TWIST - This Week in State Tax

Pennsylvania: Digital Goods Sourced for Corporate Net Income Tax Purposes Using Rules for TPP

The Pennsylvania Board of Finance and Revenue recently denied a petition protesting the Department’s application of the sourcing rules for tangible personal property to the taxpayer’s sales of digital content. The taxpayer at issue entered into licensing agreements with content rights holders to license and distribute spoken audio content in exchange for royalty payments.  The copyrighted content was sublicensed to the taxpayer’s customers, who were granted a limited license to download and use the digital content. On its original corporate net income tax returns, the taxpayer applied the costs of performance method to source its receipts.  On audit, it was uncovered that a past decision of the Board of Finance and Revenue had classified the taxpayer’s sales as sales of tangible personal property, and the auditor adjusted the sales factor for the current period accordingly. After the Board of Appeals denied relief, the taxpayer appealed. In the taxpayer’s view, its receipts should be classified as sales of intangible personal property sourced using the costs of performance method. The taxpayer contended the majority of its labor costs to maintain its digital content and execute licensing agreements (among other activities) occurred in New Jersey at its headquarters, meaning its receipts should be sourced to New Jersey.

The Board denied the appeal on the basis that the taxpayer had not established that it was selling intangibles. In the Board’s view, the taxpayer was in fact selling tangible personal property that should be sourced based on delivery location. The Board found that the digital audio books sold by the taxpayer were akin to tangible personal property under the “essence of the transaction” test that is typically applied in the sales tax context to determine the nature of a sale.  The Board noted that the books were mass produced and not customized for each customer, contained knowledge recorded in a physical form which had physical existence, and took up space on a tangible medium (e.g., disc or hard drive). In the Board’s view, the digital audio file, when downloaded by the customer, was ultimately a book recorded and stored in physical form upon a physical object. The Board also denied the taxpayer’s request for a special apportionment method.  Please contact Mark Achord with questions on BF&R Docket No. 2122314.

South Carolina: Retailer Imposed Fees Subject to Sales Tax

In a recent ruling, the South Carolina Department of Revenue addressed whether sales tax applies to separately stated fees charged in connection with the retail sale of tangible personal property. The ruling addressed situations in which retailers add “inflation fees,” “convenience fees,” or “non-cash adjustment fees,” to a customer’s receipt or invoice to recover certain operating costs.  Under South Carolina law, “gross proceeds” and “sales price” are similarly defined in both the sales and use contexts as “the total value accruing from the sale, lease or rental of tangible personal property” without deducting expenses such as the cost of goods sold and the cost of materials, labor, or service. The “measure” of the sales and use tax is the total proceeds of a sale (i.e., it is the sum of all consideration received in conjunction with the sale of tangible personal property, without any deductions, unless specifically provided). The Department concluded that the fees at issue would be included in the “gross proceeds of sales” or “sales price” and subject to sales and use tax, assuming the retail transaction was subject to sales and use tax.  If an “inflation fee,” “convenience fee,” “non-cash adjustment fee,” or similar type of fee is imposed on sales that include both exempt and taxable items, then the sales and use tax is due only on that portion of the fee related to the taxable items, provided the seller can reasonably prorate the fee between the taxable items and nontaxable items sold based on his books and records. Please contact Nicole Umpleby with questions on South Carolina Revenue Ruling #22-10.

Washington: Department Addresses Law Firm Economic Nexus; Apportionment

In a recently released determination, a Washington State Tax Review Officer addressed the manner for attributing a law firm’s receipts from providing patent acquisition services to Washington State and whether the taxpayer met the state’s B&O economic nexus standard. The taxpayer at issue was an out of state law firm that specialized in procuring patents for clients, including clients headquartered in Washington State. The Department of Revenue and the taxpayer agreed that the taxpayer’s gross receipts were apportionable income but disagreed as to the amount attributed to Washington. The taxpayer asserted that 1/64 (1.56 percent) of its receipts should be apportioned to Washington because the benefits of its patent procurement services were received equally in each of the 64 U.S. states, territories, and possessions where a client received patent protection. Accordingly, the taxpayer assigned 1/64 of its receipts to Washington; when assigned in this manner, the taxpayer did not meet the state’s economic nexus threshold for the tax year at issue. On audit, the Department determined the taxpayer’s receipts should be sourced to Washington based on the headquarters address of its customers.  The matter eventually came before the Hearing Officer.

The key issue before the Hearing Officer was where the taxpayer’s customers received the benefit of the taxpayer’s services, which was determined to be the location where the customers’ related business activity occurred.  Because acquiring patents was a detailed and time-consuming process that involved broad strategic decisions from a client’s management and corporate legal counsel, the Hearing Officer determined that the taxpayer’s customers’ relevant related business activity was strategic planning and general corporate management, rather than the customers’ selling activities.   While the patents allowed the holder to protect the market for its sale of a product that incorporates the patented invention, such protection required litigation to enforce the patent. Importantly, the taxpayer did not litigate to enforce patents, but only acquired patents for its customers. As such, the Hearing Officer concluded that the taxpayer’s services were detached from its customer’s selling activity and related more to its customers’ general strategic planning and corporate management.  Next the Hearing Officer addressed where these strategic and management decisions occurred, noting that the patent acquisition process was so cumbersome that it required “broad strategic decisions” from those management and legal personnel who are presumed to work from that customers’ headquarters. As a result, the Hearing Officer concluded that when the customers’ related business activities occurred at the customers’ headquarters in Washington State those receipts would be included in the Washington sales factor numerator. Please contact Michele Baisler with questions on Det. No. 21-0044, 41 WTD 355 (2022).

Washington: Department Provides Additional Insight on Taxation of NFTs

In July, the Department of Revenue released an interim statement addressing various tax issues related to NFTs, including how and when NFTs are taxed, how to determine the selling price of an NFT, and the sourcing rules that apply to retail sales of NFTs. The interim statement also confirmed that marketplace facilitators will be required to remit taxes on sales of NFTs, and it provided guidance on the B&O tax treatment of income from sales of NFTs.

Last week, the Department hosted a listening session for taxpayers to provide feedback and ask questions about the interim statement. On the call, a policy representative from the Department explained that Washington taxes digital goods, digital codes, and digital automated services, and that NFTs associated with such items would be subject to tax dating back to the enactment of the law imposing tax on digital goods, digital codes, and digital automated services. The representative indicated that more guidance on this issue would be forthcoming. Please stay tuned to TWIST for additional guidance on the tax treatment of NFTs.