TWIST - This Week in State Tax

Maine: Receipts Sourced to Where Taxpayer’s Clients’ Members Received Services

The Maine Supreme Judicial Court recently addressed whether a pharmacy benefit management company was entitled to apportion its service receipts based on the location of its direct clients. The taxpayer at issue was a group of corporations whose primary business was administering prescription drug and pharmacy benefits for its health insurer clients. The clients, in turn, provided benefits to their members who were the primary recipients of the taxpayer’s services.  For the 2011 tax year, the taxpayer sourced its income on a “market member” basis, meaning that receipts from the performance of pharmacy benefit management (PBM) services were sourced to the state in which the prescription drug was dispensed to members by the retail pharmacies. On later returns and without informing Maine Revenue Services, the taxpayer apportioned such receipts on a “market client basis,” i.e., to the location of the primary commercial and administrative headquarters of its clients.  Following an audit, the taxpayer’s returns were adjusted to source receipts from the PBM services on a market member basis. The taxpayer protested this adjustment, and after a trial court granted summary judgement in favor of the Maine Assessor on the apportionment issue, the taxpayer appealed.

Under Maine law, receipts from the performance of services are generally attributed to the state where the services are received. Under the Assessor’s theory, income generated from the performance of the PBM services should be attributed to that retail pharmacy location where the services were received by members when they filled prescriptions and the taxpayer provided claims processing services. The taxpayer countered that the market client method was more appropriate. It contracted with its clients, not individual members, and therefore the appropriate location to which its PBM receipts should be sourced was the commercial and administrative headquarters of its clients. The court concluded that the taxpayer’s arguments failed, and the trial court had properly granted the Assessor’s summary judgment motion. In the court’s view, the summary judgment record established that the PBM receipts resulted from the performance of claims processing services for members’ prescription drug were received at retail pharmacies in Maine. Notably, the taxpayer’s Form 10-K for 2011 stated explicitly: “Although we contract with health plans and employers, the ultimate recipients of many of our services are the members and employees of these health plans and employers.” Further, the record made clear that if members had not gone to pharmacies to fill their prescriptions, the taxpayer would not have been entitled to that revenue. Because the record established that claims-processing services were received by members at retail pharmacies in Maine, and the receipts at issue were derived from the performance of these claims processing services, the court concluded that there was no genuine issue of material fact, and the Assessor was entitled to judgment as a matter of law. For more information on Express Scripts Inc. et al. v. State Tax Assessor,  please contact Melissa DelleMonache.

Missouri: Technology Equipment Was Purchased for Resale

The Missouri Supreme Court recently affirmed an Administrative Hearing Commission (AHC) decision concluding that a taxpayer was not prohibited from claiming a resale exemption for purchases of information technology (IT) equipment because the equipment was ultimately purchased for resale. The taxpayer, a wholly owned subsidiary of a large retailer, regularly purchased IT equipment, such as electronic price scanners, credit card readers, computers, and servers, using a resale exemption. After the purchase, the taxpayer made various modifications to the IT equipment at its Missouri warehouse. The equipment was later sold at a marked-up amount to other group members for use in their brick-and-mortar stores. Group members using the equipment in the retail stores accrued and remitted use tax on these sales based on rates in the jurisdiction in which the store was located.

The Department of Revenue asserted that the taxpayer was not entitled to make these purchases using a resale exemption and owed use tax on the purchase of the equipment. In the Department’s view, the taxpayer exercised more control over the use of the purchased IT equipment than was permitted when claiming a resale exemption. The Department’ position was based Missouri Supreme Court’s holding in Custom Hardware Engineering & Consulting Inc. v. Dir. Of Revenue. In Custom Hardware, the court held that a taxpayer was barred from claiming the resale exemption because the taxpayer “tested and certified” equipment before shipping it to customers, and the taxpayer’s customers did not remit sales or use tax on the equipment they received. After the AHC held against the Department of Revenue, the Director appealed to the Missouri Supreme Court.

The court determined that the resale exemption did apply in this case, as the findings demonstrated that the taxpayer’s sole purpose was to purchase the equipment for resale. Any value added from the taxpayer’s modifications was reflected in the markup incorporated into the final sale price, as was required to claim the resale exemption. Finally, the subsequent sales were subject to use tax in the appropriate jurisdictions. As such, allowing the taxpayer to claim a resale exemption aligned with the fundamental purpose of the exemption, which was to avoid double taxation. The court also concluded that the Commission did not err when it determined that Custom Hardware did not support the Director’s arguments. In the court’s view, Custom Hardware was the “polar opposite” of the instant case in which the taxpayer purchased the IT equipment with the ultimate intent to resell it.  Please contact John Griesedieck with questions on Walmart Starco LLC v. Director of Revenue.

Ohio: Taxpayer Does Not Qualify for Agent Exclusion from CAT Base

The Ohio Board of Tax Appeals recently concluded that a food and hospitality services company that provided various managed services to businesses and government institutions was not entitled to an agency exclusion from the Commercial Activities Tax (CAT) base. The receipts at issue were related to services performed under management fee contracts. Under these contracts, the taxpayer purchased food, supplies, and other items for clients who received receipts from the register, reimbursed the taxpayer, and paid the taxpayer a management fee. The taxpayer argued that it erroneously paid CAT on these receipts that it received as an agent. The Department of Taxation denied the refunds on the basis that the taxpayer had not established an agency relationship with its clients. The taxpayer subsequently appealed.

Under the CAT, “gross receipts” generally include “the total amount realized by a person, without deduction for the cost of goods sold or other expenses incurred….” However, an exclusion applies for amounts received or acquired by an agent on behalf of another in excess of the agent's commission, fee, or other remuneration. An agent is “a person authorized by another person to act on its behalf to undertake a transaction for the other.”  In earlier cases, courts had held that the proper focus in determining an agency relationship is whether the purported agent had the actual authority to bind the principal as the purchaser in the transactions at issue. The Board determined that the taxpayer was erroneously focused on the control and risk its clients maintained over its actions as support for its position that it was an agent, rather than whether it had authority to bind the clients. In the Board’s view, the evidence showed that the taxpayer did not possess the requisite authority to qualify as an agent for CAT purposes. Importantly, the taxpayer’s contracts with clients did not provide the taxpayer with the authority to bind those clients for its purchases of goods. The Board further rejected the taxpayer’s position that the reimbursements were not gross receipts under the CAT and declined to hear the taxpayer’s constitutional challenges. Please contact Dave Perry with questions on Aramark Corporation vs. Harris.

Texas: Comptroller Issues Guidance on Elimination of the No Tax Due Report for Certain Entities

Texas Senate Bill 3 increased the franchise (margin) tax exemption from $1.0 million to $2.47 million effective for reports originally due on and after January 1, 2024. Furthermore, also effective for reports originally due on or after January 1, 2024, the bill repealed the requirement that certain businesses that fall under this exemption must file a No Tax Due Report (Form 05-163) with the Comptroller.  The bill also repealed the requirement that a new veteran-owned business file a No Tax Due Report during its initial 5-year exemption period.

The Comptroller issued guidance on these changes in its November 2023 Tax Policy News.  Notably, the Comptroller’s office is discontinuing the No Tax Due Report for the 2024 report year and beyond, and the form will no longer be available. However, certain entities will continue to be required to file a report, and the Comptroller has provided guidance on how this will be accomplished.  While taxable entities with annualized total revenue at or below the no tax due revenue threshold are not required to file a franchise tax report, they must still file a Public Information Report (PIR) or Ownership Information Report (OIR). New veteran-owned businesses are not required to file a franchise tax report for the initial five-year period that they qualify as a new veteran-owned business, and no PIR or OIR is required during this initial period. Passive entities must file either the long form or the EZ Computation form. Both forms are being updated by adding a circle to darken in the taxpayer information section at the top of the form. Other than signing the report, passive entities need not provide information in any other section of the report, and no PIR or OIR is required. REITs also must file either a long form or EZ Computation form and darken the appropriate circle in the taxpayer information section at the top of the form. Other than signing the report, REITs need not provide information in any other section of the report. However, REITs must continue to file a PIR or OIR. Taxable entities with zero Texas gross receipts must file either a long form or EZ Computation form and complete specific line items on the form to compute the entity’s total revenue and report zero on the Texas gross receipts line. Entities with zero Texas gross receipts must continue to file a PIR or OIR. As a reminder, a combined group must include all taxable entities in the combined group report even if any member, on a separate entity basis, has annualized total revenue at or below the no tax due revenue threshold. Please contact Karey Barton with questions.