Current State Tax Developments in California and Other Western States

1. Current State Tax Developments in California and Other Western States TEI Dallas Chapter January 16, 2018 Eric J. Coffill Senior Counsel

2. Arizona Audit Program Scaled Back • Corporate auditors fallen from 30 in 2001 to 10 in 2016 • Six auditors as of October 2017 • Emphasis on technological analysis and voluntary tax compliance under current Director David Bent (appointed 2016)

3. Hawaii Tax Director Maria Zielinski Abruptly Resigns • Effective December 5, 2017 • Served since 2014 • Issues involving new $60 million tax computer system • Governor in December appointed Linda Chu Takayama as Interim Director

4. Montana Legislature Adopts Apportionment Changes (Effective 1/1/2018) • HB 511 amends multiple sections of the “Montana” Compact • Expanded Definition of “apportionable income” (formerly business income) • Narrower definition of “sales” to transactions and activity in regular course of business. • Replaces COP with market sourcing for “other” than TPP sales • Unlike MTC Model, does not have “throw-out” rule. • “Reasonable Approximation” if assignment cannot be determined • New provisions on Section 18 “distortion” • Retains equally-weighted three factor apportionment formula

5. New Mexico Matter of Protest of Conagra Foods Food Ingredients Co., Inc. • NM Hearing Administrative Hearings Office, No. 17-39, Sept. 15, 2017. • Interest income received in 2008-2011 on PIK notes issued as part of a 2008 sale of segment of taxpayer’s business was nonbusiness income. • Taxpayer had treated proceeds from 2008 sale as business income Matter of the Protest of Agman Louisiana Inc. • NM Hearing Administrative Hearings Office, No. 17-47, Dec. 5, 2017. • Gain on 2013 sale of stock of 49% owned affiliate was business income under “functional” and “dispositional” tests. • Functional asset integral to taxpayer’s business in 2009-2013

6. Oregon Apollo Education Group, Inc. v. Department of Revenue (Aug. 24, 2017, Magistrate Division) • Apportionment of income from approx. 175,000 Online Courses by University of Phoenix • Faculty a “guide on the side” rather than a “sage on the stage” • “Item of income” was tuition/fees from course selection • Single course selection was the “income producing activity” • Held:  The only “direct” Costs of Performance for on-line courses were faculty costs • Curriculum development and eCampus activities not “direct” costs • Follows narrow COP approach in AT&T Corp. v. Dept. of Revenue, 357 Or. 691 (2015) • Other University of Phoenix results in other states (e.g., Nov. 30, 2017 Indiana Tax Court decision using broader COP approach)

7. Oregon Cont’d New Market-Based Sourcing for Other than TPP (Effective 1/1/2018) • S.B. 28 amends ORS 314.665(4) • Based on MTC’s model statute • But unlike MTC Model, does not have “throw-out” rule • Use “Reasonable Approximation” if assignment cannot be determined New Definition of “Apportionable” Income (Effective 1/1/2018) • H.B. 2275 amends ORS 314.610(1) • Based on MTC’s model statute • Keeps functional and transactional business income tests • Adds provision including income that is allocable/apportionable under US Constitution

8. Oregon Cont’d New Sales Factor Rules (Effective 1/1/2018) • HB 2273 amends ORS 314.610(7) • Narrower definition of “sales” to transactions and activity in regular course of business New Unitary Group Determination (Effective 1/1/2018) • SB 30 amends ORS 317.705 • In unitary determination, DOR can consider any corporation owned by same interests, including foreign affiliates. New Tax Court Judge effective January 1, 2018 • Judge Breithaupt retired.  Was appointed 2001. • Robert Manicke appointed to complete term ending 2021.

9. Utah Data Center-Related Purchases Mostly Exempt • Utah State Tax Commission Private Letter Ruling No. 16-001 (Mar. 9, 2016, released Feb. 2017) • Machinery/equipment purchased by social networking company • Qualified for exemption for purchases and leases of property used in operation of web search portal Watch Tax Commission v. See’s Candies, Inc. (No. 140401556 (Ut.Dist. Ct.) • Pending at Utah Supreme Court • Scope of state’s “section 482” power

10. Washington New B&O Tax Nexus Standard Expanded to Include Retailers (H.B. 2163), effective July 1, 2017 • “Economic nexus” extended to retailers • Nexus if more than $267,000 of Washington gross receipts in current or prior calendar year (“receipts” threshold), or • At least 25% of total yearly gross receipts sourced on Washington in current or prior year (“25% threshold). New Nexus Standard for Sales and Use Tax (H.B. 2163, effective January 1, 2018) • An attack on Quill • Requires “marketplace facilitators” whose sales to Washington consumers are $10,000 or more to either: • (1)Collect sales/use tax on sales to Washington consumers; or • (2) Comply with specific use tax notice and reporting requirements.   Trailing Nexus (WA DOR Special Notice, Nov. 2, 2017) • A person has nexus with Washington for a calendar year if they meet an applicable nexus standard during the calendar year or if they met one in the previous calendar year.

11. Washington Cont’d Tax Inclusive Pricing (Det. No. 16-0403, Wash. Dep’t of Revenue, 36 WTD 435 (Dec. 21, 2016, released Aug. 31 2017) Taxpayer, a computer sales and service store, challenged an assessment, arguing it had correctly collected and remitted sales tax on the net sales price of items and that the pricing was inclusive of sales tax. • Under WA law, sales tax is generally presumed to not be included in the sales price unless the seller advertises that the price is tax inclusive.   Based on the evidence presented the Review and Hearings Division found the taxpayer had been advertising tax-included prices. • Evidence include statements by customers, advertisements and invoices.

12. Washington Cont’d “Disassociation Doctrine” Rejected. Irwin Naturals v. Washington Dept. of Rev., 382 P.3d 689, 195 Wash.App. 788 (2016); USSC Cert. Denied (10/2/17) Taxpayer argued that while its in-state wholesale activities of nutritional supplements were subject to tax, its retail sales of those products were unrelated to its wholesale activities and thus exempt from both the sales tax and the B&O Tax. Court of Appeal rejected taxpayer’s arguments and held it had not shown it did not have a substantial nexus with Washington (i.e., in-state activity that aids in establishing or maintaining a market).  Court rejected argument the retail sales were “disassociated” from the in-state wholesale activities, and upheld sales tax and B&O tax assessments.

13. Washington Cont’d Independent Contractor Creates B&O Tax Nexus. (Det. No. 17-0075, 36 WTD 592 (Mar. 22, 2017, released Dec. 29, 2017) Review and Hearings Division upholds B&O Tax assessment on wholesaling and retailing out-of-state home decor business. Found in-state activities of independent wholesale sales representative created nexus by contributing to taxpayer's ability to maintain a market for its products within WA. USSC Denies Review in Dot Foods. Dot Foods Inc. v. Washington Department of Revenue, 372 P.3d 747 (2016); USSC Cert. Denied (5/22/17). Citing to Estate of Hambleton (2014), Washington Supreme Court upheld retroactive application of a 2010 statutory amendment (to a 1997 statute) to deny refund claims for 2006-2007. On May 22, 2017, the United States Supreme Court denied review. Shades of Hambleton v. Washington Department of Revenue, 335 P.3d 398 (2014), where USSC denied cert. in October 2015.

14. California FTB Releases FTB Notice 2017-04 (Oct. 16, 2017) • Treatment of WE Elections after Factor Presence Nexus Statute FTB Notice 2017-05 (Oct. 19, 2017 • Oral Presentations on Section 25137 Petitions • Also: 12/7/17 FTB Resolution on Ex Parte 25137 Communications Chief Counsel Ruling 2017-01 (April 7, 2017) • Application of market-based sourcing rules for non-marketing services. Source based on taxpayer’s direct customers (not its customers’ customers) Chief Counsel Ruling 2017-02 (Sept. 8, 2017) • Inclusion of goodwill for “deemed” WE election business asset test Chief Counsel Ruling 2017-03 (Oct. 18, 2017) • Reg. 25137(c)(1)(A) occasional sale exclusion Technical Advice Memorandum 2017-03 (April 6, 2017) • Application of IRC sections 382-384

15. California SBE Decisions Appeal of Leslie’s Holdings, Inc. & Subs. No. 955278(voted Nov. 15, 2017) • Interest Expense paid by taxpayer on loans to investors was nonbusiness (income)expense. • Treated as business (income) expense on original return, and amended returns then filed with nonbusiness treatment. • Held: Loan distributions that gave rise to the interest expenses not related to operating pool supply retail business. • Will require Section 40 written decision. Appeal of Bank of America Corp and Affiliates, No. 983272 (voted Nov. 14, 2017) • Dividend income received from investment in China Construction Bank was nonbusiness income. • Also a claim for refund case (like Leslie’s Holdings). • Held: 8-19% interest in Bank failed functional business income test. • Will require Section 40 written decision.

16. California Court Cases 926 North Ardmore Avenue v. County of Los Angeles,3 Cal.5th 319 (6/29/2017) • Documentary Transfer Tax due on property resulting from change of “legal beneficial” ownership under Proposition 13 Fidelity National Information Services, Inc. v. Franchise Tax Board (not to be published) (7/27/17) • Remanded for determination if stock sold was nonbusiness investment at time of sale Harley Davidson Inc. v. Franchise Tax Board (Fourth Appellate Dist.) Abercrombie & Fitch Co. v. Franchise Tax Board (Fifth Appellate Dist.) • Both pending on appeal on intrastate/interstate unitary election

17. 2017 Legislation (AB 102 and AB 131) Overhauls the California Tax System Trouble brewing at the State Board of Equalization • November 2015 Report by State Controller • March 2016 Report by Department of Finance • Calls for reform by Board Members • April 2017 call for reform by the Governor New legislation • AB 102 in June and AB 131 clean-up bill in September • State Board of Equalization gutted • Created new California Department of Tax and Fee Administration (CDTFA), operational July 1, 2017 • Created new Office of Tax Appeals (OTA), operational January 1, 2018

18. Changes at the Board of Equalization Board lost nearly all of its statutory powers • Lost administrative authority over sales tax • Lost administrative authority over 30 other tax and fee programs • Lost administrative appellate authority over all these taxes to new OTA • Lost administrative appellate authority over FTB appeals to new OTA Board retained constitutional functions • Kept property tax, insurance gross premiums tax, alcoholic beverage tax • Retained property tax regulatory authority • Retained ability to hear cases concerning these taxes No more ex parte communications as of July 1, 2017

19. The New CDTFA Effective July 1, 2017, assumed Board’s former duties for • Sales and other business taxes and fees • Appeals conferences • Settlements Massive personnel move from SBE to CDTFA New Director – Nicolas Maduros New Chief Counsel – Tad Egawa

20. Staffing the New OTA Goal of hiring 18 new Administrative Law Judges Administrative Law Judges must: • Be a member of the California bar for at least five years • Know federal and state tax law • Subscribe to Code of Judicial Ethics Hired for Sacramento and Southern California offices New Director – Mark Ibele New Chief Counsel – Kristen Kane ALJ training in December 2017

21. The Structure of OTA Hearings in Sacramento, Los Angeles and Fresno • First hearings in January 2018 Choice of representation Written opinions within 100 days Right to trial de novo in superior court confirmed No right of appeal to Superior Court from OTA for CDTFA or FTB Prepayment remedy. But pay-to-play continues at judicial level No ex parte communications with ALJs

22. Practice Before the OTA – The OTA Emergency Regulations November 6 “informal stakeholder meeting” held by OTA Overall goal of informal proceedings under regulations Generally a blend of (old) SBE RTAs and the Administrative Procedure Act • Filing the appeal • Briefing • Pre-hearing and hearing procedures • “Appeal” • Emergency Regulations Adopted December 2017 with 180 day effective period.

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25. Contact us Eric J. Coffill Senior Counsel Eversheds Sutherland (US) LLP 916.241.0508 EricCoffill@eversheds-sutherland.com stateandlocaltax.com