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New York: High court ruling may have far reaching implications for remote sellers

In what may be viewed as a departure from long-standing U.S. Supreme Court precedent by many jurists, New York’s highest court ruled in favor of a controversial remote seller law last month. The underlying law in dispute was used to impose the obligation to collect sales tax on remote sellers who only conducted business through the Internet in New York and had no employees within the state.

The relevant portion of the law reads:

…a person making sales of tangible personal property or services taxable under this article (“seller”) shall be presumed to be soliciting business through an independent contractor or other representative if the seller enters into an agreement with a resident of this state under which the resident, for a commission or other consideration, directly or indirectly refers potential customers, whether by a link on an internet website or otherwise, to the seller[.]

Amazon and Overstock.com, both appellants in the case (“Online Retailers”), argued that physical presence was required in New York in order for New York to require Online Retailers to collect New York sales tax. Neither Online Retailer had a physical presence or employees in New York. Both Online Retailers offered an “Associates Program” through which third parties (the “Associates”) agreed to place links on their own websites that, when clicked, directed users to the respective Online Retailer’s website. The Associates were compensated on a commission basis by receiving a percentage of the revenue from sales generated when a customer clicked on the Associate's link and completed a purchase from the respective Online Retailer’s site. The governing agreement for each Online Retailer stated that the Associates were independent contractors and not employees. Many of these Associates provided New York addresses when applying to the Associates Program.

The court was not convinced by the Online Retailers’ argument that the law was unconstitutional. The primary substance of Online Retailers’ arguments was that the law was in violation of the Commerce Clause because it subjected remote online sellers (without physical presence in New York) to New York sales taxes.

One of the primary U.S. Supreme Court cases cited in remote seller circumstances is Quill Corp. v. North Dakota (504 U.S. 298 (1992)). Quill Corp. held that the bright line test – “[w]hether or not a State may compel a vendor to collect a sales or use tax may turn on the presence in the taxing State of a small sales force, plant, or office” – was still valid.

However, in New York, the court held that the “presence requirement will be satisfied if economic activities are performed in New York by the seller’s employees or on its behalf.” This conclusion was reached despite the fact that physical presence was not typically associated with a website where the location of the server was remote. Through the statute cited above, the court reasoned that the New York Legislature believed there is significance to the physical presence of a resident website owner.

As discussed in our previous Multistate Tax Alerts, the Marketplace Fairness Act of 2013 introduced in Congress, is an attempt by Congress to level the playing field for remote sellers. Based on this ruling, it appears that New York is being aggressive by pursuing remote sellers related to sales being made into the state. Consequently, we will need to watch and see if other states follow New York’s lead and attempt to expand the bright line test validated in Quill. 

Click here to read the Overstock.com, Inc. v. New York State Dept. of Taxation and Finance decision.

California: Proposed legislative fix for retroactive tax on sale of qualified small business stock

An amended bill (S.B. 209) has been introduced in the California Senate which would provide a legislative fix for retroactive tax assessments that may be imposed on as many as 2,500 California investors who benefited from an unconstitutional income tax exclusion from the sale of Qualified Small Business Stock (QSBS) during tax years 2008 and later.

For almost 20 years, California tax law provided for the deferral or partial exclusion of gain from the sale or exchange of QSBS. Several requirements must be satisfied in order to be eligible for such deferral or exclusion, including that at least 80 percent of the corporation’s payroll at the time the stock was acquired was within California and at least 80 percent of the assets and payroll were within California during the taxpayers holding period for the stock.

In August of 2012, the California appellate court held in Cutler v. Franchise Tax Board (Cal. Ct. App., No. B233773, 8/28/12) that the California QSBS law discriminates on its face against interstate commerce in violation of the dormant commerce clause. The court found that discrimination exists because the law allows a deferral of income from the sale of stock in corporations maintaining assets and payroll in California, but does not provide the same deferral of income from the sale of stock in corporations maintaining assets and payroll outside of California.

The California Franchise Tax Board (FTB) interpreted Cutler as invaliding the entire California QSBS law. The FTB has determined that the only way it can remedy such discrimination is to require taxpayers who took the exclusion or deferral under the QSBS law in years still open for assessment under the four-year statute of limitations (generally 2008 and later) to pay tax and interest on those gains.

In order to avoid such retroactive taxes, Senator Ted Lieu has introduced S.B. 209, as amended, which would remove the provisions in the QSBS law, which provided that the deferral or partial exclusion of gain from the sale of QSBS only applied if the corporation maintained at least 80 percent of its assets and payroll within California during the period in which the investor held the stock. The bill differs from the FTB’s interpretation of the Cutler ruling by keeping the provisions in the QSBS law requiring that in order to qualify for the tax benefit, the corporation must have at least 80 percent of its payroll within California at the time the stock is acquired.

By keeping this 80 percent California payroll requirement at the time the stock is acquired, the bill would prevent the FTB from issuing retroactive tax assessments for tax years 2008 and later to taxpayers who met this requirement. At the same time, this QSBS tax benefit would not be available to California taxpayers who invested in corporations that did not meet this 80 percent California payroll requirement, which would have been a costly possibility for the state.

The proposed amended QSBS law would apply to sales made after August 5, 1997, and before January 1, 2013, and to sales made on and after January 1, 2016. The purpose of this three-year exclusion of the QSBS tax benefit is to cover the foregone revenue from no longer assessing the retroactive taxes, as well as covering the cost of refunds that may be issued to taxpayers who were originally denied such QSBS tax benefit because they did not meet the unconstitutional requirement that 80 percent of the assets and payroll of the corporation be maintained in California during the holding period of the stock.

However, until this or other legislation is passed on this issue, the FTB’s policy of assessing the retroactive taxes on the excluded or deferred gain from the sale of QSBS is still in effect. This month, the FTB began sending notices of proposed assessments to taxpayers who claimed such exclusions or deferral on their 2008 tax returns.

The bill is currently with the California Senate Rules Committee. 

Click here for the full text of S.B. 209.

North Carolina: New bill would simplify state business tax structure

S.B. 363, if enacted, would simplify North Carolina’s current business tax structure and create greater uniformity between the taxation of entities with limited liability. It would accomplish this by:

  • Eliminating privilege taxes;
  • Repealing franchise taxes; and
  • Replacing franchise taxes with a new business privilege tax.

The new business privilege tax would apply a relatively flat tax scheme to entities with limited liability. Businesses would be subject to a tax of $1.35 for every $1,000 of the entity’s adjusted net worth tax base. “Adjusted net worth tax base” under the bill essentially means an entity’s total assets minus its total liabilities, which is then subject to certain adjustments. The minimum business privilege tax imposed would be $500 per year. However, the business privilege tax would be capped at $5,000 for entities other than a corporation and $75,000 for holding companies. Certain exclusion from the general rules apply. For example, a single member LLC that is disregarded for federal tax purposes whose single member is a corporation would not be subject to the business privilege tax. 

Click here to read S.B. 363. 

For additional information regarding these subjects or any other multistate tax issues, please contact:

David M. Kall
216.348.5812
dkall@mcdonaldhopkins.com

Susan Millradt McGlone
216.430.2022
smcglone@mcdonaldhopkins.com

Jeremy J. Schirra
216.348.5444
jschirra@mcdonaldhopkins.com

Businesses must be vigilant and careful in managing their state and local tax liabilities and exposures. We understand this can be a daunting task. McDonald Hopkins Multistate Tax Services provides a broad range of state and local tax services including tax controversy, tax evaluation, tax planning, and tax policy. With professionals who have worked both inside and outside government agencies, our multistate tax team leverages its knowledge and experience to help clients control their complex multistate taxes.

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