Yesterday, the Multistate Tax Commission (MTC) held meetings of its Litigation, Uniformity, and Strategic Planning Steering Committees. The meetings were generally dominated by discussions of evolving apportionment issues, including litigation and significant edits to existing regulations. The Uniformity Committee also advanced its new model “engaged in business” statute.
Litigation Committee Updates
The Litigation Committee heard a presentation on and generally discussed the sourcing of digital goods. Initially focusing on sales tax sourcing, the Committee reviewed the current sourcing rules in both Streamlined Sales and Use Tax Agreement states and non-Streamlined states. The Committee also discussed sourcing rules under the proposed Digital Goods and Services Tax Fairness Act (S. 851). After discussing sales and use tax sourcing, the Committee turned to how to include digital goods in the sales factor. The MTC’s proposed Section 17 regulations are modeled on the Massachusetts sourcing rules and would impose a market sourcing regime. See our prior coverage for more information on the proposed Section 17 language.
The Litigation Committee also reviewed the extensive equitable apportionment litigation and predicted what the future might bring. The potential adoption of market-based sourcing in proposed Section 17 could mean an entirely new round of issues that could be ripe for equitable apportionment litigation under Section 18. Among those issues the Committee expects might be litigated under new sourcing regimes include issues related to defining the “market,” the possible distortion that single sales factor apportionment can create by excluding property and payroll factors from the apportionment formula, unanticipated sourcing issues, and situations where a taxpayer has “functional test” income but little or no “transactional test” income.
Uniformity Committee Updates
During the Uniformity Committee meeting, the Section 1 workgroup reported on its proposed edits to the existing MTC Uniform Division of Income for Tax Purposes Act (UDITPA) regulations. Section 1 of the Compact contains definitions and was amended last year to change the definition of business income. The draft regulation’s proposed changes added language to the definition of “apportionable income” to specify that it is all income apportionable under the United States Constitution, reorganized the structure of some definitions, and inserted new examples. The workgroup recommended conforming the regulations by universally using the terms “apportionable income,” “non-apportionable income,” and “receipts” for the terms “business income,” “nonbusiness income,” and “sales” throughout all of the UDITPA regulations (and not just those in the Section 1 regulations). Although no formal vote was taken, the Committee generally advised the workgroup to maintain a so-called five-year rule for determining when a business asset transitions to an investment asset. Under the current draft, property which has been withdrawn from use in the taxpayer’s trade or business for more than five years is presumed to be held for investment purposes. The Committee also advised the workgroup to keep in the definition of “receipts” a list of income that is presumed not to be “receipts.” Finally, the Committee requested that the workgroup give additional consideration to inserting new definitions. Potential new defined terms include “hedging,” “securities,” and “non-apportionable receipts.” The workgroup will reconvene to address the terms “gross receipts” and “trade or business.”
As expected, the Section 17 workgroup presented its model market-based sourcing regulations, which are largely based on Massachusetts regulations (830 CMR 63.38.1). The proposed language makes significant changes to the sourcing rules for receipts from sales of other than tangible personal property. The language specifies that income from marketing intangibles (for instance, trademarks) is only included in the denominator of the sales factor if the income is from a United States source (unless the licensor can demonstrate the extent to which the intangibles are used in foreign markets). The language also proposes a throw-out rule for income from marketing intangibles. Income from production intangibles (like copyrights, patents and trade secrets) is sourced to its place of actual use, if known, or if unknown, to the commercial domicile of the licensee. If a license also involves a digital good, then the sale will be sourced according to the rules for digital goods.
Sales of a contract right or government license are sourced to the state in which the right may be exercised. If an intangible does not fit within the listed sourcing rules, then it is excluded from both the numerator and the denominator of the receipts factor. The draft regulations separately address the sourcing of income from sales of digital goods. Sales of pre-written software delivered electronically and digital goods and services are sourced as if they were a service delivered electronically (that is, sourced to the place of use or delivery, depending on the identity of the customer).
The Section 17 workgroup asked the Uniformity Committee for guidance on several questions, including (1) whether examples should be included in the regulations, (2) whether “credit card processing services” should be included in the definition of professional services, (3) whether to include a de minimis rule for administrative and compliance receipts, (4) whether to address foreign tax haven jurisdictions in defining “subject to tax,” (5) how to handle the interaction of Section 17 and Section 18 (equitable apportionment), and (6) how to address related party transactions.
The Committee advised the workgroup to keep the existing examples in the regulations, reasoning that states are free to remove the examples if they wish. The Committee members agreed that “credit card processing services” should be included as a professional service. In the Committee’s opinion, this was not a change in policy, but rather a clarification that the “lending and credit card services” in the current definition of professional services include both extending credit to borrowers and processing credit card transactions. After discussing compliance benefits and the policy reasons for a de minimis rule for a small percentage of receipts, the Committee did not provide any instruction to the workgroup on this issue. Similarly, the Committee left the issues of defining “subject to tax,” the interaction between Section 17 and Section 18, and how to address related party transactions open for now.
The workgroup formed to address the Model Sales and Use Tax Nexus Statute referred its proposed language to the Uniformity Committee for consideration. The language includes a click-through nexus provision with a rebuttable presumption and a minimum threshold. This draft does not impose a collection duty on marketplace providers, but rather attributes nexus to a seller that uses a provider that engages in certain listed activities in the state. The Committee voted to move this item forward to the Executive Committee, which meets tomorrow, July 30.
Strategic Planning Steering Committee Updates
The Nexus Committee asked the Strategic Planning Steering Committee to charter a new project to investigate the creation of an information-sharing program among member states. The Steering Committee approved the development of a project description, which will be undertaken by members of the Nexus Committee. After the project description is completed, the Steering Committee will vote on whether to allow the project to move forward.