal constitutional challenges. Please contact Jennifer Bates with questions about Hologic, Inc. v. Stepp [Docket No. 217-2023-CV-282].

Download PDF >

The New York Tax Appeals Tribunal (Tribunal) reversed the portion of a taxpayer’s recent victory that related to look-through sourcing of broker-dealer income. The taxpayer, an investment bank, was parent of a combined group that included multiple registered broker-dealers. The taxpayer initially filed its New York combined returns for the relevant years by sourcing receipts of these subsidiaries based on the location of their direct contractual counterparties—the financial intermediaries such as pensions and mutual funds (the funds”) to which the broker-dealers provided investment services. It later amended the returns to source the receipts using U.S. census data as an approximation of the locations of the funds’ underlying investors (who, the taxpayer argued, ultimately bore the economic burden of the transactions).

For the years at issue, New York law generally required broker-dealer receipts to be sourced to the location of the customer to whom the broker-dealers services were provided. The Division of Taxation (Division) rejected the resulting refund, and the taxpayer appealed. On review, an Administrative Law Judge (ALJ agreed with the taxpayer that underlying investors of the institutional intermediaries were the ultimate payers for the services, but further found that state law did not provide for look-through sourcing to the underlying investor. The ALJ went on to hold, however, it was unreasonable of the Division to refuse to exercise its discretionary authority given the level of distortion caused by the statutory sourcing method.

On appeal by the Division, the Tribunal reversed the ALJ’s determination and found that the institutional investors were the customers of the broker-dealers, and the statute accordingly required sourcing of the receipts using the mailing addresses of the institutional intermediaries. The Tribunal determined that, under the sourcing rules for the years at issue, looking through the institutional intermediaries to underlying investors was not a permitted sourcing method. The Tribunal disagreed with the ALJ’s conclusion that sourcing based on the intermediaries would be impermissibly distortive, holding that there is no constitutional violation when the receipts are applied per the statute in the case of this taxpayer. The Tribunal did affirm certain aspects of the ALJ decision concerning matters other than sourcing. Please contact Russell Levitt or Aaron Balken with questions on Matter of Jefferies Group LLC & Subsidiaries and its continuing relevance to current New York law.

Download PDF >