This Week in State Tax

In a recently issued determination, the New York Division of Tax Appeals (DTA) addressed the application of a recent appellate court decision In the Matter of Charter Communications—which upheld an administrative determination that the reduced corporate tax rate applicable to “qualified emerging technology companies” (QETCs) was only available to a combined group if each group member individually met the criteria for the reduced rate—to tax years following the state’s 2015 tax reform legislation. In Charter Communications, New York addressed the combined group’s eligibility for the reduced rate for QETCs for tax years 2012 through 2014 (i.e., pre-New York tax reform years). The taxpayer in the current case, a provider of financial services technology, filed combined New York corporate franchise tax returns for tax year 2017 using the QETC rate, asserting that more than fifty percent of the group’s receipts were derived from emerging technology activities, and thus the entire group qualified to use the QETC rate. Additionally, the taxpayer later sought to apply the QETC rate to tax years 2015 and 2016, claiming refunds for those years. On audit, the Division of Taxation (Division) concluded that not all members of the combined group independently met the QETC criteria under New York law and denied application of the QETC rate under the reasoning that was later upheld in Charter Communications.

Before the DTA, the taxpayer argued that Charter Communications was not applicable to tax years following the 2015 tax reform act. It was undisputed that the taxpayer’s primary products were emerging technologies and that those emerging technologies made up more than 50% of the combined group’s activities for the relevant tax years. Relying heavily on the reasoning in Matter of Charter Communication, the DTA concluded that New York law does not permit a combined group to be treated as a single QETC unless every member qualifies as a QETC individually. In the BTA’s view, although the New York tax reform requires that a combined report be filed by a designated agent, this did not change the fundamental definition of “taxpayer” as “a corporation subject to tax” (the language relied upon in Charter Communications.) Thus, while a combined group is generally treated as a single corporation for computational purposes, a taxpayer remains defined as a single corporation subject to tax. In the event the DTA found that the QETC determination is done at the individual corporation level, the taxpayer requested the Division use its discretionary power to split the taxpayer’s group into two subgroups, on. The DTA held that the letter provided was not a discretionary adjustment request, but rather a response to request for information as part of the audit. Moreover, the DTA found that there was no statutory basis to “correct distortion of the tax rate”. As a result, the taxpayer was required to compute tax for the years at issue at the standard corporate franchise tax rates, and the assessment of additional tax and interest attributable to the disallowance of QETC preferential rate treatment was upheld.

Please contact Aaron Balken and Alec Schwartz for more information on Matter of Fidelity Nat’l Info. Servs. Inc.

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In a recently published decision, the Tennessee Court of Appeals analyzed whether the taxpayer, a seller of enterprise software and various related support services, was subject to the Tennessee business tax for its sales to Tennessee customers. The business tax is a gross receipts tax imposed on businesses engaged in certain types of business activities in the state, with various classifications used to determine the applicable tax rate.

Following an audit, the Tennessee Department of Revenue assessed business tax on the taxpayer’s receipts from the licensing of software (both on-premise and remotely accessed), subscriptions for infrastructure-as-a-service (“cloud hosting”), and various other cloud-based services such as support, configuration, training and consulting. The Department identified all of these activities as being taxable services under the Business Tax Act. The taxpayer filed a complaint with the Chancery Court which ruled that the licensing of software was not subject to the business tax because it constituted sales of nontaxable intangible property and further held that cloud hosted offerings were not subject to business tax as the sales were akin to leasing property outside of Tennessee. However, the court upheld the assessment on certain cloud-based services, finding that those services were delivered to Tennessee customers.

On appeal, the Court of Appeals agreed with the trial court that the sale of the taxpayer’s software represents the sale of intangible property. The appellate court relied on a previous Tennessee Supreme Court decision which held, for sales tax purposes, that the sale of software involves the sale of information, and that any tangible medium used in the exchange is merely incidental to the intangible property. Although the Tennessee legislature later enacted provisions expressly defining computer software to be subject to sales and use tax regardless of the nature of delivery, the previous Supreme Court’s decision did not involve business tax, and the legislature has not enacted similar changes under the Business Tax Act.

With respect to the taxpayer’s sales of cloud hosting, the appellate court disagreed with the trial court, finding that the “true object” of the transaction is access to the taxpayer’s computing infrastructure and functionalities. The trial court had considered cloud hosting to be tantamount to the leasing of tangible personal property, but the appellate court consulted dictionary definitions to determine that leasing involves the conveyance of possession and control of tangible personal property. Here, there was no evidence that any hardware or server equipment was ever physically delivered to customers. Instead, by granting access to infrastructure, the taxpayer was engaged in an activity or work for profit, which made the activity a service for purposes of the business tax.

Finally, the appellate court reviewed how the taxpayer’s cloud-based services should be sourced for purposes of the business tax. The taxpayer argued that these services were not delivered in Tennessee because nothing was physically delivered to a location in Tennessee and because none of its employees ever traveled to Tennessee to perform any services. The appellate court again consulted dictionary definitions to determine that the meaning of “delivery” includes services where electronic access is provided to someone. Because the taxpayer’s customers electronically accessed the cloud-based services from their locations in Tennessee, the services were “delivered” in Tennessee and therefore subject to the business tax. The appellate court also agreed with the Department that the use of “ship-to” addresses was a reasonable method for determining where the services were delivered. 

For any questions regarding SAP America, Inc. v. Gerregano or the Tennessee Business Tax in general, please reach out to Justin Stringfield and Chris Geer.

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Additional states have adopted tax bills addressing conformity to the One Big Beautiful Bill Act (P.L. 119-21) (OB3).

Connecticut: Connecticut’s budget bill, which was signed into law on May 26, decouples from the special transition rules found in IRC section 174A and from IRC section 174A (full expensing of domestic research and experimental expenses) for tax years ending prior to January 1, 2026. Instead, a taxpayer must deduct research or experimental expenses for tax years starting on or after January 1, 2022 and before January 1, 2026 using the rules found in IRC section 174, as in effect on July 3, 2025 before enactment of OB3. The bill also decouples from IRC section 168(n) (bonus depreciation for qualified production property) for income tax years starting on or after January 1, 2026. Please contact Michael Rylant with questions about Public Act 26-68.

Hawaii: Governor Green signed Hawaii’s IRC conformity bill on May 26. See KPMG’s May 18th TWIST for more information on the OB3 provisions of this bill.

Minnesota: Minnesota’s tax bill updates the state’s conformity date to May 1, 2026, capturing any provisions of OB3 not specifically subject to decoupling. Changes to the IRC are effective retroactively in Minnesota to the date which a provision became effective federally. Corporate taxpayers will be required to addback 80 percent of their federal deductions under IRC section 174A (full expensing of domestic research and experimental expenses), which will then be amortized over the subsequent four years. Minnesota will also require an 80 percent addback for taxpayers that retroactively claim a R&E deduction under the OB3 small business transitional election. As it relates to the transitional rule to accelerate domestic R&E expenses from tax years 2022-2024 on 2025 and 2026 tax returns, an addback is required for the full amount deducted. In contrast to the rules for corporate taxpayers, S corporations, limited liability companies, and other pass-through entities are eligible to fully deduct 174A costs.

Minnesota will also deviate from the computation of net CFC tested income (NCTI, previously global intangible low-taxed income or GILTI) under OB3. Minnesota generally allows a deduction of 50 percent of GILTI/NCTI as a dividend. For tax years beginning after December 31, 2025, the bill provides a subtraction equal to the qualified business asset investment (QBAI) deduction previously allowed for GILTI. This subtraction is not allowed to exceed the amount of NCTI. The bill also decouples from the look-through rules for related CFCs.

For pass-through entities, the bill also extends the elective pass-through entity tax until December 31, 2027.

Please contact Dale Busacker with questions about House File 2438.

New York: New York’s budget, which was signed into law by Governor Hochul on May 28, includes a number of provisions for purposes of both the New York State and New York City corporate and personal income tax. The bills included decoupling from provisions of OB3, a new pied-a-terre surcharge imposed on non-primary residences, and other state and city tax measures. Further detail on A. 10009 and S. 9009 will be forthcoming in KPMG’s June 8 TWIST. Please contact Aaron Balken and Alec Schwartz with questions.

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