At its Fall Meeting in Nashville, Tennessee on December 11-12, the MTC’s Executive Committee voted to formally contact states to solidify whether there is sufficient financial commitment to fund any potential MTC transfer pricing program. The MTC also formally announced that Iowa, Pennsylvania and Rhode Island will join the MTC audit program. Additionally, the MTC’s Uniformity Committee voted to use the Massachusetts draft market sourcing regulations as its starting point for the MTC’s own model regulations and worked on its “Engaged in Business” Model Statute.
Transfer Pricing Expertise
The MTC’s Arm’s-Length Adjustment Service (ALAS) was organized in June 2014 to develop a state program to address state transfer pricing issues. While largely dominating the international tax arena, transfer pricing has recently been thrust on to the radar of states’ tax departments. Led by Joe Garrett as chair of the group and facilitated by Dan Bucks, ALAS has identified the lack of economic expertise as the primary roadblock to addressing transfer pricing issues.
It is no surprise, then, that ALAS presented a Preliminary Design Document with a cornerstone of using third-party firms to rebut taxpayer reports supporting their intercompany transactions. By hiring these firms, the MTC seeks to ensure that intercompany transactions are conducted at arm’s-length. The second major component of the Preliminary Design is to develop state expertise in transfer pricing issues through MTC-led trainings. ALAS predicts that if green-lit by the MTC and the states, states could “conservatively” recoup approximately $25 million annually.
Importantly, ALAS noted that experienced review of company transfer pricing agreements would be useful to combined reporting states because they are, in many instances, an admission of a unitary relationship. During the ALAS presentation, Bucks noted that one of the states that recently joined the MTC audit program (PA, RI, and IA) joined the audit program because of the potential to leverage transfer pricing expertise.
ALAS is still eyeing a July 2015 launch date, and its presentation to the Executive Committee today is the next step to that goal. One key obstacle to ALAS reaching its goal is obtaining a critical mass of participating states. The Executive Committee voted to accelerate targeted outreach to states to build the number of participating states. One goal of the outreach is to determine whether there is enough interest in funding what could be a very expensive undertaking.
Market Sourcing Regulations
The MTC Uniformity Committee took a major step toward drafting its model market sourcing rules when it voted to use the proposed Massachusetts regulation as a starting point. The Massachusetts Department of Revenue released draft regulations earlier this year on the State’s new market-based sourcing law. Massachusetts switched from cost-of-performance to market-based sourcing for purposes of “sales other than sales of tangible personal property” in the sales factor of the corporate income tax in 2013. The new law takes effect for tax years beginning on or after January 1, 2014, and made Massachusetts one of the first states to adopt almost verbatim the proposed MTC rewrite for Section 17 of the Uniform Division of Income for Tax Purposes Act (UDITPA). The regulation provides guidance for taxpayers to apportion sales of real property, services and intangibles. The lengthy regulation provides more detail than any other state regulation to date on market sourcing rules and covers topics such as licensing of marketing intangibles; licensing of production intangibles; sales of intangible property; services delivered to individuals; services delivered to businesses; and digital services. Massachusetts Department of Revenue employees have led the MTC’s Working Group, and to date, the Massachusetts regulation has helped forge much of the MTC’s discussion. The Committee’s vote solidifies the link between the Massachusetts regulation and the development of the MTC’s regulation.
Model Nexus Statute
The Sales and Use Tax Subcommittee established a Model Sales and Use Tax Nexus Statute Working Group in 2013 in an attempt to create a model uniform statute for states to enact a click-through nexus statute, which New York and several other states have enacted since 2008. The Working Group expanded its initial scope beyond click-through nexus to consider other potential nexus-creating activities, such as the presence of a related entity in the state. The advanced sales tax model nexus statute has both click-through nexus and affiliate nexus standards for establishing that a retailer is “engaged in business” in a state.
For the click-through nexus provision, a retailer is presumed to be engaged in business if the retailer enters into an agreement with an in-state resident to refer potential purchasers to the retailer for a commission or other consideration. The cumulative gross receipts from such referrals by all in-state residents with referral agreements with the retailer must be greater than an unspecified dollar threshold during the immediately preceding 12 months. The model statute also contains what the Working Group calls an “exclusion for advertising,” which concludes that delivering advertising services alone into a state would not constitute doing business.
The affiliate nexus provision attributes nexus to an out-of-state retailer based upon the activities of a related party in a state. Parties are related if the retailer and other persons are in the same controlled group under IRC § 1563, are related under IRC § 267, or meet a 50% profits, capital, stock or value threshold test. The model statute’s most aggressive provision establishes that a retailer is engaged in business in a state if a related party uses the same or substantially similar trademarks, services marks or trade names. At least one court has held that attributing nexus based on the use of common marks is unconstitutional. See St. Tammany Parish Tax Collector v. Barnesandnoble.com, 481 F. Supp. 2d 575 (E.D. La. 2007). Additionally, the model statute vaguely attributes the temporary activities of an independent contractor in the state to a retailer, but this language may be altered when the Working Group makes its tweaks. The model also concluded that a retailer is engaged in business if the retailer, by agreement, has a related party that owns or leases real or tangible personal property or performs services in connection with in-state sales.
ALAS will meet again early next year. The market-based sourcing Working Group continues to meet once a week and will seemingly place more reliance on the Massachusetts regulation. The Working Group will make the tweaks in the coming weeks with the intention of bringing the model nexus statute before the Executive Committee in May 2015. If the Executive Committee acts upon the recommendation of the Uniformity Committee and advances the model statute, then a formal public hearing will be conducted on the model statute.