This Week in State Tax

The Tenth Circuit Court of Appeals recently affirmed a district court determination that a state-imposed daily fee on short-term car rentals does not violate the provisions of the federal Anti-Head Tax Act (AHTA). The AHTA, while generally prohibiting state taxation of air passengers and air commerce, also contains a specific preemption of state or local tax on any business located at a commercial airport that is not generally imposed on sales or services by the state. The district court determined that the rental fee applied to both airport and non-airport car rentals, and as such, it did not violate the AHTA. The Court of Appeals affirmed that the fee did not violate the AHTA, on the rationale that the fee is imposed on consumers, not airport businesses.

In 2024, Colorado enacted an inflation-adjusted daily fee on short term car rentals, with revenues collected to be used to finance various surface transportation and traffic congestion projects. At the district court level, the taxpayer, an association of car rental companies, argued that because the fee applies only to car rentals and not all sales and services, it violated the AHTA. The state argued that because the fee applies to both airport and non-airport car rentals, it complies with the “generally imposed” language of the AHTA. The district court sided with the state, finding that the fee was not preempted by the AHTA, and the taxpayer appealed.

The Court of Appeals affirmed the district court holding and acknowledged the fee was levied on all car rentals and not just those at airports. In reaching its conclusion, however, the appellate court focused on the language of the statute creating the fee. The taxpayer claimed that the fee was preempted by the AHTA as it was imposed on rental businesses at the airport, and the businesses would be liable for the fee and required to file related returns. The state argued that the statute imposed the fee on individuals who rented cars, and that the rental businesses merely collected the fee from consumers, in the same manner as a sales tax. The Court of Appeals determined that “fee payers” referenced in the statutory language refers to the consumers renting vehicles, not the rental businesses, as the consumers were the beneficiaries of the projects paid for by the fee.

For more information on American Car Rental Association v. Humphreys, et al., contact Molly Leszko or Steve Metz.

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The Massachusetts Appellate Tax Board recently addressed whether a taxpayer and certain affiliates were properly classified as manufacturing corporations for corporate excise tax purposes as well as the manner in which the Massachusetts Finnigan-style reallocation rule interacts with P.L. 86-272. The taxpayer’s operating structure included manufacturing affiliates that produced and processed pork products, and sales companies responsible for customer-facing activities related to selling those products. For Massachusetts apportionment purposes, the taxpayer treated the entities processing the meat products as qualified manufacturers, while treating the affiliated sales companies as non-manufacturing corporations. One of the sales corporations included in the Massachusetts combined group was an entity protected under the provisions of P.L. 86-272. On audit, the Commissioner of Revenue aggregated the activities of the sales companies with those of the manufacturing entity, reclassifying the sales companies as manufacturers per relevant regulations. Moreover, the Commissioner used the “reallocation rule” to reassign portions of the Massachusetts receipts generated by the P.L. 86-272-protected sales corporation to the sales factor numerators of other combined group members that were taxable in Massachusetts. The taxpayer challenged these assessments, and the matter was taken to the Board.

During the tax years at issue, Massachusetts required qualifying manufacturing corporations to use single-sales-factor apportionment, while non-manufacturers used a three-factor formula. [Note: The general Massachusetts apportionment for all entities is now single sales factor.] The taxpayer challenged the Commissioner’s application of the state’s “combination rule,” which treats the manufacturing and selling activities of related combined group members together when property manufactured by one member is sold by another to third parties. The Board upheld the regulation and its application to the taxpayer, concluding that the regulation reasonably coordinated Massachusetts’ combined reporting rules with the statutory apportionment provisions for manufacturers. The Board found it reasonable to attribute the manufacturers’ apportionment characteristics to the selling entities when those entities later sold the manufactured products to third parties because intercompany sales by the manufacturing members were eliminated from the apportionment factor. The Board further emphasized that each entity was still required to independently satisfy the manufacturing substantiality tests; the regulation merely attributed certain manufacturing-related sales and apportionment characteristics to the selling entities for purposes of determining whether the single factor manufacturer apportionment rule applied.

The Massachusetts reallocation rule, to which the Board next turned, is a Finnigan-style apportionment provision under which each taxable member of a unitary group is required to increase the numerator of its sales factor by its proportionate share of the aggregate Massachusetts sales of nontaxable members of the group, which in this case was the P.L. 86-272-protected entity. The Board framed the central question as whether Massachusetts could, consistent with P.L. 86-272 and the Supremacy Clause, include the protected entity’s Massachusetts sales in the numerator of the sales factor of other group members when the protected entity itself could not be taxed on its net income. The Board held that the “person” protected by P.L. 86-272 is the specific corporation whose activities are being evaluated and P.L. 86-272 protects that corporation’s net income (not just the entity itself) from state income taxation when the in-state activities of the entity do not exceed protected solicitation. In the Board’s view, Massachusetts could not accomplish indirectly that which is prohibited by P.L. 86-272 by reallocating the protected entity’s Massachusetts sales to other taxable group members and including those receipts in their sales factor numerators. Doing so would have the effect of taxing the protected entity’s income in contravention of federal law. In its analysis, the Board reviewed cases from several other states and found them not persuasive as to the matter before them or not relevant as not involving a P.L. 86-272-protected entity.

Please contact James Carregal and Jenny Ek with questions about Smithfield Packaged Meats Corp. v. Commissioner of Revenue, No. C344811.

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A Nebraska district court rejected both the taxpayer’s and the Department of Revenue’s proposed method for apportioning income deemed received under the Tax Cuts and Jobs Act (TCJA) one-time inclusion of accumulated untaxed controlled foreign corporation (CFC) earnings (Section 965 Income) in 2017. In that year, the taxpayer reported more than $280 billion of gross Section 965 Income for federal purposes. On its original Nebraska return, the taxpayer excluded Section 965 Income from both its tax base and apportionment factor. The Department issued an adjustment including approximately $160 billion of net Section 965 Income (the $280 billion of gross income minus federal deductions) in the taxpayer’s pre-apportionment tax base and the full $280 billion of gross Section 965 Income in the sales factor denominator. The taxpayer protested, arguing that Section 965 Income should be excluded from the tax base or, alternatively, that sales factor representation should be based on the gross receipts of the CFCs in the years generating the accumulated earnings that were deemed repatriated in 2017. The Tax Commissioner denied the protest and affirmed the assessment. On review, after the taxpayer withdrew its deductible-dividend argument following the Nebraska Supreme Court decision in Precision Castparts, the district court considered whether statutory or alternative apportionment applied and whether either party’s proposal satisfied the equitable apportionment requirements.

The district court first considered whether alternative apportionment was permitted. Given that neither Section 965 Income (as included by the Department in the denominator of the sales factor) nor CFC gross receipts (as included by the taxpayer in the denominator of the sales factor) were part of the standard apportionment formula, the court concluded that the proposals of both parties constituted alternative apportionment methods. The court further held that the 2017 deemed repatriation of Section 965 Income earned over multiple years qualified as a “unique and nonrecurring factual situation” justifying alternative apportionment.

The court, however, rejected both the Commissioner’s and the taxpayer’s proposed alternative apportionment methods, concluding that neither produced an equitable result under the alternative apportionment statute. The Commissioner’s method improperly added the taxpayer’s Section 965 Income to the sales factor denominator even though Nebraska’s sales factor is based on gross receipts rather than income (thereby measuring the foreign activity that generated the Section 965 Income on a different and smaller basis than the rest of the sales factor and increasing the portion of income apportioned to Nebraska). The taxpayer’s method, by contrast, improperly increased the denominator by including multiple years of CFC gross receipts while comparing those receipts to only one year of Nebraska sales, creating a significant temporal mismatch that favored the taxpayer. The court further found that both methods suffered from calibration defects because they did not properly align the denominator with either the gross receipts generating the Section 965 Income or the net amount of Section 965 Income included in the taxpayer’s Nebraska tax base.

The court remanded the matter to the Department to craft an equitable remedy that addressed its concerns. The court indicated that an equitable formula should: (a) represent the 965 Income on a basis consistent with the gross receipts foundations of the sales factor; (b) be calibrated such that any amount added to the denominator is consistent with the amount of income added to the base; and (c) address the temporal mismatch by reconciling the periods reflected in the numerator, denominator and income subject to apportionment.

Please contact Kara Hernandez with questions about Apple, Inc. v. Department of Revenue or other Nebraska income tax matters.

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