This Week in State Tax

In December 2024, the Michigan Department of Treasury (Department) issued a Revenue Administrative Bulletin (RAB) providing updated guidance on the requirements for allocating nonbusiness income. Specifically, allocation of nonbusiness income is now considered a form of alternative apportionment that requires approval from the Department before the filing of an original or amended return containing such an allocation. The RAB policy is being applied on audit.

A request for alternative apportionment must be submitted to the Department 90 days prior to the due date (including extensions) of the return, or 90 days prior to the submission of an amended return, for which alternative apportionment is to be used. To receive approval for allocating nonbusiness income, a taxpayer must provide clear and convincing evidence that the statutory method would create an unconstitutional result. Hence, to overcome the presumption that the statutory formula is fair, the taxpayer must demonstrate either that the statutorily attributed business activity is out of all appropriate proportion to its actual business activity within the state and would cause a grossly distorted result, or that the statutory formula would unconstitutionally tax extraterritorial activity of the taxpayer.

In evaluating the reasonableness of a taxpayer’s proposed alternative to the statutory apportionment formula, the Department considers the filing position in other states as relevant, including whether the taxpayer has requested alternative apportionment in other states. If the application of a taxpayer’s proposed method of apportionment results in income being untaxed in all jurisdictions, the bulletin notes that the Department views this as unreasonable. The Department has indicated it will try to respond to requests for alternative apportionment within 60 days of filing. If the taxpayer does not receive a response within 60 days, the taxpayer may treat the request as deemed denied. Taxpayers may appeal denied alternative apportionment requests only to the Michigan Court of Claims.

Recall that an RAB states the Department’s position on a matter; although it is not binding authority, it may be relied on by taxpayers until it is revoked by the Department, new legislation is passed on the issue, or binding judicial precedent is provided.  The policy in the RAB is applicable to the individual income tax, corporate income tax and the Michigan business tax. Contact Dan De Jong with questions about Revenue Administrative Bulletin 2024-24. 

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The Texas Comptroller of Public Accounts issued a memo describing its intended standards for classifying sales-type leases as retail or wholesale sales for purposes of the Texas franchise tax. Recall that Texas imposes a 0.375 percent tax rate (rather than 0.75 percent) on the taxable margin of taxpayers engaged primarily in retail or wholesale trade.  Taxable margin is determined by computing 70 percent of total revenue from the entity’s entire business, subtracting $1 million from the total revenue or, at the taxpayer’s election, subtracting either the cost of goods sold (COGS) or compensation. In determining the applicable tax rate and eligible expenses for the COGS deduction, the state court of appeals, in Hegar v. Xerox Corp. (2021), ruled that the statutory use of the word “sales” did not require a transfer of title to property and includes certain leases that qualify as sales-type leases.

In the new guidance, the Comptroller clarifies that it will treat any arrangement that qualifies as a sales-type lease under Financial Accounting Standard (FAS) 13 as a “sale” for purposes of determining both the character of the taxpayer’s primary business and its cost of goods sold. To qualify as a sales-type lease under FAS 13, the collectability of the minimum lease payments must be reasonably predictable, and no important uncertainties can surround the amount of reimbursable costs yet to be incurred by the lessor. In addition, at least one of the following criteria must be met: (1) the lease transfers ownership of the property to the lessee by the end of the lease term; (2) the lease contains a bargain purchase option; (3) the lease term is equal to 75 percent or more of the estimated economic life of the leased property; or (4) the present value of minimum payments must equal or exceed 90 percent of the excess of the fair value of the leased property. Please contact Jeffrey Benson with questions about STAR Document 202507015M.

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As part of a determination following the appeal of a sales tax audit, the Virginia Tax Commissioner recently ruled that the Department of Taxation (Department) was updating its documentation standards regarding software delivery. Virginia law provides that software is considered taxable tangible personal property if it is delivered in tangible form; if it is delivered via electronic transmission, it is exempt. Historically, the Department imposed a rebuttable presumption that software was conveyed in tangible form and therefore subject to sales and use tax. To overcome the presumption, taxpayers were required to provide documentation in the form of a sales invoice, contract, or other sales agreement expressly certifying that the software was delivered electronically and that no tangible medium was included in the transaction.

The determination notes that the process of delivering computer programs and software updates has evolved significantly since the Commonwealth adopted its presumption. The widespread use of the internet and other technologies has transformed how software is bought and sold, rendering the prior presumption outdated. Going forward, the Department will no longer require taxpayers to provide documentation expressly certifying the electronic delivery of software. Instead, software will be presumed to be electronically delivered unless documentation indicates otherwise or the software is provided in connection with the sale of tangible personal property. The Department may request documentation demonstrating that software was not provided in connection with the sale of tangible personal property.

The determination setting forth the new policy involved several purchases of software, maintenance contracts, licensing fees, and setup fees. Upon review, invoices related to electronically delivered software and maintenance contracts not related to tangible personal property were removed from the audit. Notably, though, the Department reaffirmed that maintenance contracts involving both hardware and software remain taxable, and software provided in conjunction with tangible personal property is still subject to tax. Invoices held to be taxable included computers and network switches with installed software and maintenance contracts. For more information on Virginia Public Document Ruling No. 25-98, contact Jeremy Jester.

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