04.11.2014 Southeast State & Local Tax: Important Developments - March 2014
The Williams Mullen Southeast State and Local Tax (SESALT) team is pleased to provide you with a comprehensive recap of recent legislation around the U.S.
Conformity with the Internal Revenue Code. Virginia’s date of conformity is January 2, 2013. Virginia will continue to disallow bonus depreciation for certain assets under IRC § 168(k) and income tax deductions related to applicable high yield discount obligations under IRC § 163(e)(5)(F). Virginia also will continue to disallow income tax exclusions related to cancellation of debt income realized in connection with a reacquisition of business debt at a discount after December 31, 2008 and before January 1, 2011. For taxable years beginning on and after January 1, 2013, Virginia fully conforms to the federal domestic production activities deduction under IRC § 199. Va. P.D. 14-18.
- Withholding Taxes. A recent ruling from the Department of Taxation reminds pass-through entities that they must pay a withholding tax on taxable income from Virginia sources that is allocable to a non-resident owner. The amount of withholding tax equals 5% of the nonresident owner's share of income from Virginia sources of all nonresident owners that may be lawfully taxed by Virginia and is allocable to a nonresident owner. The pass-through entity must remit the withholding tax on Virginia Form 502 (Pass-Through Entity Return of Income and Return of Nonresident Withholding). Non-resident owners who file a Virginia Form 763 (Nonresident Income Tax Return) may receive a credit for the amount of income tax withheld by the pass-through entity. Va. P.D. 14-39.
Port-Related Credits. The 2014 General Assembly passed legislation that makes several changes to port-related tax credits, effective January 1, 2014. Among the changes, the International Trade Facility Tax Credit (“ITFTC”) increases from $250,000 to $1.25 million. The threshold for the increased amount of cargo that must be transported through maritime port facilities in Virginia to qualify for the ITFTC is reduced from 10 percent to 5 percent. The annual amount of the Barge and Rail Usage Tax Credit (“BRUTC”) that may be issued is reduced from $1.5 million to $500,000. The legislation also provides that taxpayers may claim the BRUTC and the Port Volume Increase Tax Credit (“PVITC”) for the same cargo, as long as they meet the criteria for both credits. See H.B. 873, Leg. 2014 (Va. 2014); see also Impact Statement.
- Research and Development Expense Tax Credit. Beginning with the 2014 tax year, the annual cap for the Research and Development Expenses Tax Credit increases from $5 million to $6 million. The amount of credits that each taxpayer may claim increases to (i) 15 percent of the first $234,000 in qualified expenses paid or incurred by the taxpayer or (ii) 20 percent of the first $234,000 if the qualified research was conducted in conjunction with a Virginia institution of higher learning. Partnerships, LLCs and S corporations may now elect to receive and claim the credit at the entity level. The sunset date for the credit is extended from December 31, 2015 to December 31, 2018. All changes are effective for taxable years beginning on after January 1, 2014, except that the provisions increasing the annual credit cap are effective for fiscal years beginning on or after July 1, 2014. S.B. 623, Leg. 2014 (Va. 2014) see also Impact Statement.
SALES AND USE TAX
Manufacturing Exemption – Computer Software. The Department of Taxation released guidance regarding sales of computer software programs to manufacturing businesses. The ruling addresses the requirements to claim the manufacturing exemption for hardware and software sales under 23 Va. Admin. Code § 10-210-920, the exemptions for pre-written or custom software under Va. Code § 58.1-609.5, the need to obtain valid exemption certificates in order to claim such exemptions and guidance concerning the taxability of cloud computing services. Va. P.D. 14-42.
- Manufacturing Exemption – Electricity. The Department of Taxation held that the Taxpayer, a manufacturer of electricity, was entitled to the manufacturing and processing exemption under Va. Code § 58.1-609.3. The Department further held that the equipment used in the immediate production of electricity (e.g. the solar panels, inverters, wires, cables and step-up transformers) was entitled to the manufacturing exemption. The racking and mounting equipment, conduit and meters, however, were not entitled to the exemption because they are not an immediate part of the production of electricity and are merely facilitative. In reaching its conclusion, the Department noted its longstanding policy that the production of electricity for sale or resale is a process entitled to the industrial manufacturing and processing exemption. Va. P.D. 14-37.
BUSINESS PROFESSIONAL AND OCCUPATIONAL LICENSE TAX
New Procedure Allows Appeals to Local Commissioners. Effective July 1, 2014, taxpayers may appeal decisions by Virginia localities regarding their BPOL tax classification or sub-classification, regardless of whether the appeal is in conjunction with an assessment, examination, audit or any other action taken by the locality. Taxpayers also will be able to request written rulings from the locality. Under current procedures, BPOL appeals and letter ruling requests must be filed with the Department. Each locality imposing the BPOL tax or fee must maintain on its website the specific procedures that must be followed. H.B. 497, Leg. 2014 (Va. 2014) see also Impact Statement.
- Transactions between Members of Affiliated Group. The Department of Taxation held that three partnerships did not qualify for the exemption to the BPOL under Va. Code § 58.1-3703(C)(10) for transactions between members of an affiliated group. In order to be affiliated, a group of entities must satisfy either the parent-subsidiary test or the brother-sister test. The partnerships did not satisfy the parent-subsidiary test because they did not share a common corporate parent. The partnerships also did not satisfy the brother-sister test, which only applies if the owners are five or fewer individuals, estates, or trusts that satisfy both the total membership and common ownership prongs under 23 Va. Admin. Code § 10-500-50. Va. P.D. 14-20; see also Va. P.D. 13-163.
- Arbitrary Method of Valuation. The North Carolina Court of Appeals upheld the Property Tax Commission’s finding that Union County failed to consider water and sewer availability in its valuation of two parcels of land owned by the taxpayer. Further, the court concluded that the record sufficiently supported the Commission’s finding that Union County’s arbitrary method of assessment resulted in an assessment of the parcels that substantially exceeded the market values of the parcels. The court applied the whole record test and found that the Commission’s findings were rationally based on testimony provided by the appraisal manager of Union County who also was a mass appraiser certified by the State of North Carolina. In the Matter of the Appeal of Pace / Dowd Properties Ltd., N.C. Ct. App., Dkt. No COA13-759 (2014).
- Nexus Created by Lack of Economic Substance with Parent. Maryland’s highest court affirmed a Maryland Court of Appeals decision holding that two-out-of-state subsidiaries with no in-state physical presence were subject to Maryland corporate income tax. According to the court, nexus was established because the subsidiaries did not have economic substance separate from their parent, an entity with operations in Maryland. Among other factors, the court noted that (i) the subsidiaries depended on the parent for their income, (ii) there was a circular flow of money between the subsidiaries and their parent, (iii) the subsidiaries relied on their parent for core functions and services and (iv) there was a general absence of any substantive activity by the subsidiaries that would separate them from the parent. Gore Enterprise Holdings, Inc v. Comptroller of the Treasury, Md. Ct. App. No. 36 Sept. Term 2013 (2014).
DISCTRICT OF COLUMBIA
- Contingent Settlement in Online Travel Companies Litigation. DC Attorney General Irvin B. Nathan announced that his office has reached a contingent settlement with six major online travel companies (OTCs). If the DC Court of Appeals affirms a Superior Court ruling in favor of the District, the OTCs will pay the District $60.9 million plus interest for sales tax on hotel rooms booked online. The Superior Court’s ruling established liability dating back over a decade. The case alleged that OTCs were selling DC hotel rooms at retail prices, but were remitting hotel room taxes based on the lower wholesale prices that the OTC paid to District hotels. The Superior Court issued a summary judgment order holding that the District was entitled to receive taxes on hotel rooms based on the OTC’s retail prices, rather than their wholesale prices. Press Release, Office of the DC Attorney General (Feb. 24 2014).
AROUND THE NATION
- Online Travel Companies Not Liable for Transient Occupancy Tax in California. California’s Second Appellate District Court of Appeals held that San Diego’s Transient Occupancy Tax does not apply to amounts charged by online travel companies (“OTC”). The City’s ordinance imposes tax only on rent charged by a hotel operator. The City argued that the rent for hotel rooms should not be limited to the wholesale rate charged by the hotel operator and should instead include the OTC’s markup as part of the total charged to the customer. The Court of Appeal rejected the City’s argument and found that the tax base did not include the service fees charged by the OTC for its services. In re Transient Occupancy Tax Cases, Cal. Ct. App. Dkt. No B243800 (March 27, 2014)