Michigan: Treasury to issue new auditing standards and provide increased access to audit documentation
On March 20, 2014, Michigan Gov. Rick Snyder signed legislation (H.B. 4291) to ensure taxpayers have the right to request and receive all relevant audit work papers, as well as the audit report of findings supporting the audit determination.
“Undergoing a tax audit is a difficult process, and this bill will make sure taxpayers who are being audited have access to all pertinent information so they can be as prepared as possible,” Gov. Snyder said in a statement.
The Michigan Department of Treasury (Department) has one year from the date of enactment of this legislation to promulgate auditing standards, which shall include, but not be limited to, confidentiality, technical training, independence, due professional care, planning, supervision, understanding of the entity being audited (including internal control and risk assessment), audit evidence and documentation, sampling and sampling projections, and elements of the audit report of findings.
The legislation requires that the Department start the process by sending the taxpayer a letter of inquiry, stating “in a courteous and non-intimidating manner,” the Department’s opinion that the taxpayer needs to provide further information or owes additional tax to Michigan, and explaining the reasons for such opinion. The legislation also provides the taxpayer with the right to request an informal conference regarding the audit.
The legislation provides time periods during which certain steps in the audit process must be taken. The legislation provides that for any audit commenced after Sept. 30, 2104, the Department must complete fieldwork and provide a written preliminary audit determination for any tax period no later than one year after the applicable expiration of the statute of limitations for Michigan tax returns, without taking into account the statutory periods of extension of such statute of limitations. However, this limitation does not apply if the taxpayer and the Department have agreed in writing to extend the applicable statute of limitations.
In addition, for audits commenced after Sept. 30, 2014, unless otherwise agreed by the Department and the taxpayer, the final assessment must be issued within nine months of the date that the Department provided the taxpayer with the preliminary audit determination. The assessment must be issued within this time frame unless the taxpayer requests a reconsideration of the preliminary audit determination or requests an informal conference.
Wisconsin: Governor signs legislation reducing income and property taxes
On March 24, 2014, Wisconsin Gov. Scott Walker signed S.B. 1 which provides tax relief in excess of $500 million. S.B. 1 makes a number of changes to accomplish this tax relief, primarily by reducing personal income taxes and property taxes.
S.B. 1 provides broad personal income tax relief by reducing the lowest of Wisconsin’s four income tax brackets by 0.4 percent. This 0.4 percent reduction applies to the lowest income bracket in Wisconsin’s bracketed progressive tax system.
S.B. 1 also cuts property taxes by approximately $406 million by changing how the state’s technical colleges are funded. This would amount to a property tax reduction of approximately $100 on the median-valued Wisconsin home.
In addition to these tax cuts, Gov. Walker instructed the Secretary of the Department of Revenue to reduce the state’s income tax withholding table rates by $323 million. While this move does not reduce taxes, Wisconsin workers will see larger net paychecks (albeit lower tax refunds on their returns).
In all, this tax cut package will provide approximately $859 million in tax relief through fiscal year 2015.
U.S. Judiciary hearing foretells coming of potential poison pill to the Marketplace Fairness Act of 2013
On March 12, 2014, the U.S. House Judiciary Committee held a hearing entitled “Exploring Alternative Solutions on the Internet Sales Tax Issue” (the Hearing). The purpose of the Hearing was to explore a number of potential solutions to state sales taxation of remote or out-of-state sellers.
The Hearing indicates that House GOP leaders are considering variations of the following general idea as a compromise to the Marketplace Fairness Act of 2013 (the Act): Create a national rule for sales taxation based on the location of the seller, not the buyer (i.e., an origin of the seller-based approach for at least remote sales). While this patently appears as a potentially elegant solution, it is not without its hazards and also is likely to receive harsh debate from businesses, state-level legislators and state governors.
In this article, we will explore the proposal of the Hon. Christopher Cox and also add several counterpoints offered by Mr. Stephen P. Kranz.
In Quill v. North Dakota, 504 U.S. 298, the U.S. Supreme Court reaffirmed the bright line test under the Commerce Clause of the U.S. Constitution as it applies to sales tax—in order for a state to impose an obligation on an out-of-state seller, physical presence is required. This is, and has been, the test applicable to determining whether a remote seller can be obligated to collect and remit sales tax.
As background for the Hearing, House Judiciary Committee Chairman Bob Goodlatte gave some foundational statements highlighting the importance of remote seller issues that the U.S. currently faces (albeit potentially with his own agenda implicitly therein). Some paraphrased highlights from his opening statement are:
- Over the last three years, shopping center foot traffic has fallen 50 percent.
- Internet commerce is booming—in the forth quarter of 2013, retail e-commerce sales were $69.2 billion, an increase of 16 percent over the same period the prior year.
- Traditional (i.e., brick and mortar) retailers continue to argue that the physical presence rule continues to place them at a disadvantage. “Show rooming,” where customers go to a brick and mortar store to see a product only to purchase it online, continues to be a problem. Chairman Goodlatte claimed these consumers draw on the retailer’s knowledge and then buy the item online specifically to save on sales tax.
- While consumers in 45 states with a sales tax still owe it if it is not collected by the seller (via use tax), it is “widely ignored by consumers and unenforced by states for both practical and political reasons.” Collectively, it is estimated that states are losing $23 billion in revenue annually.
- Chairman Goodlatte’s criticisms of the Act:
- The public views the imposition of sales tax on online sales as taxing the Internet (i.e., it is viewed a “new” tax). Young voters oppose “taxing the Internet” at a rate of 73 percent.
- Compliance under the Act is not sufficiently simple. The free software required under the Act does not address integration costs, does not help the direct mail industry and provides no method for handling “use based exemptions” common in agriculture and medical device sales.
- The Act exposes remote sellers to multiple audits in jurisdictions in which they have no voice. Chairman Goodlatte assumes this is why hotel taxes have reached 18.27 percent in Manhattan because they fall primarily on out-of-towners who cannot vote.
- The Act provides “remote sellers with no direct recourse to protest unfair or unwise enforcement, making them prime targets.”
Key points of Hon. Christopher Cox’s Home Rule and Revenue Return approach
Mr. Cox advanced a “Home Rule and Revenue Return” approach to remote seller sales tax collection and remission in his testimony after establishing a foundation for his solution. Mr. Cox summarized the details of his Home Rule and Revenue Return approach in 10 concepts restated, in part, below (for more complete details of these concepts, read the transcript of Mr. Cox’s statement):
- Establish a multistate compact. New federal legislation would authorize a multistate compact (the Compact) to enable the collection of taxes on remote sales between sellers and purchasers in Compact states. A member state of the Compact would require its in-state businesses to collect and remit sales tax on sales to purchasers located in other Compact states.
- Uniform national standard. The federal legislation would point states to the Compact as the sole method for imposing tax on sales made by a business to purchasers located in states where the business has no physical presence.
- State sovereignty and optional participation. Each state could choose whether to join the Compact. If a state joins, then businesses in that state would continue to apply the same tax rates and rules as before. In addition, a business in that state would also collect tax on sales to purchasers in other Compact states where the business does not have a physical presence. If a state chose not to join the Compact, business in that state would continue collecting sales tax on sales to purchasers in other states where the business also has a physical presence [as they do now].
- Home jurisdiction. Since the fundamental principle of the concept is that every business—whether brick-and-mortar, online or catalog—will collect and file taxes in the state where it is located, the legislation must clearly define where a business is “located” for this purpose. Once a state joins the Compact, each business with a physical presence in that state would designate one principal place of business in the United States. This will be its “Home Jurisdiction.” The designation could not be manipulated: the seller’s Home Jurisdiction would be the Compact state in which the greatest number of employees works, per payroll tax records. [Mr. Cox also describes situations where “number of employees” would be an inappropriate measure.] Nothing in this concept would change the collection of sales tax at the register. In-store purchases will still collect at the store’s local rates and rules. Home jurisdiction only apples [sic] to sellers in compact states selling into another compact states [sic] where the seller has no physical presence.
- One simple rule for tax collection. Once a business in a Compact state designates its Home Jurisdiction, it will be required to collect sales tax on any sale to residents of other Compact states where it has no physical presence[, subject to certain rules][.] No state, whether or not it has joined the Compact, could demand payments or audits from a business that has no physical presence in that state.
- One source of audit for remote sales. Every business will be subject to audit only by the state and local tax authorities where it has a physical presence, just as occurs now. A business that sells to customers in states where it has no physical presence would be subject to audit on those sales only by its Home Jurisdiction.
- Legal challenges to state tax authorities. Business taxpayers would have the right to enforce the Principles of the federal legislation in reply to legal demands from Compact states.
- No multiple taxation. Compact states would not impose additional tax liability on their residents who purchase from out-of-state sellers, beyond what is collected from the purchaser under the terms of the Compact. A purchaser would therefore not be liable for additional “use tax” if the out-of-state seller’s Home Jurisdiction tax rate were less than the purchaser’s state and local sales tax rate.
- Privacy rights protected. The federal legislation would require all Compact states to adopt privacy and data security safeguards for any purchaser information they collect in the course of administering sales tax filing or use tax reporting.
- Revenue return. The federal legislation would require Compact states to periodically forward sales tax revenue paid by out-of-state purchasers to the states where the purchasers reside.
In Mr. Cox’s concluding remarks, he indicates he believes the Home Rule and Revenue Return plan he advances is a better alternative to the Act in that it is sufficiently simple enough that small businesses may not need an exemption, all businesses would use the same tax rates and rules they already use today for in-state sales, there would be little new compliance burden, there would be no need to integrate new software to look up rates and rules for the other 45 states, and retailers would continue filing tax returns and face audits only in their home states.
A contrarian view to origin-based sales tax regimes—testimony of Mr. Stephen P. Kranz
Mr. Stephen P. Kranz, a lawyer and partner at the law firm of McDermott Will & Emery, also testified at the Hearing and expressed several viewpoints in contrast to those expressed by Mr. Cox. His main point was that “[a] radical departure from the existing sales tax regimes is not needed.”
a. The outcome of Congressional inaction—an increasingly confusing and unconstitutional regime
Mr. Kranz stated that in the past decade, individual states have adopted aggressive, dissimilar and burdensome laws attempting to impose sales tax collection obligations on remote sellers. According to Mr. Kranz, Congressional inaction has caused states to engage in self-help legislation to address their sales tax collection issues, which include (a) click-through nexus legislation; (b) use tax reporting legislation; and (c) unilateral “Quill is dead” legislation.
Click-through nexus legislation (also known as affiliate nexus laws) are laws which usually require in-state website operators who are in an arrangement with an out-of-state retailer to direct traffic to such retailer’s site in exchange for compensation when a sale is made on such retailer’s site. If an out-of-state retailer engages in such arrangements, click-through nexus laws require the retailer to collect and remit taxes to the remote state. Examples covering such laws are discussed in our own Multistate Tax Update articles on May 16, 2013, Dec. 5, 2013 and Oct. 24, 2013. As Mr. Kranz notes, such legislation usually has a greater impact on the small, self-made bloggers and other small business rather than the large companies who can simply maneuver around these click-through laws if they chose to do so.
Use tax reporting legislation are laws that attempt to address the remote seller issue by requiring the seller to provide tax notifications and reports to consumers, collecting such information and then reporting certain information to the applicable state government. An example of a recently enacted use tax reporting legislation has been discussed in a previous Multistate Tax Update article (see the discussion of Colorado law here).
Finally, “Quill is dead” legislation completely ignores the physical presence test. These laws expressly ignore Supreme Court precedent and claim that the state’s sales tax law is sufficiently simple enough, that it does not present an “undue burden” on interstate commerce (and, thus, the laws are “constitutional”) and imposes sales tax obligations directly on remote sellers. Such laws demonstrate the level of frustration with the current system, even if such laws would be invalidated on constitutional grounds if challenged.
In addition, Mr. Kranz discussed the 2013 Bloomberg BNA Annual Survey of State Tax Departments. In that survey were examples of various theories state tax departments have considered when arguing a remote seller has sales tax nexus, even in the absence of an explicit statutory provision (e.g., a state tax department may attempt to impose a click-through nexus regime against a remote seller even in the absence of remote seller legislation in that state).
Finally, Mr. Kranz stated that Congressional inaction has increased litigation in the remote seller area, and increased uncertainty for remote sellers and consumers. In order for consumers to comply with their use tax obligations under current law, they would have to track all of their purchases where tax was not collected, determine whether the item purchased was taxable, determine the appropriate tax rate to apply, and calculate and remit the proper amount of tax. This is a high burden for consumers compared to the historical collection of sales taxes at the point of sale.
b. Criticisms by Mr. Kranz of origin sourcing proposals
Mr. Kranz offered the following thoughts and criticisms of origin sourcing regimes in his testimony:
Origin sourcing, with or without a redistribution compact, turns our state consumption tax system into a tax on production and suffers from constitutional infirmity.
- A 1099-style reporting regime for consumer purchases threatens consumer privacy.
- Without Congress affirmatively addressing the remote sales tax authority question, states that rely on sales tax as a primary tax may need to prepare to impose an income tax.
- A proposal where there is a multistate compact to collect and redistribute sales tax based on the origin of the seller has a number of unintended and perverse consequences, namely:
- This decouples the choice of how to tax a transaction from the jurisdiction receiving the benefit of the tax. Mr. Kranz posits this “is the equivalent of letting France unilaterally decide whether the US will get revenue from a phone call between a woman in Ohio and her friend in Paris.”
- While the origin system would apply only where a particular remote seller does not have a physical presence under Quill, it is frequently unclear whether a vendor has the requisite physical presence in a state. This may cause remote sellers to be at risk in situations where they collected an origin tax when they were actually obligated to collect the destination state’s sales tax rate and apply the destination state’s rules.
- Customers will be confused because they will be subject to different tax rates based not only on where the vendor is located, but also on whether the vendor is physically present in the state in which the customer is located. Asking consumers to pay tax on a point of origin basis for remote sales “is no less absurd than [claiming that]...facts that are not under their control or understood to them [are] tantamount to asking them to pay tax.”
- No other country in the world utilizes origin sourcing for consumption taxes.
- Origin sourcing would likely result in the elimination of sales tax as a funding option for the states. States that did not eliminate sales taxes would lose their business base as remote sellers move their operations to states without a sales tax.
- Origin sourcing creates an incentive for companies to move abroad—U.S. companies would be forced to collect sales tax on exports while imports would not be subject to sales tax.
As you can see from these highlights from the Hearing, the Act does not create nor does there appear to be a perfect solution to the remote seller sales tax issue. What is clear is that it is unlikely that the House will pass the Act and that Congress’ continued failure to act will only cause further issues for both sellers and consumers alike. Nonetheless, if Congress does act, we should all hope the solution is carefully thought out and creates fairness and simplicity, while reducing the number of jurisdictions to which a remote seller is required to file sales tax returns.
For additional information regarding these subjects or any other multistate tax issues, please contact:
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