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Texas: State passes law to stop sales tax evasion

In an effort to prevent tax evasion, the State of Texas enacted S.B. 529 which criminalizes the knowing sale, purchase, transfer, use, or possession of software that alters sales data. Nicknamed “zappers,” this type of software is uploaded onto USB drives or other devices capable of plugging into a cash register and modifying sales data. Since most point of sale systems are otherwise unalterable, some retailers use this software to falsify transaction data, enabling them to evade sales and income taxes by underreporting sales.

Typically, a retailer using a “zapper” first makes a sale and collects sales tax on the full sales price. Next, the retailer inserts a zapper into the cash register and accesses the transaction data recorded on the register. The software then either alters or completely erases sales data, resulting in a lower tax liability for the retailer. Afterwards, the retailer pulls the zapper out of the cash register, leaving no sign of tampering.

Not only do retailers manage to avoid paying their full tax liability, but zappers enable the retailer to still collect sales taxes on the full retail price from a customer. The register then reports a lower tax total to the state, and the retailer pays that lower total, keeping the remainder of the excess tax collected from the customer.

Small and medium sized businesses are generally the ones employing these devices, but in some zapper cases, the avoided taxable income has still been in the millions. In Detroit, for example, the owner of 12 restaurants was accused back in 2008 of hiding $20 million from the State of Michigan through the use of a zapper. Even with this level of tax evasion, critics allege that there is no way to enforce the law. Nonetheless, such critical positions have not stopped states like Texas from passing laws like S.B. 529 and making the offense punishable as a felony.

This law is just one part of the broadening and intensifying fight against sales tax evasion. Many states are enacting legislation to stop online retailers from avoiding collecting and remitting sales taxes on transactions with out-of-state customers. Also, Congress is in the process of deciding whether to pass the Marketplace Fairness Act, which would give states more power to collect sales taxes from online retailers. This bill in Texas, however, shows that sales tax evasion is not only an online issue, but a brick and mortar issue as well.

Click here to read the text of S.B. 529.

South Carolina: Governor signs legislation providing tax credit for certain early stage investments

On June 14, 2013, South Carolina Governor Nikki Haley signed the “High Growth Small Business Job Creation Act of 2013” (Act) which provides a nonrefundable income tax credit for investments by angel investors in certain early-stage businesses headquartered in South Carolina.

Businesses must register with and be certified by the Secretary of State in order to be recognized as a qualifying businesses in which an angel investor may obtain a tax credit under this Act for certain qualifying investments. In order to be a qualifying business, certain criteria must be met, including the following:

  • Headquartered in South Carolina
  • Formed no more than five years before the qualifying investment was made
  • Gross income of $2 million or less on a consolidated basis in any complete fiscal year before registration
  • Employ 25 or fewer people in South Carolina at the time of registration as a qualified business
  • Primarily engaged in manufacturing, processing, warehousing, wholesaling, software development, information technology, research and development, and certain business services

To qualify for the tax credit under the Act, angel investors must:

  • Be individual taxpayers or pass-through entities formed for investment purposes that have no business operations
  • Not have committed capital under management exceeding $5 million
  • Not be capitalized with funds raised or pooled through private placement memoranda directed to institutional investors

The following do not qualify as angel investors under the Act:

  • Venture capital funds
  • Commodity funds with institutional investors
  • Hedge funds do not qualify as angel investors

An angel investor who makes a qualified investment in a qualified business will be entitled to receive a nonrefundable income tax credit of up to 35 percent of such qualified investment, which is capped at $100,000 per year. Fifty percent of such tax credit may be applied to the angel investor’s income tax liability in the first year the qualified investment is made, and the remainder may be carried forward for up to 10 years. Such tax credits may be transferred subject to certain limitations.

The total number of tax credits allowed under the Act will not exceed $5 million in any one calendar year. Investments made after December 31, 2012 are eligible for this tax credit.

South Carolina businesses should act quickly to become registered and certified with the Secretary of State so that their investors may take advantage of this tax credit.

Click here to read the full text of the Act.

Connecticut: Department of Revenue Services clarifies state’s drop shipment rule

On June 19, 2013, the Connecticut Department of Revenue Services (Department), issued a Policy Statement (PS 2013(3)) providing guidelines for the application of Connecticut’s sales and use tax rules for drop shipments. A drop shipment is a shipment sent directly by a manufacturer to a customer, but billed through a wholesaler or distributor. The Policy Statement aimed to clarify the definition of a retail sale, subject to sales and use tax, under Connecticut statute. The statute defines “retail sale” as:

[t]he delivery in this state of tangible personal property by an owner or former owner thereof or by a factor, if the delivery is to a consumer pursuant to a retail sale made by a retailer not engaged in business in this state, is a retail sale in this state by the person making the delivery. Such person shall include the retail selling price of the property in such person’s gross receipts. Conn. Gen. Stat. §12-407(a)(3)(A).

The Policy Statement clarifies that the statute imposes sales tax liability on out-of-state wholesalers or manufacturers of tangible personal property who are registered in Connecticut and deliver property in Connecticut on behalf of retailers who are not engaged in business in the state of Connecticut. Since even this explanation can prove confusing to many, the Policy Statement goes further and provides an example of such a situation in which this statute could be triggered: a customer located in Connecticut orders merchandise from an unregistered out-of-state seller (Seller UNR). Seller UNR purchases the merchandise from a registered out-of-state wholesaler or manufacturer (Seller R) to meet the customer’s order. Next, Seller UNR makes arrangements with Seller R to ship the merchandise directly to the customer. Seller R delivers the merchandise to the customer using its own vehicles or ships the merchandise Free On Board (F.O.B.) destination. The Policy Statement explains that typically, in such a situation, since Seller UNR is an unregistered seller and therefore not registered to collect sales and use taxes from its Connecticut customer, the unregistered seller will only bill the customer the sale price and shipping and handling charges. As the drop shipper, Seller R will be required to bill the customer for Connecticut sales tax due on the sale, unless the customer provides acceptable evidence that Seller R is not to collect sales taxes from the customer. As this article will explain, the disunion between the two sellers in this process can be problematic.

The Policy Statement provides that under Connecticut statute the registered seller is required to charge the customer for the actual sales tax due to the extent the registered seller has knowledge of the unregistered seller’s actual sale price to the customer. In the event the registered seller is not aware of the actual sale price charged by the unregistered seller, the registered seller is to collect sales tax on the amount that the registered seller charged the unregistered seller for the merchandise. The customer will then be responsible to pay the Department the sales taxes due on the difference between what was collected by the registered seller and the sales taxes actually attributable to the sale. This customer true up obligation may trip up some customers who believe they paid full sales tax on the sale when the customer paid the registered seller’s sales tax bill.

However, the customer will not be responsible to pay the sales and use tax if it can demonstrate the goods are nontaxable by a certificate presented to the wholesaler. The Policy Statement identifies acceptable certificate forms including:

  1. A Connecticut resale certificate
  2. A Multistate Tax Commission Uniform Sales & Use Tax Certificate
  3. A Connecticut exemption certificate
  4. A direct payment permit from the customer

The Policy Statement concludes by drawing distinctions for certain circumstances in which this sales and use tax statute would not apply. The statutory drop shipment rule will not apply if the wholesaler or manufacturer is not registered as a retailer in Connecticut. Furthermore, the rule will not apply if the wholesaler or manufacturer is registered in Connecticut but the property is accepted for transport by a common carrier outside of Connecticut, in which case the title to the property transfers to the customer when the common carrier accepts the property; thus the retail sale is deemed to have occurred outside of Connecticut and it is not subject to Connecticut sales tax. This situation is commonly seen in transportation contracts including phrases such as “F.O.B. shipping point,” “F.O.B. seller’s plant” or “F.O.B. seller’s city.”

Companies should consider the Department’s Policy Statement when determining whether they need to collect sales taxes from their customers. Customers, likewise, should be aware of this policy when paying sales taxes.

Click here to read the Department’s Policy Statement.

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

Multistate Tax Services

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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