TWIST - This Week in State Tax

The California Office of Tax Appeals (OTA) recently denied the FTB’s petition for rehearing in Matter of Appeal of Microsoft Corporation. The primary substantive issue in Microsoft was what portion of a qualifying dividend paid by a qualified foreign subsidiary and received by a California water’s-edge group member was reflected in the sales factor. Specifically, is the entire dividend amount included in the sales factor or just the amount remaining after applying the 75 percent dividends received deduction allowed under R&TC section 24411? On its original return, Microsoft included in its sales factor denominator only the 25 percent of the dividend amount that was included in the California income base. Subsequently, Microsoft filed an amended return including all the dividends in the sales factor; this resulted in an approximate $94 million refund.  The dividends at issue were distributed following the taxpayer’s payment of the one-time transition tax under IRC section 965. After the FTB denied the refund, the taxpayer appealed to the OTA. After an oral hearing, the OTA issued an Opinion holding that: (1) qualifying dividends deducted from income under R&TC section 24411 are includable the sales factor; (2) gross receipts from the qualifying dividends are not excludable from the sales factor as a substantial and occasional sale, and (3) the FTB had not shown that the use of an alternative apportionment method was warranted.  The FTB subsequently filed a petition for rehearing (PFR) on the basis that the holdings in the Opinion were contrary to California law.

In its Opinion on the PFR, the OTA first addressed its holding that the deducted dividends were included in the sales factor. The FTB relied on Legal Ruling 2006-01 as support for its position that activities that gave rise to income or losses excluded from the apportionable tax base, due to exemption, exclusion, deduction, or otherwise, were required to be excluded from the apportionment formula. The OTA noted that the plain language of the law provides that the sales factor includes all gross receipts unless excluded. There was no exclusion applicable here, and the OTA declined to apply the “basic principles of apportionment” advocated by FTB in favor of the plain language of the statute.   The OTA observed further that its conclusion was consistent with Minnesota Beet, a recent precedential OTA opinion holding that deductible cooperative income was nevertheless included in the sales factor.  In its PFR, the FTB presented for the first-time legislative history for the dividends received deduction that suggested it was viewed by the legislature as an exemption or exclusion.  The OTA, however, declined to consider this newly submitted evidence and concluded that the FTB had not established that the Opinion was contrary to law with respect to its first holding.

The OTA next rejected the FTB’s contention that the Opinion was contrary to law because it concluded that the dividends were not excluded from the sales factor under a regulatory exclusion for receipts from a substantial, occasional sale of a fixed asset or other property held in the regular course of the taxpayer's trade or business. While dividends are “sales,” the exclusion at issue was limited in scope and applied to a sale of property.  Next, in a lengthy discussion as to whether inclusion of the dividends created distortion under both a quantitative and qualitative analysis, the OTA concluded that it did not err when it ruled in the Opinion that the FTB did not meet its burden of proving by clear and convincing evidence that the standard apportionment formula did not fairly represent the extent of Microsoft’s activities in California. Finally, the OTA concluded the Opinion was not contrary to law with respect to its conclusion that there were not irregularities in the appeal proceedings that prevented fair consideration of the appeal, including the denial of a request for additional briefings and interruptions during the opening arguments. Please contact Oksana Jaffe with questions. 

Recently, the Minnesota Department of Revenue issued guidance on its website addressing the retail delivery fee that applies beginning on July 1, 2024. Recall, this new $0.50 fee is imposed on each taxable transaction involving certain retail deliveries in Minnesota. Generally, deliveries subject to the fee include those transactions of $100 or more that are subject to the sales tax. It should be noted that sales of clothing over $100 are also subject to the fee, despite being exempt from Minnesota’s sales tax. Product-based exemptions from the fee exist for drugs; medical devices, accessories, and supplies; food, food ingredients, or prepared food; and baby products. Certain of the baby products exempt from the retail delivery fee are subject to sales tax; other baby products will be exempt from both the fee and the sales tax. To the extent a transaction contains taxable and exempt items, only the taxable items are considered for purposes of calculating the $100 taxable items threshold. The guidance confirms that shipping charges will be included in determining whether the transaction is subject to the fee. For example, if a taxpayer orders $90 of taxable goods and the shipping charge is $15 dollars, the fee applies. The retail delivery fee is​ not refundable if any or all items purchased are returned to a retailer or if the retailer provides a refund or credit in the amount equal to or less than the purchase price. If the retail delivery is canceled, the fee must be​ refunded to the purchaser. The delivery fee itself is not subject to sales tax if separately stated on the receipt or invoice.

There are also certain retailers that are not required to collect the fee. Specifically, retailers that made Minnesota retail sales totaling less than $1 million in the previous calendar year are not required to collect the fee. Marketplace facilitators are required to collect the fee for sales facilitated on behalf of certain retailers only. Importantly, marketplaces will need to determine which of their retailers (i.e., marketplace sellers) had $100,000 or more of facilitated sales into Minnesota during the previous calendar year and collect the fee on sales made by those marketplace sellers exceeding the $100,000 taxable sales threshold. When calculating the threshold to determine if a particular retailer is not required to collect the fee, all retail sales (both taxable and nontaxable) are counted. However, sales made for resale are not counted.

The recent guidance confirms that the Department will register retailers for the retail delivery fee.  It is not clear whether the Department will also register marketplace facilitators. A retailer that is not registered may register itself via its e-Services account. The fee will be reported on the new Retail Delivery Fee tax line of the Sales and Use Tax Return. If the purchaser of the goods has a direct pay permit, the retailer is still required to collect and remit the fee to the Department. Please contact Alana Purvis with questions. 

The Governor of Oklahoma, Kevin Stitt, recently signed House Bill 1955, which eliminates Oklahoma’s 4.5 percent state tax imposed on the retail sale of food and food ingredients. The term “food and food ingredients” includes bottled water, candy, and soft drinks, but does not include alcoholic beverages, dietary supplements, marijuana and marijuana infused products, prepared food, or tobacco. While House Bill 1955 does not affect any sales or excise tax levied on food and food ingredients by a local government, it does prohibit any sales or excise tax increase voted on prior to June 30, 2025, from applying to food and food ingredients.

The effective date of this bill is projected to be 90 days after the end of the current legislative session, which is expected to adjourn no later than May 31, 2024.  Please stay tuned to TWIST for future legislative updates. 

Legislation that sets forth standards for when corporate taxpayers can be required to file a unitary combined return has passed both houses of the South Carolina legislature. Recall, in the 2014 Media General case, the South Carolina Supreme Court held that unitary combined reporting was an apportionment methodology that could be used to equitably apportion a taxpayer's income to the state. Just this past year, the state’s Administrative Law Court upheld forced combination as a means of correcting what it viewed was a flawed transfer pricing methodology. 

House Bill 298 would amend the section of the South Carolina Code that allows a taxpayer to petition for, or the Department to require, the employment of any other method to effectuate an equitable allocation and apportionment of the taxpayer's income. Under the bill, the first step toward combination is that the Department must have “reason to believe” that a corporation’s tax return does not accurately reflect South Carolina income due to transactions that lack economic substance or are not at fair market value. What it means to have a “reason to believe,” or the level of certitude in that belief, is not addressed in the bill.  However, if the Department determines that it has the appropriate “reason to believe,” it may request additional information from the taxpayer so that it may determine whether the taxpayer’s intercompany transactions have economic substance and are conducted at fair market value. The taxpayer has 90 days to provide the requested information. The bill does provide some guidance for determining whether the taxpayer’s intercompany transactions fail either of these tests. Most of the guidance addresses whether a transaction has economic substance. In determining whether transactions are not at “fair market value,” House Bill 298 simply states that the Department shall apply the standards contained in the IRC section 482 regulations. While the mere reference to the IRS section 482 regulations appears sparse on its face, one must remember that there is a large body of federal guidance interpreting IRC section 482 that would now be instructive in South Carolina. If the Department determines that the intercompany transactions lack economic substance or are not at fair value, then before it can require a combined return the Department must demonstrate that correction cannot be achieved by adding back, eliminating, or otherwise adjusting the intercompany transactions.  It is not clear how it will be determined that these actions are insufficient to accurately reflect the taxpayer’s net income.  Finally, if the Department determines a combined return is required, it must provide notice to the taxpayer to submit the combined return within 90 days. The Department or the taxpayer may propose a combination of fewer than all members of the unitary group, provided, however, the Department may not require a combination of fewer than all members of the unitary group without the taxpayer’s consent. A combined return generally must include all members of the taxpayer’s affiliated group that are conducting a “unitary business,” which term is not defined in House Bill 298. Several types of entities would be statutorily excluded from the combined return including: (i) corporations not required to file federal income tax returns, (ii) certain non-captive insurance companies, (iii) exempt organizations, (iv) foreign corporations, and (v) corporations with at least 80 percent of their gross income being active foreign business income as defined in IRC section 861(c)(1)(B).

One important aspect in the bill is that the Department must provide a written statement of its findings to the taxpayer if it adjusts the taxpayer’s income or requires a combined return. The written statement shall be provided no later than 90 days after the Department issues a proposed assessment.

House Bill 298 adopts provisions for taxpayers that wish to affirmatively obtain written advice as to whether the Department will require a redetermination of the corporation’s income or whether combined reporting will be required. The guidance must be provided within 120 days of the receipt of any information that may be requested by the Department to make the requested determination. The revised law will take effect upon approval by the Governor and applies to all open tax periods excluding assessments under judicial review by the South Carolina Administrative Law Court, Court of Appeals, or Supreme Court. Please contact Jeana Parker with questions.