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2017 NYU SALT Institute

Review and Preview of Federal Constitutional Issues

December 4, 2017Jeffrey A. FriedmanPartner, Eversheds Sutherland (US)

Richard D. PompProfessor of Law, University of Connecticut School of LawAdjunct Professor of Law, New York University School of Law

− Nexus

− Discrimination

− Fair Apportionment

− Tax Injunction Act

− First Amendment

− Other Developments

Agenda

Nexus

South Dakota v. Wayfair, Inc., et al., No. 28160-a-GAS (S.D. Sept. 13, 2017)

Nexus – Recent Petition

─ On March 22, 2016, South Dakota enacted S.B. 106, which asserts nexus against remote sellers with $100,000 gross revenue from annual sales in the state or 200 separate transactions involving delivery into the state, effective May 1, 2016.• The law allowed expedited court proceedings to address the law’s

constitutionality and precluded enforcement until the law’s constitutionality was resolved.

─ South Dakota then filed a declaratory judgment action against remote sellers with no physical presence in the state.

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South Dakota v. Wayfair, Inc., et al., No. 28160-a-GAS (S.D. Sept. 13, 2017)

Nexus – Recent Petition

─ On March 6, 2017, the South Dakota Sixth Judicial Circuit Court ruled in favor of the remote sellers because the sellers lack physical presence in South Dakota, under Quill. The court held that S.B. 106 fails to satisfy Quill’s physical presence requirement and its application of the Commerce Clause.

─ On September 13, 2017, the South Dakota Supreme Court upheld the lower court’s holding that S.B. 106 is unconstitutional under Quill and stated that “[h]owever persuasive the State’s arguments on the merits of revisiting the issue, Quill has not been overruled.”• The court saw “no distinction between the collection obligations

invalidated in Quill and those imposed by S.B. 106.”

─ Petition for a writ of certiorari filed on October 3, 2017 (No. 17-494).

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Crutchfield, Inc. v. Harding, No. CL17001145-00 (Va. Cir. Ct., filed Oct. 24, 2017)

Nexus

─ On September 22, 2017, the Massachusetts Department of Revenue adopted 830 CMR 64H.1.7.• Effective October 1, 2017, the regulation requires an Internet vendor

with a principal place of business outside of Massachusetts to register, collect, and remit sales and use tax if the vendor has more than $500,000 in Internet sales into the state and 100 or more sales into the state during the previous 12 months.

─ The regulation provides that the following activities constitute an in-state physical presence:1) Property interests in and/or the use of in-state software (e.g.,

apps) and ancillary data (e.g., cookies) distributed to or stored on in-state customers’ computers or devices;

2) Contracts and/or relationships with content distribution networks resulting in use of in-state servers and other hardware and/or related in-state services; and/or

3) Contracts and/or relationships with marketplace facilitators, and/or delivery companies resulting in in-state services.

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Crutchfield, Inc. v. Harding, No. CL17001145-00 (Va. Cir. Ct., filed Oct. 24, 2017)

Nexus

─ On October 24, 2017, Crutchfield, Inc. filed suit in Albemarle County Circuit Court in Virginia, where it is headquartered, against the Massachusetts Department of Revenue challenging the validity of the regulation.

─ The taxpayer argues that the regulation is “invalid and of no legal effect” because it violates the Commerce Clause and the federal Internet Tax Freedom Act (ITFA).

─ Virginia law permits a Virginia business to file suit to prevent another state from collecting and remitting sales and use tax that constitutes an undue burden on interstate commerce in violation of the Commerce Clause.

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Irwin Naturals v. Dep't of Revenue, 382 P.3d 689, (Wash. App. Ct 2016), review denied, 388 P.3d 1256 (Wash. 2017), cert. denied, No. 17-91 (Oct. 2, 2017)

Nexus – Recently Denied Petition

─ The US Supreme Court declined to review a Washington Supreme Court’s decision denying review of a lower court opinion that the Commerce Clause did not prohibit the state from imposing the B&O tax or requiring the taxpayer to collect sales taxes.

─ The lower court rejected the taxpayer’s argument that the Commerce Clause prohibited the state from imposing the B&O tax and from sales tax collection because the taxpayer’s retail sales were dissociated from its in-state wholesale activities.

8

Target Brands, Inc. v. Dep’t of Revenue, No. 2015CV33831 (Colo. 2nd Dist. Ct. Jan. 20, 2017)

Nexus

─ A Colorado district court found that despite lacking any physical presence in Colorado, Target’s wholly-owned subsidiary, TBI, that managed Target’s brands had substantial nexus in Colorado because its IP licenses were used there.

─ The court determined that TBI was “doing business” in the state by: • Choosing to license its IP for use by Target in Colorado; • Relying on Target to present TBI’s IP in the best possible light in

the state; and • Receiving hundreds of millions of dollars in income related to the

use of its IP in Colorado.

─ The court found that Colorado’s assertion of authority over TBI did not violate the Commerce Clause.

9

Scholastic Book Clubs, Inc. v. Riley, No. 155237 (Ga. Tax Tribunal Feb. 14, 2017)

Nexus

─ The Tax Tribunal held that Scholastic, a remote seller with limited connections to Georgia, has nexus in Georgia and must collect sales tax.

─ The tribunal held that Scholastic has constitutional nexus “through its reliance on Georgia [teachers] to solicit and maintain a market in Georgia.”

─ The tribunal rejected Scholastic’s argument that it lacked a physical presence in the state under Quill, finding that the teachers’ presence could be attributed to Scholastic for constitutional nexus purposes.

─ The tribunal’s decision puts Georgia in line with Alabama, Connecticut, California, Kansas and Tennessee, and at odds with Michigan, Arkansas and Ohio.

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Discrimination

Fl. Dep’t of Revenue v. DIRECTV, Inc., 215 So.3d 46 (Fl. Apr. 13, 2017), cert. filed, No. 17-379 (Sept. 12, 2017)

Discrimination – Recent Petition

─ Satellite companies brought action against the Florida Department of Revenue arguing that a provision of the Communications Services Tax Simplification Law imposing a 6.8% tax rate on cable service and a 10.8% tax rate on satellite service is unconstitutional for favoring cable companies.

─ The Florida Supreme Court held that satellite and cable companies were similarly situated, but the different treatment of the providers did not violate the dormant Commerce Clause because both providers' services were interstate in nature.

─ Certiorari denied by the US Supreme Court in DIRECTV, LLC v. Mass. Dep’t of Revenue, 470 Mass. 647 (Mass. 2015), cert. denied, No. 14–1499 (Nov. 2, 2015) and DIRECTV, Inc. v. Roberts, 477 S.W.3d 293 (Tenn. Ct. App. 2015), cert. denied, No. 14–1524 (Nov. 2, 2015). Both cases held that cable and satellite providers are not similarly situated.

12

CSX Aftermath – Disparity Allowed in Alabama & TennesseeDiscrimination

─ In March 2015, the US Supreme Court held that a tax disparity is permissible under the 4-R Act if the competitors are subject to another “roughly comparable” tax from which the rail carrier is exempt or if the state offers another sufficient justification. Ala. Dep’t of Revenue v. CSX Transp., Inc., 135 S.Ct. 1136 (2015).

CSX Transp., Inc. v. Ala. Dep’t of Revenue, No. 2:08-cv-00655-AKK, 2017 WL 1164766 (N.D. Ala. 2017), appeal filed, No. 17-11705 (11th Cir. Apr. 14, 2017)─ On remand, the district court found that Alabama did not force rail

carriers to use dyed diesel and sales tax and fuel-excise tax paid by motor carriers were roughly equivalent to tax paid by rail carriers, and thus Alabama's tax scheme did not violate the 4–R Act.

Ill. Cent. R.R. Co. v. Tenn. Dep't of Revenue, No. 3:10-cv-00197, 2017 WL 1347269 (M.D. Tenn. Apr. 12, 2017), appeal filed, No. 17-5553 (6th Cir. May 15, 2017)─ On remand, the US District Court for the Middle District of

Tennessee held that Tennessee’s 7% sales tax on railroad carriers for railroad fuel purchases was not discriminatory under the 4-R Act because motor carriers are subject to a comparable 18.4% excise tax on motor carrier fuel.

13

S. California Edison v. Nev. Dep't of Taxation, 398 P.3d 896 (Nev. July 20, 2017)

Discrimination

─ The Nevada Supreme Court held that although a state statute exempting only minerals mined in-state from use tax was unconstitutional for violating the dormant Commerce Clause, the utility company was not entitled to a refund because it did not demonstrate the existence of substantially similar competitors that were advantaged by the unconstitutional tax.

─ The court found that all coal-fired power companies in Nevada are subject to use tax for out-of-state coal purchases because Nevada mines do not produce commercially viable coal.

─ The court declined to consider other energy producers to be similarly situated competitors.

14

D & H Distributing Company v. Comm’r of Revenue, 79 N.E.3d 409 (Mass. July 31, 2017)

Discrimination

─ The Massachusetts Supreme Judicial Court held that in-state wholesalers are obligated to collect and remit sales tax on products sold to out-of-state retailers and then delivered to in-state customers (drop shipment sales).

─ The court also held that the state’s drop shipment rule does not violate the dormant Commerce Clause because the same sales tax will be applied if the transaction occurs entirely within the state.

─ Transactions subject to sales tax under the drop shipment rule (as retail sales) are exempt from use tax.

15

Genentech, Inc. v. Comm’r of Revenue, 476 Mass. 258 (Mass. Jan. 12, 2017)

Discrimination

─ The Massachusetts Supreme Judicial Court upheld the Appellate Tax Board’s decision that a drug producer was a qualified manufacturer and was required to use the state’s single sales factor apportionment formula.

─ In determining that the drug producer’s manufacturing receipts are substantial, as is required to determine a “manufacturer,” the court declined to include receipts from the redemption of short-term investments by the company’s treasury department.

─ The court also found that the application of the single-factor formula did not unconstitutionally discriminate against interstate commerce.

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Fair Apportionment

Shared Imaging, LLC v. Hamer, No. 1-15-2817 (Ill. App. Ct. June 28, 2017)

Fair Apportionment

─ The Appellate Court of Illinois held that Illinois use tax was fairly apportioned under Complete Auto Transit even though the taxpayer’s property was stored in Illinois and used outside the state.

─ The taxpayer was engaged in the business of leasing trailers and other mobile equipment outfitted with medical devices and instruments. The taxpayer leased its equipment to customers both within and outside of Illinois.

─ The court concluded that the existence of a credit provision, which allows a tax credit for sales and use tax paid to another state, satisfied the fair apportionment requirement of the Complete Auto Transit test because “the danger of multistate taxation is averted.”

18

Upper Moreland Twp. v. 7 Eleven Inc., 160 A.3d 921 (Pa. Commw. Ct 2017)

Fair Apportionment

─ A Pennsylvania township’s application of its local privilege tax on 100% of 7-Eleven’s receipts from franchise stores in Pennsylvania is found to violate the fair apportionment prong of the Complete Auto Transit test because the activities that generated those receipts resulted from interstate economic activities.

─ The court found that the receipts were at least partially from interstate commerce – e.g., receipts from support services that came from 7-Eleven’s corporate headquarters in Texas.

19

Matkovich v. CSX Transportation, Inc., 793 S.E.2d 888 (W.V. 2016), cert. denied, No. 16-1251 (Oct. 2, 2017)

Other Complete Auto Transit Test Cases

─ The US Supreme Court declined to review a West Virginia Supreme Court of Appeals’ decision in favor of the taxpayer, a Virginia corporation that operates an interstate rail transportation system with trains and rail yards running throughout West Virginia.

─ The Court held that a use tax credit must be granted to an interstate company for sales taxes paid to the municipalities of other states on purchases of motor fuel.

─ The Court ruled that the Tax Commissioner’s interpretation that the credit was only available if sales taxes were paid to other states, but not states’ subdivisions (e.g., cities, counties, etc.), violates the dormant Commerce Clause because it fails the fair apportionment and discrimination prongs of the Complete Auto test.

20

ETC Mktg. Ltd. v. Harris Cnty. Appraisal Dist., No. 15-0687 (Tex. Apr. 28, 2017)

Other Complete Auto Transit Test Cases

─ The Texas Supreme Court held that a county's ad valorem tax on natural gas stored for interstate resale does not violate the Commerce Clause after finding the tax met all four prongs of the Complete Auto Transit test.

─ The court reasoned that:• The gas has substantial nexus with the county because it was not

merely in transit through the county;• The tax was fairly apportioned because it was limited only to the

amount of gas in the county on a certain day;• The tax does not discriminate against interstate commerce

because it applies equally to gas that will be sold in the state and gas that will be sold outside the state; and

• The tax is fairly related to services provided by the state because the stored gas benefits from services (specifically, fire department services).

21

Tax Injunction Act

Tax Injunction Act – Recently Denied Petition

─ The US Supreme Court declined to review the 8th Circuit Court of Appeals’ decision upholding the district court’s order dismissing the company’s action as barred by the Tax Injunction Act (TIA).

─ The company argued that its suit was not barred by the TIA because its claim was that the imposition of Ohio’s Commercial Activities Tax in this case was barred by Public Law (P.L.) 86-272.

─ The Court of Appeals rejected the company’s argument finding that P.L. 86-272 “does not explicitly provide for exclusive federal jurisdiction, and numerous appellate state court decisions have applied [P.L. 86-272] to specific state tax cases.”

23

Diversified Ingredients, Inc. v. Testa, 846 F.3d 994 (8th Cir. 2017), cert. denied, No. 16-1266 (June 12, 2017)

Islamic Ctr. of Nashville v. Tennessee, 872 F.3d 377 (6th Cir. Sep. 20, 2017)

Tax Injunction Act

─ The 6th Circuit Court of Appeals held that the TIA barred a religious nonprofit organization from bringing a suit in federal court over the state’s denial of an application for a retroactive property tax exemption.

─ Despite the federal grounds for the suit, federal jurisdiction was not appropriate under the TIA because Tennessee provided an efficient alternative for an appeal.

24

First Amendment

Expressions Hair Design v. Schneiderman, 137 S.Ct. 1144 (Mar. 29, 2017)

First Amendment – Recent Decision

─ In a unanimous ruling, the US Supreme Court ruled that a New York statute, which prohibits identifying a surcharge to customers for credit card payments, regulates speech and is therefore subject to heightened scrutiny.

─ The case was remanded to the 2nd Circuit Court of Appeals to determine whether New York’s statute violates the First Amendment.

─ The decision likely implicates state and local tax laws that either prohibit or require taxpayers to identify taxes and fees in customer invoices.

26

S&P Global Inc. f/k/a McGraw-Hill Financial, Inc. v. New York City Tax Appeals Tribunal, 2017 NY Slip Op. 01448 (1st Dep’t, Feb. 23, 2017)

First Amendment

─ The Appellate Division affirmed a lower court’s decision holding that McGraw-Hill’s receipts from its credit rating business were receipts arising from the performance of services and sourced to where the services were performed, rejecting a characterization of “other business receipts” which would be sourced to where the receipts were earned.

─ The Appellate Division also upheld that McGraw-Hill did not have a First Amendment right to source its credit ratings receipts for New York City general corporation tax purposes using an “audience-based” methodology similar to that available to publishers and broadcasters because the court found the City “did not seek to impose a different sourcing method for the same type of revenue, namely, advertising, against different members of the press engaged in a substantially similar business.”

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Other Developments

In the Matter of S&P Global Inc. f/k/a McGraw-Hill Financial, Inc., No. 825598 (N.Y. Div. Tax App. Nov. 16, 2017)

Agreement Tax Savings Limitation

─ The New York Division of Tax Appeals (DTA) found that a New York tax savings limitation provision in an agreement between the taxpayer and the Division of Taxation (DOT) is limited to corporate franchise tax under N.Y. Tax Law § 209, and did not apply to Metropolitan Transportation Authority (MTA) surcharge tax under Tax Law § 209-B.• In 1997, the taxpayer and the DOT entered into an agreement, which

included a discretionary adjustment methodology to calculate the taxpayer’s business allocation percentage. The agreement included a New York tax savings limitation, providing that “[a]ny annual New York tax savings arising from [the discretionary adjustment methodology] shall not exceed $6.8 million.”

─ The DTA held that the taxpayer’s MTA surcharge tax savings are the mechanical result of applying the statutory MTA surcharge tax calculation and not the result of applying the discretionary adjustment methodology.

─ Therefore, the MTA surcharge tax savings did not fall within New York tax savings limitation imposed by the agreement.

29

JetSuite Inc. v. Los Angeles Cnty., No. B279273 (Cal. Ct App. Oct. 10, 2017)

Situs – Due Process v. Commerce Clause

─ The California Court of Appeal held that the state had the authority to tax the full value of jets owned by an air taxi service, as the jets did not establish taxable situs outside of California when they touched down in other states.

─ Landing in other states, without more, does not give those states taxable situs over the jets under the traditional due process test for situs.

─ The court rejected the taxpayer’s argument that the internal consistency doctrine requires application of California’s special situs rule for fractionally owned aircrafts (versus single owner aircrafts) to all aircrafts because situs is a function of due process, not the dormant Commerce Clause.• The court further explained that the Due Process Clause and

Commerce Clause reflect different constitutional concerns and “a test from one cannot be imported willy nilly to the other.”

30

Dulles Duty Free, LLC v. County, 803 S.E.2d 54 (Va. Aug. 24, 2017)

Import-Export Clause

─ The Supreme Court of Virginia found that a county's imposition of a Business, Professional, and Occupational License (BPOL) tax on the gross receipts of an airport duty-free store violated the Import–Export Clause.

─ The store made 90% of its sales to international customers, and the imposition of the BPOL tax on its gross receipts was in its “operation and effect” a direct tax on the export goods in transit.

─ The BPOL tax could however be applied to the store's domestic sales.

31

Matter of Bayerische Beamtenkrankenkasse AG, No. 824762 (NYS Tax App. Trib., Sept. 11, 2017)

Tax Treaties

─ The court reversed the Administrative Law Judge's determination and found that the Division of Taxation’s attempt to use alternative apportionment for a German company, which provided non-life insurance services in Europe and invested in real estate investment partnerships in New York during the tax years at issue, was improper under New York tax law because such use conflicts with the United States-Germany tax treaty.

─ The petitioner asserted that impermissible discrimination under the treaty did not require less favorable treatment, but more broadly prohibits taxation that is “other or more burdensome” than the taxing requirements imposed on the taxing country’s nationals. • The court found that the ordinary meaning of “other or more

burdensome” includes different treatment and accordingly, the petitioner did not need to prove that an alternative liability calculation would result in a lower tax than that asserted in the notice of deficiency.

32

Franchise Tax Bd. v. Hyatt, No. 53264, 2017 WL 4079069 (Nev. Sept. 14, 2017)

Full Faith and Credit Clause

─ In 2016, the US Supreme Court effectively affirmed that the Nevada courts had jurisdiction to hear suit against another state’s agency. The Court also held that that Nevada could not allow awards against out-of-state agencies that are greater than it could award against in-state agencies. Franchise Tax Bd. v. Hyatt, 136 S.Ct. 1277 (2016).

─ On remand, the Nevada Supreme Court held that the California Franchise Tax Board (FTB) was not entitled to immunity from an individual taxpayer's bad-faith tort claims and, therefore, was liable for damages due to fraud and intentional infliction of emotional distress.

─ However, the court held that the FTB was entitled to Nevada’s statutory damages cap of $50,000 and immunity from punitive damages “to the same extent that a Nevada government agency would receive statutory caps under principles of comity.”

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This communication cannot be used for the purpose of avoiding any penalties that may be imposed under federal, state or local tax law.

Contact Us

Jeffrey A. FriedmanPartner Eversheds Sutherland (US) LLP202.383.0718JeffFriedman@eversheds-sutherland.com

Richard D. Pomp Professor of Law, University of ConnecticutAdjunct Professor of Law, New York University860.570.5251richard.pomp@law.uconn.edu