TWIST - This Week in State Tax

California: Indoor Go-Kart Venue Assessed Tax on Lease of Tangible Personal Property

The California Office of Tax Appeals (OTA) recently concluded that a taxpayer furnishing go-karts to customers at its indoor racing venue was engaged in leasing tangible property and was required to collect sales tax on the rental receipts.  The taxpayer offered various go-kart racing packages to customers, including a one-time “arrive and drive” option, as well as multi-race packages and group options. Before they could drive a go-kart, most customers were required to purchase a $5.95 driver’s license, which provided for the use of a helmet, head sock and other items, and was valid for a year. The taxpayer purchased the go-karts from Italy and did not pay tax on the purchase. Following an audit, the California Department of Tax and Fee Administration (CDTFA) determined that the taxpayer was renting or leasing the go-karts to customers and was required to collect sales tax on the renal receipts. The CDTFA also determined that the $5.95 license fee was a taxable mandatory charge related to the rentals. The taxpayer made a few different arguments that the transactions were not taxable leases. The first was that certain go-kart rentals were excluded from the definition of the term “lease” under a California regulation because the charges were for less than $20, the go-karts were used for less than twenty-four hours at a time, and were used on the taxpayer’s premises.  The OTA rejected the taxpayer’s position that the charges were for less than $20; even the least expensive option was over $20 because customers had to purchase the mandatory license. The taxpayer also asserted that the price per race in the multi-race packages was less than $20 and that these races must be evaluated separately because an individual could only possess and use one go-kart at a time. The OTA, relying on a California regulation providing that rental charges for separate items under a single rental agreement must be aggregated when evaluating whether a charge for a rental is less than $20, again rejected this argument.  

The taxpayer next argued that under the true-object test, it was providing a non-taxable amusement service. The OTA noted at the outset that the rental of skis, surf boards, and other entertainment-related equipment could all constitute leases, and the fact that amusement was derived from using this equipment did not disqualify the equipment’s rentals from being leases. Regardless, the test for whether something is a lease versus the provision of an amusement is whether possession and control of the property is transferred to the lessee, as distinguished from situations in which the lessor retains possession of and operates the property under a service agreement. In the OTA’s view, the nature of go-kart racing was more akin to sporting activities in which participants exercised extensive control over the rented equipment, such as skiing or surfing, than activities involving property over which participants have little to no control, such as amusement park or carnival rides. The taxpayer’s control over the go-karts was limited to the following: programming go-karts to a variety of pre-set speeds to accommodate various skill levels; automatically reducing the go-kart speed while in the pit area; and remotely turning off the go- karts in the case of emergencies. Otherwise, racers generally controlled speed and direction of the go-karts. Accordingly, the OTA concluded that the taxpayer was not providing a nontaxable amusement service. The OTA determined that the mandatory annual license fee fell squarely within the term “payment required by the lease” and was therefore subject to sales tax along with the rental of go-karts. Please contact Jim Kuhl with questions on In re K1 Speed, Inc.

Delaware:  Unclaimed Property Notices Mailed; Companies Have 90 Days to Respond to Invitation Letters

The Delaware Secretary of State’s Office (Secretary) has confirmed that on or around July 14, 2023 it mailed letters to companies inviting them to join the state’s Unclaimed Property Voluntary Disclosure Agreement (VDA) Program.

As stated in previous mailings, companies that do not respond and enroll in the VDA Program within 90 days of the date of the letter will be referred to Delaware’s Department of Finance for audit. As such, it is imperative that companies be on the lookout for these mailings and respond in a timely manner.

Background

The VDA invitation letters are usually addressed to a company’s Chief Financial Officer or other high-level executive and can be easily overlooked. Companies at risk of receiving this outreach have historically ranged from middle-market companies through Fortune 100 companies, both privately and publicly held, across a wide range of industries including oil and gas, retail, banking, utilities, technology, media, healthcare, manufacturing, pharmaceutical, and consumer products. Companies that do not file unclaimed property reports, have not recently been audited by Delaware for unclaimed property, and/or have not recently completed a VDA with the state should be on heightened alert.

Further, we have observed a marked increase in the receipt of audit notices and other state correspondence by companies that either (A) have a long filing history but may have made recent acquisitions that caused them to acquire liabilities, (B) have inadvertently excluded certain categories of property typical of their industries, or (C) companies that have formed within the last ten years but have experienced growth that has outpaced their compliance programs (e.g., start-ups that have recently gone public, software-as-a-service companies, and companies with online and transient customer bases such as payment processers and online marketplaces). While many of these companies may believe they have minimal unclaimed property exposure, providing records for the entire VDA lookback period and completing the program is often challenging.

In both unclaimed property audits and the VDA Program, Delaware state law requires a look-back period of ten report years, plus the five-year dormancy period for most property types, which equates to a 15-year transactional review period. With many companies unable to readily produce complete accounting records for the entire lookback period due to constraints like system limitations and record retention policies, both types of reviews can be challenging. Further, Delaware law authorizes the use of an estimate to account for periods in the review where complete books and records are not available. In many instances, there is a risk that estimation (a liability typically not already accounted for on a company’s balance sheet) may be necessary.

Considerations for Businesses Receiving an Invitation Letter & Benefits of the VDA Program

While both programs share the same lookback period, there are significant benefits to enrolling in the VDA Program versus being selected for audit, which include but are not limited to:

• Waiver of Delaware’s statutory penalties and interest charges. All penalties and interest are waived for companies that complete the VDA Program in good faith. By contrast, the State Escheator’s authority to waive penalties and interest for companies under audit is limited. For audits authorized on or after August 1, 2021, a 20 percent assessment of interest on past due property uncovered (including estimated amounts) is now considered “un-waivable,” unless a company elects participation in an “expedited audit” option, which contains its own risks and an “un-waivable” one percent interest assessment.
• More favorable review criteria. A 90-day aging criteria for voided disbursement checks applies under the VDA Program, while a normal audit uses a 30-day period and presumes that all checks voided more than 30 days after issuance are unclaimed property liabilities unless the company under audit can prove otherwise. This can provide a substantial benefit in terms of reduction of volume of checks requiring review, as well as the associated dollars of potential exposure.
• Control over the process. Under the VDA Program, a company is allowed to perform a “self-review” of its own records to identify and remediate areas of exposure. This contrasts with a standard audit in which third-party auditors will review all records and entities that they determine are “in-scope,” can require extensive supporting documentation to support any claims that assessed items are not unclaimed property liabilities, and can calculate their own assessments of liability that must then be refuted by the company under audit.
• Limited options. As previously noted, businesses that do not enroll in the VDA Program may be selected for audit by Delaware’s Department of Finance and State Escheator. For audits authorized after August 1, 2021, businesses may request an “expedited” audit program. Considerations related to the “expedited” audit program include:
  • Expedited audit requests by businesses are granted or denied at the sole discretion of the State Escheator within 60 days of the request. If accepted, a holder must provide “sufficient responses” to auditor requests within prescribed timeframes generally following an 18-month timeline. If a holder provides sufficient responses during the expedited audit, the Escheator must provide an audit report within two years, as compared to historical audits that have typically taken three to five years (or more) to complete.
  • The State Escheator cannot waive the 20 percent assessment of interest on past due property for audits authorized on or after August 1, 2021. However, if a business elects to resolve an examination through the expedited audit process, it may only be subject to a reduced one percent interest assessment.

KPMG Observations

Holders of unclaimed property that received audit notices from Delaware are often companies that did not respond to an invitation to participate in the Delaware’s VDA Program or were undergoing a multi-state unclaimed property audit. Delaware’s unclaimed property law allows the state to initiate audits of companies without first sending a VDA invitation if (A) an audit was initiated by another state, (B) the company applied for or entered into a VDA with Delaware prior to June 30, 2012, or (C) the company enrolled but later withdrew from Delaware’s VDA program on its own or was removed from the program due to not working in good faith to complete the program.

There are many companies receiving audit notices right now that did not respond to VDA invitation mailings that went out earlier this year. Companies receiving audit notices should consider the following:

• Securing a non-disclosure agreement with Delaware or—most often—the third-party audit firm conducting the audit on behalf of multiple states, prior to disclosing any information to the auditor.
• Requesting a list of states invited to participate in the audit—as well as copies of all state audit notices sent—from the third-party audit firm conducting the audit to confirm the auditor is indeed authorized to be conducting the audit on behalf of the state.
• How the company’s fact pattern may limit the scope of the audit (e.g., entities divested via stock acquisition, entities that underwent bankruptcies, etc.) and whether the auditors are entitled to receive all information being requested (e.g., data requests extending beyond the lookback periods employed by the states, etc.).
• The periods for which records are available and/or researchable, which will be important as the auditors will use certain “base years” to develop error ratios for the calculation of potential estimated assessments for the state(s) of incorporation participating in the audit.

Companies that receive a VDA invitation letter, a compliance review notice, or an unclaimed property audit notice from Delaware or other states should evaluate next steps and risk areas related to unclaimed property non-compliance. Additionally, companies that are incorporated in Delaware but are not in compliance and have not yet received an invitation should proactively assess their overall compliance with unclaimed property and consider enrolling in Delaware’s unclaimed property VDA Program.

Contacts

For more information, please contact Will King | +1 (214) 840-6107 | williamking@kpmg.com, or Marion Acord | +1 (404) 222-3053 | marionacord@kpmg.com.

Mississippi: Computer Software Direct Pay Permits Available Now

Earlier this year, Mississippi Senate Bill 2449 amended Mississippi’s tax law to address the taxation of computer software and computer software services. “Computer software services,” which are taxable if performed in Mississippi, are now defined to mean the technical design and programming of computer software, including installing, configuring, debugging, modifying, testing, or troubleshooting computer hardware, networks, programs, or computer software.  A nonexclusive list of services are excluded from the definition of “computer software services,” including platform as a service or infrastructure as a service; information and data processing services, and services that use a computer, computer equipment, or computer software as a tool to perform or complete that service; Internet access services or charges; payment processing or banking services; real estate listing or pricing services; electronic advertising and marketing services; and social media services. Effective July 1, 2023, an exemption is available for purchases of remotely accessed software hosted on servers located outside of Mississippi.

In recent Notice 73-23-12, the Department announced that customers that are charged for computer software and/or computer software services that include both taxable and nontaxable items may reasonably allocate payment to each separately identifiable item or service encompassed by the fee or payment if properly supported by the books and records of the seller, service provider, user, or consumer. Beginning July 1, 2023, purchasers of computer software and/or computer software services may apply for a computer software direct pay permit. The permit will allow the customer to purchase computer software and/or computer software services exempt from Mississippi sales or use tax and then remit the correct tax directly to the Mississippi Department of Revenue. The permit may be accepted only by vendors who sell, rent, or lease computer software and/or computer software services. Manufacturers and other entities that already have regular Direct Pay Permits do not need to apply for the Computer Software Direct Pay Permit. Please contact Randy Serpas with questions on Mississippi’s new direct pay permit.