U.S. Supreme Court agrees to hear case on controversial Colorado “tattletale” use tax law
On July 1, 2014, the U.S. Supreme Court granted certiorari to Direct Marketing Association v. Brohl. This case arrives at the U.S. Supreme Court after the 10th Circuit Court declined to rule on the constitutionality of a 2010 Colorado use tax reporting law (Direct Marketing Ass'n v. Brohl, 735 F.3d 904 (10th Cir. 2013)).
The 2010 Colorado law (Colo. Rev. Stat. 39–21–112(3.5)(c) & (d)) requires out-of-state retailers that do not collect Colorado sales taxes on sales to Colorado purchasers and whose gross sales in Colorado exceed $100,000 to:
Provide transactional notices to Colorado purchasers, notifying them that use taxes are due and to file a return;
Send annual purchase summaries to Colorado purchasers and inform such purchasers of their use tax obligations; and
Annually report Colorado purchaser information to the Colorado Department of Revenue.
Businesses and the general public have largely opposed this law. Businesses are averse to taking on such administrative burdens, as well as the associated costs relating to complying, especially the burden of informing the government that its customers owe use tax (hence, the “tattletale” moniker). Similarly, customers are skeptical of the government’s desire to collect information on their purchases, citing privacy concerns, and are apprehensive about potential government action against them if they are not reporting and paying their use tax.
Conversely, as 10th Circuit Court recognized, “use tax collection is elusive. Most Colorado residents do not report or remit use tax despite the legal obligation to do so.” This disregard of state tax law by state residents and the loss of tax dollars was the impetus for state lawmakers to enact the 2010 changes to the use tax law.
The U.S. Supreme Court agreeing to hear this case adds yet another case of national interest to the potential impending (and acute) changes forthcoming to state taxation in the coming year. The Court has had an influx of state tax-related petitions lately. The Court denied certiorari to a case concerning New York’s affiliate nexus law. However, the Court recently granted certiorari to Comptroller v. Wynne, a case which will address the following question:
Does the United States Constitution prohibit a state from taxing all income of its residents—wherever earned—by mandating a credit for taxes paid on income earned in other states?
The Multistate Tax Update will continue following developments of significance to state taxation in the U.S. Supreme Court.
Illinois: Industrial insureds may be required to pay taxes on insurance premiums
The Illinois General Assembly passed S.B. 3324 which imposes a 3.5 percent tax on paid premiums to unauthorized insurers by a certain class of businesses. The bill awaits Governor Patrick Quinn’s signature. If the bill is neither signed nor vetoed by August 14, it automatically becomes law.
In some circumstances, states will tax insured businesses on the premiums they pay to insurers if such insurers are not authorized by the taxing state. In general, in Illinois, insurers are unauthorized if they do not maintain certificates of authority with the Illinois Director of Insurance. As a result, businesses operating in Illinois, therefore, typically cannot purchase insurance from an insurer that does not possess such a certificate.
An exception to this general rule is the “industrial insured” exception. Pursuant to 215 ILCS 121-2.08, a business is not obligated to purchase insurance from an authorized insurer if the business is an “industrial insured.” An “industrial insured” is generally a business that meets certain threshold requirements, such as a certain employment-force size or minimum annual gross revenues. Along with the new tax on certain insurance premiums, S.B. 3324 will alter the definition of an industrial insured to substantially raise the threshold requirements that a business would need to meet in order to qualify as an industrial insured.
Under the Nonadmitted and Reinsurance Reform Act of 2010, which was enacted as part of the Dodd-Frank Act, only a business entity’s home state may tax businesses on the premiums they pay to unauthorized insurers. 15 USC § 8202(a). Therefore, under current Illinois and federal law, a business whose home state (generally, where a business’ principal place of business is located) is Illinois is not subject to state taxes on insurance premiums for unauthorized insurance in any state because Illinois does not currently impose such a tax and other states are prohibited by federal law from imposing such a tax on a business with an Illinois home-state.
The Illinois General Assembly passed S.B. 3324, amending 215 ILCS 121-2.08 and its applicability to industrial insureds. S.B. 3324 imposes the same tax on the premiums of unauthorized insurance policies that is imposed on surplus line transactions, which is 3.5 percent of the insurance premiums. The imposition of this tax on Illinois industrial insureds obtaining unauthorized insurance coverage would act to eliminate the tax savings advantage that Illinois businesses qualifying as industrial insureds have had by maintaining their Illinois home-state status.
S.B. 3324 would also require an annual filing with the Surplus Line Association of Illinois of substantially similar disclosures as those required of surplus line producers, such as:
The name of the unauthorized insurer;
A description and location of the insured property; and
The amount insured.
If it becomes law, S.B. 3324 would apply to insurance obtained on and after Jan. 1, 2015.
California: Sales and use tax partial exemption goes into effect for specified industries
California law now provides for a partial exemption from state sales and use tax for equipment purchased for manufacturing, research and development by certain qualified purchasers and certain lessees, as of July 1, 2014. This partial exemption applies only to state sales and use tax and does not affect city, county, or district sales taxes.
The partial exemption reduces the state sales and use tax for qualified property purchases by 4.1875 percent from July 1, 2014 to Dec. 31, 2016, and by 3.5625 percent from Jan. 1, 2017 to June 30, 2022. Currently, the California sales and use tax rate is 7.5 percent, which means that purchases qualifying for this partial exemption will be taxed at a sales and use tax rate of 3.3125 percent from now through Dec. 31, 2016. Through Dec. 31, 2016, this reduced rate will yield a savings of $41.88 for every $1,000 in purchases of qualified property. However, each qualified person or combined reporting unit cannot claim partial exemptions for more than $200 million in qualified purchases in any given calendar year.
Overview of qualification requirements
In order to be eligible for the sales and use partial tax exemption, the taxpayer must be a qualified person purchasing qualified property for a qualified use. The partial exemption applies to qualified persons which are businesses that include, in reference to the 2012 North American Industry Classification System, code 3111-3399 (manufacturing), 541711 (biotech research and development), and 541712 (physical, engineering, and life sciences research and development).
The California law provides that qualified property subject to the partial tax exemption includes (but is not limited to):
Machinery and equipment;
Certain equipment or devices used or required to operate, control, regulate, or maintain the machinery;
Certain tangible personal property used in pollution control; and
Certain special purpose buildings and foundations used as an integral part of the manufacturing, processing, refining, fabricating, or recycling process, or that constitute a research or storage facility used during those processes.
However, qualified property does not include any consumables with a useful life of less than one year; furniture and equipment used to store products completed once the manufacturing process has completed; and property used primarily in administration, general management, or marketing. Furthermore, qualified property which would otherwise fall within the partial tax exemption will not be eligible if the purchaser intends to lease the property in substantially the same form as it was acquired.
In addition, qualified property must be used 50 percent or more in one of these activities:
Manufacturing, processing, refining, fabricating, or recycling tangible personal property;
Researching and developing;
Maintaining, repairing, measuring, or testing any qualified property; or
Uses by a contractor purchasing property for use in the performance of a construction contract for a qualified person, provided that the qualified person will use the resulting improvement to real property as an integral part of the manufacturing, processing, refining, fabricating, or recycling process or as a research of storage facility for use in connection with those processes.
If within one year from the date of the purchase of the property, the taxpayer uses the property in a manner that does not qualify for the exemption, converts its use of the property from an exempt use to some other use not qualifying for the exemption, or removes it from the state of California, the exemption will no longer apply and the taxpayer will be required to pay the full sales and use tax.
Partial exemption procedure
If a purchaser believes that they may be eligible for this partial exemption, they can take advantage of the lower tax rate by using an exemption certificate. Exemption certificates are available through the California Board of Equalization. Exemption certificates must be presented to the seller of the property in a timely manner around the time of the purchase. A timely presentation of the exemption certificate includes:
Before the retailer bills the purchaser for the qualified property;
Within the retailer’s normal billing or payment cycle;
At or prior to delivery of the qualified property to the purchaser or purchaser’s representative; or
No later than 15 days after the date of purchase.
The retailer is then required to retain the exemption certificate for 4 years after the partial tax exemption is claimed. The Board of Equalization currently has example exemption certificates here and here.
A company that thinks it may be eligible for the partial sales and use tax exemption should evaluate its business and purchases to ascertain if they are in line with the guidelines provided above and should consider taking the necessary steps in order to claim this partial exemption from California sales and use tax.
For additional information regarding these subjects or any other multistate tax issues, please contact:
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.