COST SPRING AUDIT STATE DEVELOPMENTS May, 2008

As of 5/13/08

ALABAMA STATE DEVELOPMENTS

ALASKA STATE DEVELOPMENTS Bob Mahon Mike Young Perkins Coie LLP Perkins Coie LLP 1201 Third Avenue, Suite 4800 1201 Third Avenue, Suite 4800 Seattle, WA 98101 Seattle, WA 98101 Tel. (206) 359-6360 Tel. (206) 359-6359 Fax (206) 359-7360 Fax (206) 359-7359 Email: RMahon@perkinscoie.com Email: MikeYoung@perkinscoie.com www.perkinscoie.com www.perkinscoie.com I. INCOME/FRANCHISE TAXES

Apportionment rules for water transportation carriers. The Alaska Department of Revenue promulgated regulations, effective August 8, 2007, providing for the apportionment of the business income of "water transportation carriers." The regulations use a "days-spent-in-port" methodology to assign payroll, property, and sales associated with each ship. 15 Alaska Admin. Code §§ 19.1410 – 1490.

II. TRANSACTIONAL TAXES

There have been no notable Alaska sales, use, or transactional tax developments in the past year.

III. PROPERTY TAXES

A. Judicial Developments

Property tax on large vessels upheld. The Alaska Supreme Court recently upheld a city ad valorem property tax on certain large vessels docking at private facilities inside the city. The court concluded that the city's port-day apportionment formula resulted in fair apportionment under the Commerce and Due Process Clauses. The state supreme court also concluded that the property tax was not a "tonnage duty" and, therefore, did not violate the Tonnage Clause of the U.S. Constitution. City of Valdez v. Polar Tankers, Inc., 2008 WL 1836710 (Alaska) (April 25, 2008).

IV. OTHER TAXES

A. Legislative Developments

Alaska's Clear and Equitable Share (ACES) Tax Replaces Petroleum Profits Tax. Alaska enacted its ACES tax in December 2007 to replace the Petroleum Profits Tax. The ACES tax is generally imposed on the net value of oil and gas after deductions for certain operating expenses. The rate is imposed at a base rate of 25%, with progressively higher rates when the production tax value of oil exceeds $30 per barrel. The ACES tax also contains a gross receipts tax component that acts as a floor or minimum tax. Most provisions of the ACES tax were imposed retroactively to July 1, 2007.

B. Judicial Developments

Retaliatory insurance tax upheld. The Alaska Supreme Court held that a Washington non-profit corporation was subject to Alaska's retaliatory tax and that the Division of Insurance properly interpreted and applied the tax. The court also concluded that the retaliatory tax did not violate the taxpayer's state equal protection or due process rights. Premera Blue Cross v. State of Alaska, 171 P.3d 1110 (Alaska 2008).

V. AUTHORS' BIOGRAPHIES Mike Young is a partner in Perkins Coie, a 600-lawyer firm with fourteen offices in the United States and Asia. He helps clients reduce their cost of doing business through state and local tax planning and litigation, particularly in Washington, Oregon and Alaska. Mr. Young is Editor-in-Chief of THE JOURNAL OF MULTISTATE TAXATION; Editor-in-Chief of the ABA SALES AND USE TAX DESK BOOK; Adjunct Professor (Tax), University of Washington School of Law; Past Chair of the ABA Committee on State and Local Taxes, and of its Subcommittees on Sales & Use Taxes, Interstate Transactions, and Important Developments; Past Chair of the Tax Section, Washington State Bar Association. Mr. Young has taught or spoken at New York

University, Georgetown University, University of Washington, Council on State Taxation, Tax Executives Institute, Institute of Professionals in Taxation, American Bar Association and others. Mr. Young received his B.S. from the United States Naval Academy (1966); his J.D. from the University of Washington (1975); and was Managing Editor of the Washington Law Review. Bob Mahon is a partner in the Seattle, Washington office of Perkins Coie, where his practice focuses on state and local tax planning, controversies, and litigation. Mr. Mahon is an Adjunct Professor (Tax) at the University of Washington School of Law. He currently serves as the President of the Tax Section of the Washington State Bar Association and has served for six years as chair of its State and Local Tax Committee. Mr. Mahon writes and speaks frequently on state and local tax topics, including authoring a monthly "U.S. Supreme Court Update" column in the JOURNAL OF MULTISTATE TAXATION AND INCENTIVES. He is also actively involved in numerous civic activities, including serving as the Vice Chair of the Seattle Ethics and Elections Commission and a member of the City of Seattle's Campaign Public Financing Advisory Committee. Mr. Mahon received his B.A. with honors from Grinnell College (1992); his J.D. with high distinction from the University of Iowa (1995); and his LL.M. in Taxation from the University of Washington (1996).

ARIZONA STATE DEVELOPMENTS

ARKANSAS STATE DEVELOPMENTS Michael O. Parker, Esq. DOVER DIXON HORNE PLLC 425 West Capitol, 37th Floor Little Rock, AR 72201 Phone: (501)375-9151 Fax: (501)372-7142 e-mail: mparker@ddh-ar.com Website: www.ddh-ar.com INTRODUCTION: 2007-2008 LEGISLATIVE SESSIONS The 86th General Assembly (2007 Regular Session) of the Arkansas Legislature convened January 8, 2007, and adjourned on May 1, 2007. Tax cuts dominated the legislative agenda, fueled by a budget surplus projected to exceed $900 Million entering the 2007-2009 budget cycle (since adjusted downward for 2008-2009). Unfortunately, legislative veterans remember that only three short years earlier, the Legislature passed the largest tax increase in Arkansas history primarily in the form of a 7/8% increase in sales tax. This tax increase turned out to be much larger than necessary to meet revenue objectives during the recent period of economic expansion. The net result will be to shift a significant amount of state tax burden from individual consumers to business and industry. These events recall the similar tax shift that occurred when the voters approved property tax rebates for individual homeowners funded through a 1/2% sales tax increase in 2001. A more complete summary of the Acts of the 2007 Regular Session was included in the COST Arkansas State Development Summaries for the Spring and Fall 2007 Audit Sessions. Only a few 2007 Acts of significant interest are included in this Spring 2008 Developments Summary. Unless a specific date is noted, new Acts from 2007 were effective 90 days following adjournment (July 31, 2007), and in the case of Income Tax Acts, applied to tax years beginning on or after January 1, 2007.

More recently, the First Extraordinary Session of the 86th General Assembly (2008 Special Session) convened March 31, 2008 and adjourned April 2, 2008. After many years of decline in natural gas production, Arkansas is now the beneficiary of a major exploration and development effort referred to as the “Fayetteville Shale Play.” The 2008 Special Session increased severance taxes on natural gas for the first time in more than 50 years to provide funds to repair and upgrade Arkansas roadways. The increase in severance taxes takes effect January 1, 2009. I. INCOME/FRANCHISE TAXES A. Legislative Developments Act 218. Updates reference dates to January 1, 2007 for several (but not all) IRC sections adopted in Arkansas by reference, including:

• 26 U.S.C. §21 (credit for household and dependent care services) • 26 U.S.C. §72 (recovery of cost of contribution to retirement plans; exclusion from gross income

of proceeds from life insurance, endowment, and annuity contracts) • 26 U.S.C. §101 (benefits paid on illness or death of insured) • 26 U.S.C. §112 (combat zone compensation) • 26 U.S.C. §121 (gain from sale or exchange of residential property) • 26 U.S.C. §135 (definition of “higher education institution”) • 26 U.S.C. §152 (definition of “dependent”) • 26 U.S.C. §163 (deductions for interest expenses) • 26 U.S.C. §170 (deductions for charitable contributions) • 26 U.S.C. §194 (amortization of qualified reforestation expenses) • 26 U.S.C. §197 (amortization of goodwill and other intangibles) • 26 U.S.C. §219, 404, 406-416, 457 (annuities, retirement savings, employee benefit plans) • 26 U.S.C. §223 (deduction for deposit to health savings accounts) • 26 U.S.C. §263A (inventory cost treatment of certain expenses) • 26 U.S.C. §274 (expense deductions for entertainment, business meals, travel, etc.) • 26. U.S.C. §332, 334, 337, 338 (liquidation of corporations)

• 26 U.S.C. §351, 354-358, 361, 362, 367, 368 (gain or loss on corporate organization and reorganization)

• 26 U.S.C. §401 (qualified deferred compensation plans) • 26 U.S.C. §470 (leasing transactions between taxpayers) • 26 U.S.C. §529 (tuition savings) • 26 U.S.C. §611-613, 614, 616, 617 (depletion allowance) • 26 U.S.C. §664 (charitable remainder trusts) • 26 U.S.C. §692 (combat zone compensation) • 26 U.S.C. §709 (amortization of partnership organizational expenses) • 26 U.S.C. §911 (foreign income exclusion) • 26 U.S.C. §912 (foreign income exclusion) • 26 U.S.C. §1033 (gain from involuntary conversion of property) • 26 U.S.C. §1211-1237, 1239-1257 (capital gains and losses) • 26 U.S.C. §7872 (taxation of below-market loans) • Subchapter M (RIC’s, REIT’s and REMIC’s) • Subchapter S (S Corporations)

Additionally, the Act:

• Extends the time a taxpayer has to report adjustments to income made by the IRS from 30 days to 90 days; and

• Clarifies that railroads and public utilities are required to pay income tax levied under any

applicable provision of Title 26, Chapter 51, Subchapter 2. Act 369. Clarifies and adjusts extension periods for returns, including:

• Provides a maximum allowable extension of 180 days to file any tax return, except for a corporation income tax return;

• Allows DFA to grant a corporation income taxpayer’s written request for an extension of 60

days in addition to any extension period granted to the file a federal return; and

• Provides an extension period to file an income tax return for an exempt organization that is required to file an income tax return that corresponds to the extension allowed to file a federal return.

Act 380. Updates IRC Subchapter S reference date to January 1, 2007; requires that S election and shareholder consents be filed on forms prescribed by DFA; and requires that an S corporation attach a copy of its federal Subchapter S income tax return to its Arkansas Subchapter S income tax return. Act 613. Updates the reference date for IRC §179 regarding the depreciation and expensing of property to January 1, 2007, but in an interesting twist, only took effect after the Chief Fiscal Officer of the State certified that additional funding has been provided to state general revenues from other funding sources and is available for use in fiscal years 2008 and 2009 in an amount sufficient to replace the general revenue reduction caused by the Act. Act 990. Provides a 25 year income tax exemption for a prospective windmill blade manufacturing company if it locates in the state in 2007, spends $150 million within 4 years, hires 500 employees within 2 years and hires 1000 employees within 5 years. B. Judicial Developments Weiss v. Maples, 2007 WL 853440 (Ark., March 22, 2007). A series of recent cases ruled as unconstitutional a statutory provisions stating that no participant in a public or private employment related retirement plan was allowed to deduct or recover his or her cost of contributions when computing income for state income tax purposes. This case addressed the timing and procedure for deducting the non-taxable cost of contributions, and held the Department was not authorized to prescribe the approach provided in IRC §72, prior to 2005 when the law was changed. For 2003 and 2004, benefits will be exempt from tax until all after-tax employee contributions have been returned.

C. Administrative Developments New corporate income tax regulations and individual income tax regulations are in revision and may be issued this year. Rule 2006-3 (amended 10/2007) sets out rules for mandatory withholding on nonresident members of pass-through entities. D. Trends/Outlook for 2008-2009 The next regular legislative session is scheduled to convene January, 2009. II. TRANSACTIONAL TAXES (SALES/USE TAXES)

A. Legislative Developments Act 87 (7/1/07). Exempts all dyed distillate special fuel (generally, diesel fuel used for agricultural, construction and other off road purposes that is exempt from special highway taxes) from sales and use tax and levies a substitute excise tax of 6¢ per gallon, with exception for any portion of the fuel that is biodiesel fuel. Continues to exempt vessels, barges, and commercial watercraft; railroads; municipal buses; and the United States Government. The tax is to be collected by suppliers and reported and paid by the 20th of the month by electronic funds transfer, or by any person that uses dyed distillate special fuel on which the 6¢ gallonage tax has not been paid. Act 110 (7/1/07). Reduces the state sales tax on food and food ingredients to 3% beginning on July 1, 2007. Remaining tax includes 2.875% levied by statute and 0.125% levied in the Arkansas Constitution. Includes definitions for food and food ingredients. Continues prospect that rate may decrease to 0% in the event of Congressional action authorizing the state to collect sales and use tax from sellers with no physical presence in the state resulting in revenues equal to or greater than 150% of the sales tax collected on food and food ingredients. Act 179 (1/1/08). Part of Streamlined Sales Tax conformity package. Under existing law, local sales and use taxes only apply to the first $2,500 of any single transaction, but this cap is removed 01/01/2008. Single transaction is defined by local ordinance. Act provides for a rebate of local sales and use tax paid on business purchases (only) in excess of the first $2,500 on a single transaction beginning 01/01/2008. Other purchases in excess of $2,500, such as purchases by individuals for personal use, will be subject to full combined state and local rate, with exceptions for motor vehicles, aircraft, watercraft and manufactured homes. “Single transaction” is uniformly defined as any sale of tangible personal property or a taxable service reflected on a single invoice for which an aggregate sales or use tax amount has been paid. Act 180 (6/30/07). Part of Streamlined Sales Tax conformity package. Extends the effective date of various code sections implementing the Streamlined Sales and Use Tax Agreement from July 1, 2007 to January 1, 2008. Act 181 (1/1/08). Part of Streamlined Sales Tax conformity package.

• Amends Arkansas law to adopt definitions required for Arkansas to be in compliance with the

Streamlined Sales and Use Tax Agreement;

• Amends §26-52-427, concerning property purchased for use in the performance of a construction contract to provide for a rebate instead of an exemption;

• Amends §26-52-433 to extend the exemption for medical equipment to durable medical equipment,

mobility enhancing equipment, prosthetic devices, and disposable medical supplies;

• Repeals §26-52-507 concerning sales by florists (but see Act 860 below). Act 182. Part of Streamlined Sales Tax conformity package. Moves taxes presently codified in the gross receipts tax chapter of the Arkansas code to a new Chapter 63 for special excise taxes. The taxes included are:

• Short-term rental tax; • Short-term rental vehicle tax;

• Residential moving tax; and • Tourism tax

Act 185 (3/1/07). Reduces the state sales and use tax rate on natural gas and electricity purchased by Arkansas manufacturers for use directly in their manufacturing processes to 4.5% effective July 1, 2007; further reduced to 4% effective July 1, 2008. Natural gas and electricity purchased by the manufacturer for other purposes is not subject to the reduced rate. The manufacturer must separately meter the natural gas and electricity or otherwise establish the separate uses according to rules issued by DFA. Only manufacturers falling within NAIC sectors 31, 32 or 33 are eligible for the reduced sales and use tax rates. DFA may require that a utility company obtain a certificate of eligibility from a manufacturer prior to the sale of natural gas or electricity at the reduced rate. ACT 361. Clarifies that all taxable services may be purchased by holders of retailers permits on a tax free basis, in the event the services are purchased for resale and the tax will be charged to and collected from the ultimate consumer. Act 388. The “Charitable Bingo and Raffles Enabling Act,” provides for the administration of charitable bingo and raffles in Arkansas by the Department of Finance and Administration. Levies an excise tax of one cent (1¢) of each bingo face (card) sold by a licensed distributor to a licensed authorized organization and an excise tax of ten percent (10%) of the gross receipts derived form the sale of all bingo equipment other than bingo faces. The excise tax is due and payable from the licensed distributors that sell the bingo faces and other bingo equipment. The tax shall be reported and paid to the DFA on or before the fifteenth (15th) day of the month following the month of the sale, along with the required information. Act 455. Extends “tasting” events currently allowed at wineries and by wine wholesalers to include beer and spirits. Licensed retail sellers of wine, beer, and spirits must obtain a sampling permit from ABC. The Act limits the number of ounces or servings that may be provided in a “sample.” Any wine, beer, or spirits withdrawn from inventory and used for a tasting event are subject to tax as a withdrawal from stock. Act 548 (1/1/08). Exempts from sales and use tax the sale of natural gas and electricity used in the manufacturing of new motor vehicle tires for motor vehicles that are required to be registered for highway use. The natural gas and electricity must be separately metered from natural gas and electricity used for other purposes or the separate uses must be established according to rules issued by DFA. Passed for the benefit of a manufacturer in a border city area (Texarkana) that is impacted by the elimination of the special border city exemption under the Streamlined Sales and Use Tax Agreement. Act 550. Repeals conflicting language in the Code to make it clear that a motor vehicle lessor has the option of purchasing the vehicle exempt from tax and collecting tax on the rental payments, or paying tax at the time of registration of the vehicle. Act 690. Clarifies that alternative motor fuels derived from nonpetroleum sources, such as animal oils and cooking oil, are not classified as motor fuels or distillate special fuels for motor fuel and special fuel tax purposes. Act 860. Director is authorized to delay destination sourcing for florists until July 1, 2009 if permitted by the Streamlined Sales Tax Governing Board, to prevent undue hardship to Arkansas florists. Act 869 (7/1/07). Levies a 1% excise tax on retail sales of beer, to replace an expiring 3% excise tax.

B. Judicial Developments Ryan & Company AR, Inc. v. Weiss, 2007 WL 2792237 (Ark. September 27, 2007). Letter opinions issued under Rule GR-75 are subject to disclosure in redacted form with all taxpayer identifying information removed under the Arkansas Freedom of Information Act. Citifinancial Retail Services Div. v. Weiss, 2008 WL 151557 (Ark. January 17, 2008). Refunds of sales taxes paid by merchants at time of sale are not recoverable by credit card companies financing the sales and subsequently claiming bad debt deductions on delinquent accounts for federal and state income tax purposes.

C. Administrative Developments

Arkansas Gross Receipts Tax Rules and Compensating Use Tax Rules were comprehensively revised, effective December 1, 2006. Numerous changes affecting business and industry include taxation and computer software and manufacturing machinery and equipment, such as palletizing machinery and dies and molds. Additional information available upon request.

Rule 2007-3 provides Rules for applying the reduced rate for sales of food and food ingredients (Act 110

above). A state Sales and Use Tax Guide with examples, calculation tables and a decision chart has also been released. Rule 2007-4 provides Rules for the operation of charitable bingo and raffles. (Act 388 above). Application

forms are also provided. Rule 2007-5 provides Rules for claiming the reduced rate for natural gas and electricity used directly in

manufacturing (Act 185 above). An application form was also provided.

D. Trends/Outlook for 2008/2009

The next regular legislative session is scheduled to convene January, 2009. III. PROPERTY TAXES

A. Legislative Developments

Act 660. Where the surface rights to land and the mineral rights are severed, the value of surface rights where a well is drilled shall reflect diminished utility of the land resulting from the drilling. No more than one acre of use/productivity valuation eligible land will be assessed at its minimum value per acre where the well is drilled. The value of market value based land, up to one acre in size, shall reflect diminished utility caused by drilling. The amount of diminished utility will be proved in the market place or when no market evidence is readily available a 25% reduction from the value of otherwise comparable land will be used to reflect the assessed value of the surface right. Act 827. Technical corrections to the Arkansas Code. Sections 202 through 204 amend ad valorem tax provisions and Section 203 clarifies that the assessed value of homestead property is not adjusted based on the current appraised value if title to the homestead is transferred subject to a life estate retained by the homestead owner or beneficiary of the homestead if held in a revocable trust. Act 994. Clarifies the methods and procedures for establishing the productivity valuation of agricultural, pasture and timber land based on capitalization rates ranging from 8% to 12%. The values of these lands are to be calculated annually and updated in each county when completing reappraisal. Act 1036. Shortens the minimum time between certification of delinquent lands to the Land Commissioner and tax sale from 2 years to1 year. Shortens the time for contesting the validity of a conveyance of delinquent lands by the Land Commissioner from 2 years to1 year. Clarifies the provisions that apply when the Land Commissioner transfers tax-forfeited lands to state institutions or government entities. Act 1037. Expands the notice requirements for quiet title actions, and clarifies the taxes that must be paid, settled or released prior to confirming a public sale.

B. Judicial Developments City of Fayetteville, Arkansas v. Washington County, Arkansas, et al., 2007 WL 1219743 (Ark. April 26, 2007). Tax increment financing programs are not able to divert any portion of minimum school millage or voter approved library millage for community development or redevelopment purposes.

C. Administrative Developments D. Trends/Outlook for 2008/2009

The next regular legislative session is scheduled to convene January, 2009.

IV. OTHER TAXES A. Miscellaneous Taxes 1. Legislative Developments

Act 276 (1/1/08). Adopts Uniform Estate Tax Apportionment Act providing detailed rules for apportioning federal estate tax and state estate taxes, if any, among the beneficiaries of estates. Act 582 (3/28/07). Imposes a service charge of fifty cents per month on prepaid cellular service, voice over internet protocol and other non-traditional telephone service to fund 911 service network. Act 732 (5/1/07). Levies a tax of 3% on any single payment of $1,200 or more in winnings on a single wager from electronic games of skill at Oaklawn Jockey Club and Southland Greyhound Park. Tax is deducted and withheld in the same manner as the 7% racing winnings tax. Acts 3 & 4 of 1st Special Session (01/01/2009). Increases severance tax on natural gas from $.003/mcf (three-tenths of one cent/1,000 cubic feet) to five percent (5%) of market value, with lower rates for “new discovery gas,” “high-cost gas” and “marginal gas.” 2. Judicial Developments 3. Administrative Developments 4. Trends/Outlook for 2008/2009 The next regular legislative session is scheduled to convene January, 2009. B. Tax Credits and Incentives

1. Legislative Developments

Act 518. The “Delta Geotourism Incentive Act” provides an income tax credit of up to 25% for investments of $25,000 or more in “geotourism-supporting businesses in economically distressed areas in the Lower Mississippi River Delta. The maximum investment for purposes of the credit is $100,000.

Act 566 (3/28/07). Establishes the “Equity Investment Incentive Act of 2007" to be administered by the Department of Economic Development. Provides income tax credits equal to 33 1/3% of approved investments in start-up companies in targeted business sectors that sign incentive agreements and meet certain criteria. Credits may offset up to 50% of the investor’s state income tax liability, over a total period of up to 10 years. Act 990. Provides a 25 year income tax exemption for a prospective windmill blade manufacturing company if it locates in the state in 2007, spends $150 million within 4 years, hires 500 employees within 2 years and hires 1000 employees within 5 years. Act 1039 (7/1/06). Adjusts the procedures and credits available under the Arkansas Tourism Development Act:

• Provides for review and advice by the Director of the Department of Parks and Tourism prior to approving eligible companies.

• Requires specific approval by the Director of ADED in order for a lodging facility exceeding a

specific cost and size to qualify for benefits, prior to April 1, 2009.

• Provides a 25% credit for project costs incurred by qualified amusement parks in excess of $1 million and additional flexibility in the special rules amusement parks must follow to qualify for credits. Credits may offset liability for up to 100% of gross receipts tax (sales tax) and tourism gross receipts tax over a total period of up to 10 years.

Act 1045 (4/4/07). Adopts the “Research Park Authority Act.”

• Authorizes the authority board to levy and collect a tax or fee upon tenants of the research park or from property owners within the district.

• Authorizes the authority board to issue tax exempt revenue bonds.

• Property of research park authorities is exempt from local and municipal taxes.

• Extends the existing income tax credit for donations of “state-of-the-art” machinery and equipment

to qualified educational institutions to donations to support a research park authority.

• Includes research parks among projects that can be funded using local sales taxes for capital improvements.

Act 1203 (4/4/07). Provides a tax rebate to small beer and malt beverage manufacturers (less than 25,000 barrels per year) of $7.50 per barrel of beer or malt beverage sold or offered for sale in Arkansas, with a claim period beginning January 1, 2006. Act 1596. Amended the Consolidated Incentive Act of 2003 in various respects, taking effect after the Chief Fiscal Officer of the State certified that additional funding has been provided to state general revenues from other funding sources and is available for use in fiscal years 2008 and 2009 in an amount sufficient to replace the general revenue reduction caused by the Act. The Act:

• Allows the Directors of ADED and DFA to authorize the counting of existing employees as new full-time permanent employees.

• Provides for a new incentive program for “technology based enterprises” in targeted business

sectors, in the form of an alternate income tax credit or sales and use tax credit of 2% to 8% of project costs depending on project size in a range of $250,000 to over $2 million. Credits may offset 50% to 100% of state income tax liability depending on wage levels, over a total period of up to 10 years.

Provides additional incentives for “technology based enterprises” of 5% of payroll for new full time permanent employees for a period of up to 10 years.

• Increases the research and development tax credit for businesses that conduct in-house research and qualify for federal research and development tax credits from 10% to 20% of the amount spent, and adjusts the time for earning credits from 5 years to 3 years, with an additional 2 years available for incremental increases in expenditures after the 3rd year. Also eliminates the maximum $10,000 credit limit in existing law. Credits may offset up to 100% of state income tax liability, over a total period of up to 10 years.

• Establishes an “Innovate Arkansas Fund” for the support of a contract between ADED and an entity

to provide support for the development of knowledge-based and technology-based companies in Arkansas.

Act 1607. Increases the amount of income tax credit that may be claimed in any year for donations of “state-of-the-art” machinery and equipment to qualified educational institutions from 50% to 100% of a taxpayer’s net tax liability.

2. Judicial Developments See, City of Fayetteville, Arkansas v. Washington County Arkansas, et al. Part III, above. 3. Administrative Developments Rule 2007-3. Provides rules for claiming benefits under the Delta Geotourism Incentive Act of 2007 (Act

518 above). 4. Trends/Outlook for 2008/2009 The next regular legislative session is scheduled to convene January, 2009.

V. OTHER NOTES OF INTEREST

See, INTRODUCTION, for comments on 2007-2008 Legislative Sessions. VI. PROVIDER’S BRIEF BIOGRAPHY/RESUME MICHAEL O. PARKER is a member of the Little Rock law firm of Dover Dixon Horne PLLC where his practice emphasizes taxation, business law and regulatory issues. He received his B.A. degree from Vanderbilt University and his J.D. degree, with honors, from the University of Arkansas School of Law at Fayetteville. Mr. Parker is a member of the American (Taxation Section), Arkansas and Pulaski County bar associations, is chairman of the Arkansas Tax Advisory Council and a member of the Multi-State Tax Compact Advisory Council. Other organizational activities include service as special tax counsel and legislative representative on tax issues for the Arkansas State Chamber of Commerce and Associated Industries of Arkansas, and as a private sector representative for Arkansas in the Streamlined Sales Tax Project (SSTP). Mr. Parker is a past chairman of the Section on Taxation of the Arkansas Bar Association. Honors include continued selection for Best Lawyers in America, Tax Law, 2008. He is the author of the Arkansas chapter of the American Bar Association’s Sales and Use Tax Deskbook, and is a frequent author of articles on Arkansas tax issues. Arkansas Supreme Court cases include Mississippi River Transmission Corporation v. Pledger, 347 Ark. 543, 65 S.W.3d 867 (2002), Fox, et. al v AAA U Rent It, et. al., 341 Ark. 483, 17 S.W.3d 481(2000) and Ryan & Company AR, Inc. v. Weiss. 200 WL 2792237 (Ark. September 27, 2007).

CALIFORNIA STATE DEVELOPMENTS Jeffrey M. Vesely, Esq. (415) 983-1075 jeffrey.vesely@pillsburylaw.com Kerne H. O. Matsubara, Esq. (415) 983-1233 kerne.matsubara@pillsburylaw.com Annie H. Huang, Esq. (415) 983-1979 annie.huang@pillsburylaw.com Pillsbury Winthrop Shaw Pittman LLP P.O. Box 7880 San Francisco, CA 94120

I. Deductibility of Dividends/Expense Attribution

A. Farmer Bros. v. FTB, 108 Cal. App. 4th 976 (2003), cert. denied, 540 U.S. 1178 (2004)

1. California Court of Appeal held California Revenue and Taxation Code (RTC) § 24402 unconstitutional under the Commerce Clause. RTC § 24402 allows a dividends received deduction for dividends from noninsurance companies. Similar to RTC § 24410, which was previously held to be unconstitutional in Ceridian, the deduction under RTC § 24402 is limited by the payor’s presence in California as determined by its apportionment factors. The Court held that such a limitation violated the Commerce Clause.

2. A full dividends received deduction was allowed by the Court subject to the ownership limitations contained in RTC § 24402(b).

3. California Supreme Court denied review. The United States Supreme Court denied the Franchise Tax Board’s (FTB) petition for a writ of certiorari on February 23, 2004.

4. FTB Policy Regarding Post-Farmer Bros.

a. For years ended prior to December 1, 1999, taxpayers will be allowed a full dividends received deduction subject to the ownership limitations contained in RTC § 24402(b). The expense attribution provisions of RTC § 24425 will be applied.

(1) For water’s edge taxpayers, a full dividends received deduction will be allowed under RTC § 24402 rather than a 75 percent deduction under RTC § 24411. Further, no foreign investment interest offset will be applied. Rather, the expense attribution provisions of RTC § 24425 will be applied.

b. For years ending on or after December 1, 1999, no deduction will be allowed under RTC § 24402. The FTB will attempt to identify all taxpayers who have claimed a deduction under RTC § 24402 and will disallow that deduction.

(1) For water’s edge taxpayers, the 75 percent dividends received deduction will be allowed.

(2) In a non-precedential summary decision, River Garden Retirement Home, SBE Case No. 297405 (September 12, 2006), the State Board of Equalization (SBE) agreed with the FTB and ruled that no deductions were allowable to the taxpayer under RTC § 24402 for the 1999 and 2000 taxable years.

(a) On October 2, 2007, the taxpayer filed suit for refund in the San Francisco Superior Court (No. CGC-07-467783).

(b) On February 8, 2008, the trial court sustained the FTB’s demurrer without leave to amend on the ground that the plaintiff failed to state a cause of action.

(3) Abbott Laboratories, et al. v. FTB, Los Angeles Superior Court No. BC369808 (August 9, 2007)

(a) On April 20, 2007, the taxpayer filed a suit for refund challenging the FTB’s policy of disallowing dividends received deduction under RTC § 24402 for the 1999 and 2000 tax years.

(b) On August 9, 2007, the trial court sustained the FTB’s demurrer without leave to amend and dismissed the case.

(i) The trial court held that in light of Farmer Brothers, the plaintiffs could not state a cause of action under RTC § 24402. The court went on to hold that it would not reform RTC § 24402.

(ii) The trial court did not discuss the severability provisions of RTC § 23057: “If any chapter, article, section, subsection, clause, sentence or phrase of this part which is reasonably separable from the remaining portions of this part, or the application thereof to any person, taxpayer or circumstance, is for any reason determined unconstitutional, such determination shall not affect the remainder of this part, nor, will the application of any such provision to other persons, taxpayers or circumstances, be affected thereby.”

(c) On December 7, 2007, the taxpayer filed a notice of appeal.

(4) City of Modesto v. National Med, Inc., 128 Cal. App. 4th 518 (2005)

(a) City tax case in which Court of Appeal, based on the Due Process Clause, declined to reform a prior unconstitutional ordinance to retroactively apply an apportionment provision since the period of retroactivity sought by the City was not “modest.”

B. Ceridian Corporation v. FTB, 85 Cal. App. 4th 875 (2000)

1. Court of Appeal held that RTC § 24410, which allowed a dividends received deduction for dividends received from an insurance company, was unconstitutional under the Commerce Clause of the U. S. Constitution. RTC § 24410 allowed a deduction only where the payee was commercially domiciled in California. Under RTC § 24410, the deduction was further limited by the payor’s presence in California as determined by its apportionment factors. The Court held both restrictions violated the Commerce Clause since they favored domestic (California) corporations over their foreign competitors.

2. Case also raises the retroactive versus prospective remedy issue. While Ceridian was allowed a full deduction and accordingly obtained its refund, the Court left open the remedy with respect to other taxpayers.

3. FTB Policy Regarding Post-Ceridian

a. For years ended prior to December 1, 1997, taxpayers will be allowed a full deduction for insurance company dividends. However, the expense attribution provisions of RTC § 24425 will be applied.

b. For years ending on or after December 1, 1997, no deduction will be allowed for insurance company dividends. The FTB will attempt to identify all taxpayers who have claimed a deduction under RTC § 24410 and will disallow that deduction.

4. Assembly Bill No. 263

a. On September 29, 2004, legislation was enacted which would reverse FTB’s policy statement for taxable years ending on or after December 1, 1997.

(1) For years ending on or after December 1, 1997 and beginning before January 1, 2004, taxpayers were allowed to elect to claim an 80-percent dividends received deduction. No expense attribution would be allowed.

(a) Taxpayers were required to make a retroactive irrevocable election.

(b) At least 80 percent of each class of stock of the insurance company must be owned.

(c) Election applied only to taxable years during the election period for which the statute of limitations was open or if the statute had closed for any taxable year, to taxable years for which a final tax determination had not been made because of a dispute over the dividends received deduction or the expenses related to that deduction.

(d) Elections were required to be made by filing amended returns which had to be filed by March 28, 2005.

(2) For years beginning on or after January 1, 2004, a dividends received deduction would be allowed. No restriction on the use of expense attribution.

(a) Deduction would be equal to 80% of the qualified dividends (increases to 85% in 2008).

(b) Dividend deduction may be reduced if insurance company overcapitalized (“anti-stuffing”).

(c) Certain transfers of property to insurers in an exchange described in various IRC provisions and which would otherwise result in non-recognition of gain will be deemed taxable events.

(3) FTB Notice 2004-6 was issued by the FTB to inform taxpayers how to make the election.

b. AB 263 also amended RTC § 24425 for taxable years beginning on or after January 1, 2004.

(1) Deductions disallowed to non-insurer for specified expenses paid or incurred to the insurer if the amount paid would constitute income to the insurer if the insurer were subject to California franchise tax.

(2) Interest payable to third parties by an affiliated taxpayer is subject to disallowance if the borrowed funds are used to contribute capital to the insurer.

(a) This disallowance does not apply to situations where the borrowed funds are loaned to the insurer.

5. Taxpayers not electing under AB 263 will be subject to the FTB’s policy referred to above in I.B.3.b above.

a. The FTB’s policy has not been sustained and may be subject to attack under various theories.

6. Argonaut Group, Inc., SBE Case No. 287738 (June 28, 2006)

a. In a letter decision, the SBE ruled that the taxpayer could not include its insurance company subsidiaries in its combined report “by proxy,” under RTC § 25137, for purposes of determining its California franchise tax liability.

b. Petition for rehearing denied on November 20, 2006.

C. American General Realty Investment Corp., Inc., SBE Case No. 156726 (June 25, 2003)

1. In a summary decision, the SBE concluded that the FTB properly disallowed under RTC § 24425, a portion of the interest expenses incurred by the taxpayer’s unitary financial and real estate subsidiaries on the theory that the interest expenses were indirectly traceable to insurance company dividends which were deductible under Ceridian.

2. On April 28, 2005, the SBE’s decision was reversed in the San Francisco Superior Court (No. CGC-03-425690). The trial court concluded that no interest expense deductions should be disallowed.

a. The trial court concluded that RTC § 24344(b) should be applied before RTC § 24425 and thus since the taxpayer’s business interest income exceeded the total amount of interest expense being deducted against business income, all of the interest expense could be deducted.

b. The trial court also concluded that even if RTC § 24425 was applicable, none of the taxpayer’s interest expense was incurred to purchase or carry the insurance company stock, to contribute equity capital to the insurance company or to refinance any indebtedness directly or indirectly used for any such purpose.

c. The trial court concluded that under the facts presented, the debt was incurred solely for purpose of conducting the consumer finance and real estate businesses and the debt proceeds were used exclusively to generate taxable income in the ordinary course of their respective businesses.

d. On September 14, 2005, the trial court granted the taxpayer’s request for attorneys’ fees based on market rates.

e. The FTB did not appeal.

D. Beneficial California, Inc., SBE Case No. 203445 (September 1, 2005)

1. In a summary decision, the SBE unanimously concluded that none of the taxpayer’s interest expense should be disallowed under RTC § 24425. The SBE found that under the facts and circumstances of the case, the requisite connection between the interest expense and the insurance company which paid the deductible dividends was absent.

E. Mercury General Corporation, SBE Case No. 145450 (June 25, 2003)

1. In a letter decision similar to American General, the SBE affirmed the FTB’s disallowance of the deduction of administrative expenses and interest expense under RTC § 24425 on the theory that the expenses were indirectly traceable to insurance company dividends which were deductible under Ceridian.

2. The taxpayer’s petition for rehearing was granted with respect to the deduction of administrative expenses, not interest expense. On March 28, 2006, the SBE reaffirmed its decision disallowing the deduction of administrative expenses.

3. On April 24, 2007, the taxpayer filed a suit for refund in the San Francisco Superior Court challenging the SBE’s decision (No. CGC-07-462688).

II. Apportionment Formula

A. Sales Factor

1. Gross receipts from treasury function activities. Numerous suits for refund pending.

a. General Motors Corporation v. FTB, 39 Cal. 4th 773 (2006)

(1) California Supreme Court concluded that, except with respect to repurchase agreements (“repos”), gross proceeds from the sale of marketable securities in the course of treasury function activities, including redemptions on maturity, are to be included in the sales factor. The Court remanded for further proceedings the issue whether inclusion of such proceeds in the sales factor is distortive under RTC § 25137. In the case of repos, only the interest received from repos should be included in the sales factor.

(2) The Court also concluded that research credits can only be used by the member of the unitary group which generated the credit, not the entire group. (See III.C. below.)

(3) On January 29, 2007, the Court of Appeal remanded the case to the trial court to resolve the matter consistent with the Supreme Court’s decisions in General Motors and Microsoft.

b. Microsoft Corporation v. FTB, 39 Cal. 4th 750 (2006)

(1) California Supreme Court held that gross proceeds from the sale of marketable securities, including redemptions on maturity, are includible in the sales factor.

(2) Based on the specific facts in the case, the Court concluded that the FTB sustained its burden of proving that the inclusion of gross receipts from treasury function activities in the denominator of the sales factor created a distortion under RTC § 25137. (See II.B.1. below)

c. Limited Stores, Inc. v. FTB, 152 Cal. App. 4th 1491 (2007)

(1) Trial court concluded that the return of principal must be excluded from the gross receipts generated by the taxpayer’s sale of short-term financial investments and thus from the sales factor.

(2) In dicta, the court held that the inclusion of gross receipts would be distortive.

(3) On July 28, 2005, Court of Appeal affirmed in an unpublished opinion (No. A102915).

(4) On October 26, 2005, the California Supreme Court granted the taxpayer’s petition for review. The matter is deferred pending General Motors and Microsoft.

(5) On November 15, 2006, the California Supreme Court returned the case to the Court of Appeal with instructions to that court to vacate its prior decision and reconsider the case in light of General Motors and Microsoft.

(6) Upon remand, the Court of Appeal held that the return of principal from short-term financial instruments was a “gross receipt” for sales factor purposes.

(7) The Court further held that inclusion of gross receipts in the sales factor was distortive under RTC § 25137 because the taxpayer’s treasury functions were qualitatively different from its principal, retail store business.

d. General Mills, Inc. & Subsidiaries v. FTB, San Francisco Superior Court No. CGC-05-439929 (Aug. 9, 2007)

(1) Trial court concluded that commodity hedging transactions did not generate gross receipts for sales factor purposes.

(2) Because of its holding above, the court did not consider the issue whether inclusion of such receipts would be distortive under RTC § 25137.

(3) Case is pending on appeal.

e. Square D Co. v. FTB, San Francisco Superior Court No. CGC-05-442465 (Apr. 11, 2007)

(1) Trial court concluded that the taxpayer’s gross receipts from Eurodollar time deposits were includible in the sales factor.

(2) However, the court also concluded that the FTB proved, by clear and convincing evidence, that the inclusion of such receipts was distortive under RTC § 25137.

(3) The case is now closed.

f. Toys R Us, Inc. v. FTB, Sacramento Superior Court No. 01 AS 04316 (August 21, 2003)

(1) Trial court concluded that the term “gross receipts” in RTC §§ 25120 and 25134 does not include the return of capital from the taxpayer’s investment in short-term paper and thus only the interest earned from those investments is includible in the sales factor.

(2) In dicta, the court held that if the return of capital was included in the sales factor, RTC § 25137 would apply.

(3) On April 5, 2006, the Court of Appeal affirmed the trial court’s decision in a published opinion. The opinion was modified on May 4, 2006 (138 Cal. App. 4th 339).

(a) The Court of Appeal disagreed with the trial court regarding the meaning of the term “gross receipts.” The Court concluded that return of capital is included within gross receipts under RTC §§ 25120 and 25134.

(b) The Court of Appeal concluded that under RTC § 25137, the inclusion of return of capital resulted in distortion and thus should be excluded.

(4) Both the FTB and the taxpayer filed petitions for rehearing. The Court of Appeal denied both petitions. The Court, however, modified the opinion to strike its original burden of proof discussion and to instead note that under RTC § 25137, the party seeking to deviate from the standard apportionment formula bears the burden of proof.

(5) On July 26, 2006, the California Supreme Court granted the taxpayer’s petition for review. The matter is deferred pending General Motors and Microsoft.

(6) On November 15, 2006, the California Supreme Court returned the case to the Court of Appeal with instructions to that court to vacate its prior decision and reconsider the case in light of General Motors and Microsoft.

g. Montgomery Ward and Co., Inc., SBE Case No. 133828 (October 3, 2002)

(1) In a summary decision, the SBE held that inclusion of the return of capital portion of the taxpayer’s sales of various financial investments resulted in a distortion of the formula and thus those receipts were to be excluded.

(2) On December 10, 2007, the SBE’s decision was reversed in San Diego Superior Court (No. GIC 802767). In granting summary judgment for the taxpayer, the trial court concluded that the FTB failed to meet its two-part burden of showing distortion and that its proposed alternative to the standard apportionment formula is reasonable.

h. Colgate-Palmolive Co., SBE Case No. 152028 (November 12, 2002)

(1) In a summary decision, the SBE concluded that the taxpayer’s gross receipts from its investment activity were not includible in the sales factor due to the fact the taxpayer failed to prove that it engaged in any income producing activities. The taxpayer employed independent contractors to perform the vast majority of the investment activities, while its own personnel performed de minimis investment activity. Under Regulation 25136(b), the work performed by independent contractors is not an income producing activity.

(2) Case pending in Sacramento Superior Court (No. 03AS00707).

i. Numerous treasury function appeals are pending at the SBE. The SBE is moving forward on one case. Home Depot USA, Inc., SBE Case No. 298683. All other cases are deferred until at least 30 days after a final decision is issued in Home Depot.

2. Proposed FTB Regulation 25137(c)(1)(D)

a. Effective for taxable years beginning on or after January 1, 2007, the FTB proposed an amendment to Regulation 25137(c) which would exclude from the sales factor all interest, dividends and gains (gross and net) in connection with the taxpayer’s treasury function.

b. “Treasury function” is defined as “the pooling, management, and investment of intangible assets for the purposes of satisfying the cash flow needs of the trade or business . . . .” It includes the use of futures and options contracts to hedge foreign currency fluctuations, but does not include futures and options transactions to hedge price risks of the products or commodities consumed, produced or sold by the taxpayer.

c. Registered broker-dealers and other taxpayers principally engaged in the business of purchasing and selling intangibles of the type typically held in a taxpayer’s treasury function is not considered to be performing a treasury function.

3. FTB Legal Ruling 2006-1

a. On April 28, 2006, the FTB issued a legal ruling to address the issue of how to reflect, for apportionment factor purposes, activities related to income that is excluded from the measure of tax, in whole or in part.

b. The FTB concluded that deductible dividends are not to be included in the sales factor to the extent of the amount which is deducted. Thus, for a 75-percent dividends received deduction under RTC § 24411, only 25 percent of the dividend would be included.

(1) This is contrary to the FTB’s proposed amendments to Regulation 25106.5-1.

(2) The proposed amendments to Regulation 25106.5-1 are intended to clarify the FTB staff’s position that deductible dividends (RTC §§ 24402, 24410 and 24411)

are includible in the sales factor while eliminated dividends (RTC § 25106) are not to be included. See IV.D. below.

4. FTB Legal Ruling 2006-2

a. On May 3, 2006, the FTB issued a legal ruling to address the application of the “on behalf of” rule of Regulation 25136(b). Under Regulation 25136(b), receipts from services or sales of intangible personal property are assigned to the state where the “income producing activity” was performed, based on where the greater costs of performance occurred. Income producing activity generally does not include activities performed on behalf of a taxpayer, such as those of an independent contractor.

b. When a contractor and subcontractor are members of the same unitary combined reporting group, the activities of the subcontractor will be considered income producing activities directly engaged in by the contractor for purposes of the “on behalf of” rule.

(1) Payments made by the contractor to the subcontractor will be assigned to the location where the subcontractor actually performed the service.

(2) FTB’s analysis assumes that members of a combined report must be treated as a single corporate enterprise. Query whether the FTB essentially has applied a Finnigan analysis and whether FTB’s analysis is consistent with its position on credit “siloing” at issue in the pending General Motors case.

(3) FTB recognizes that, in the case of water’s edge taxpayers, the “on behalf of” rule excludes activities performed by members outside the water’s edge combined report.

c. On June 4, 2007, the FTB issued Chief Counsel Ruling 2007-2 which deals with the issue whether the investment activities of third party investors who manage investments on behalf of a taxpayer pursuant to an agreement, constitute income producing activity under RTC § 25136 and Regulation 25136.

(1) The FTB distinguished Legal Ruling 2007-2 and concluded that the receipts were not generated by income producing activities and thus were excludible from the sales factor.

d. The FTB held an interested parties meeting in January 2008 to consider amending Regulation 25136, regarding the assignment of sales of other than tangible personal property, to conform to recent changes by the Multistate Tax Commission relating to the “on behalf of” rule under MTC Regulation IV.17.

5. FTB Legal Ruling 2006-3

a. On May 5, 2006, the FTB issued a legal ruling to address how gains resulting from an IRC § 338(h)(10) or IRC § 338(g) election are apportioned for California purposes.

b. FTB analyzes three scenarios in which an IRC § 338(h)(10) or IRC § 338(g) election has been made. FTB describes which apportionment factors should be used to report the gain from the deemed sale of assets pursuant to the election.

c. FTB does not directly address the issue whether the resulting gain is business or nonbusiness income, but instead assumes that, in each instance, the gain on the deemed asset sale is business income.

6. FTB Legal Ruling 2003-3

a. On December 4, 2003, the FTB issued a legal ruling to address the issue when income producing activity exists with respect to a business income dividend so that the dividend is includible in the sales factor.

b. The FTB concluded that a dividend payee that participates in the management and operations of the dividend payor is engaged in income producing activity with respect to the dividend so that the dividend is includible in the payee’s sales factor.

c. Departure from the FTB’s position set forth in its Multistate Audit Technique Manual Section 7562.

d. This ruling becomes quite relevant in post-Ceridian and post-Farmer Bros. years where the FTB is disallowing deductions for RTC § 24410 and RTC § 24402 dividends. The FTB is applying it on audit.

7. FTB Legal Ruling 2005-1

a. On March 21, 2005, the FTB issued a legal ruling to address the issue of what constitutes a “personal service” for purposes of attributing gross receipts to California using the so-called “time-spread method” provided by Regulation 25136(d)(2)(c).

b. Under the time-spread method, gross receipts for performing personal services are attributed to a state based on a ratio of time spent performing the services within and without the state.

(1) Separate income producing activities in each state.

c. Time-spread method applies only when capital is not a material income producing factor.

8. Amendments to Regulation 25128

The FTB held an interested parties meeting in January 2008 to discuss whether Regulation 25128, relating to double- vs. single-weighting of the sales factor, should be amended to provide greater clarity with respect to what constitutes “banking or financial business activity.”

9. Assembly Bill No. 1591/Senate Bill No. 98

a. Proposed legislation to hyperweight the sales factor, based on a taxpayer’s new investment in California, did not pass.

b. Assembly Bill No. 2114 introduced on February 20, 2008.

B. Distortion

1. Microsoft Corporation v. FTB, 39 Cal. 4th 750 (2006)

a. The California Supreme Court concluded that the FTB sustained its burden of proving the inclusion of gross receipts from treasury function activities in the denominator of the sales factor created a distortion under RTC § 25137. The Court further concluded that the FTB’s “cure” for the distortion of including net receipts from the redemption transactions was reasonable. In reaching these conclusions, the Court emphasized the following:

(1) RTC § 25137 is not confined to correcting unconstitutional distortions.

(2) The comparison of low margin sales (treasury function) with higher margin sales (software transactions) presents a problem for Uniform Division of Income for Tax Purposes Act (“UDITPA”). UDITPA’s sales factor contains an implicit assumption that a corporation’s margins will not vary inordinately from state to state.

(3) The comparison of margins in determining whether distortion exists under RTC § 25137 is not a prohibited separate accounting analysis.

(4) RTC § 25137 is not to be applied in only unique non-recurring situations.

(5) While the “cure” the FTB proposed in this case was reasonable, the Court cautioned that the FTB’s approach might fail the test of reasonableness in another case. For example, if, unlike the instant case, the treasury operations provide a substantial portion of a taxpayer’s income, the use of RTC § 25137 may be inappropriate.

(6) The party seeking to apply RTC § 25137 has the burden of proving by clear and convincing evidence that the standard formula does not fairly represent the extent of the taxpayer’s business activities in California.

b. The Court’s decision opens the door for challenges to the standard apportionment formula for both taxpayers and the government. The endorsement of a comparison of margins between functions of the unitary business is a significant development.

c. FTB Audit Practice. Currently, auditors are analyzing whether distortion exists in the treasury function setting under four different tests—Microsoft, Merrill Lynch, Pacific Telephone and Toys-R-Us. If the taxpayer fails any of the four tests, the auditors are instructed to remove the gross receipts from the sales factor.

d. FTB Notice 2006-3 (Sept. 28, 2006).

(1) The FTB announced that, for purposes of applying FTB Notice 2004-5, a taxpayer that excludes from the sales factor the amount realized on the redemption of marketable securities as part of its treasury function, and includes only the interest income and net gains from such securities, will not be subject to the accuracy related penalty under RTC § 19164.

(2) The FTB based its position on Microsoft and Pacific Telephone.

e. Technical Advice Memorandum 2007-3.

(1) In TAM 2007-3, the FTB set forth the types of treasury activity information that should be collected from taxpayers upon audit post-Microsoft and General Motors, including the taxpayer’s main line of business, the number of treasury and total employees, the gross margin from treasury function compared to other activities and the percentage of total income that would be assigned to the location of the treasury function.

(2) Purpose of the information is to enable the FTB to perform a quantitative distortion analysis.

2. Weyerhaeuser Company, SBE Case Nos. 104355 and 246164

a. Case involves distortion issues pertaining to the taxpayer’s timber activities in the State of Washington vis-à-vis its activities in California.

b. The taxpayer’s Washington timber activities generate virtually all of its unitary income, yet the standard apportionment formula does not reflect this fact. The taxpayer is contending that RTC § 25137 should be applied to correct the distortion.

c. Case also involves the proper inclusion of gross receipts for taxpayer’s treasury function in the sales factor. The FTB is arguing that the gross receipts from the taxpayer’s treasury function activity should be excluded from the sales factor under RTC § 25137. The taxpayer disagrees and is arguing that if the FTB has sustained its burden of proof under

RTC § 25137 on this issue, then so has the taxpayer with respect to its Washington timber activities.

d. Other issues include the inclusion of a proper value for government-owned property in the property factor and various manufacturers’ investment tax credit (MIC) issues.

e. Oral argument held January 25, 2005.

f. The SBE deferred its decision on the treasury function sales factor and the Washington timber distortion issues pending the California Supreme Court’s decision in General Motors. Further briefs on the distortion issues will be filed following the SBE’s decision in Home Depot (see II.A.1.i. above).

3. Microsoft Corporation v. FTB, San Francisco Superior Court No. CGC-08-471260. Suit for refund filed on January 22, 2008, raising the following issues for the 1995 and 1996 tax years:

a. Whether royalty income from computer software products should be sourced outside California based upon costs of performance for sales factor purposes.

b. Whether gross receipts from marketable securities should be included in the sales factor.

c. Whether the value of trademarks, copyrights, patents and other intangible assets should be included in the property factor.

d. Whether a deduction under RTC § 24402 should be allowed for dividends received for the years at issue.

4. Proposed Regulation 25137-14

a. The proposed regulation provides for an alternative apportionment methodology for mutual fund service providers that looks to the location of the underlying shareholders of the mutual funds, for purposes of assigning receipts to the numerator of the sales factor. See FTB Notice 2005-3.

b. On April 4, 2007, the proposed regulation was approved by the FTB.

5. Airline Apportionment Formula

a. Alaska Airlines, Inc., SBE Case No. 342596 (March 1, 2007), CCH Calif. Tax Rptr. ¶ 404-226. In a letter decision, the SBE held that the FTB incorrectly applied Regulation 25137-7, California’s special apportionment formula for airlines.

b. FTB held an interested parties meeting on March 27, 2008 to discuss how Regulation 25137-7 should be interpreted and administered.

6. Trucking Apportionment Formula

a. Swift Transportation Co., Inc., SBE Case No. 266318 (February 4, 2008), CCH Calif. Tax Rptr. ¶ 404-616. In a letter decision, the SBE upheld the FTB’s position that the special apportionment formula for trucking companies set forth in Regulation 25137-11 applied to all members of the taxpayer’s combined reporting group and not just the trucking company.

b. FTB has scheduled an interested parties meeting on July 10, 2008 to discuss updating Regulation 25137-11.

7. Special Industry and Other Proposed Regulations

a. The FTB held an interested parties meeting in January 2008 to consider revising Regulation 25137-8, regarding apportionment for the motion picture and television industry.

b. The FTB held an interested parties meeting in January 2008 to consider revising Regulation 25137-12, regarding apportionment for print media businesses.

III. Credits

A. Enterprise Zone Hiring Credits

1. Deluxe Corporation, 2006-SBE-003 (December 15, 2006)

a. Case involved challenge to FTB’s position of looking behind vouchers obtained from local enterprise zones. The taxpayer is arguing “voucher reliance” and that RTC § 23622.7 only requires that a certificate (voucher) be obtained from the enterprise zone or other appropriate agency and provided to the FTB upon request.

b. On January 31, 2006, the SBE held in a 4-1 vote that the FTB is permitted to look behind the vouchers. Post-hearing briefs were filed regarding whether the 51 remaining employees qualify for the credit.

c. On December 15, 2006, the SBE issued a formal opinion confirming the decision in January that the FTB is permitted to look behind the vouchers. In a letter decision issued that same day, the SBE concluded that 15 of the 51 employees at issue qualified for the credit.

d. On April 11, 2007, the taxpayer filed a suit for refund in the San Francisco Superior Court (No. CGC-07-462305).

e. Trial is scheduled for July 14, 2008.

2. Dicon Fiberoptics, Inc. v. Franchise Tax Board, Los Angeles Superior Court No. BC 367885

a. On March 13, 2007, a suit for refund was filed challenging the FTB’s authority to look behind the vouchers.

b. On August 17, 2007, the trial court sustained the FTB’s demurrer without leave to amend.

c. On October 3, 2007, an order of dismissal of plaintiff’s action was filed.

d. Case is pending on appeal.

3. Jessica McClintock and Jessica McClintock, Inc., SBE Case Nos. 304497 and 304512 (August 14, 2007)

a. Case involved the following issues: (1) whether subsection (c) of Section 1603 of the JTPA (“the 10% exception”) provides a separate eligibility category for purposes of the hiring credit; and if yes, then (2) whether the employees in question were eligible for services under subsection (c) of section 1603 of the JTPA.

b. The FTB argued that subsection (c) does not provide a separate eligibility category. The FTB further argued that individuals who could be enrolled in a JTPA program pursuant to subsection (c) were not “eligible” for JTPA services under RTC § 23622.7 and could only constitute qualified employees for purposes of the hiring credit if they were actually enrolled under the JTPA. The FTB also argued that "older worker" is not a barrier to employment because it is not enumerated in the statute.

c. The SBE voted 5-0 to grant the taxpayer's refund claims. The SBE held that for the 10% exception, an employee only needs to be eligible for JTPA services (and not required to be enrolled in JTPA) to be a qualified employee. The SBE further held that “older worker” is a barrier to employment for purposes of the 10% exception because of the legislative

history, EDD publications and the FTB's own audit manual. The SBE concluded that the “older worker” need not meet low-income guidelines.

d. On April 1, 2008, the FTB announced in its Tax News that based on purported “new information,” it is taking the position in pending appeals at the SBE that an individual must be both 55 years or older and meet low-income guidelines.

4. On November 27, 2006, vouchering regulations were issued by the Department of Housing and Community Development.

5. Taiheiyo Cement USA, Inc., SBE Case No. 332855 (February 4, 2008).

a. In a letter decision, the SBE sustained the FTB’s disallowance of the enterprise zone sales and use tax credit for property that the taxpayer currently expensed.

B. Manufacturers’ Investment Tax Credit

1. Save Mart Supermarkets, 2002-SBE-002 (February 6, 2002)

a. On February 6, 2002, the SBE issued a rare formal opinion in the first MIC case to reach the Board. This was the first in a series of taxpayer victories in MIC cases in 2002 and 2003.

b. The case involved the issue of whether Save Mart was a qualified taxpayer with respect to its bakery and meat processing activities.

Both activities are described in Division D of the SIC Manual.

c. The FTB argued that Save Mart was not a qualified taxpayer because “its primary activity” was retail (not manufacturing) and therefore should be assigned SIC Code 5411. As SIC Code 5411 is not in the manufacturing section of the SIC Manual, Save Mart did not meet the statutory requirement.

d. Save Mart argued that it was a qualified taxpayer under the plain meaning of the statute and that the FTB’s “qualified taxpayer” regulation (23649-3) was invalid because it imposed restrictions not contemplated by the MIC statute. Under that regulation, the FTB required that the taxpayer be classified or assigned a manufacturing SIC Code while the statute only requires that the taxpayer’s activities be “described in” the manufacturing section of the SIC Manual.

e. Save Mart further argued that even if Regulation 23649-3 was somehow valid, Save Mart was a qualified taxpayer because it satisfied the three requirements under Regulation 23649-3(b)(1)(B), the “separate establishment” test.

f. The SBE agreed with Save Mart and overturned the FTB’s qualified taxpayer regulation (Regulation 23649-3).

g. The SBE specifically held that the MIC statute should be liberally construed in favor of taxpayers in order to effectuate the purposes of the legislation, i.e., to encourage manufacturing in the State.

h. On September 3, 2003, the California Legislative Counsel issued an opinion that concluded that the SBE did not have the authority in Save Mart to declare an FTB regulation invalid. The opinion is not binding.

i. The FTB is refusing to follow Save Mart.

2. Costco Wholesale Corporation, SBE Case No. 266592 (October 25, 2005), CCH Calif. Tax Rptr. ¶ 403-908

a. In a 4-1 vote, the SBE reaffirmed its decision in Save Mart.

b. In a letter decision, the SBE held that Costco was a qualified taxpayer with respect to its bakery and meat processing activities.

3. Safeway, Inc., SBE Case Nos. 268637, 283211 (December 13, 2005)

a. In a summary decision, the SBE reaffirmed its decision in Save Mart and concluded that Safeway was a qualified taxpayer with respect to its bakery and meat processing activities. With the exception of a meat box, the SBE also concluded that the property used in these activities was qualified property.

4. Jon and Rita Minnis and Milpitas Materials Company, 2002-SBE-003 (June 20, 2002)

a. The SBE concluded in a formal opinion, that a cement mixer truck, comprised of a truck chassis and mixer barrel, constituted a single integrated piece of manufacturing equipment and thus the entire truck was qualified property for purposes of the MIC.

b. The SBE rejected the FTB’s attempt to bifurcate the truck into two components—manufacturing (mixing drum) which qualified for the MIC and transportation (chassis) which did not.

c. The SBE refused to follow FTB Legal Ruling 2001-4.

5. Bronco Wine Company, 2002-SBE-006 (September 12, 2002)

a. Late in 2002, the SBE again ruled against the FTB in another formal opinion.

b. The SBE concluded that wine tanks which had a capacity of 215,000 gallons were qualified property for purposes of the MIC. The SBE relied on the fact that the tanks could be moved and placed in productive use without damaging the property during the move.

c. The FTB had taken the position that smaller wine tanks qualified as tangible personal property but that the larger wine tanks were “inherently permanent structures” under Whiteco Industries, Inc. v. Commissioner, 65 T.C. 664 (1975).

6. California Steel Industries, Inc., 2003-SBE-001-A (July 9, 2003)

a. In a formal Opinion on Petition for Rehearing in 2003, the SBE once again rejected the FTB’s position.

b. The SBE held that payments made to third party contractors that are directly allocable to qualified property and are capitalized, constitute qualified property for purposes of the MIC.

7. Baxter Healthcare Corporation, SBE Case No. 140712 (May 28, 2003)

a. In a summary decision, the SBE confirmed its decision in California Steel regarding the capitalized labor issue.

b. The SBE also held that payments made to in-house engineers which are directly allocable to qualified property and are capitalized, constitute qualified property for purposes of the MIC.

c. The SBE also concluded that certain facilities were special purpose buildings and foundations and thus qualified property.

d. The SBE held that the heating, ventilating and air conditioning systems installed in clean rooms were not qualified property.

8. Lienau, SBE Case Nos. 156798, 156810, 156814 and 156808 (July 9, 2003)

a. In another taxpayer victory, the SBE held in a summary decision that the gain realized by a California S corporation, passed through to its shareholders, on the receipt of insurance proceeds for equipment losses and deferred under IRC § 1033 was chargeable to the capital account and thus constituted qualified costs for purposes of the MIC.

9. LSI Logic, Inc. and Cypress Semiconductor Corporation, SBE Case Nos. 142330 and 173287 (August 7, 2003)

a. In a controversial summary decision, the SBE voted 2-1 to grant refund claims under RTC § 6902.2. Under that statute, a taxpayer may claim a sales tax refund in lieu of the MIC. The in-lieu credit cannot be claimed any earlier than the MIC could have been claimed and the amount of the in-lieu credit cannot be in excess of the amount of the MIC that could have been claimed by the taxpayer.

b. In these cases, the taxpayers used research and development credits to eliminate their franchise tax liability. They did not claim MIC credits, although they would have been entitled to do so. The taxpayers thus claimed the in-lieu credit under RTC § 6902.2 in the amount of the MIC they otherwise could have claimed.

c. The SBE rejected its staff’s arguments that the Legislature did not intend to allow taxpayers to claim both the R&D credit and the MIC in-lieu refund because such could essentially make the MIC a refundable credit.

d. On September 29, 2003, Senate Bill No. 1064 was signed into law overturning on a prospective basis the LSI and Cypress decisions. SB 1064 permits any taxpayer that had filed a MIC in-lieu claim under RTC § 6902.2 on or before the date of the LSI and Cypress decisions (August 7, 2003) to obtain that refund.

e. On January 25, 2005, the SBE granted refund claims of a series of taxpayers who filed MIC in-lieu of claims on or before August 7, 2003.

10. Sierra Pacific, SBE Case No. 268309 (September 1, 2005), CCH Calif. Tax Rptr. ¶ 403-852

a. In a letter decision, the SBE unanimously held that the taxpayer’s steam generation assets which were primarily used to produce steam for use in its wood manufacturing process were qualified property for purposes of the MIC.

11. Foster Poultry Farms, SBE Case Nos. 268417, 268429, 268418, 268431 (May 17, 2006), CCH Calif. Tax Rptr. ¶ 404-013

a. In a summary decision, the SBE ruled that the taxpayer’s electrical substations were qualified property for purposes of the MIC. The SBE rejected the FTB’s contention that the electrical equipment was not tangible personal property. See Scott Paper Co. v. Commissioner, 74 T.C. 137 (1980).

12. Granite Construction Corporation, SBE Case No. 301578 (November 21, 2006), CCH Calif. Tax Rptr. ¶ 404-094.

a. In a letter decision, the SBE ruled that a taxpayer which manufactured aggregate for both external sales and for use in its manufacturing of asphalt and ready-made concrete was entitled to claim the MIC.

13. Penny-Newman Grain Co., Inc., SBE Case No. 338714 (Feb. 8, 2007), Calif. Tax Rptr. ¶ 404-209

a. In a letter decision, the SBE ruled that the taxpayer did not prove that its railroad tracks and scales was qualified property for MIC purposes.

14. MIC Repealed

a. The MIC was repealed by its own terms and ceased to be operative as of January 1, 2004.

b. Various bills have been introduced to revive the MIC, but none have passed.

c. MIC credits for years prior to 2004 and which have not yet been used, may be carried forward until fully utilized.

C. Separate But Unitary

1. General Motors Corporation v. FTB, 39 Cal. 4th 773 (2006)

a. California Supreme Court rejected the taxpayer’s argument that a research expense credit should be applied against the tax liability of the unitary group, or in the alternative, should be “intrastate-apportioned” against the tax liability of each of the taxpayer-members of the unitary group.

b. The Court accepted the FTB’s argument that the credit should be limited to the taxpayer which incurred the research expenses.

2. Cases pending in the administrative process challenging the siloing of credits under RTC § 25137.

IV. Water’s Edge Election

A. Fujitsu Holdings, Inc. v. FTB, 120 Cal. App. 4th 459 (2004)

1. California Court of Appeal concluded that for purposes of calculating the Subpart F inclusion ratio under the water’s edge combined report, dividends from lower-tier controlled foreign corporations should be excluded and not taken into account under RTC § 25106. In addition, the Court concluded that California has adopted the previously taxed income provisions of IRC § 959.

2. The Court also concluded that refunds of UK Advance Corporation Tax payments are dividends under California law and thus subject to elimination under RTC § 25106.

3. On the preferential ordering v. pro rata dividend deduction issue, the Court also concluded that the elimination provisions of RTC § 25106 are to be applied prior to the 75-percent dividends received deduction provisions of RTC § 24411.

4. In the only portion of the opinion in which the Court agreed with the FTB, the Court concluded that California’s water’s edge method of reporting does not facially discriminate against foreign commerce. The court distinguished the Kraft v. Iowa decision on the basis of the “footnote 23” argument which has been accepted by some other states.

5. The FTB’s petition for review was denied by the California Supreme Court.

B. Baxter Healthcare Corporation, SBE Case No. 150881 (August 1, 2002)

1. In a summary decision, the SBE concluded that Treasury Regulation 1.954-2(b) (1) excluded from Subpart F income for California water’s edge purposes, the dividend paid by one foreign subsidiary to another foreign subsidiary.

2. The SBE agreed with the taxpayer that IRC § 959(b) was incorporated into California law through the operation of Treasury Regulation 1.954-2(b)(1).

C. Apple Computer, Inc., 2006-SBE-02 (November 20, 2006)

1. On November 20, 2006, the SBE issued a formal opinion and agreed with the FTB—contrary to Fujitsu (see IV.A.3. above)—that the dividends paid by a controlled foreign corporation that was

partially included in a water’s edge combined report is prorated among the RTC § 25106 dividend elimination provision and the RTC § 24402 dividend deduction provision.

2. On January 16, 2008, the taxpayer filed a suit for refund in San Francisco Superior Court (No. CGC-08-471129).

D. FTB Proposed Amendments to Regulations 24411 and 25106.5-1

1. On February 9, 2005, the FTB staff requested approval from the 3-member FTB to proceed with amendments to Regulations 24411 and 25106.5-1.

2. The amendments are designed to reverse the Court of Appeal decision in Fujitsu regarding the dividend ordering rules of RTC § 25106 and RTC § 24411.

3. In response to opposition voiced at the FTB meeting, the staff was ordered to hold a symposium for interested parties rather than proceed directly into the formal regulatory process. See FTB Notice 2005-1.

4. On April 4, 2007, the FTB approved going forward into the formal regulatory process. A public hearing was held on January 16, 2008. FTB staff issued a report dated March 6, 2008 in response to public comments.

5. On March 6, 2008, the FTB staff pulled the regulation from the Board agenda and decided to not move forward on the regulation.

E. FTB Notice 2004-8

1. On December 1, 2004, the FTB requested public comment on a discussion draft of proposed amendments to Regulation 25110(d)(2)(F)3.

2. The proposed amendments address the manner in which deductions with respect to non-effectively connected income (“NECI”) of a foreign corporation included in a water’s edge combined report are to be determined.

3. In FTB Notice 2005-2, FTB staff requested examples under the proposed amendments.

4. FTB staff’s request to move forward on the proposed regulations has not been approved by the 3-member FTB.

5. During a 3-member FTB meeting on September 20, 2006, FTB Multistate Tax Counsel Benjamin Miller reported that FTB staff determined that the Legislature did not intend to include NECI in the water’s edge combined report.

6. On January 23, 2007, the FTB filed with the Secretary of State a revised version of proposed Regulation 25110 which incorporates FTB staff’s concession and provides that certain types of NECI is excluded from the definition of United States source income. The Regulation is effective February 23, 2007.

F. Proposed Legislative and Regulatory Amendments

1. In Legislative Proposal 08-03 the FTB proposed to revise the way in which the income from a controlled foreign corporation (CFC) is included in the water’s edge combined report. Currently, Subpart F income from a CFC is not included in the combined report. Rather, the ratio of a CFC’s Subpart F income to its earnings and profits (the “inclusion ratio”) is used to determine the extent to which the CFC’s income and apportionment factors are included in the combined report. In LP 08-03, the inclusion ratio method would be replaced by the inclusion in the combined report of 100 percent of the Subpart F income from a CFC, subject to a 27 percent deduction.

2. The FTB scheduled an interested parties meeting on March 25, 2008 to discuss updating existing Regulation 25111 and proposed Regulation 25113. The purpose of the meeting is to address changes to the existing regulation providing for the contract method of making a water’s edge election and discuss the content of a new regulation incorporating making a statutory water’s edge election.

3. The FTB scheduled an interested parties meeting on March 25, 2008 to discuss updating existing Regulation 25114 regarding presumptions arising from federal audit for water’s edge taxpayers.

V. Business/Nonbusiness Income

A. Vidco Express, Inc., SBE Case No. 378528 (November 16, 2007)

1. In a letter decision, the SBE determined that the gain on the sale of the taxpayer’s Michigan commercially domiciled business was business income.

2. The SBE rejected the taxpayer’s argument that the business essentially consisted of goodwill and that the gain from the sale therefrom should be treated as nonbusiness income allocated to Michigan as gain from the sale of intangible property.

3. The SBE also rejected the taxpayer’s alternative argument that apportionment of the gain under the standard apportionment formula was distortive.

VI. California Tax Amnesty … Not?

A. General Electric Company v. Franchise Tax Board, San Francisco Superior Court No. 449157

1. The taxpayer challenged the validity of the Amnesty Penalty under RTC § 19777.5 (SB 1100) in a declaratory relief action.

2. It was the taxpayer’s position that the Amnesty Penalty is invalid for a number of reasons and sought a declaration from the Court to that effect.

a. The taxpayer alleged that the Amnesty Penalty is unconstitutional under the Due Process Clause due to the absence of a plain, speedy and efficient remedy to challenge the merits of the penalty either in court or administratively.

b. The taxpayer alleged that the Amnesty Penalty is unconstitutional under the Due Process Clause due to its retroactive nature.

c. The taxpayer alleged that the FTB’s interpretation of “due and payable” in RTC § 19777.5 is at odds with RTC § 19049. The taxpayer requested a declaration from the Court, consistent with RTC § 19049, that no Amnesty Penalty will arise if the taxpayer pays the amount of the assessment on or before it receives a notice and demand for payment or within 15 days thereafter.

3. The FTB filed a demurrer to the complaint on the ground that the action was not ripe. The Court sustained the demurrer with leave to amend. On May 10, 2006, the taxpayer filed an amended complaint, to which the FTB filed another demurrer on ripeness grounds. The Court sustained the FTB’s demurrer.

4. On September 15, 2006, the taxpayer filed a notice of appeal.

5. On July 13, 2007, after briefs were filed and while the case was awaiting oral argument, the case settled and the appeal was dismissed.

B. David A. and Cheryl D. Duffield v. Franchise Tax Board, San Francisco Superior Court No. CGC-07-459331.

1. Suit for refund of personal income taxes, interest and Amnesty Penalty. In addition to the merits of the dispute, the taxpayer is challenging the validity of the Amnesty Penalty. There are no ripeness issues in this case.

2. Case was scheduled to go to trial in April 2008, but has been postponed.

C. Assembly Bill No. 561

1. Pending legislation sponsored by the FTB. The bill has been amended a number of times and is presently in the suspense file.

2. Some of the provisions include the following:

a. Allows for a Chief Counsel review of whether the Amnesty Penalty should be abated.

(1) Taxpayer must show the underpayment of tax arose from an item for which substantial authority exists; or

(2) Underpayment is due to RAR adjustments. This is limited to situations where the taxpayer was first contacted by the IRS concerning an examination after March 31, 2005; or

(3) Taking into account all facts and circumstances, holding the taxpayer liable for the Amnesty Penalty is against equity and good conscience.

(4) Review of the Chief Counsel’s decision is permitted only under an abuse of discretion standard.

b. Converts the Amnesty Penalty to interest.

c. Allows for reduction in the Amnesty Penalty to the extent it is due to change in interpretation of law.

d. Authorizes payment of a refund or credit for one year after the operative date of the bill, even if the one year statute of limitations under RTC § 19306 has expired, if the overpayment resulted from the provisions of the bill.

D. FTB Notice 2005-6

1. On November 28, 2005, the FTB issued procedures relating to tax deposits pursuant to California’s conformity (AB 115) to the “tax deposit” provisions of IRC § 6033.

2. The tax deposit provisions (RTC § 19041.5) replace the “deposit in the nature of a cash bond” provisions.

3. The FTB also will apply the tax deposit rules to amounts that were paid outside California’s 2005 amnesty program (e.g., protective claim payments).

4. Interest on tax deposit amounts that are returned to the taxpayer will be paid at the statutory overpayment rate.

5. The FTB announced that it has developed new forms, Forms 3576-3579, Tax Deposit Voucher, to designate a remittance as a tax deposit for a specific tax year. In addition, Form 3581, Tax Deposit Refund or Transfer Request, should be used to request a tax deposit refund, designate the application of a tax deposit to a different tax year, or apply a tax deposit to convert an administrative protest or appeal to an administrative refund action.

VII Anti-Tax Shelter Legislation

A. Senate Bill No. 614 and Assembly Bill No. 1601 1. Anti-tax shelter legislation was enacted in October 2003. It was generally effective January 1, 2004,

but may apply to certain transactions entered into prior to that date.

2. Generally conformed to existing federal law regarding tax shelter registration, list maintenance and disclosure of reportable transactions.

3. Provided for various penalties in connection with the use of tax shelters, including enhanced penalties for noneconomic substance transaction understatements (up to 40%) and reportable transaction understatements (up to 30%).

4. Also provided for penalties aimed at tax shelter promoters, advisers and return preparers.

5. Extended the statute of limitations to eight years for proposed deficiency assessments relating to abusive tax avoidance transactions.

6. Directed the FTB to identify and publish California “listed transactions,” pursuant to which the FTB issued Chief Counsel Announcement 2003-1 on December 31, 2003 identifying certain REIT and RIC transactions as listed transactions for California purposes.

7. SB 614 and AB 1601 also provided for a “voluntary compliance initiative” (VCI) for the period January 1, 2004 through April 15, 2004 during which eligible taxpayers voluntarily could pay all tax and interest due as a result of their use of tax shelter for taxable years beginning before 2003 to avoid tax shelter penalties.

8. Legislation (Assembly Bill No. 115) was enacted on October 7, 2005 to conform to certain federal rules relating to reportable transactions.

B. Challenges to FTB’s Disallowance of REIT and RIC Dividend Deductions

1. City National Corporation v. FTB, Los Angeles Superior Court No. BC334772

a. The taxpayer is challenging the FTB’s disallowance of REIT and RIC dividend deductions.

b. The FTB’s demurrer on procedural grounds was sustained without leave to amend.

c. On January 16, 2007, the Court of Appeal reversed the lower court and held that the taxpayer was not barred from proceeding with its suit for refund.

d. On April 11, 2007, the California Supreme Court denied the FTB’s petition for review.

e. The case is currently pending in the trial court.

2. City National Corporation v. FTB, Sacramento Superior Court No. 06AS02275

a. In an action similar to the above case but for subsequent taxable years, the taxpayer is claiming a refund with respect to REIT dividend deductions.

C. FTB Notice 2007-3

1. On July 31, 2007, the FTB issued Notice 2007-3 announcing that taxpayers who either failed to file or filed an incomplete IRS Form 8886, Reportable Transaction Disclosure Statement, with the FTB, have 60 days to file them before the FTB will assess penalties. Taxpayers filing a disclosure statement in accordance with Notice 2007-3 should file the statement with the FTB’s Abusive Tax Shelter Unit.

VIII Penalties

A. FTB Notice 2004-5

1. On August 6, 2004, the FTB announced that accuracy related penalties may be asserted against taxpayers who file California franchise tax original returns inconsistent with the standard allocation and apportionment provisions of RTC §§ 25120-25136 and who have not obtained prior approval from the FTB.

a. Applicable to returns with a due date, determined without extensions, after October 14, 2004.

b. For returns with a due date before October 15, 2004, a statement attached to the return that adequately discloses that the taxpayer’s return is inconsistent with the standard allocation and apportionment rules, or that the taxpayer has relied on RTC § 25137 will be considered adequate disclosure.

2. Existing FTB Regulation 19164 provides an exception to the accuracy related penalty for understatements of tax which are attributable to the taxpayer’s good faith determination, whether based on the facts or unresolved legal issues, of either (i) the contours of the taxpayer’s unitary business(es) or (ii) business vs. nonbusiness income items. Neither the amendments to the accuracy related penalty under SB 1100 (see VI.A.1. above) nor FTB Notice 2005-1 eliminates the exceptions provided under Regulation 19164.

B. FTB Notice 2006-3

1. The FTB announced that, for purposes of applying FTB Notice 2004-5 (see above), a taxpayer that excludes from the sales factor the amount realized on the redemption of marketable securities as part of its treasury function, and includes only the interest income and net gains from such securities, will not be subject to the accuracy related penalty under RTC § 19164.

2. The FTB based its position on the California Supreme Court’s August 17, 2006 decision in Microsoft (see II.A.1.b. above) and Pacific Telephone & Telegraph, 78-SBE-028 (May 4, 1978).

IX Miscellaneous

A. Procedural Issues

1. Ordlock v. Franchise Tax Board, 38 Cal. 4th 897 (2006)

a. The California Supreme Court reversed the decision of the appellate court and held that the FTB was not time-barred from issuing an assessment based on a federal change that occurred after the normal four-year statute of limitations had expired.

2. FTB Protest Procedures Modified

a. The FTB issued two notices pertaining to the processing of docketed protests. See FTB Notices 2006-5 and 2006-6.

b. The intention is to attempt to achieve greater efficiency in the processing of protests.

c. Reduced timeframes for the processing of protests (12-18-24 months).

3. SBE Rules of Practice Modified

a. The SBE has issued revised Rules for Tax Appeals.

B Attorneys Fees

1. In four recent decisions, courts have granted requests for attorney’s fees for taxpayers in litigations against the FTB.

a. Fujitsu Holdings, Inc. v. FTB, 120 Cal. App. 4th 459 (2004)

(1) Time-Bar Issue

(a) The taxpayer made payment of taxes for 1988 during the pendency of protest.

(b) The FTB’s position was that the suit for refund was untimely for 1988.

(i) RTC § 19335 converted protest into claim for refund.

(ii) After the SBE decision upholding the FTB’s denial of the protest, Fujitsu’s subsequent claim for refund was a nullity.

(iii) Fujitsu’s suit for refund for 1988 was not filed within 90 days of the SBE’s decision.

(c) The FTB did not apply the payment to the protest until after the SBE decision.

(d) Trial court held the FTB could not invoke RTC § 19335 to bar refund suit.

(e) The time-bar issue was not appealed by the FTB.

(2) Attorneys Fees Awarded With Respect to Time-Bar Issue

(a) RTC § 19717 provides that reasonable litigation costs, including attorneys fees may be recovered.

(i) FTB’s position must not be substantially justified.

(ii) Taxpayer must substantially prevail. (b) Court of Appeal held that the FTB’s position was not “substantially

justified.”

(i) FTB’s application of the payment after SBE decision was critical in the Court’s view.

(c) The taxpayer did substantially prevail even though the time-bar issue was not the most significant issue in the litigation.

b. Milhous v. FTB, California Court of Appeal No. D044362 (August 15, 2005)

c. American General Realty v. FTB, San Francisco Superior Court No. CGC-03-425690 (2005)

(1) See I.C. above.

(2) Trial court granted the taxpayer’s request for attorneys fees based on market rates.

(3) The FTB did not appeal the trial court’s decision.

d. Agnew v. SBE, 134 Cal. App. 4th 899 (2005)

(1) In a sales and use tax case, the taxpayer’s request for attorney fees was not granted under RTC § 7156.

(2) However, costs, including expert witness fees, were awarded.

(a) See California Code of Civil Procedure Sections 998 and 1032.

e. Cardinal Health v. SBE, San Francisco Superior Court No. CGC-04-437052 (May 2006)

(1) Case dealt with the issue whether the SBE’s denial of a sales and use tax exemption was proper.

(2) Trial court ruled in favor of the taxpayer and granted its request for attorneys fees based on market rates.

(3) On appeal, in an unpublished decision, the Court of Appeal reversed the granting of attorneys fees.

f. Northwest Energetic Services, LLC v. FTB, San Francisco Superior Court No. CGC-05-437721 (March 3, 2006)

(1) Attorneys fees were granted based on a “private attorney general” doctrine (California Code of Civil Procedure Section 1021.5).

(2) On appeal, the Court of Appeal reversed and remanded the case to the trial court on the issue of attorney fees. 159 Cal App. 4th 841 (2008).

2. On August 23, 2007, the FTB issued Information Letter 2007-2, which states that in order for a taxpayer to prevail on a request for attorneys fees under RTC § 19717, the taxpayer must exhaust all administrative remedies, including an appeal to the SBE.

C Limited Liability Company Issues

1. Northwest Energetic Services, LLC v. FTB, San Francisco Superior Court No. CGC-05-437721 (March 3, 2006)

a. The trial court concluded that California’s LLC fee under RTC § 17942 violates the Commerce and Due Process Clauses because it is based on worldwide gross income and not apportioned between gross income sourced within and without California.

b. The LLC in Northwest Energetic was a Washington state LLC that registered to do business in California, but never had any sales, property, payroll or other activity in California.

c. While the court’s decision appears to conclude that the LLC fee is unconstitutional and cannot be imposed on any LLC, including those with California activities, it remains uncertain whether a California court would be as willing to conclude the fee is unconstitutional for an LLC that generated all, or most, of its income from California sources.

d. On appeal, the Court affirmed but reversed and remanded the case to the trial court on the issue of attorney fees. 159 Cal App. 4th 841 (2008). The FTB did not seek review of the LLC fee issue by the California Supreme Court.

e. On April 14, 2008, the FTB issued Notice 2008-2 summarizing the information needed for taxpayers filing claims for refund based on the Northwest Energetic decision.

f. For taxable years beginning on or after January 1, 2007, legislation was enacted that provides that total income from all sources reportable to California means gross income, plus cost of goods sold, derived from or attributable to California within the meaning of specified provisions of the Corporation Tax Law relating to apportionment and allocation.

2. Ventas Finance I, LLC v. FTB, San Francisco Superior Court No. CGC-05-440001 (November 7, 2006)

a. Similar to Northwest, the trial court concluded the LLC fee under RTC § 17942 was an unfairly apportioned tax.

b. The Court concluded that RTC § 17942 could not be reformed to add an apportionment mechanism since that was contrary to the Legislature’s intent.

c. The taxpayer had approximately 10 percent of its revenues from California sources.

d. Case is pending on appeal.

3. Bakersfield Mall LLC v. FTB, San Francisco Superior Court No. CGC-07-462728 (pending)

a. A limited liability company that does business solely within California filed suit challenging the constitutionality of the LLC fee. The suit seeks class status for LLCs that derive all income from within California.

b. The FTB’s demurrer was overruled and the case is currently pending in trial court.

D Financial Corporation Classification

1. On March 12, 2007, the FTB issued Chief Counsel Ruling 2007-1 dealing with how to determine whether a corporation is a financial corporation under California law.

2. The precise issue addressed was whether a corporation’s income from non-financial activities can give rise to financial income for purposes of the gross income test in determining financial corporation status.

3. The FTB concluded that the focus should be on whether the activity generating the income was the “business of national banks,” not on the character of the income.

E Federal Conformity

1. FTB Chief Counsel Ruling 2007-3

a. On July 17, 2007, the FTB issued a ruling confirming that a transaction was tax-free for California purposes under IRC § 355(b), as in effect prior to amendment by the Tax Increase Prevention and Reconciliation Act of 2005 (“TIPRA”).

b. The IRS issued a private letter ruling that the transaction was tax-free under IRC § 355(b), as amended by TIPRA, which permits a corporation to satisfy the “active trade or business” requirement if the affiliated group to which the corporation belongs is engaged in the active conduct of a trade or business.

c. Because California has not yet conformed to the TIPRA amendments to IRC § 355(b), the FTB analyzed the transaction under the pre-TIPRA rules. The FTB ruled that the transaction, as described in the IRS ruling, did not satisfy the tax-free requirements under pre-TIPRA IRC § 355(b). However, the taxpayer undertook additional steps in the transaction, which the FTB determined satisfied the active trade or business requirement under pre-TIPRA IRC § 355(b) and did not constitute a noneconomic substance transaction subject to penalties.

F California Compliance Resolution Program (IRC § 409A)

1. On February 23, 2007, the FTB issued Notice 2007-1. The purpose of the Notice was to advise employers participating, or intending to participate, in the IRS Compliance Resolution Program (Announcement 2007-18), that they may also participate in the corresponding California Compliance Resolution Program.

CONNECTICUT STATE DEVELOPMENTS

Richard W. Tomeo, Esq. Robinson & Cole, LLP 280 Trumbull Street Hartford, CT 06106 860-275-8278 860-275-8299 (fax) rtomeo@rc.com http://www.rc.com I. INCOME/FRANCHISE TAXES A. Legislative Developments The Connecticut General Assembly is in session at this writing. No tax changes of significance have been adopted at this time. Listed below are several pending bills affecting tax matters that warrant attention: (1) S.B. No. 657 would provide a 10% earned income credit under the personal income tax for individuals eligible for the federal EIC. Proposal to adopt a state-level economic stimulus rebate was removed by amendment. (2) S.B. No. 5798 would provide tax credit for green buildings certified as such by the United States Green Building Council. The credit for any year may not exceed 60% of allowable costs, can be carried forward for five years and is transferable. (3) While a specific bill cannot be identified at this writing, the annual aggregate cap on tax credits for digital animation production, which was initially adopted in 2007, is likely to increase from $15 million to $25 million over a period of years. (4) H.B. No. 5554 would extend the existing tax credit for film production and film infrastructure to activities related to live productions of theater in venues owned or operated by nonprofit organizations. The credit is in the amount of 30% of production costs and 20% of infrastructure costs. (5) H.B. No. 5156 would permit the transfer of tax credits by an insurance company or health care center to an affiliate of the transferor, provided that the credit is used against the insurance companies, hospital and medical services corporation taxes provided in Chapter 207 of the Connecticut General Statutes. (6) H.B. No. 5937 would extend the Neighborhood Assistance Act tax credit to persons subject to the personal income tax, and permit the utilization of such credits earned by LLCs, partnerships or S corporations. (7) S.B. No. 592 would enact a new income tax credit for angel investors in a qualified

Connecticut business. The credit would be in the amount of 25% of eligible cash investments, subject to a cap of $125,000, may be carried forward for five years and would be transferable.

(8) S.B. No. 594 would permit state grants to fund capital improvements by municipalities and nonprofits to be paid to a federally certified qualified community development entity or to a business investing in

such an entity, thus permitting such funding to facilitate use of federal New Market Tax Credits. (9) S.B. No. 401 would require the Department of Economic and Community Development to study emerging industries in the state and to report to the Commerce Committee by January 1, 2009 with respect to a next generation industries tax credit. (10) S.B. No. 658 would create a study of the current corporation business tax structure, including consideration of a unitary or combined reporting regime and an alternative business activity tax. B. Judicial Developments (1) Achillion Pharmaceuticals, Inc. v. Law, Super. Ct. No. CV 06-4012046S, J.D. New Britain (February 7, 2008), the court held that that portion (2/3) of the rolling research and development tax credit available under CGS §12-217n that is not refundable in the year of generation is not available for refund in a subsequent year. The taxpayer has appealed the decision. C. Administrative Developments (1) Policy Statement PS 20077(4)(Sep. 20, 2007) explains the treatment of eligible film production companies, payroll services companies and film production loan-out companies for purposes of income tax, income tax withholding, business entity tax, corporation business tax and sales and use taxes. II. Transactional Taxes A. Legislative Developments Pending bills of particular interest before the General Assembly include the following: (1) H.B. No. 5939 would clarify application of the sales and use tax to manufacturers of asphalt who sell to a purchaser who fulfills a paving contract, indicating that such sale shall not be subject to tax. The bill would also confirm that the manufacturing machinery exemption shall apply to purchases by such paving contractor. (2) S.B. No. 593 would provide an exception from health and athletic club services for amounts charged for Pilates instruction. (3) S.B. No. 220 would exempt sale of tangible personal property or services to state-chartered credit unions, putting them on a parity with federally-charted credit unions. (4) In January 2008 the Connecticut Streamlined Sales Tax Commission issued its evaluating the changes that would be required for the sales and use tax if the State were to become a full member of the Streamlined Sales Tax Governing Board. The report recommended that Connecticut not move forward to join the SSTP because of the problems presented by multiple tax rates and the prohibition of exemptions based upon the value of an item. The Commission recommended that decision be deferred until Congressional action regarding taxation of remote sellers. B. Judicial Developments

(1) In DaimlerChrysler Corporation v. Law, 937 A.2d 675 (CT. 2007), the Supreme Court held an automobile manufacture that had refunded vehicle sales prices, including sales tax, to customers who returned the vehicles under the Connecticut "lemon law" was not entitled to a refund of such returned taxes from the DRS. The court found that the vehicle sales were completed transactions and that a refund claim action was barred by sovereign immunity. (2) In Key Air Inc. v. Law, Super. Ct. No. CV 06-4009597, J.D. New Britain (December 5, 2007), the court held that job-related training of the pilots employed by the taxpayer, a certificated air carrier, were subject to the exclusion from taxable business management services because the training was rendered in connection with aircraft having a maximum certificated take-off weight of six thousand pounds or more. The court further suggested that, because such training was performed outside Connecticut, they would not be subject to use tax even if the trained pilots operated within Connecticut. This aspect of the court's opinion may open the door to refund claims for other job-related training performed for Connecticut employers at out-of-state sites. (3) In Sikorsky Aircraft Corp. v. Law, Super. Ct. No. 06-4009194, J.D. New Britain (May 16, 2007), the court overruled the denial by DRS of the taxpayer's refund claim taxes paid in connection with the purchase of personal property used in connection with research and development for aircraft manufacturing. The matter has been the subject of a rehearing by the court and remains pending at this writing.. C. Administrative Developments (1) Informational Publication IP 2007(4)(Sep. 1, 2007) provides guidance for retailers making sales in more than one municipality subject to the requirement to file disaggregated sales tax information. (2) Ruling 2007-3 held that a taxpayer leasing "dark" fiber optic cable is leasing tangible personal property and that the provision of "lit" fiber optic cable constitutes a taxable telecommunications service. III. Property Taxes A. Legislative Developments (1) S.B. No. 701 would require a $100,000 homestead exemption for Targeted Investment Communities and communities with a designated manufacturing plant (currently 18 communities). The bill has been opposed by the business community as requiring a shift in tax burdens from residences to businesses. (2) H.B. No. 5936 would provide for a property tax exemption, without local option, for buildings equipped with active, passive or hybrid solar energy heating or cooling systems. B. Judicial Developments (1) Hotshoe Enterprises, LLC v. Hartford, 284 Conn. 833 (2008), affirmed in a per curiam opinion the trial court's holding that the statutory exemption for land belonging to the state of Connecticut applied to condominium hangars located at a state-owned airport. (2) In Dominion Nuclear Connecticut, Inc. v. Waterford, Super. Ct. No.

03-0566126S, J.D. New Britain (November 8, 2007), the court determined the value of a nuclear power station relying principally upon the purchase price paid for the facility in the context of a de- regulation sale transaction, less the value of intangible assets. (3) C.C.C. Real Estate, Inc. v. Waterbury, Super. Ct. J.D. No. 04-4000166S, J.D. New Britain (November 15, 2007), held that a title holding company exempt under I.R.C. § 501(c)(2) was exempt from property tax on real property leased to an affiliated 501(c)(3) organization. (4) In HealthSouth Corp. v. Waterbury et al., Super. Ct. Nos. CV 05- 4011048 et al., J.D. New Britain (March 13, 2008), the court denied the taxpayer's claim for a writ of mandamus to require assessors to correct the tax rolls to remove non-existent assets that the taxpayer had added to its books to inflate its value and meet Wall Street earnings expectations. A plaintiff seeking mandamus relief must possess clean hands. (5) In Aspetuck Land Trust, Inc. v. Bridgeport, Super. Ct. No. CV 06- 4016847S, J.D. Bridgeport (March 3, 2008), the court held that land held by a federally-tax exempt land trust for open-space conservation is not exempt from property tax under the Connecticut exemption for charitable use unless the property is used for "some minimal educational or other charitable activity." (6) In Hartford/Windsor Healthcare properties, LLC et al. v. Hartford, Super. Ct. No. CV 07-4014469, J.D. New Britain (April 2, 2008), the court held that nursing home properties are not eligible for the property tax relief program in C.G.S. § 12-62n for residential and apartment properties. IV. Procedural Matters A. Legislative Developments (1) H.B. 702 would clarify that the burden of proof for all taxpayers appealing tax determinations to the Superior Court is the preponderance of the evidence, not clear and convincing evidence, as has been found recently by the court. The bill would also require the Commissioner of Revenue Services to notify promptly any taxpayers whose return information maintained electronically might have been compromised or disclosed without authorization. B. Administrative Developments (1) Policy Statement PS 2008(2)(Jan. 22, 2008), updates guidance regarding the procedures to be followed by taxpayers seeking private letter rulings. V. Biography Richard W. Tomeo is a partner in the law firm of Robinson & Cole, LLP. He holds a J.D. degree from the University of Connecticut School of Law and an LL.M. in Taxation from George Washington University. He is a past chair of the Connecticut Bar Association Tax Section and the current chair of its Corporation Business Tax Subcommittee. Mr. Tomeo serves on the editorial board of the Journal of Multistate Taxation, is the Senior Topical Editor for Taxation, Connecticut Bar Journal, and is a contributing author to the ABA Sales and Use Tax Deskbook and the CCH Guidebook to Connecticut Taxes.

COLORADO STATE DEVELOPMENTS Alan Poe Holland & Hart LLP 8390 East Crescent Parkway, Suite 400 Greenwood Village, Colorado 80111 Telephone: 303-290-1616 Fax: 303-975-5295 apoe@hollandhart.com www.hollandhart.com I. INCOME TAX

A. Legislative Development Colorado Moves to Single Sales Factor Apportionment Formula House Bill 08-1380 was approved by both houses of the Colorado legislature and is now awaiting the Governor’s signature, which is expected. When signed by the Governor, the new law will eliminate Colorado’s long-standing option for multistate corporations to choose annually (1) to allocate and apportion income under a three-factor formula pursuant to the Multistate Tax Compact or (2) to apportion income under a two-factor formula based on property and revenue that did not include a throwback rule. Highlights of the new law include the following:

• The new law will apply to tax years beginning on or after January 1, 2009. • Nonbusiness income will be allocated based on typical allocation rules. • Business income will be apportioned to Colorado based on a single sales apportionment factor, which

includes a throwback rule. • Foreign source income will not be included in the calculation of the apportionment factor. • A taxpayer will be able to elect each year to treat all income as business income. • Special rules will apply to taxpayers engaged in the business of publishing magazines or periodicals and to

mutual fund service corporations. • The previous prohibition on carrying net operating losses to years in which a different apportionment formula

was used will be eliminated. B. Judicial Developments Colorado Supreme Court to Review Applicability of Limit on Conservation Easement Credits to Tenants in Common The Colorado Supreme Court granted a petition for a writ of certiorari to review the decision of the Colorado Court of Appeals in Kenna v. Huber, 179 P.3d 189 (Colo. App. 2007). The Court of Appeals held that a $100,000 limit on the amount of credit that a taxpayer could claim for a donation of a conservation easement applied separately to each tenant in common in a property. The Court of Appeals invalidated a regulation promulgated by the Department of Revenue stating that the credit generated by the donation of a conservation easement by tenants in common was limited to $100,000. The Court of Appeals, however, remanded the case to the trial court for consideration of whether a 2006 statute that specifically limited the credit to $100,000 for a donation by tenants in common applied retroactively to the 2000 and 2001 tax years. State District Court Allows Taxpayer to Amend Return to Elect Use of Combined-Consolidated Return Colorado allows a corporate taxpayer that is required to file a combined income tax return to elect to file a combined consolidated income tax return, which permits the inclusion in the return of certain entities that would not be included in a combined income tax return. However, prior to 2002, that option was not generally publicized by the Colorado Department of Revenue. By regulation, the Department of Revenue also required that a taxpayer’s election to file a

consolidated income tax return for a tax year be made no later than the extended due date for the taxpayer’s income tax return for that tax year. Cendant Corporation and certain of its affiliates filed a combined income tax return in Colorado for the 2001 tax year. Shortly after filing that return, the Cendant employee responsible for filing the return learned for the first time – at a COST conference – that Colorado permitted the combined-consolidated filing option. The employee immediately filed an amended Colorado income tax return for tax year 2001, using the combined-consolidated return option. The Department of Revenue rejected the amended return, based on its regulation requiring that a taxpayer make an election to file a consolidated income tax return no later than the extended due date for the taxpayer’s income tax return for the tax year. In Cendant Corporation and Subsidiaries v. Department of Revenue, Case No. 07CV676, the Denver District Court held that the Department of Revenue erred in rejecting the amended return. Finding that the lack of notice or information about the combined-consolidated return option deprived taxpayers of the opportunity to elect that option, the court determined that the amended return constituted a timely election to file a combined-consolidated return, even though the amended return was filed after the extended due date for Cendant’s income tax return for tax year 2001. The Department of Revenue appealed the district court’s decision to the Colorado Court of Appeals. That appeal is currently pending. C. Administrative Development Regulation Implementing Ruling Program Promulgated The Colorado Department of Revenue finally published a final regulation (Regulation 24-35-103.5), effective June 30, 2008, to implement a 2006 statute authorizing the Department to issue private letter rulings and information letters. Under the regulation, a taxpayer may request a non-binding information letter (issued at no cost) on the interpretation or application of any tax administered by the Department (including income tax). A taxpayer may also request a binding private letter ruling (which requires the payment of a variable fee that is based on the amount of work projected by the Department to be needed to issue the private letter ruling) regarding the tax consequences of a proposed or completed transaction.

II. TRANSACTION TAXES

A. Legislative Developments Machinery Used in Cleanroom Operations Exempt from State Sales and Use Tax House Bill 07-1277 created a new exemption from state sales and use tax, effective for fiscal years beginning on or after July 1, 2007, and before July 1, 2017, for machinery comprising a cleanroom used to produce tangible personal property. A cleanroom is defined as an environment with a level of environmental pollutants equal to or less than the maximum number of particles per cubic meter specified by ISO 14644-1, class 6. Machinery comprising a cleanroom includes integrated systems, fixtures, process piping, valves, electrical components, chillers, pumps, ducts, air management systems, tanks, motors, computers, or any other related apparatus that constitutes an assemblage of interrelated machines with separate functions that collectively operate in a continuous process to reduce contamination or to control airflow, temperature, humidity, chemical purity, other environmental conditions, or manufacturing tolerances. Machinery comprising a cleanroom also includes production equipment, moveable cleanroom partitions, and cleanroom lighting. However, a building or a permanent, nonremovable component of a building does not qualify as cleanroom machinery. Section 39-26-722, C.R.S. Certain Machinery Used to Produce Electricity Exempt from State Sales and Use Tax In late 2006, in a use tax refund case, the Executive Director of the Colorado Department of Revenue ruled that machinery used to produce electricity did not qualify for the manufacturing machinery exemption from state sales and use tax under section 39-26-709, C.R.S. This ruling was directly contrary to a 2001 ruling by a previous Executive Director, which held that machinery used to produce electricity did qualify for the manufacturing machinery exemption. The 2006 ruling is now on appeal in the Denver District Court.

In the meantime, a number of independent power projects, including many renewable energy projects, were bid, developed, and constructed while the 2001 ruling was in place. In House Bill 07-1279, the Colorado legislature provided protection to those projects by enacting an exemption from state sales and use tax for machinery used in the production of electricity from a renewable energy source (regardless of when the project was built) and for machinery used in the production of electricity in a facility for which a long-term power purchase agreement was fully executed between February 5, 2001 (the date of the 2001 ruling) and November 7, 2006 (the date of the 2006 ruling). Section 39-26-709(1)(a)(III) and (IV), C.R.S. In HB 08-1368, the portion of this exemption applicable to renewable energy projects was moved to a separate statutory section and was defined to be an exemption for components (including wind turbines, rotors, and blades, solar modules, trackers, generating equipment, supporting structures or racks, inverters, towers and foundations, balance of system components such as wiring, control systems, switchgears, and generator step-up transformers, and concentrating solar power components that include mirrors, plumbing, and heat exchangers) used in the production of alternating current electricity from a renewable energy source. House Bill 08-1368 is awaiting the Governor’s signature, which is expected. B. Judicial Developments Colorado Court of Appeals Upholds City’s Use Tax on Theater’s Use of Motion Picture Film Reels In Cinemark USA, Inc. v. Seest, __ P.3d ___, 2008 WL 451752 (February 21, 2008), the Colorado Court of Appeals rejected a theater’s argument that the City of Fort Collins use tax did not apply to the theater’s use of motion picture film reels that the theater obtained from film distributors. The Court of Appeals previously ruled against another theater on the same issue in a case arising under the City of Westminster use tax. American Multi-Cinema, Inc. v. City of Westminster, 910 P.2d 64 (Colo. App. 1995). However, in 2003, the Colorado Supreme Court issued its decision in City of Boulder v. Leanin’ Tree, Inc., 72 P.3d 361 (Colo. 2003), in which the Supreme Court held that a right acquired by a greeting card company to use art in manufacturing greeting cards was an intangible right not subject to use tax. The theater argued that the Leanin’ Tree case effectively overruled the American Multi-Cinema decision. The Court of Appeals disagreed with the theater and held that, under the case-by-case, “totality of the circumstances” test adopted by the Supreme Court in Leanin’ Tree, the theater’s use of the motion picture film reels was subject to use tax. The Court of Appeals based this decision on its conclusion that, under the totality of the circumstances, the clear purpose of the theater’s transactions with the film distributors was the theater’s use of a physical product, the motion picture film reels. The Court of Appeals also rejected the theater’s arguments that its customers (the movie-goers) were the ultimate consumers of the film reels, and that no taxable event occurred because the distributors merely loaned the motion picture film reels to the theater. The theater filed a petition for a writ of certiorari in the Colorado Supreme Court, asking that Court to exercise its discretion to review the decision of the Court of Appeals. That petition is currently pending. Colorado Court of Appeals Grants City Sales and Use Tax Exemption to Catholic Church’s Retirement Community In Catholic Health Initiatives of Colorado v. City of Pueblo, __ P.3d ___, 2007 WL 2493686 (Colo. App. 2007), the Colorado Court of Appeals held that a continuing care retirement community in Pueblo that was owned and operated by an affiliate of the Catholic Church was engaged in a religious activity and therefore qualified for an exemption from City of Pueblo sales and use tax on all of its purchases and use of tangible personal property. Noting that the term “regular religious functions and activities” was not defined in the Pueblo sales and use tax ordinance, the Court of Appeals concluded that the use to which the retirement community’s property was put was consistent with the owner’s sincerely held religious belief. The City of Pueblo filed a petition for a writ of certiorari in the Colorado Supreme Court, asking that Court to exercise its discretion to review the decision of the Court of Appeals. That petition is currently pending.

State District Court Finds that City Violated TABOR and Orders Refund In HCA – Healthone, LLC v. City of Lone Tree, Case No. 06CV1915 (2007), the Douglas County District Court held that the City of Lone Tree violated the Taxpayer Bill of Rights (TABOR) by failing to obtain advance voter approval of the city’s general use tax. Prior to 2006, the city generally advised taxpayers that the city’s use tax was limited to construction and building materials. The city granted refunds to certain taxpayers of use tax erroneously paid by those taxpayers on items other than construction and building materials. However, when HCA – Healthone, LLC sought a refund of use tax it erroneously paid on items other than construction and building materials, the city denied that refund claim. The city argued that various ordinances adopted by the city authorized the general use tax and were either approved by the voters at the time of adoption or were retroactively approved by the voters. The district court disagreed, finding that the ordinances approved by the voters did not impose a general use tax and that retroactive approval by the voters was not permitted under TABOR. The court ordered that the refund be paid to the taxpayer, with simple interest at 10% per year as provided by TABOR, and that the taxpayer be awarded its costs and attorneys fees, also as provided by TABOR. The City of Lone Tree appealed the district court’s decision to the Colorado Court of Appeals. That appeal is currently pending. State District Court Defines Construction and Building Materials Under Colorado law, counties are permitted to impose use taxes only on registered motor vehicles and construction and building materials. Section 29-2-109, C.R.S. Rio Blanco County adopted a use tax on construction and building materials. The county asserted that the use tax applied to casing, tubing, pipes, wellheads, surface equipment, and processing plants used in connection with the drilling for, extraction of, and processing of oil and gas in the county. In Board of County Commissioners v. Exxonmobil Oil Corporation, Case No. 06CV1557 (2007), the Denver District Court held that Rio Blanco County’s application of its use tax to the taxpayer’s equipment exceeded the county’s statutory authority. The court concluded that the usual and ordinary meaning of construction and building materials did not encompass the equipment used in the taxpayer’s drilling, extraction, and processing operations. Rio Blanco County appealed the district court’s decision to the Colorado Court of Appeals. That appeal is currently pending. C. Administrative Developments Regulation Implementing Ruling Program Promulgated The Colorado Department of Revenue finally published a final regulation (Regulation 24-35-103.5), effective June 30, 2008, to implement a 2006 statute authorizing the Department to issue private letter rulings and information letters. Under the regulation, a taxpayer may request a non-binding information letter (issued at no cost) on the interpretation or application of any tax administered by the Department (including state and state-administered local sales and use tax). A taxpayer may also request a binding private letter ruling (which requires the payment of a variable fee that is based on the amount of work projected by the Department to be needed to issue the private letter ruling) regarding the tax consequences of a proposed or completed transaction. Procedural Trap Catches Taxpayers Taxpayers need to be aware of a potential procedural trap in connection with appeals of sales and use tax assessments issued by local jurisdictions in Colorado. Under a state statute (section 29-2-106.1, C.R.S.), a taxpayer is permitted to appeal a local sales or use tax assessment for de novo review by either the Executive Director of the Colorado Department of Revenue or a state district court. In order to exercise this right, the taxpayer must file the appeal within 30 days after exhausting local remedies. Exhaustion of local remedies occurs when the local jurisdiction holds a hearing and issues a decision, or after 90 days

(extended to 180 days if the taxpayer causes the delay) from the date of the taxpayer’s protest if no hearing has been held or no decision has been issued. At least one home rule city (Commerce City) has delayed hearings and decisions beyond the 180 days and then has argued that the taxpayer lost its right to appeal in accordance with the state statute unless the taxpayer filed an appeal within 30 days after the expiration of the 90-day or 180-day period, even though no decision had been issued. The Executive Director of the Department of Revenue has upheld Commerce City’s position in at least a couple of unreported cases. While this result is unconscionable and appears to be limited for now to Commerce City, taxpayers should be aware of this risk. A taxpayer who protests a local sales or use tax assessment should always calendar the 90-day and 180-day periods and should file a protective appeal with the Executive Director of the Department of Revenue or the state district court within 30 days after the expiration of the 90-day or 180-day period, even if no decision has been issued by the local jurisdiction. The taxpayer should also document any extension of the 90-day period to 180 days.

III. PROPERTY TAXES

A. Judicial Developments Colorado Court of Appeals Holds that Nonfacilities-Based Reseller of Long Distance Telephone Service is a

Public Utility for Property Tax Purposes In OPEX Communications , Inc. v. Property Tax Administrator, 166 P.3d 225 (Colo. App. 2007), the Colorado Court of Appeals held that a reseller of long distance telephone service in Colorado was a public utility for property tax purposes, even though it owned no real or tangible personal property in the state. As a result, the taxpayer was subject to assessment by the Property Tax Administrator, who considers the value of taxpayers’ intangible property (here, toll access contracts with Qwest Communications and Global Crossing) in assessing taxpayers for property tax purposes. If the taxpayer had not been classified as a public utility for property tax purposes, it would have been subject to assessment, if at all, only by county assessors, who cannot consider the value of taxpayers’ intangible property in assessing taxpayers. Since the taxpayer owned no real or tangible personal property in Colorado, the taxpayer would not have paid any property tax in Colorado if it had not been classified as a public utility. Colorado Court of Appeals Applies $250 Per Item Personal Property Tax Exemption In EchoStar Satellite, L.L.C. v. Arapahoe County Board of Equalization, 171 P.3d 633 (Colo. App. 2007), the Colorado Court of Appeals applied a personal property tax exemption for items that cost less than $250 to personal property owned by a provider of direct broadcast satellite television service and located at its customers’ homes. The statute exempted personal property held for consumption by a business, and delegated to the Property Tax Administrator the authority to define that term. The Property Tax Administrator by rule defined the term to include items with an acquisition cost of $250 or less. The taxpayer argued that each set top box and each noise filter located at a customer’s home was a separate item, and that, since each such item cost less than $250, all such items were exempt from personal property tax. The county assessor, supported by the Property Tax Administrator, argued that the set top boxes and the noise filters were component parts of larger systems, and that the $250 threshold should be applied at the system level. Since the system cost substantially more than $250, the county assessor argued that the personal property tax exemption did not apply to the taxpayer’s set top boxes and noise filters. The Court of Appeals agreed with the taxpayer and held that, under the rule promulgated by the Property tax Administrator, each set top box and each noise filter was a separate item that qualified for the personal property tax exemption because each such item cost less than $250. The Property Tax Administrator revised the applicable rule late in 2007, to eliminate the reference to “items.” The applicability of the new rule to set top boxes and noise filters has not been tested. Colorado Court of Appeals Bars Second Abatement or Refund Petition

In Red Junction, LLC v. Mesa County Board of County Commissioners, 174 P.3d 841 (Colo. App. 2007), the Colorado Court of Appeals held that a taxpayer could not file a second abatement or refund petition to adjust the value assigned to the taxpayer’s golf course for property tax purposes. The taxpayer protested the 2004 valuation assigned to the golf course and obtained a partial reduction in that valuation. The taxpayer sought further review of the 2004 valuation, contending that the revised valuation was still excessive. While that appeal was pending, the taxpayer filed an abatement or refund petition for tax year 2003, requesting that the valuation assigned to the golf course for 2003 be reduced to the revised 2004 valuation. Since the 2003 and 2004 tax years were part of the same biennial reassessment cycle, the abatement or refund petition was granted. The taxpayer subsequently obtained a further reduction in the 2004 valuation assigned to the golf course, through its appeal that was pending when the 2003 abatement or refund petition was granted. The taxpayer then filed a second abatement or refund petition, requesting that the 2003 valuation be further reduced to the final 2004 valuation. The Court of Appeals held that the taxpayer’s second abatement or refund petition for 2003 was barred by the doctrine of res judicata or claim preclusion. The lesson for taxpayers is clear. A taxpayer may file only one abatement or refund petition for a tax year, so any abatement or refund petition should request the lowest valuation that a taxpayer may reasonably expect to obtain, and the abatement or refund process should be pursued until the taxpayer is fully satisfied with the valuation assigned to the taxpayer’s property

IV. AUTHOR’S RESUME Alan Poe is a partner in the Denver Tech Center office of Holland & Hart LLP, a law firm with offices in Colorado,

Idaho, Montana, Nevada, New Mexico, Utah, Wyoming, and Washington, D.C. Alan’s practice focuses almost exclusively on state and local taxation and federal income tax litigation. He has appeared as counsel for taxpayers in more than twenty appellate cases and in dozens of unreported court and administrative agency cases. He also assists clients in state and local tax planning and in negotiating state and local tax incentives. Alan is the Chairman of the Board of Directors and Legal Counsel to the Colorado Association of Commerce and Industry, which is the state chamber of commerce. Alan is a member of the Committee on State and Local Taxes of the American Bar Association Section of Taxation, an affiliate member and an affiliate sales tax member of the Institute for Professionals in Taxation, and a member of COST’s Practitioner Connection. Alan earned his J.D. in 1976 from the University of Virginia (Articles Editor, VIRGINIA LAW REVIEW; Order of the Coif) and his B.A. (with highest distinction) in 1973 from Centre College of Kentucky (Phi Beta Kappa).

DISTRICT OF COLUMBIA STATE DEVELOPMENTS

DELAWARE STATE DEVELOPMENTS Stanford L. Stevenson, III, Esquire Richards, Layton & Finger One Rodney Square 920 North King Street Wilmington, DE 19801 Phone: (302) 651-7707 Fax: (302) 498-7707 E-mail: sstevenson@rlf.com

I LITIGATION DEVELOPMENTS

A. Bank Franchise Tax

Delaware Bank Franchise Tax Constitutionally Applied to Taxpayer but Determination of Penalties Reversed. In Lehman Brothers Bank, FSB v. State Bank Commissioner, 937 A.2d 95 (Del. 2007) ("Lehman"), the Delaware Supreme Court upheld (i) the Delaware State Bank Commissioner's (the "Commissioner") assessments of additional bank franchise tax against the taxpayer for the years 2000-2003; and (ii) the Commissioner's denials of the taxpayer's claims for refund of Delaware bank franchise tax for those periods. However, the Delaware Supreme Court reversed the Commissioner's assessment of late payment penalties and remanded the case for reconsideration of such issue. See Lehman, 937 A.2d at 117. Under Delaware bank franchise tax law, the taxation of a federal savings bank depends upon whether the federal savings bank is "headquartered" in Delaware. A federal savings bank headquartered in Delaware is generally subject to Delaware bank franchise tax on all of its income except income earned by an out-of-state subsidiary or branch and subject to tax by another state. See 5 Del. C. § 1101(a). A federal savings bank not headquartered in Delaware is subject to Delaware bank franchise tax only on income earned by branches of such federal savings bank located in Delaware. See 5 Del. C. § 1101(b). Although the taxpayer's federal charter indicated its "home office" was in Delaware, the taxpayer argued that it was "headquartered" outside of Delaware because the taxpayer's commercial domicile was outside of Delaware. The Delaware Supreme Court affirmed the conclusion of the Delaware Superior Court upholding the Commissioner's assessment of additional Delaware bank franchise tax because it found the taxpayer to be domiciled in Delaware and, thus, generally subject to Delaware tax on one hundred percent (100%) of its income in the absence of any branches or subsidiaries.

The taxpayer further argued that the application of the Delaware bank franchise tax to one hundred percent (100%) of the taxpayer's income (i) violated the Commerce Clause of the United States Constitution because the Delaware bank franchise tax was not fairly apportioned; and (ii) violated the Due Process Clause of the United States Constitution because there was no rational relationship between the taxed income and the values connected with Delaware. With regard to the Commerce Clause analysis, the Delaware Supreme Court applied the standards established by Complete Auto Transit, Inc. v. Brady to the issue, but concluded that Delaware's "structural" apportionment system satisfied the requirements. See Lehman, 937 A.2d at 113. With regard to the Due Process Clause analysis, the Delaware Supreme Court affirmed the Delaware Superior Court ruling that there was a rational relationship between the taxed income and the values connected with Delaware, the taxing state. See Lehman, 937 A.2d at 114.

Finally, the taxpayer argued that the Commissioner erred by refusing to abate the late payment penalties. The Delaware Supreme Court indicated that the record did not disclose any basis for the Commissioner's refusal to abate such penalties. The Delaware Supreme Court noted there was a nearly a three-year delay between the filing of the initial return and the proposed assessment of additional tax, and that (i) the taxpayer had timely filed its returns and followed the reporting position of its predecessor; (ii) the taxpayers sought and relied upon the advice of independent tax advisors in preparing amended returns; and (iii) the taxpayer contested the matter in good faith based on legal positions that were not frivolous. Accordingly, the Delaware Supreme Court reversed the judgment of the Delaware Superior Court affirming the assessment of the penalties. The Delaware Supreme Court remanded the matter back to the Delaware Superior Court with instructions to remand the matter back to the Commissioner for reconsideration in accordance with the Delaware Supreme Court opinion.

On April 28, 2008, the United States Supreme Court denied the taxpayer's Petition for Writ of Certiorari with respect to the Delaware Supreme Court decision affirming the assessment of additional Delaware bank franchise tax.

B. Administration

Notice of Proposed Assessment Mandatory to Support Such Assessment. In Simpson v. Department of Revenue (Del. T.A.B. Nos. 1444, 1450, 1456, February 14, 2008), the Delaware Tax Appeal Board (hereinafter the "Board") granted the taxpayer's motion to vacate an October 31, 2007 decision of the Board. In such earlier decision, the Board had held that an S corporation's failure to comply with the statutory requirement to withhold and remit Delaware income tax with respect to the portion of the distributive share of a nonresident shareholder representing Delaware source income, is not cured by the proper reporting of such amounts and payment of the Delaware income tax by the nonresident shareholder. However, in its motion to vacate such decision, the taxpayer argued that the Director of Revenue had failed to send a Notice of Proposed Assessment to the taxpayer's correct last known address as required by 30 Del. C. § 521(c). The Board found that the language of 30 Del. C. § 521(c) was clear and mandatory. Finding that the Director had failed to comply with such requirement, the Board vacated its prior decision and stayed the matter pending the Director's issuance of a Supplemental Notice of Proposed Assessment within the meaning of 30 Del. C. § 521(d).

FLORIDA STATE DEVELOPMENTS Jim Ervin Holland & Knight LLP 315 Calhoun Street, Suite 600 Tallahassee, FL 32301 Office Phone: 850/224-7000 Direct Dial: 850/425-5649 Facsimile: 850/425-5800 Office Email: jim.ervin@hklaw.com Company Website: www.hklaw.com

I. INCOME/FRANCHISE TAXES

A. Legislative Developments

● HB 5065, the annual piggyback bill bringing Florida's income tax law into conformity with the federal law, was approved. However, the piggyback excludes the bonus depreciation provisions contained in Sections 102 and 103 of the Economic Stimulus Act of 2008, Public Law 110-185. Excluding these provisions from the piggyback avoided an estimated $150 million negative revenue impact for fiscal year 2008/2009 that would have resulted from including these provisions in the piggyback. HB 5065 also changed the timing for making estimated payments from the first day of the particular month to the last day of the preceding month. This change was primarily aimed at estimated payments that would have otherwise been due July 1, 2009. These payments will now be due June 30, 2009 which effectively will move approximately $94 million into fiscal year 2008/2009 that would otherwise have been attributable to fiscal year 2009/2010.

● HB 7135 amended various income tax credits for certain renewable energy activities.

● HB 1237 proposed the adoption of water's edge combined reporting. The bill was heard in one committee, voted down and did not resurface.

B. Judicial Developments

● Golden West Financial Corporation, et al v. Florida Department of Revenue, Case No. 1D07-0135, Florida First District Court of Appeal, 02/19/2008 – The appellate court held that the Department's separate return limitation year ("SRLY") rule was invalid because it was contrary to the statutory piggy-back of federal provisions relating to net operating losses. The Florida rule prohibited the application of NOL carry-forwards to an affiliated group arising from losses incurred by group members during years when separate Florida returns were filed. This treatment was inconsistent with the treatment of such NOL's under federal income tax provisions and, therefore, was inconsistent with the statutory piggy-back provisions.

C. Administrative Developments

● Technical Assistance Advisement 07C1-002 (April 23, 2007) – Consolidated Filing Requirements: If an affiliated group becomes part of another affiliated group as the result of a merger, and ceases to exist for purposes of its federal consolidated return election, such affiliated group ceases to exist for purposes of the Florida consolidated return election.

● Technical Assistance Advisement 07C1-007 (October 17, 2007) – Nexus: The activities of unrelated authorized vendors are sufficient to create corporate income tax nexus for the taxpayer because, without these vendors, the taxpayer could not operate its business in Florida.

D. Trends/Outlooks

● As in 2007, the Department initially proposed legislation that would mandate inclusion of royalty income (and rental income) in the sales factor for corporate tax apportionment purposes. Also as in 2007, the Department withdrew this proposal soon after it was first made. The same is true of a proposal to adopt federal penalty provisions for the Florida income tax.

● The Department likely will continue to resist classification of income as non-business income, will resist use of alternative apportionment methods, and will continue to evaluate deconsolidation requests on a case-by-case and fact-specific basis.

With regard to non-business income, the Department will be considering the Meadwestvaco decision and its effect on the issue in Florida.

II. TRANSACTION TAXES

A. Legislative Developments

● Due in large part to discussions and developments from the Tax and Budget Reform Commission's meetings (see section VI below), there were committee workshops and other legislative discussions concerning the possible repeal of numerous sales tax exemptions and adoption of a sales tax on services. Many business and trade groups spoke in opposition to broad-based repeal of exemptions and taxation of services. No legislation was introduced or considered and the mood of most legislators did not appear to be one of repealing exemptions or increasing taxes.

● The Legislature did not approve sales tax "holidays" in 2008 for clothes, school supplies and hurricane-preparedness items. These tax holidays had been approved in prior years.

B. Judicial Developments

None of note in this area.

C. Administrative Developments

● Technical Assistance Advisement 07A-040 (November 7, 2007) – Software: Support services and customized software are taxable when sold in conjunction with the lease of taxable computer hardware.

● Technical Assistance Advisement 07A-043 (November 8, 2007) – Drop Shipments: An out-of-state dealer, registered in Florida for sales and use tax purposes, is obligated to collect sales tax on a sale to an unregistered out-of-state buyer with no nexus with the State, where the merchandise will be drop-shipped to the out-of-state buyer’s customer in Florida from a vendor/drop shipper’s facility in Florida, and the Florida dealer has submitted its Annual Resale Certificate to the vendor/drop shipper.

D. Trends/Outlooks

● Due to the declining economy and resulting declining tax revenues, the Legislature recently adopted a budget for fiscal 2008/2009 that cut expenditures by $4 billion. No new taxes or tax increases were adopted. However, if the economists' predictions are correct, the downward trend in revenues will continue which could lead to measures increasing taxes. The question will be how much budget-cutting can continue.

● Florida lawmakers continue to balk at adoption of the streamlined sales tax for fear that it could be construed as a tax increase. However, the proposal may receive more serious consideration during the 2009 Legislative Session given that the Tax and Budget Reform Commission (see section VI below) has recently recommended its adoption. The Commission also recommended that the Legislature create a Joint Legislative Sales and Use Tax Exemption Review Committee to conduct periodic comprehensive reviews of all sales and use tax exemptions and make recommendations for the repeal or retention of the various exemptions.

III. PROPERTY TAXES

A. Legislative Developments

● Amendment 1 to the Florida Constitution was approved by the Florida electorate on January 29, 2008. There are four main elements to Amendment 1: doubling the $25,000 homestead exemption to $50,000 (except for school district taxes); "portability" for the Save Our Homes limitations on assessments (up to $500,000); $25,000 tangible personal property tax exemption; and, 10% limitation on increases in assessments on non-homestead property. Procedures are now being adopted by the Department of Revenue and County Property Appraisers to implement these changes.

● Legislation intended to improve the process by which property is assessed and taxpayers challenge their assessment was unsuccessful again. Among the proposals at issue during the 2008 Legislative Session were: reduction in the taxpayer's burden of proof; attorneys' fees to prevailing taxpayers; interest on tax refunds; and clarification of the standards for

assessing property. However, the Tax and Budget Reform Commission (see section VI below) has recommended to the Legislature that legislation be adopted reducing the burden of proof on taxpayers challenging assessments.

B. Judicial Developments

● In a decision not yet final, the Florida Supreme Court overruled 30 years of precedent and held that ad valorem tax increment financing arrangements required approval of the voters whose ad valorem taxes were used. The decision in Strand v. Escambia County, Case No. SC06-1894 (September 6, 2007), resulted in multiple credit alerts and is the cause of great concern among state and local officials. Tax increment financing and similar financing schemes implicated by the decision are used to finance community redevelopment, community development, school construction, roads, private prisons and a host of other public infrastructure. On September 20, 2006, the Court issued a revised opinion and scheduled oral arguments for rehearing. The revised opinion removed any issue with regard to bonds issued or validated prior to the opinion becoming final. Additionally, the revised opinion removed any issue with regard to certificates or obligations issued in reliance upon State v. School Board of Sarasota County, 561 So. 2d 549 (Fla. 1990). Oral argument on the rehearing motions took place on October 9, 2007 but no further action has been taken by the Court.

C. Administrative Developments

● The Department has not taken further action on its draft tangible personal property tax guidelines. It has, however, moved ahead with the process for adoption of market area guidelines. http: //sun6.dms.state.fl.us/dor/rules/tppag. html

D. Trends/Outlooks

● It will take some time before the full impact of the Amendment 1 changes can be determined. Many local government entities are predicting dire consequences from reduced property tax revenues. Proposals by the Tax and Budget Reform Commission (see section VI below) will, if adopted in November, further impact property taxes in Florida. Further changes and developments in the property tax area seem certain but predicting exactly what they will be is a problematic exercise at this time.

IV. OTHER TAXES

A. Legislative Developments

No significant developments noted.

B. Judicial Developments

No significant developments noted.

C. Administrative Developments

No significant developments noted.

D. Trends/Outlooks for 2008

● Some are calling for legislative action to reverse or limit the Florida Supreme Court decision in Crescent Miami Center LLC v. Department of Revenue, 903 So.2d 913 (Fla. 2005), which resolved a conflict among the District Courts by ruling that no documentary stamp tax is due on a deed transferring unencumbered real estate between related parties. The decision has resulted in avoidance of tax in high value, arms-length, third-party transactions and this avoidance has prompted newspaper stories calling for closing of the loophole. Legislation was introduced during the 2008 Legislative Session and was passed by the Senate but rejected by the House.

V. OTHER NOTES OF INTEREST

● The Department of Revenue's "administrative bill" failed to pass during the 2008 Legislative Session. The bill contained a variety of items relating primarily to tax administration. Although some of the items proposed by the Department were mildly controversial, it appears that certain amendments by third parties were the primary contributors to the legislation's demise.

● The Department of Revenue is continuing work on proposed rules for addressing the waiver of penalties that are automatically imposed under Florida law. The initial proposals generated fairly hostile reaction from the business community, and the Department considered those comments and refined its proposal. Work continues on the guidelines, which can be found at: http://sun6.dms.state.fl.us/dor/rules/12-130076.html

VI. TAX & BUDGET REFORM COMMISSION

The Tax and Budget Reform Commission ("TBRC") is a 25-member body appointed by the Governor, House Speaker and Senate President. The Commission is mandated by the Florida Constitution to meet every 20 years, examine Florida's taxation and budget structure, and recommend constitutional changes to be placed directly on the next general election ballot for voter approval. The Commission may also recommend statutory changes to tax and budget laws. The Commission began meeting in April 2007, and was required to submit any proposed constitutional amendments no later than May 4, 2008. On April 25, 2008, the TBRC completed its work and approved seven constitutional proposals to be added to the 2008 General Election ballot. On November 4, 2008, the voters of Florida will have the opportunity to vote on the following proposals.

● Tax Exemption for Wind Hardening and Renewable Energy Creation

If approved by voters, this amendment would allow the Legislature, by general law, to exempt from assessed value of residential homes, improvements made to protect property from wind damage and installation of a new renewable energy source device.

● Working Waterfront

If approved by voters, this amendment would assess specified working waterfront properties based on current use rather than highest and best use. This includes:

- Land use predominantly for commercial fishing purposes;

- Land accessible to public and used for vessel launches;

- Marinas and drystacks that are open to the public; and

- Water dependant marine manufacturing facilities.

● Tax Exemption for Conservation Property

If approved by voters, this amendment would provide property tax exemption for real property that is perpetually used for conservation; and, for land not perpetually encumbered, requires the Legislature to provide classification and assessment of land use for conservation purposes solely on the basis of character or use (like agriculture is today).

● Public Funding for Religious Institutions

If approved by voters, this amendment would repeal the limit on the power of the state to spend funds directly or indirectly in aid of sectarian institution. Commonly referred to as the Blaine Amendment, this proposal eliminates this language in the Constitution and replaces it with language that would prevent the state from excluding individuals and entities from a generally available public benefit or a contract to provide government services on the basis of religion.

● Community College Funding

If approved by voters, this amendment would authorize local option sales tax by local referendum to supplement funding for public community colleges. Approved taxes would sunset after five years.

● Tax Swap: Replacing State Required School Property Tax with Equivalent State Revenues to Fund Education

If approved by voters, this amendment would eliminate the required local effort portion of property taxes by 2010, (estimated to be $9 billion). The Legislature would be required to replace this portion by either:

- Elimination of sales tax exemptions;

- Increase sales tax up to one penny;

- Spending reductions; or

- Other taxes.

This proposal also includes a five percent assessment cap on non-homesteaded property.

● Sixty-five Percent on Classroom Instruction and Education Funding for School Choice Programs

If approved by voters, this amendment would require that at least 65 percent of school funding received by school districts be spent on classroom instruction, rather than administration. This proposal would also provide that the requirement to provide a "uniform, efficient, safe, secure and high quality system of free public schools" is a minimum non-exclusive duty. This proposal would reverse legal precedent prohibiting public funding of private school alternatives to public school programs without creating an entitlement.

(Note: The TBRC also made recommendations to the Legislature for proposed legislation. The recommendations relating to state and local taxes are referenced above under the specific tax headings. These recommendations were made near the end of the 2008 Legislative Session such that the Legislature did not have the ability to consider them during that session.)

VII. PROVIDER'S BIO

Jim Ervin is a partner in the Tallahassee office of Holland & Knight LLP. He has practiced exclusively in the state tax area for over 20 years. He has a multi-forum state tax practice that covers the legislative, administrative and judicial areas. Jim is a member of the executive council of The Florida Bar Tax Section, a member of the American Bar Association’s Tax Section, and is listed in The Best Lawyers in America, in Chambers USA – America's Leading Business Lawyers, and in the Florida Trend 2008 Florida Legal Elite.

GEORGIA STATE DEVELOPMENTS John M. Allan, J.D., C.P.A. Kirk Kringelis, J.D., M.B.A. JONES DAY JONES DAY 1420 Peachtree Street, N.E. 1420 Peachtree Street, N.E. Suite 800 Suite 800 Atlanta, GA 30309-3053 Atlanta, GA 30309-3053 (404) 581-8012 (404) 581-8565 (404) 581-8330 (fax) (404) 581-8330 (fax)

I. UPDATES—GENERAL PROVISIONS FOR GEORGIA TAX DEVELOPMENTS

A. Participation in Multistate Tax Commission as a Sovereignty Member

Effective July 1, 2007, Georgia became a sovereignty member of the Multistate Tax Commission. As part of its increased involvement with the Multistate Tax Commission, Georgia will participate in the Multistate Tax Commission’s sales and use tax audit program.

II. UPDATES ON GEORGIA CORPORATE INCOME TAX

A. Legislative Updates

1. Phase-in of Single Sales Factor Apportionment Formula

In 2005, the Georgia Legislature enacted a statute whereby the corporate income tax apportionment formula will gradually convert to a single sales factor over a three-year period, beginning with tax year 2006. For tax years beginning in 2006, the three apportionment factors are weighted 80% for gross receipts, 10% for property, and 10% for payroll. For tax years beginning in 2007, the apportionment factors are weighted 90% for gross receipts, 5% for property and 5% for payroll. Finally, for tax years beginning in 2008, the gross receipts factor is weighted at 100%. However, the special apportionment formulas for air carriers and credit card data processing companies remain the same. The Department enacted a regulation regarding the State’s adoption of a single-sales factor in December 2005.

O.C.G.A. § 48-7-31; GA. COMP. R. & REGS. 560-7-7-.03 (effective beginning January 1, 2006).

2. Internal Revenue Code Conformity

• For tax years beginning on or after January 1, 2008, references to the Internal Revenue Code (“I.R.C.”) in Georgia’s income tax provisions mean the I.R.C. of 1986 as of January 1, 2008, excluding: § 168(k), [but not excepting § 168(k)(2)(A)(i) (defining “qualified property”), § 168(k)(2)(D)(i) (excluding “alternative depreciation property” from the definition of “qualified property”), and § 168(k)(2)(E) (creating special rules for determining when certain property was placed in service)]; § 199; § 1400L; § 1400N(d)(1) (allowing bonus depreciation for Gulf Opportunity Zone property); § 1400N(j) (providing that specified liability losses should be increased for Gulf Opportunity Zone public utility casualty losses); and § 1400N(k) (providing for the treatment of net operating losses attributable to Gulf Opportunity Zone losses).

O.C.G.A. § 48-1-2(14) (as amended by H.B. 926 effective April 9, 2008 and applicable to taxable years beginning on or after January 1, 2008).

• For tax years beginning after December 31, 2006 but before January 1, 2008, references to the I.R.C. in Georgia’s income tax provisions mean the I.R.C. of 1986, provided in federal law enacted on or before January 1, 2008, excluding: § 168(k), [but not excepting § 168(k)(2)(A)(i) (defining “qualified property”), § 168(k)(2)(D)(i) (excluding “alternative depreciation property” from the definition of “qualified property”), and § 168(k)(2)(E) (creating special rules for determining when certain property was placed in service)]; § 199; § 1400L; § 1400N(d)(1) (allowing bonus depreciation for Gulf Opportunity Zone property); § 1400N(j) (providing that specified liability losses should be increased for Gulf Opportunity Zone public utility casualty losses); and § 1400N(k) (providing for the treatment of net operating losses attributable to Gulf Opportunity Zone losses). For such taxable years, provisions of the I.R.C. of 1986 which were as of January 1, 2008, enacted into law but not yet effective are effective for purposes of Georgia taxation on the same dates upon which they become effective for federal tax

purposes. The provisions of O.C.G.A. § 48-1-2(14.2) supersede and control any provision of O.C.G.A. § 48-1-2(14) to the contrary.

• O.C.G.A. § 48-1-2(14.2) (as added by H.B. 926 effective April 9, 2008 and applicable to taxable years beginning after December 31, 2006 but before January 1, 2008).

3. Undocumented Workers

Effective July 1, 2007, withholding agents are required to withhold the 6% state income tax from compensation paid to an individual reported on Form 1099 for the following individuals:

• Those who have failed to provide a taxpayer identification number (“TIN”); • Those who have failed to provide a correct TIN; • Those who have provided a TIN issued by the Internal Revenue Service for nonresident aliens.

Those who fail to comply with the withholding requirements become liable for the taxes required to have been withheld unless they are exempt from federal withholding requirements and have so informed the Georgia Commissioner of Revenue.

O.C.G.A. §§ 48-7-100(11), 48-7-101(i) (as amended by S.B. 184 effective July 1, 2007).

For tax years beginning on or after January 1, 2008, wages or remuneration paid to undocumented workers in the amount of $600 or more will not be allowed as a deductible business expense for Georgia income tax purposes. This prohibition applies whether or not a Form 1099 was issued relating to the wages or remuneration. Exceptions to this prohibition apply to the following:

• Businesses domiciled in Georgia that are exempt from compliance with federal employment verification procedures;

• Individuals hired by the taxpayer prior to January 1, 2008; • Any taxpayer that does not directly compensate or employ the individual being paid; • Wages or remuneration paid for labor services to any individual who holds and presents to the

taxpayer a valid license or identification card issued by the Georgia Department of Driver Services.

O.C.G.A. §§ 48-7-21(b)(15), 48-7-21.1 (as amended by S.B. 184 effective July 1, 2007).

B. Regulatory Updates and Judicial Decisions

1. Interest and/or Dividend Income on Government Obligations

Regulation 560-7-3-.10 was adopted to provide rules for determining the interest expense related to interest and dividend income received on government obligations.

The provisions of O.C.G.A. §§ 48-7-21 and 48-7-27 require Georgia taxpayers to add back or subtract interest and/or dividend income on certain United States, state, and local government obligations. Interest and/or dividend income is required to be added back if the obligations are subject to Georgia taxation, but were exempt federally and thus were excluded from federal gross income. Interest and/or dividend income must be subtracted if the obligations were taxable federally, but are exempt for Georgia purposes.

In addition, certain adjustments must be made to reflect the fact that Georgia taxes this interest and/or dividend income net of related interest expense. In order to treat all government obligations consistently, the same formula is used to determine interest expense directly or indirectly attributable to the production of the interest or dividend income. The taxpayer's total interest expense is multiplied by a fraction to determine such direct and indirect interest expense. The numerator of the fraction is the total of the average adjusted bases of the obligations at issue, and the denominator is the total of the average adjusted bases for all assets of the taxpayer.

GA. COMP. R. & REGS. r. 560-7-3-.10 (adopted effective March 23, 2008).

III. UPDATES ON GEORGIA SALES & USE TAX

A. Legislative & Regulatory Updates

1. Prepayment of Local Sales and Use Taxes on Motor Fuels

House Bill 219 amended O.C.G.A. § 48-8-2 to remove the exclusion of local sales and use taxes on motor fuels from the definition of a “prepaid state tax” and to add the definition of a “prepaid local tax”. A “prepaid local tax” is any local sales and use tax which is levied on the sale or use of motor fuel and imposed in an area consisting of less than the entire state, including, but not limited to, such taxes authorized by or pursuant to constitutional amendment; by or pursuant the Metropolitan Atlanta Rapid Transit Authority Act of 1965 or by or pursuant to Article 2, 2A, 3, or 4 of this Chapter 8 of Title 48 of the O.C.G.A. The tax is based on the same average retail sales price as set forth in O.C.G.A. § 48-9-14(b)(2)(B) (relating to the prepaid state tax on motor fuels). The average retail sales price is used to compute the prepaid sales tax rate for local jurisdictions by multiplying such retail price by the applicable rate imposed by the jurisdiction.

O.C.G.A. § 48-8-2 (as amended by H.B. 219 effective January 1, 2008).

2. Exemptions for Jet Fuel

House Bill 193 amended O.C.G.A. § 48-8-3 to provide a sales/use tax exemption or partial exemption for the sale or use of jet fuel by a qualifying airline at a qualifying airport. The exemption applies only to transactions occurring on or after July 1, 2007 and prior to July 1, 2009. The sale or use of jet fuel to or by a qualifying airline at a qualifying airport is exempt from the first 1.80% of the 4% state sales and use tax but still is subject to the remaining 2.20% of the 4% state sales and use tax. The sale or use of jet fuel to or by a qualifying airline at a qualifying airport is also exempt from the County Special Purpose Local Option Sales Tax. Except as previously noted, the exemption does not apply to any other local sales and use tax levied or imposed at anytime in any area consisting of less than the entire state, however authorized, including, but not limited to, the Metropolitan Atlanta Rapid Transit Authority Act of 1965, the County Sales Tax for Educational Purposes, the Joint County and Municipality Sales and Use Tax, the Homestead Option Sales and Use Tax, or the Water and Sewer Projects Cost Tax.

A “qualifying airline” is any person which is authorized by the Federal Aviation Administration or appropriate agency of the United States to operate as an air carrier under an air carrier operating certificate and which provides regularly scheduled flights for the transportation of passengers or cargo for hire. A “qualifying airport” is any airport in Georgia that has had more than 750,000 takeoffs and landings during a calendar year.

O.C.G.A. § 48-8-3 (as amended by H.B. 193 effective May 30, 2007 and applicable to transactions occurring on or after July 1, 2007 and prior to July 1, 2009).

3. Exemptions for Tangible Personal Property Sold or Used in Connection with the Construction of an Alternative Fuel Facility

House Bill 186 amended O.C.G.A. § 48-8-3 to provide a sales/use tax exemption for sales of tangible personal property to, or used in or for the construction of, an alternative fuel facility primarily dedicated to the production and processing of ethanol, biodiesel, butanol, and their by-products, when such fuels are derived from biomass materials such as agricultural products, or from animal fats, or the wastes of such products or fats. The exemption applies only to sales occurring during the period July 1, 2007 through June 30, 2012. An “alternative fuel facility” is any facility located in Georgia which is primarily dedicated to the production and processing of ethanol, biodiesel, butanol, and their by-products for sale. “Used in or for the construction" means any tangible personal property incorporated into a new alternative fuel facility that loses its character of tangible personal property. However, the term does not mean tangible personal property that is temporary in nature, leased or rented, tools, or other items not incorporated into the facility.

Any corporation, partnership, limited liability company, or any other entity or person that qualifies for the exemption must conduct at least a majority of its business with entities or persons with which it has no affiliation. The exemption does not apply to sales of tangible personal property that occur after the production and processing of biodiesel, ethanol, butanol, and their by-products has begun at the alternative fuel facility.

O.C.G.A. § 48-8-3 (as amended by H.B. 186 effective May 24, 2007).

4. Exemption for Donations of Prepared Food and Beverages to Nonprofit Agencies

House Bill 169 amended O.C.G.A. § 48-8-3 to provide a sales/use tax exemption during the period July 1, 2007 through June 30, 2009 for prepared food and beverages which are donated to a qualified nonprofit

agency and which are used for hunger relief purposes. A “qualified nonprofit agency” is an entity which is exempt from taxation under Internal Revenue Code § 501(c)(3) and which provides hunger relief.

O.C.G.A. § 48-8-3 (as amended by H.B. 169 effective July 1, 2007).

5. Exemption for Donations of Prepared Food and Beverages Following Natural Disasters

House Bill 169 amended O.C.G.A. § 48-8-3 to provide a sales/use tax exemption during the period July 1, 2007 through June 30, 2009 for prepared food and beverages which are donated following a natural disaster and which are used for natural disaster relief purposes.

O.C.G.A. § 48-8-3 (as amended by H.B. 169 effective July 1, 2007).

6. Exemption for School Supplies, Clothing, and Related Items

House Bill 128 amended O.C.G.A. § 48-8-3 to update the “sales/use tax holiday” dates for the sale of a “covered item” to include the period from August 2, 2007 through August 5, 2007. A “covered item” is generally defined to include:

• Articles of clothing and footwear with a sales price of $100 or less per article of clothing or pair of footwear, excluding accessories such as jewelry, handbags, umbrellas, eyewear, watches, and watchbands;

• A single purchase, with a sales price $1,500 or less, of personal computers and personal computer related accessories purchased for noncommercial home or personal use, including personal computer base units and keyboards, personal digital assistants, handheld computers, monitors, other peripheral devices, modems for Internet and network access, and nonrecreational software, whether or not they are to be utilized in association with the personal computer base unit. Computer and computer related accessories do not include furniture and any systems, devices, software, or peripherals designed or intended primarily for recreational use; and

• Noncommercial purchases of general school supplies to be utilized in the classroom or in classroom related activities, such as homework, up to a sales price of $20 per item including pens, pencils, notebooks, paper, book bags, calculators, dictionaries, thesauruses, and children's books and books listed on approved school reading lists for pre-kindergarten through twelfth grade.

O.C.G.A. § 48-8-3 (as amended by H.B. 128 effective May 22, 2007).

7. Exemption for Energy Efficient Devices

House Bill 128 amended O.C.G.A. § 48-8-3 to update the “sales/use tax holiday” dates for the sale of “energy efficient products” to include the period from October 4, 2007 through October 7, 2007. An exemption from the sales and use tax applies to energy efficient products with a sales price of $1,500 or less per product purchased for noncommercial home or personal use. An “energy efficient product” is “any energy efficient product for noncommercial home or personal use consisting of any dishwasher, clothes washer, air conditioner, ceiling fan, fluorescent light bulb, dehumidifier, programmable thermostat, refrigerator, door, or window, the energy efficiency of which has been designated by the United States Environmental Protection Agency and the United States Department of Energy as meeting or exceeding each such agency's energy saving efficiency requirements or which have been designated as meeting or exceeding such requirements under each such agency's Energy Star program.”

O.C.G.A. § 48-8-3 (as amended by H.B. 128 effective May 22, 2007).

8. Exemption for Tangible Personal Property Used in the Maintenance or Repair of Aircraft

House Bill 282 amended O.C.G.A. § 48-8-3 to provide a sale/use tax exemption during the period July 1 through June 30, 2009 for the sale or use of engines, parts, equipment, and other tangible personal property used in the maintenance or repair of aircraft when such engines, parts, equipment, and other tangible personal property are installed on such aircraft that is being repaired or maintained in Georgia so long as such aircraft is not registered in Georgia.

O.C.G.A. § 48-8-3 (as amended by H.B. 282 effective July 1, 2007).

9. Credit or Refund for Prepaid Tax on Motor Fuels Resold to Exempt Government Entities

House Bill 219 amended O.C.G.A. § 48-8-30, related to the imposition of sale and use taxes, to provide a credit or refund to distributors licensed under Chapter 9 of Title 48 of the O.C.G.A. which purchase any motor fuel on which the prepaid state tax or prepaid local tax or both have been imposed and then resell the such motor fuel to a governmental entity that is totally or partially exempt from the prepaid tax under O.C.G.A. § 48-8-3(1). The amount of the credit or refund is the amount of the prepaid state tax and/or prepaid local tax rates for which such governmental entity is exempt multiplied by the gallons of motor fuel purchased for its exclusive use. To be eligible for the credit or refund, the distributor must reduce the amount it charges for the fuel sold to such governmental entity by an amount equal to the tax from which the governmental entity is exempt. Should a distributor have a sales/use tax liability, the distributor may elect to take a credit for those sales against such liability.

O.C.G.A. § 48-8-30 (as amended by H.B. 219 effective January 1, 2008).

10. Imposition of Local Sales and Use Taxes on Motor Fuels

House Bill 219 amended O.C.G.A. § 48-8-30 to impose a prepaid local tax on the sale or use of motor fuels (see amendments to O.C.G.A. § 48-8-2). The prepaid local tax is imposed at the time the prepaid state tax is imposed under O.C.G.A. § 48-9-14(b)(2)(B).

O.C.G.A. § 48-8-30 (as amended by H.B. 219 effective January 1, 2008).

11. Compensation of Dealers

House Bill 219 amended O.C.G.A. § 48-8-50, relating to compensation of dealers, to provide that the deduction for dealers currently authorized under O.C.G.A. § 48-8-50 should also be combined with the deductions authorized under the Homestead Option Sales and Use Tax and under the Water and Sewer Projects Cost Tax.

O.C.G.A. § 48-8-50 (as amended by H.B. 219 effective January 1, 2008).

12. Amendment to Imposition of Joint County and Municipality Sales and Use Tax

House Bill 219 amended O.C.G.A. § 48-8-82 to provide that the joint county and municipal sales and use tax is applicable to sales of motor fuels as a prepaid local tax as that term is defined in O.C.G.A. § 48-8-2(5.2).

O.C.G.A. § 48-8-82 (as amended by H.B. 219 effective January 1, 2008).

13. Amendment Relating to Administration and Collection of Joint County and Municipality Sales and Use Tax

House Bill 219 amended O.C.G.A. § 48-8-87 to provide that the joint county and municipal sales and use tax is applicable to sales of motor fuels as a prepaid local tax as that term is defined in O.C.G.A. § 48-8-2(5.2).

O.C.G.A. § 48-8-87 (as amended by H.B. 219 effective January 1, 2008).

14. Amendment to Homestead Option Sales and Use Tax Definitions

House Bill 264 amended O.C.G.A. § 48-8-101, relating to the homestead option sales and use tax definitions, to provide for the definition of an “existing municipality” as a municipality created prior to January 1, 2007, lying wholly within or partially within a county. A “qualified municipality” is defined as a municipality created on or after January 1, 2007, lying wholly within or partially within a county.

O.C.G.A. § 48-8-101 (as amended by H.B. 264 effective May 29, 2007).

15. Amendment to Imposition of Homestead Option Sales and Use Tax

House Bill 219 amended O.C.G.A. § 48-8-102 to provide that the homestead option sales and use tax is applicable to sales of motor fuels as a prepaid local tax as that term is defined in O.C.G.A. § 48-8-2(5.2).

O.C.G.A. § 48-8-102 (as amended by H.B. 219 effective January 1, 2008).

16. Amendment Relating to Administration and Collection of Homestead Option Sales and Use Tax

House Bill 219 amended O.C.G.A. § 48-8-104 to provide that the homestead option sales and use tax is applicable to sales of motor fuels as a prepaid local tax as that term is defined in O.C.G.A. § 48-8-2(5.2).

O.C.G.A. § 48-8-104 (as amended by H.B. 219 effective January 1, 2008).

17. Amendment Relating to Imposition of County Special Purpose Local Option Sales and Use Tax

House Bill 219 amended O.C.G.A. § 48-8-110.1 to provide the county special purpose local option sales and use tax is applicable to sales of motor fuels as a prepaid local tax as that term is defined in O.C.G.A. § 48-8-2(5.2).

O.C.G.A. § 48-8-110.1 (as amended by H.B. 219 effective January 1, 2008).

18. Amendment Relating to Administration and Collection of County Special Purpose Local Option Sales and Use Tax

House Bill 219 amended O.C.G.A. § 48-8-113 to provide that the county special purpose local option sales and use tax is applicable to sales of motor fuels as a prepaid local tax as that term is defined in O.C.G.A. § 48-8-2(5.2).

O.C.G.A. § 48-8-113 (as amended by H.B. 219 effective January 1, 2008).

19. Amendment Relating to Imposition of Municipal Water and Sewer Projects and Costs Tax

House Bill 219 amended O.C.G.A. § 48-8-201 to provide that the municipal water and sewer projects and costs tax is applicable to sales of motor fuels as a prepaid local tax as that term is defined in O.C.G.A. § 48-8-2(5.2).

O.C.G.A. § 48-8-201 (as amended by H.B. 219 effective January 1, 2008).

20. Amendment Relating to Administration and Collection of Municipal Water and Sewer Projects and Costs Tax

House Bill 219 amended O.C.G.A. § 48-8-204 to provide that the municipal water and sewer projects and costs tax is applicable to sales of motor fuels as a prepaid local tax as that term is defined in O.C.G.A. § 48-8-2(5.2).

O.C.G.A. § 48-8-204 (as amended by H.B. 219 effective January 1, 2008).

21. Amendment Relating to Reports of Motor Fuel Deliveries

House Bill 219 amended O.C.G.A. § 48-9-9, relating to reports of motor fuel deliveries, to require that “every person transporting motor fuel over the public highways or navigable waters of this state shall have in such person’s possession an invoice, bill of sale, or other document which identifies… the city or county … of destination” in addition to other items currently required to be identified. The provisions of O.C.G.A. § 48-9-9, relating to reports required by the operator of a terminal who receives motor fuel in bulk for storage, were also amended to require that, in addition to other items currently required to be included on reports filed with the Commissioner, the reports include the city or county of destination of the deliveries as reflected on the bills of lading issued by the terminal operator.

O.C.G.A. § 48-9-9 (as amended by H.B. 219 effective January 1, 2008).

22. Exemption for Tangible Personal Property Purchased by the George L. Smith II Georgia World Congress Center Authority

House Bill 219 amended O.C.G.A. § 10-9-10 to extend the exemption to sales and use taxes on tangible personal property purchased by the George L. Smith II Georgia World Congress Center Authority for use exclusively by the Authority.

O.C.G.A. § 10-9-10 (as amended by H.B. 219 effective July 1, 2007).

23. Exemption for Tangible Personal Property Purchased by the Jekyll Island-State Park Authority

House Bill 219 amended O.C.G.A. § 12-3-274 to extend the exemption to sales and use taxes on tangible personal property purchased by the Jekyll Island-State Park Authority for use exclusively by the Authority.

O.C.G.A. § 12-3-274 (as amended by H.B. 219 effective July 1, 2007).

24. Exemption for Tangible Personal Property Purchased by the Georgia Ports Authority

House Bill 219 amended O.C.G.A. § 52-2-37 to extend the exemption to sales and use taxes on tangible personal property purchased by the Georgia Ports Authority for use exclusively by the Authority.

O.C.G.A. § 52-2-37 (as amended by H.B. 219 effective July 1, 2007).

B. Regulatory Updates

1. Drugs, Durable Medical Equipment, and Other Medical Devices

Regulation 560-12-3-.30 was amended to set forth the application of the Georgia sales and use tax to drugs, durable medical equipment, prosthetic devices, and other medical items. The regulation provides detailed definitions with respect to each of these items. A summary of the provisions related to taxability are set forth below.

Drugs

In general, the sale of prescription drugs or insulin for human beings is not subject to Georgia sales and use tax. However, when a prescription drug or insulin is dispensed for human beings by a physician, hospital, or any other person licensed to dispense prescription drugs in the operation of their profession, and the charge for the prescription drug is not itemized on the invoice, bill, or statement to the patient, the prescription drug is deemed to be used by the physician, hospital, or other person licensed to dispense prescription drugs and not eligible for the prescription drug exemption provided for under O.C.G.A. § 48-8-3(47). In the event the charge for a prescription drug or insulin is itemized on the invoice, statement, or bill to the patient, the transaction is deemed eligible for the prescription drug exemption.

Unless otherwise exempt, all sales of over-the-counter drugs are subject to Georgia sales and use tax regardless of whether they are dispensed under a prescription, even if the over-the-counter drug is purchased on the advice or recommendation of a physician. Examples of over-the-counter drugs include dietary supplements, vitamins, minerals, herbs, aspirin, acetaminophen, ibuprofen, cold remedies, antacids, laxatives, and cold sore gels.

Dealers must maintain sufficient prescription documentation to support exempt sales.

Durable Medical Equipment

The sale or use of durable medical equipment (as defined under Titles XVIII and XIX of the federal Social Security Act) is exempt from Georgia sales and use tax when paid for directly by funds of the State of Georgia or the United States under Medicare or Medicaid programs. The regulation provides a number of examples of durable medical equipment.

Prosthetic Devices

The sale or use of physician-prescribed prosthetic devices is exempt from sales and use tax. The regulation provides a number of examples of prosthetic devices.

Other Medical Items

• The sale of oxygen, eyeglasses, or contact lenses, when prescribed by any person licensed by law to prescribe such item, is exempt from sales and use tax.

• The sale of blood measuring devices, other monitoring equipment, or insulin delivery systems when used exclusively by diabetics is exempt from sales and use tax.

• The sale of hearing aids, insulin syringes, or blood measuring strips is exempt from sales and use tax.

• The sale of wheelchairs and any accompanying equipment attached or adapted to wheelchairs is exempt from sales and use tax when sold to or used by a permanently disabled person.

• The sale or use of all other medical items that are not prescription drugs for human beings, durable medical equipment, or prosthetic devices is subject to Georgia sales and use tax unless otherwise exempt under O.C.G.A. § 48-8-3.

GA COMP. R. & REGS. R. 560-12-3-.30 (amended effective January 10, 2008).

C. Judicial Decisions

1. Georgia Dep’t of Revenue v. Owens Corning, 2008 WL 1773612 (Ga. 2008)

The Georgia Supreme Court addressed the issue of whether a taxpayer was entitled to a refund of sales taxes it paid on purchases of repair and replacement parts for manufacturing machinery under the version of O.C.G.A. § 48-2-3(34)(A) (the “Exemption Statute”) in effect during the period from July 1, 1997 through December 31, 1999 (the “Tax Period”). The Georgia Supreme Court reversed the decision by the Court of Appeals and held that no clear, unambiguous exemption for machinery repair parts existed under the 1997 version of the Exemption Statute.

The version of the Exemption Statute in effect during the Tax Period provided a sales tax exemption for “[m]achinery, including components thereof, ..., used directly in the manufacture of tangible personal property when the machinery is bought to replace or upgrade machinery in a manufacturing plant presently existing in this state.” The taxpayer argued that the language of the Exemption Statute should be interpreted to exempt repair and replacement parts which replaced or upgraded components of the designated machinery.

The Georgia Supreme Court initially stated the principles of statutory construction that "every exemption, to be valid, must be expressed in clear and unambiguous terms, and, when found to exist, … will be strictly construed" and that "the interpretation of a statute by an administrative agency which has the duty of enforcing or administering it is to be given great weight and deference." In addition, the court noted that the historical taxation of machinery repair parts continued from the inception of the sales and use tax through 1994.

The Georgia Supreme Court then held that nothing in the language of the 1997 version of the Exemption Statute created an explicit exemption from sales tax for machinery repair parts. The court determined that, at best, the language might create some ambiguity that "replacement components" could possibly include repair parts, but that, in cases of ambiguity, the statute must be interpreted in favor of the tax, not the exemption. The court reasoned that if the legislature had wished to reverse the historical trend (of taxing machinery repair parts) in the 1997 amendment to the Exemption Statute, it would have done so explicitly. The Georgia Supreme Court determined that the 2000 amendment to the Exemption Statute, which created a prospective phased-in exemption for machinery repair parts, was the first time that the Legislature expressed an intent to provide an exemption for machinery repair parts.

2. Ethicon, Inc. v. Georgia Dep’t of Revenue, 2008 Ga. App. LEXIS 366 (Ga. Ct. App. 2008)

This appeal involved two cases between Ethicon, Inc. (“Ethicon”) and the Georgia Department of Revenue (“Department”). In the first case, Case No. A07A2024, the trial court granted summary judgment to the Department and held that Ethicon's purchases of certain repair and maintenance parts for its manufacturing machinery in Georgia were not tax-exempt pursuant to the 1997 version of O.C.G.A. § 48-8-3(34)(A) (the "1997 Manufacturing Machinery Exemption"). Ethicon appealed the trial court’s determination.

In the second case, Case No. A07A2025, the trial court granted summary judgment to Ethicon and held that Ethicon's purchases of argon and nitrogen for use at its Cornelia Plant were tax-exempt under the 1997 version of O.C.G.A. § 48-3-8(35)(A)(ii) (the "1997 Industrial Materials Exemption"). The Department appealed the trial court’s determination.

In Case No. A07A2024, Ethicon contended that the trial court erred in its finding that the 1997 Manufacturing Machinery Exemption applied only to machinery components purchased to "upgrade" machinery. The Court of Appeals agreed and concluded that the trial court erred in relying on the Court of Appeal's decision in Inland Paperboard & Packaging, Inc. v. Georgia Dep’t of Revenue, 616 S.E.2d 873 (Ga. Ct. App. 2005), for the proposition that repair and replacement parts were not exempt under the 1997

Manufacturing Machinery Exemption because the holding in Inland was based on the 1994 version of such exemption rather than the 1997 version.

The Court of Appeals determined that its decision in Owens Corning v. Ga. Dept. of Revenue, 645 S.E.2d 644 (Ga. Ct. App. 2007) was controlling precedent. In Owens Corning, the Court of Appeals held that the 1997 Manufacturing Machinery Exemption, on its face, plainly "provide[s] a sales tax exemption for the designated machinery bought to replace or upgrade existing machinery and to expand that exemption to also include components of designated machinery bought to replace or upgrade existing machinery." Based on the parties’ stipulations, the Court of Appeals found that genuine issues of material fact remained as to whether Ethicon's purchases were exempt under the 1997 Manufacturing Machinery Exemption and reversed the trial court’s grant of summary judgment.

In Case No. A07A2025, the Department contended that the trial court erred in granting Ethicon summary judgment upon the finding that nitrogen and argon gases were "coated upon or impregnated into" Ethicon's products, entitling it to a tax refund for its purchases thereof pursuant to the 1997 Industrial Materials Exemption. The 1997 Industrial Materials Exemption provided an exemption from the Georgia sales and use tax for the sale, use, storage, or consumption of “[i]ndustrial materials other than machinery and machinery repair parts that are coated upon or impregnated into the product at any stage of its processing, manufacture, or conversion.” The statute further provided that “the term ‘industrial materials’ does not include “natural or artificial gas, oil, gasoline, electricity, solid fuel, ice, or other materials used for heat, light, power, or refrigeration in any phase of the manufacturing process.”

The Department argued that Ethicon's purchases of nitrogen and argon were taxable because: 1) the foregoing exemption was limited to "raw materials purchased to put a product together”; 2) neither gas was “coated upon” Ethicon's sutures and needles because Ethicon failed to show that the gases were applied for a specific purpose and that they "adhere" thereto as paint would; and 3) both gases were used for the production of heat.

The Court of Appeals disagreed with each of the Department’s contentions and upheld the trial court’s decision. First, the Court of Appeals determined that, on its face, it was evident that the 1997 Industrial Materials Exemption was not limited to the raw materials that ultimately comprise a manufacturer's end product (i.e., Ethicon’s sutures and needles). Instead, the court concluded that the exemption extended to "industrial materials," unrestricted by any qualifying language. Second, despite the Department’s claims to the contrary, the Court of Appeals determined that Ethicon purchased and used nitrogen and argon for a specific purpose in manufacturing its sutures and needles and that the gases at issue adhered to Ethicon's non-absorbable sutures and needles. Finally, the Court of Appeals ruled that the Department had failed to provided evidence showing that Ethicon used nitrogen and argon as a heat source in the manufacturing process.

3. Resourcing Services of Atlanta v. Georgia Dep’t of Revenue, 2007 Ga. App. LEXIS 1235 (Ga. Ct. App. 2007)

The Court of Appeals of Georgia addressed the issue of whether Resourcing Services of Atlanta (“RSA”), a contractor, was liable for Georgia sales and use tax under O.C.G.A. § 48-8-63 on purchases of tangible personal property for use in the taxpayer’s performance of a contract with the Fulton-DeKalb Hospital Authority (the “Authority”), a tax-exempt entity. RSA contended that it was not subject to sales and use tax because it acted as the agent of the Authority and thus the purchase was by the Authority, an entity exempt from the tax. Relying upon the Ga. Comp. R. Regs. 560-12-26 (dealing with real property construction contractors), RSA further contended that it was not subject to the tax under the contractor provision in O.C.G.A. § 48-8-63 because it was not a contractor as the term is used in O.C.G.A. § 48-8-63. RSA also argued that other jurisdictions considering the issue have held that agents acting on behalf of a tax-exempt entity are not subject to sales and use taxes (i.e., that a tax upon the agent of a tax-exempt entity is really a tax upon the entity). The Department contended that RSA was subject to tax because it was a separate entity from the Authority and was a maintenance contractor that used and consumed the tangible personal property during its management of the Authority's facilities. The sales tax provisions of O.C.G.A. § 48-8-63 provided that “[e]ach person who … contracts to furnish tangible personal property and to perform services under the contract within this state shall be deemed to be

the consumer of the tangible personal property and shall pay the sales tax imposed by this article at the time of the purchase.” The use tax provisions of O.C.G.A. § 48-8-63 provided that “[e]ach person who contracts to perform services in this state and who is furnished tangible personal property for use under the contract by the person, …, for whom the contract is to be performed, when a sales or use tax has not been paid to this state by the person supplying the tangible personal property, shall be deemed to be the consumer of the tangible personal property so used and shall pay a use tax based on the fair market value of the tangible personal property so used.” The Court of Appeals affirmed the trial court’s decision and held that the fact that RSA was a for-profit entity and that RSA purchased tangible personal property for use in performing its functions on behalf of the Authority, left no doubt that sales and use taxes should be imposed under O.C.G.A. § 48-8-63 (b) or (c), as may be appropriate. The court found that there was no "derivative" sales tax exemption based on any agency relationship that RSA had with the tax-exempt Authority. On March 10, 2008, the Georgia Supreme Court denied RSA’s petition for certiori. 4. Graham v. Palmtop Properties, Inc., 284 Ga. App. 730 (Ga. Ct. App. 2007)

The Georgia Court of Appeals addressed the issue of whether Palmtop Properties, Inc. (“Palmtop”) the purchaser of a franchise service station could be held liable as a successor in interest for delinquent Georgia sales and use taxes accrued by a previous owner. After unpaid sales taxes had accrued, Palmtop purchased a service station which had been operated by a corporation (“SSC”) but which was titled in the name of SSC’s officer.

The successor liability statute, O.C.G.A. § 48-8-46, provides that any dealer liable for state sales and use tax, interest, or penalty who sells out his business or stock of goods or equipment or quits the business must make a final return and payment within 15 days after the date of selling or quitting the business. The dealer's successor or assigns, if any, must withhold a sufficient amount of the purchase money to cover the amount of the taxes, interest, and penalties due and unpaid until the former owner produces either a receipt from the Commissioner showing that the taxes, interest, and penalties have been paid or a certificate from the Commissioner stating that no sales and use taxes, interest, or penalties are due. If the purchaser of a business or stock of goods or equipment fails to withhold the purchase money as required, he is personally liable for the payment of any sales and use taxes, interest, and penalties accruing and unpaid by any former owner or assignor.

Palmtop failed to withhold any of the purchase price or procure a receipt or certificate from the Commissioner with respect to the unpaid sales and use taxes. After Palmtop had purchased the property, the Department issued a notice of Official Assessment and Demand for Payment to SSC. Shortly thereafter, the Department then issued a notice of Official Assessment and Demand for Payment to Palmtop as the successor to SSC. The Department asserted that Palmtop was liable under O.C.G.A. § 48-8-46 as a successor to SSC because it purchased all of the real estate “used in” SSC’s business and certain other property.

The Court of Appeals held that O.C.G.A. § 48-8-46 did not cause Palmtop to become personally liable for SSC’s unpaid taxes simply because it bought assets “used in” SSC’s business. The court ruled that a purchaser’s liability under the statute was that of “any former owner or assignor” and that Palmtop could not be held liable because SSC never owned the real estate or other property purchased by Palmtop.

The Department also contended that Palmtop was liable as a successor to SSC because its officer was SSC’s alter ego. The Department argued that SSC’s officer was its alter ego because the officer held all property transferred to Palmtop as SSC’s nominee and because SSC was the beneficial owner of the property. The Court of Appeals held that the equitable principles of alter ego and nominee theory could not be applied to impose successor liability on Palmtop. The court ruled that the Department failed to show that those principles had ever been applied in a context similar to that of successor liability and that, even if the officer’s property was subject to a tax lien, Palmtop paid value for the property and took without notice of a recorded lien or any apparent knowledge of improper dealings. The Court of Appeals determined that the State could have protected itself by filing a lien but had failed to do so.

5. JD Design Group, Inc. v. Graham, 646 S.E.2d 227 (Ga. 2007)

In a case subsequent to Palmtop, the Georgia Supreme Court addressed the issue of whether a purchaser of real estate and most of the assets of a business could be held liable as a successor in interest for delinquent Georgia sales taxes owed by the seller even when the Department had not recorded any liens against the seller’s business. JD Design Group, Inc. (“JD Design”) purchased most of the assets of an existing business, Parker’s Flower Shoppe (“Parker”), and JD Design’s sole shareholder purchase the real estate on which the business operated. An outstanding balance of sales tax was due even though Parker had stated in the asset purchase agreement that all taxes due had been paid and although there were no tax liens recorded against Parker. Several months after the purchase, the Department issued an assessment against JD Design as successor to Parker.

The successor liability statute, O.C.G.A. § 48-8-46, provides that any dealer liable for state sales and use tax, interest, or penalty who sells out his business or stock of goods or equipment or quits the business must make a final return and payment within 15 days after the date of selling or quitting the business. The dealer's successor or assigns, if any, must withhold a sufficient amount of the purchase money to cover the amount of the taxes, interest, and penalties due and unpaid until the former owner produces either a receipt from the Commissioner showing that the taxes, interest, and penalties have been paid or a certificate from the commissioner stating that no sales and use taxes, interest, or penalties are due. If the purchaser of a business or stock of goods or equipment fails to withhold the purchase money as required, he is personally liable for the payment of any sales and use taxes, interest, and penalties accruing and unpaid by any former owner or assignor.

JD Design argued initially that O.C.G.A. § 48-8-46 did not apply because JD Design bought less than all of the assets of Parker. The Georgia Supreme Court held that statute does not by its terms limit its application to purchasers of all the assets of a business and that JD Design’s purchase of the inventory, furniture, fixtures, equipment, vehicles, goodwill, and other assets of Parker constituted a purchase of the “stock of goods or equipment” of a dealer who quits the business and brought the sale within the statute.

JD Design also argued that, even if the statute applied, JD Design was an innocent purchaser for value who could not be liable because the Department’s failure to file a lien deprived JD Design of notice of the seller’s liability for unpaid sales tax. The Georgia Supreme Court held that the statute effectively put JD Design on notice of the possibility of tax liability not apparent from a search of the lien recordings because it imposed on JD Design a duty to inquire and also provided JD Design the means to protect itself (i.e., by withholding or requiring Parker to produce a certificate from the Commissioner that no taxes were due).

JD Design further argued that the Department should be estopped from following its claim for delinquent taxes beyond the original taxpayer because the Department’s statutory entitlement to two means of ensuring payment of the tax (i.e., the requirement that the purchaser withhold and the ability of the Department to file a lien) was unfair. The Georgia Supreme Court held that JD Design’s position was foreclosed by the “well-settled principle that the state cannot be estopped from asserting its right, on account of negligence … of its officers, and can only be estopped by legislative act or resolution.”

In a footnote, the Georgia Supreme Court stated that the Court of Appeals decision in Palmtop did not require a different result because the decision in that case turned on whether the entity which owed the taxes was the entity from which the business was purchased and not whether the purchaser was a bona fide purchaser.

6. Budlong v. Graham, Civil Action No. 1:05-CV-2910-RWS (N.D. Ga. May 16, 2007)

The United States District Court for the Northern District of Georgia addressed the issue of whether O.C.G.A. § 48-8-3(15)(A) and O.C.G.A. § 48-8-3(16), relating to the exemption from sales and use taxes for religious papers and holy scriptures, violated the First and Fourteenth Amendments of the United States Constitution. The District Court held that O.C.G.A. § 48-8-3(15)(A) and O.C.G.A. § 48-8-3(16) discriminated on the basis of protected content without advancing a compelling state interest in violation of the First and Fourteenth Amendments of the United States Constitution and, therefore, issued an order enjoining the continued enforcement of those statutes.

IV. UPDATES ON GEORGIA PROPERTY TAX

A. Legislative and Regulatory Updates

1. Amendment to Equalized Property Tax Digest Contents

House Bill 182 amended O.C.G.A. § 48-5-274 to revise the contents of the equalized property tax digest to exclude from the contents “all real and personal property exempted from taxation” (rewording of existing provision) and “the difference between the value of all taxable property within any tax allocation district and the tax allocation increment base of such tax allocation district as defined under paragraph (15) of Code Section 36-44-3 for which consent has been obtained pursuant to Code Section 36-44-9.” The statute was also amended to provide that, in addition to other items currently required to be excluded, the locally assessed valuation of the county property tax assessment digest for the preceding calendar year should be determined “exclusive of the difference between the value of all taxable property within any tax allocation district and the tax allocation increment base of such tax allocation district as defined under paragraph 15 of Code Section 36-44-3 for which consent has been obtained pursuant to Code Section 36-44-9.”

O.C.G.A. § 48-5-274 (as amended by H.B. 182 effective May 30, 2007).

2. Prohibition Against County Tax Commissioners Buying Property at Tax Foreclosure Sales

House Bill 222 added O.C.G.A. § 48-4-23 to prevent county tax commissioners and certain individuals employed in the office of the tax commissioner working on behalf of the tax commissioner from buying property at tax foreclosure sales.

House Bill 222 provides that a tax commissioner and any person employed in the office of the tax commissioner working on behalf of the tax commissioner may not, directly or indirectly, acquire an interest in, buy, or profit from any real property sold at public auction by the county for which such tax commissioner or employee thereof serves for delinquent taxes, except that such tax commissioner or employee thereof may purchase property sold at public auction for delinquent taxes if such tax commissioner or employee has any ownership interest in the property and had an ownership interest in the property at the time the taxes became delinquent.

Violations of the provisions of O.C.G.A. § 48-4-23 constitute a misdemeanor and, upon conviction, are punishable by imprisonment for a period of not more than one year, by a fine not to exceed $1,000, or both. Furthermore, any sale, transfer, or acquisition of interest in any real property in violation of O.C.G.A. § 48-4-23 is void.

O.C.G.A. § 48-4-23 (as added by H.B. 222 effective July 1, 2007).

3. Amendment to Definition of Bona Fide Conservation Use Property

House Bill 321 amended O.C.G.A. § 48-5-7.4 to revise the definition of "bona fide conservation use property" by adding a new paragraph, O.C.G.A. § 48-5-7.4(1)(A.1). The newly added provisions of O.C.G.A. § 48-5-7.4(1)(A.1) state that the following rules will apply to determine beneficial interests in bona fide conservation use property held in a family owned farm entity as described in division O.C.G.A. § 48-5-7.4(1)(C)(iv):

A person who owns an interest in a family owned farm entity as described in division (1)(C)(iv) of this subsection shall be considered to own only the percent of the bona fide conservation use property held by such family owned farm entity that is equal to the percent interest owned by such person in such family owned farm entity; and

48-5-7.4(a)(1)(A.1)(ii) A person who owns an interest in a family owned farm entity as described in division (1)(C)(iv) of this subsection may elect to allocate the lesser of any unused portion of such person's 2,000 acre limitation or the product of such person's percent interest in the family owned farm entity times the total number of acres owned by the family owned farm entity subject to such bona fide conservation use assessment, with the result that the family owned farm entity may receive bona fide conservation use assessment on more than 2,000 acres.

O.C.G.A. § 48-5-7.4 (as amended by H.B. 321 effective July 1, 2007).

4. Amendment to Ad Valorem Tax Exemption for Institutions of Purely Public Charity

House Bill 445 amended O.C.G.A. § 48-5-41(d)(2) relating to the ad valorem tax exemption for institutions of purely public charity to provide that "[w]ith respect to [O.C.G.A. § 48-5-41(a)(4) relating to institutions of purely public charity], a building which is owned by a charitable institution that is otherwise qualified as a

purely public charity and that is exempt from taxation under Section 501(c)(3) of the federal Internal Revenue Code and which building is used by such charitable institution exclusively for the charitable purposes of such charitable institution, and not more than 15 acres of land on which such building is located, may be used for the purpose of securing income so long as such income is used exclusively for the operation of that charitable institution."

O.C.G.A. § 48-5-41 (as amended by H.B. 445 effective May 23, 2007).

5. Homestead Exemption from Chattooga County Ad Valorem Taxes

Senate Bill 242 provides for a homestead exemption from Chattooga County ad valorem taxes for residents of that city who are 70 years of age or older.

“Ad valorem taxes for county purposes” are defined as “ad valorem taxes for county purposes levied by, for, or on behalf of Chattooga County, including, but not limited to, ad valorem taxes to pay interest on and to retire county bonded indebtedness.” “Homestead” is defined as “homestead as defined and qualified in Code Section 48-5-40 of the O.C.G.A., as amended, with the additional qualification that it shall include only the primary residence and not more than five contiguous acres of homestead property.” “Income” is defined as “federal adjusted gross income for income tax purposes from all sources.” A “senior citizen” is defined as “a person who is 70 years of age or over on or before January 1 of the year in which application for the exemption under this Act is made.”

The amount of the homestead exemption depends on the person’s income. Each resident of Chattooga County who is a senior citizen is granted an exemption on that person's homestead from all Chattooga County ad valorem taxes for county purposes in the full value of that homestead if that person's income, together with the income of the spouse of such person who resides within such homestead, does not exceed $15,000 for the immediately preceding taxable year. The exemption is limited to 80% if that person's income (and spouse’s income) exceeds $15,000 but is not more than $16,250 for the immediately preceding taxable year. The exemption is limited to 60% if that person's income (and spouse’s income) exceeds $16,250 but is not more than $17,500 for the immediately preceding taxable year. The exemption is limited to 40% if that person's income (and spouse’s income) exceeds $17,500 but is not more than $18,750 for the immediately preceding taxable year. The exemption is limited to 20% if that person's income (and spouse’s income) exceeds $18,750 but is not more than $20,000 for the immediately preceding taxable year.

The exemption must be claimed and returned as provided in O.C.G.A. § 48-5-50.1, as amended. The exemption is automatically renewed from year to year as long as the owner occupies the residence as a homestead.

The exemption granted by Senate Bill 242 does not apply to or affect any state ad valorem taxes, county or independent school district ad valorem taxes for educational purposes, or municipal ad valorem taxes for municipal purposes. The homestead exemption is in addition to any other homestead exemption applicable to Chattooga County ad valorem taxes for county purposes.

The exemption granted by Senate Bill 242 applies to all taxable years beginning on or after January 1, 2008.

Senate Bill 242 (effective May 30, 2007 and applicable January 1, 2008).

6. Homestead Exemption for Senior Citizens from Newton County Ad Valorem Taxes for School District Maintenance and Operations Purposes

Senate Bill 316 provides for a homestead exemption from Newton County ad valorem taxes for school district maintenance and operations purposes in an amount equal to $30,000 of the assessed value of the homestead. The exemption is available to residents of the county who are 65 years of age or older and whose gross income does not exceed $25,000.

"Ad valorem taxes for school district maintenance and operations purposes" is defined to mean "all ad valorem taxes for the school district levied by, for, or on behalf of Newton County for the maintenance and operation of facilities for the county school district, including, but not limited to, any ad valorem taxes to pay interest on and to retire bonded indebtedness for the local school board or any authority operating on behalf of the school district." "Homestead" is defined to mean "homestead as defined and qualified in Code Section

48-5-40 of the O.C.G.A., as amended." "Senior citizen" is defined to mean "a person who is 65 years of age or over on or before January 1 of the year in which application for the exemption under this Act is made."

Each resident of the Newton County school district who is a senior citizen and whose annual adjusted gross income does not exceed $25,000, is granted an exemption on that person's homestead from Newton County ad valorem taxes for school district maintenance and operations purposes in the amount of $30,000 of the assessed value of that homestead. The value of that property in excess of such exempted amount remains subject to taxation.

The exemption must be claimed and returned as provided in O.C.G.A. § 48-5-50.1, as amended. The exemption is automatically renewed from year to year as long as the owner occupies the residence as a homestead.

The exemption granted by Senate Bill 316 does not apply to or affect state ad valorem taxes, county ad valorem taxes for other county purposes, or city ad valorem taxes, if any. The homestead exemption is in addition to and not in lieu of any other homestead exemption applicable to ad valorem taxes.

Senate Bill 316 (effective May 18, 2007 applicable January 1, 2009).

7. Homestead Exemption from City of Lyons Ad Valorem Taxes for Municipal Purposes

House Bill 573 provides for a homestead exemption from City of Lyons ad valorem taxes for municipal purposes in an amount equal to the amount by which the current year assessed value of a homestead exceeds the base year assessed value of such homestead. “Ad valorem taxes for municipal purposes” are defined as “all municipal ad valorem taxes for municipal purposes levied by, for, or on behalf of the City of Lyons, including, but not limited to, ad valorem taxes to pay interest on and to retire municipal bonded indebtedness.” The “base year” generally is “the taxable year immediately preceding the taxable year in which the exemption under this Act is first granted to the most recent owner of such homestead.” However, with respect to any person who applies for and is granted the homestead exemption under House Bill 573 for the 2008 tax year, the base year assessed value of the homestead is the 2004 assessed value of the homestead. The “homestead” is the “homestead as defined and qualified in Code Section 48-5-40 of the O.C.G.A., as amended, with the additional qualification that it shall include not more than five contiguous acres of homestead property.”

Each resident of the City of Lyons is granted an exemption on that person’s homestead from City of Lyons ad valorem taxes for municipal purposes in an amount equal to the amount by which the current year assessed value of that homestead exceeds the base year assessed value of that homestead. The exemption does not apply to taxes assessed on improvements to the homestead or additional land that is added to the homestead after January 1 of the base year. If any real property is added to or removed from the homestead, the base year assessed value is adjusted to reflect such addition or removal and the exemption is recalculated accordingly. The value of that property in excess of such exempted amount remains subject to taxation.

The exemption must be claimed and returned as provided in O.C.G.A. § 48-5-50.1, as amended. The exemption is automatically renewed from year to year as long as the owner occupies the residence as a homestead.

The exemption granted by House Bill 573 does not apply to or affect state ad valorem taxes, county ad valorem taxes for county purposes, or county or independent school district ad valorem taxes for educational purposes. The homestead exemption is in addition to and not in lieu of any other homestead exemption applicable to municipal ad valorem taxes for municipal purposes.

House Bill 573 (effective May 29, 2007 and applicable January 1, 2008).

8. Homestead Exemption from City of Santa Claus Ad Valorem Taxes for Municipal Purposes

House Bill 575 provides for a homestead exemption from City of Santa Claus ad valorem taxes for municipal purposes in an amount equal to the amount by which the current year assessed value of a homestead exceeds the base year assessed value of such homestead. “Ad valorem taxes for municipal purposes” are defined as “all municipal ad valorem taxes for municipal purposes levied by, for, or on behalf of the City of Santa Claus, including, but not limited to, ad valorem taxes to pay interest on and to retire municipal bonded indebtedness.” The “base year” generally is “the taxable year immediately preceding the taxable year in which the exemption under this Act is first granted to the most recent owner of such homestead.” However, with respect to any person who applies for and is granted the homestead exemption under House Bill 575 for the 2008 tax year, the base year assessed value of the homestead is the 2004 assessed value of the homestead. The “homestead” is the “homestead as defined and qualified in Code Section 48-5-40 of the O.C.G.A., as

amended, with the additional qualification that it shall include not more than five contiguous acres of homestead property.”

Each resident of the City of Santa Claus is granted an exemption on that person’s homestead from City of Santa Claus ad valorem taxes for municipal purposes in an amount equal to the amount by which the current year assessed value of that homestead exceeds the base year assessed value of that homestead. The exemption does not apply to taxes assessed on improvements to the homestead or additional land that is added to the homestead after January 1 of the base year. If any real property is added to or removed from the homestead, the base year assessed value is adjusted to reflect such addition or removal and the exemption is recalculated accordingly. The value of that property in excess of such exempted amount remains subject to taxation.

The exemption must be claimed and returned as provided in O.C.G.A. § 48-5-50.1, as amended. The exemption is automatically renewed from year to year as long as the owner occupies the residence as a homestead.

The exemption granted by House Bill 575 does not apply to or affect state ad valorem taxes, county ad valorem taxes for county purposes, or county or independent school district ad valorem taxes for educational purposes. The homestead exemption is in addition to and not in lieu of any other homestead exemption applicable to municipal ad valorem taxes for municipal purposes.

If approved by an election of the voters in November 2007, the exemption granted by House Bill 575 will apply to all taxable years beginning on or after January 1, 2008.

House Bill 575 (effective May 29, 2007).

9. Homestead Exemption from City of Vidalia Ad Valorem Taxes for Educational Purposes

House Bill 574 provides for a homestead exemption from City of Vidalia ad valorem taxes for educational purposes in an amount equal to the amount by which the current year assessed value of a homestead exceeds the base year assessed value of such homestead.

“Ad valorem taxes for educational purposes” are defined as “all ad valorem taxes for educational purposes levied by, for, or on behalf of the City of Vidalia independent school district, including, but not limited to, ad valorem taxes to pay interest on and to retire independent school district bonded indebtedness.” The “base year” generally is “the taxable year immediately preceding the taxable year in which the exemption under this Act is first granted to the most recent owner of such homestead.” However, with respect to any person who applies for and is granted the homestead exemption under House Bill 574 for the 2008 tax year, the base year assessed value of the homestead is the 2004 assessed value of the homestead. The “homestead” is the “homestead as defined and qualified in Code Section 48-5-40 of the O.C.G.A., as amended, with the additional qualification that it shall include not more than five contiguous acres of land immediately surrounding such residence.”

Each resident of the City of Vidalia independent school district is granted an exemption on that person's homestead from City of Vidalia independent school district ad valorem taxes for educational purposes in an amount equal to the amount by which the current year assessed value of that homestead exceeds the base year assessed value of that homestead. The exemption does not apply to taxes assessed on improvements to the homestead or additional land that is added to the homestead after January 1 of the base year. If any real property is removed from the homestead, the base year assessed value is recalculated accordingly. The value of that property in excess of such exempted amount remains subject to taxation.

The exemption must be claimed and returned as provided in O.C.G.A. § 48-5-50.1, as amended. The exemption is automatically renewed from year to year as long as the owner occupies the residence as a homestead.

The exemption granted by House Bill 574 does not apply to or affect state ad valorem taxes, county ad valorem taxes for county purposes, county school district ad valorem taxes for educational purposes, or municipal ad valorem taxes for municipal purposes. The homestead exemption is in addition to and not in lieu of any other homestead exemption applicable to municipal ad valorem taxes.

House Bill 574 (effective May 16, 2007 applicable January 1, 2008).

10. Homestead Exemption from City of Vidalia Ad Valorem Taxes for Municipal Purposes

House Bill 576 provides for a homestead exemption from City of Vidalia ad valorem taxes for municipal purposes in an amount equal to the amount by which the current year assessed value of a homestead exceeds the base year assessed value of such homestead. “Ad valorem taxes for municipal purposes” are defined as

“all municipal ad valorem taxes for municipal purposes levied by, for, or on behalf of the City of Vidalia, including, but not limited to, ad valorem taxes to pay interest on and to retire municipal bonded indebtedness.” The “base year” generally is “the taxable year immediately preceding the taxable year in which the exemption under this Act is first granted to the most recent owner of such homestead.” However, with respect to any person who applies for and is granted the homestead exemption under House Bill 576 for the 2008 tax year, the base year assessed value of the homestead is the 2004 assessed value of the homestead. The “homestead” is the “homestead as defined and qualified in Code Section 48-5-40 of the O.C.G.A., as amended, with the additional qualification that it shall include not more than five contiguous acres of homestead property.”

Each resident of the City of Vidalia is granted an exemption on that person’s homestead from City of Vidalia ad valorem taxes for municipal purposes in an amount equal to the amount by which the current year assessed value of that homestead exceeds the base year assessed value of that homestead. The exemption does not apply to taxes assessed on improvements to the homestead or additional land that is added to the homestead after January 1 of the base year. If any real property is added to or removed from the homestead, the base year assessed value is adjusted to reflect such addition or removal and the exemption is recalculated accordingly. The value of that property in excess of such exempted amount remains subject to taxation.

The exemption must be claimed and returned as provided in O.C.G.A. § 48-5-50.1, as amended. The exemption is automatically renewed from year to year as long as the owner occupies the residence as a homestead.

The exemption granted by House Bill 576 does not apply to or affect state ad valorem taxes, county ad valorem taxes for county purposes, or county or independent school district ad valorem taxes for educational purposes. The homestead exemption is in addition to and not in lieu of any other homestead exemption applicable to municipal ad valorem taxes for municipal purposes.

If approved by an election of the voters in November 2007, the exemption granted by House Bill 576 will apply to all taxable years beginning on or after January 1, 2008.

House Bill 576 (effective May 16, 2007).

11. Homestead Exemption for Senior Citizens from City of Union City Ad Valorem Taxes for Municipal Purposes

House Bill 618 provides for a homestead exemption from City of Union City ad valorem taxes for municipal purposes in an amount equal to $25,000 of the homestead for residents of that city who are 65 years of age or older. “Ad valorem taxes for municipal purposes” are defined as “all ad valorem taxes for municipal purposes levied by, for, or on behalf of the City of Union City, except for any ad valorem taxes to pay interest on and to retire municipal bonded indebtedness.” The “homestead” is the “homestead as defined and qualified in Code Section 48-5-40 of the O.C.G.A., as amended.” A “senior citizen” is a person who is “65 years of age or over on or before January 1 of the year in which application for the exemption under subsection (b) of this section is made.”

Each resident of the City of Union City who is a senior citizen is granted an exemption on that person’s homestead from City of Union City ad valorem taxes for municipal purposes in an amount of $25,000 of the assessed value of that homestead. The value of that property in excess of such exempted amount remains subject to taxation.

The exemption must be claimed and returned as provided in O.C.G.A. § 48-5-50.1, as amended. The exemption is automatically renewed from year to year as long as the owner occupies the residence as a homestead.

The exemption granted by House Bill 618 does not apply to or affect state ad valorem taxes, county ad valorem taxes for county purposes, or county or independent school district ad valorem taxes for educational purposes. The homestead exemption is in addition to and not in lieu of any other homestead exemption applicable to municipal ad valorem taxes for municipal purposes.

House Bill 618 (effective May 18, 2007 and applicable January 1, 2008).

12. Homestead Exemption for Disabled Residents of City of Union City Ad Valorem Taxes for Municipal Purposes

House Bill 618 provides for a homestead exemption from Union City ad valorem taxes for municipal purposes in an amount equal to $2,000 of the homestead for disabled residents of that city. “Ad valorem

taxes for municipal purposes” are defined as “all ad valorem taxes for municipal purposes levied by, for, or on behalf of the City of Union City, except for any ad valorem taxes to pay interest on and to retire municipal bonded indebtedness.” The “homestead” is the “homestead as defined and qualified in Code Section 48-5-40 of the O.C.G.A., as amended”.

In order to qualify for the exemption, the person claiming such exemption is required to obtain a certificate from not more than three physicians licensed to practice medicine under Chapter 34 of Title 43 of the O.C.G.A., as amended, certifying that in the opinion of such physician or physicians such person is mentally or physically incapacitated to the extent that such person is unable to be gainfully employed and that such incapacity is likely to be permanent. The certificate or certificates constitute part of and must submitted with the application for the homestead exemption.

A person may not receive the homestead exemption unless the person or person's agent files an application with the governing authority of the City of Union City, or the designee thereof, giving such additional information relative to receiving such exemption as will enable the governing authority of the City of Union City, or the designee thereof, to make a determination regarding the initial and continuing eligibility of such owner for such exemption.

The exemption must be claimed and returned as provided in O.C.G.A. § 48-5-50.1, as amended. The exemption is automatically renewed from year to year as long as the owner occupies the residence as a homestead

The exemption granted by House Bill 618 does not apply to or affect state ad valorem taxes, county ad valorem taxes for county purposes, or county or independent school district ad valorem taxes for educational purposes. The homestead exemption is in addition to and not in lieu of any other homestead exemption applicable to municipal ad valorem taxes for municipal purposes.

The exemption granted by House Bill 618 applies to all taxable years beginning on or after January 1, 2008.

House Bill 618 (effective May 18, 2007 and applicable January 1, 2008).

13. Homestead Exemption for Senior Citizens from City of Woodstock Ad Valorem Taxes for Municipal Purposes

House Bill 632 provides for a homestead exemption from City of Woodstock ad valorem taxes for municipal purposes in an amount equal to $100,000 of the homestead for residents of that city who are 62 years of age or older. “Ad valorem taxes for municipal purposes” are defined as “all ad valorem taxes for municipal purposes levied by, for, or on behalf of the City of Woodstock, including, but not limited to, any ad valorem taxes to pay interest on and to retire municipal bonded indebtedness.” The “homestead” is the “homestead as defined and qualified in Code Section 48-5-40 of the O.C.G.A.” A “senior citizen” is a person who is “62 years of age or over on or before January 1 of the year in which application for the exemption under subsection (b) of this section is made.”

Each resident of the City of Woodstock who is a senior citizen is granted an exemption on that person’s homestead from City of Woodstock ad valorem taxes for municipal purposes in an amount of $100,000 of the assessed value of that homestead. The value of that property in excess of such exempted amount remains subject to taxation.

The exemption must be claimed and returned as provided in O.C.G.A. § 48-5-50.1, as amended. The exemption is automatically renewed from year to year as long as the owner occupies the residence as a homestead.

The exemption granted by House Bill 632 does not apply to or affect state ad valorem taxes, county ad valorem taxes for county purposes, or county or independent school district ad valorem taxes for educational purposes. The homestead exemption is in addition to and not in lieu of any other homestead exemption applicable to municipal ad valorem taxes for municipal purposes except that, for senior citizens, it is the sole homestead exemption applicable to City of Woodstock ad valorem taxes for city purposes.

If approved by an election of the voters in November 2007, the exemption granted by House Bill 632 will apply to all taxable years beginning on or after January 1, 2008. If House Bill 632 is approved by the voters, the current act providing a homestead for senior citizens of the City of Woodstock, approved April 13, 2007 (Ga. L. 2001, p. 3797), will be repealed in its entirety as of January 1, 2008.

House Bill 632 (effective May 18, 2007).

14. Homestead Exemption for Disabled Veterans or Their Unremarried Surviving Spouses from City of Woodstock Ad Valorem Taxes for Municipal Purposes

House Bill 633 provides for a homestead exemption from City of Woodstock ad valorem taxes for municipal purposes in an amount equal to $100,000 of the homestead for disabled veterans or their unremarried surviving spouses, if deceased, on a current or subsequent homestead. “Ad valorem taxes for municipal purposes” are defined as “all ad valorem taxes for municipal purposes levied by, for, or on behalf of the City of Woodstock, including, but not limited to, taxes to retire bonded indebtedness.” The “homestead” is the “homestead as defined and qualified in Code Section 48-5-40 of the O.C.G.A.” A “disabled veteran” is:

• A wartime veteran who was discharged under honorable conditions and who has been adjudicated by the Department of Veterans Affairs of the United States (“U.S.”) as being totally and permanently disabled and entitled to receive service connected benefits so long as he or she is 100% disabled and receiving or entitled to receive benefits for a 100% service connected disability;

• An American veteran of any war or armed conflict in which any branch of the armed forces of the U.S. engaged, whether under U.S. command or otherwise, who is disabled due to the loss or loss of use of both lower extremities such as to preclude locomotion without the aid of braces, crutches, canes, or a wheelchair; due to blindness in both eyes, having only light perception, together with the loss or loss of use of one lower extremity; or due to the loss or loss of use of one lower extremity together with residuals of organic disease or injury which so affect the functions of balance or propulsion as to preclude locomotion without resort to a wheelchair;

• Any disabled veteran who is not entitled to receive benefits from the Department of Veterans Affairs but who qualifies otherwise, as provided for by Article VII, Section I, Paragraph IV of the Constitution of Georgia of 1976;

• An American veteran of any war or armed conflict who is disabled due to loss or loss of use of one lower extremity together with the loss or loss of use of one upper extremity which so affects the functions of balance or propulsion as to preclude locomotion without the aid of braces, crutches, canes, or a wheelchair;

• A veteran becoming eligible for assistance in acquiring housing under Section 2101 of Title 38 of the United States Code as hereafter amended on or after July 1, 1999.

Any disabled veteran who is a resident of the City of Woodstock is granted an exemption in the amount of $100,000 on the assessed value of his or her homestead which such veteran owns and actually occupies as a residence and homestead. The exemption is from all ad valorem taxation for city purposes. The value of all property in excess of the exemption granted to the disabled veteran remains subject to taxation. The unremarried surviving spouse or minor children of any such disabled veteran is also be entitled to an exemption in the amount of $100,000 on the assessed value on his or her homestead which such person owns and actually occupies as a residence and homestead. The exemption is from all ad valorem taxation for city purposes. The value of all property in excess of the exemption granted to the unremarried surviving spouse or minor children remains subject to taxation.

Each disabled veteran is required to file for the exemption only once. Once filed, the exemption is automatically renewed from year to year, except as provided in House Bill 633 § 1(e) (see below). The exemption is extended to the unremarried surviving spouse or minor children at the time of the disable veteran’s death so long as they continue to occupy the home as a residence and homestead. In the event a disabled veteran who would otherwise be entitled to the exemption dies or becomes incapacitated to the extent that he or she cannot personally file for such exemption, the spouse, the unremarried surviving spouse, or the minor children at the time of the disabled veteran’s death may file for the exemption and such exemption may be granted as if the disabled veteran had made personal application therefor.

As stated above, the exemption is automatically renewed from year to year. However, not more often than once every three years, a city employee may require the holder of an exemption to substantiate his or her continuing eligibility for the exemption. In no event may the city require more than three doctors´ letters to substantiate eligibility.

The exemption granted by House Bill 633 does not apply to or affect state taxes, county taxes, or county school district taxes for educational purposes. The homestead exemption is in addition to, and not in lieu of, any other homestead exemption applicable to City of Woodstock ad valorem taxes for city purposes except

that for disabled veterans it is the sole homestead exemption applicable to City of Woodstock ad valorem taxes for city purposes.

If approved by an election of the voters in November 2007, the exemption granted by House Bill 633 will apply to all taxable years beginning on or after January 1, 2008.

House Bill 633 (effective May 18, 2007).

15. Amendment to Homestead Exemption from Heard County and Heard County School District Ad Valorem Taxes

House Bill 693 amended “An Act to provide for homestead exemptions from Heard County ad valorem taxes for county purposes and from Heard County School District ad valorem taxes for educational purposes for certain residents of that county and school district," approved April 13, 1992 (Ga. L. 1992, p. 6107) (the “Act”), to increase the homestead exemption for citizens age 65 and older. Section 3 of the Act was amended to provide that “each resident of the Heard County School District who is 65 years of age or older is granted an exemption on that person’s homestead from all Heard County School District ad valorem taxes for educational purposes in the amount of $20,000 of the assessed value of that homestead.”

If approved by an election of the voters in November 2007, the amendments provide in the Act will be effective on January 1, 2008 and the increase in the exemption from Heard County School District taxes for educational purposes will apply to all taxable years beginning after December 31, 2007.

House Bill 693 (effective May 16, 2007).

16. Homestead Exemption from Liberty County Ad Valorem Taxes for County Purposes

House Bill 767 amended “An Act to provide a homestead exemption from Liberty County ad valorem taxes for county purposes in an amount equal to the amount by which the current year assessed value of a homestead exceeds the adjusted base year assessed value of such homestead," approved May 17, 2004 (Ga. L. 2004, p. 3818) (the “Act”) to extend the exemption to repairs or improvements to the homestead not exceeding 5%.

“Ad valorem taxes for county purposes” are defined as “ad valorem taxes for county purposes levied by, for, or on behalf of Liberty County, including, but not limited to, any ad valorem taxes to pay interest on and to retire county bonded indebtedness.” The “base year” means “the taxable year immediately preceding the taxable year in which the exemption under this Act is first granted to the most recent owner of such homestead; provided, however, that the tax commissioner shall adjust the base year assessed value annually by the lesser of 3 percent or the percentage change in the Consumer Price Index for all urban consumers, U. S. City Average, all items 1967-100, or successor report as reported by the United States Department of Labor Bureau of Labor Statistics.” The “Homestead” is the “homestead as defined and qualified in Code Section 48-5-40 of the O.C.G.A., as amended, with the additional qualification that it shall include only the primary residence and not more than five contiguous acres of land immediately surrounding such residence.” An “improvement” means “repairs or improvements or both during any 12 month period which combined exceed 5 percent of the adjusted base year assessed value of the homestead."

If approved by an election of the voters in November 2007, the amendments to the Act will be effective on January 1, 2008 and will apply to the 2008 and subsequent tax years.

House Bill 767 (effective May 29, 2007).

17. Amendment to Homestead Exemption from Liberty County School District Ad Valorem Taxes

House Bill 768 amended the Act entitled "An Act to provide a homestead exemption from Liberty County School District ad valorem taxes for educational purposes in an amount equal to the amount by which the current year assessed value of a homestead exceeds the adjusted base year assessed value of such homestead," approved May 17, 2004 (Ga. L. 2004, p. 3821).

The definition of “ad valorem taxes for educational purposes” was amended to mean “all ad valorem taxes for educational purposes levied by, for, or on behalf of the Liberty County School District, including, but not limited to, any ad valorem taxes to pay interest on and to retire school district bonded indebtedness.”

The definition of “base year” was amended to mean “the taxable year immediately preceding the taxable year in which the exemption under this Act is first granted to the most recent owner of such homestead; provided, however, that the tax commissioner shall adjust the base year assessed value annually by the lesser of 3 percent or the percentage change in the Consumer Price Index for all urban consumers, U. S. City Average,

all items 1967-100, or successor report as reported by the United States Department of Labor Bureau of Labor Statistics.”

The definition of “homestead” was amended to mean “homestead as defined and qualified in Code Section 48-5-40 of the O.C.G.A., as amended, with the additional qualification that it shall include only the primary residence and not more than five contiguous acres of land immediately surrounding such residence.”

The definition of “improvement” was amended to mean “repairs or improvements or both during any 12 month period which combined exceed 5 percent of the adjusted base year assessed value of the homestead.”

House Bill 768 (effective May 16, 2007 and applicable January 1, 2008).

18. Homestead Exemption for Senior Citizens from City of Buchanan Ad Valorem Taxes for Municipal Purposes

House Bill 771 provides for a homestead exemption from City of Buchanan ad valorem taxes for municipal purposes in the amount of $35,000 of the assessed value of the homestead for residents of that city who are 65 years of age or older. “Ad valorem taxes for municipal purposes” are defined as “all ad valorem taxes for municipal purposes levied by, for, or on behalf of the City of Buchanan, including, but not limited to, any ad valorem taxes to pay interest on and to retire municipal bonded indebtedness.” The “homestead” is the “homestead as defined and qualified in Code Section 48-5-40 of the O.C.G.A., as amended.” A “senior citizen” is a person who is “65 years of age or over on or before January 1 of the year in which application for the exemption under subsection (b) of this section is made.”

Each resident of the City of Buchanan who is a senior citizen is granted an exemption on that person’s homestead from City of Buchanan ad valorem taxes for municipal purposes in an amount of $35,000 of the assessed value of that homestead. The value of that property in excess of such exempted amount remains subject to taxation.

The exemption must be claimed and returned as provided in O.C.G.A. § 48-5-50.1, as amended. The exemption is automatically renewed from year to year as long as the owner occupies the residence as a homestead.

The exemption granted by House Bill 771 does not apply to or affect state ad valorem taxes, county ad valorem taxes for county purposes, or county or independent school district ad valorem taxes for educational purposes. The homestead exemption is in addition to and not in lieu of any other homestead exemption applicable to municipal ad valorem taxes for municipal purposes.

If approved by an election of the voters in November 2007, the exemption granted by House Bill 771 will be effective on January 1, 2008 and will apply to all taxable years beginning on or after January 1, 2008.

House Bill 771 (effective May 16, 2007).

19. Homestead Exemption for Harris County for Senior Citizens or Disabled Residents

House Bill 788 amends the homestead exemption from Harris County ad valorem taxes for residents who are 65 years of age or over or disabled and meet certain income qualifications, approved April 1, 1994 (Ga. L. 1994, p. 4551). The definition of “ad valorem taxes for county purposes” is amended to mean “ad valorem taxes for county purposes levied by, for, or on behalf of Harris County, including taxes to retire bonded indebtedness.” The definition of “ad valorem taxes for school purposes” is amended to mean “ad valorem taxes for educational purposes levied by, for, or on behalf of the Harris County school district, including taxes to retire bonded indebtedness." Each resident of Harris County who is disabled or 65 years of age or older is granted an exemption on that person's homestead from Harris County ad valorem taxes for county purposes in the amount of $20,000 of the assessed value of that homestead for taxable years beginning on or after January 1, 2009, if that person's gross income, together with the income of the spouse of such person who resides within such household does not exceed $50,000 for the immediately preceding taxable year. In addition, each resident of Harris County who is disabled or 65 years of age or older is granted an exemption from Harris County ad valorem taxes for school purposes in the amount of $10,000 of the assessed value of that homestead for the taxable year beginning January 1, 2009, and in the amount of $20,000 of the assessed value of that homestead for taxable years beginning on or after January 1, 2010, if that person's gross income, together with the income of the spouse of such person who resides within such homestead, does not exceed $35,000 for the immediately preceding taxable year.

In the case of a homestead which is jointly owned by a person and such person's spouse, the exemption applies to any such homestead if either spouse is 65 years of age or older or disabled. House Bill 788 (effective May 16, 2007 and applicable January 1, 2009). 20. Contracts with County Tax Commissioner to Assess and Collect Municipal Taxes

House Bill 486 amended O.C.G.A., § 48-5-359.1, relating to contracts with the county tax commissioner to assess and collect municipal taxes and prepare the tax digest, to provide different requirements for counties with fewer than 50,000 tax parcels and counties with 50,000 or more tax parcels. For counties with fewer than 50,000 tax parcels, the previous provisions of O.C.G.A. § 48-5-359.1 continue to apply such that any such county and any municipality wholly or partially located within such county may contract, subject to approval by the tax commissioner of the county, for the tax commissioner to prepare the tax digest for such municipality; to assess and collect municipal taxes in the same manner as county taxes; and, for the purpose of collecting such municipal taxes, to invoke any remedy permitted for collection of municipal taxes.

For counties with 50,000 or more tax parcels, House Bill 486 amended O.C.G.A. § 48-5-359.1 to provide that any county and any municipality wholly or partially located within such county may contract for the tax commissioner to prepare the tax digest for such municipality; to assess and collect municipal taxes in the same manner as county taxes; and, for the purpose of collecting such municipal taxes, to invoke any remedy permitted for collection of municipal taxes. However, any contract between the county governing authority and a municipality must specify an amount to be paid by the municipality to the county which amount will substantially approximate the cost to the county of providing the service to the municipality.

O.C.G.A. § 48-5-359.1 (as amended by House Bill 486 effective May 24, 2007).

21. Amendment Regarding Payment of Tax Bills by New Purchasers of Property

House Bill 380 amended O.C.G.A. § 48-3-3, relating to tax executions by tax collectors and tax commissioners, by renumbering O.C.G.A. § 48-3-3(e) as O.C.G.A. § 48-3-3(e)(1) and by providing that “a new purchaser of property shall not be required to pay the interest specified in Code Section 48-2-40, or the penalty specified in Code Section 48-2-44, until 60 days after the tax collector or tax administrator has forwarded a tax bill to the new purchaser in accordance with” O.C.G.A. § 48-3-3(e)(1).

O.C.G.A. § 48-3-3 (as amended by H.B. 380 effective July 1, 2007).

22. State Ad Valorem Tax Rate

On August 10, 2007, the Governor of Georgia issued an Executive Order pursuant to O.C.G.A. § 48-5-8 to levy the state ad valorem tax at the rate of $0.25 for each $1,000.00 of assessed value of property.

B. Judicial Decisions

1. CSX Transp., Inc. v. Georgia State Board of Equalization, 128 S. Ct. 467 (U.S. 2007)

The United States Supreme Court held that, under the Railroad Revitalization and Regulatory Reform Act (the "4-R Act"), railroads may challenge state methods for determining the value of railroad property, as well as how those methods are applied.

In valuing CSX Transportation, Inc.'s ("CSX") railroad property, the Department used the "unit rule", under which it first determined the market value of the railroad as a whole and then allocated a portion of that value to Georgia. The parties agreed that the unit rule was the appropriate rule for valuing CSX's property but disagreed as to the valuation methodologies used to determine the market value as a whole. Georgia's appraiser used three different valuation methodologies and ultimately arrived at a valuation of $7.8 billion. In contrast, the valuation methodologies used by CSX's appraiser resulted in a valuation of $6 billion.

CSX filed suit in United States District Court and contended that Georgia's assessment violated the 4-R Act. Under the 4-R Act, a district court may enjoin the tax if state assesses a railroad's property at a ratio of assessed value to true market value that exceeds by more than 5% the ratio of assessed value to true market value for other commercial and industrial property in the state. CSX alleged that Georgia had grossly overestimated the market value of its in-state property while accurately valuing other commercial and industrial property in the state. According to CSX, the result was discriminatory because its rail property was

taxed at a ratio of assessed-to-market value that was considerably more than 5% greater than the same ratio for the other property in Georgia.

The District Court upheld the assessment and concluded that the 4-R Act does not generally allow a railroad to challenge the state's chosen methodology as long as the state's methods are rational and not motivated by discriminatory intent. The Court of Appeals affirmed. The United States Supreme Court reversed and held that railroads may challenge state methods for determining the value of railroad property, as well as how those methods are applied.

The United States Supreme Court initially explained that Congress enacted the 4-R Act to prohibit states from discriminating against railroads by taxing railroad property more heavily than other commercial property in the state. Georgia argued that railroads could only challenge the state's application of valuation methodologies. However, the United States Supreme Court disagreed and stated that it did "not see how a court can go about determining true market value if it may not look behind the State's choice of valuation methods." The court found a "total lack of textual support for Georgia's position" and stated that the "dichotomy the State presses would eviscerate the statute by forcing courts to defer to the valuation estimate of the State, when discriminatory taxation by States was the very evil the Act aimed to ban."

The United States Supreme Court found Georgia's position "untenable". The court reasoned that "[g]iven the extent to which the chosen methods can affect the determination of value, preventing courts from scrutinizing state valuation methodologies would … force district courts to accept as 'true' the market value estimated by the State, one of the parties to the litigation." If Georgia's interpretation was adopted, the United States Supreme Court felt that "States … would be free to employ appraisal techniques that routinely overestimate the market worth of railroad assets" and that "[b]y then levying taxes based on those overestimates, States could implement the very discriminatory taxation Congress sought to eradicate."

Georgia argued that allowing railroads to introduce their own valuation estimates would lead to a clash of experts, which courts would have no reasonable way to settle. The United States Supreme Court disagreed and concluded that Congress had directed courts to find true market value and that Congress had believed such a determination was susceptible to judicial inquiry. In the court's view, Georgia was essentially asking for a limitation on the types of evidence that courts could consider as part of their factual inquiry. The United States Supreme Court determined that Congress would have explicitly imposed such a limitation if it had wanted to do so.

The United States Supreme Court also rejected Georgia's contention that allowing courts to question state valuation methodologies would ignore the principles of federalism. The court concluded that the 4-R Act clearly authorized railroads to challenge a state's valuation methodologies. The court also questioned Georgia's contention that its selection of valuation methodologies was an important state policy choice intimately connected to its taxing power because Georgia did not prescribe a particular methodology as a matter of state law.

Finally, the United States Supreme Court rejected Georgia's argument that the court's interpretation would destroy a state's discretion to choose its own valuation methodologies. The court found that the 4-R Act only prohibited discrimination, not the use of any particular valuation methodology.

2. Monroe County v. Georgia Power Co., 655 S.E.2d 817 (Ga. 2008)

The Georgia Supreme Court addressed the issue of whether a county in making a final property tax assessment could reappraise the fair market value of property owned by taxpayers that are required to make a return to the State Commissioner. The Georgia Supreme Court affirmed the Court of Appeals' decision and held that, in making a final property tax assessment pursuant to O.C.G.A. § 48-2-18(d), a county may alter the assessment ratio used by the Commissioner in his proposed assessment, but that the county does not have authority to alter the apportioned fair market value determined by the Commissioner.

Georgia Power filed a property (ad valorem) tax return, including its estimate of the property’s fair market value, with the Georgia State Board of Equalization. The State Commissioner reviewed and approved the valuation estimated by Georgia Power, apportioned it among the various counties in which Georgia Power owned such property, and proposed an assessment ratio. However, pursuant to its power to make a “final assessment” under O.C.G.A. § 48-2-18(d), the Monroe County Board of Tax Assessors (“the Monroe Board”) rejected the State Commissioner's fair market valuation and also raised the assessment ratio.

Georgia Power objected on the ground that even if counties had the power to raise assessment ratios, county boards are not empowered to change the State Commissioner's determination of fair market value, which would undermine the longstanding employment of a "unit tax" method of assessing utility properties as a whole at the state level. The Monroe Board asserted that it had the authority to reset not only the assessment ratio imposed on Georgia Power's Monroe County property, but also the fair market value of that property as appraised by the State Commissioner. In support of its assertion, the Monroe Board cited O.C.G.A. § 48-2-18(d), which provides that “within 30 days after receipt of the [State Commissioner's] proposed digest of assessments, the county board of tax assessors shall make the final assessment of the property in question and provide notice to the taxpayer.”

The Georgia Supreme Court determined that although the legislature altered the ad valorem tax structure in 1988, it intended to retain the unit tax method for taxation of public utilities. The court concluded that although the 1988 legislation increased the role of counties in the ad valorem tax structure, that new role was limited to determining the appropriate assessment ratio to be applied to the amount of apportioned property as determined by the State Commissioner. The Georgia Supreme Court found its conclusion consistent with its holding in Telecom USA, Inc. v. Collins, 393 S.E.2d 235 (Ga. 1990).

Furthermore, the Georgia Supreme Court stated that several statutory provisions indicated that counties may not set values for public utility property. The court based its conclusions on O.C.G.A. § 48-5-263(b)(1) (stating that county tax appraisers may make fair market value appraisals except for property returned directly to the Commissioner); O.C.G.A. § 48-5-264.1 (providing that the chief appraiser and local assessors may go upon property to make value appraisals other than property directly returned to the Commissioner); O.C.G.A. § 48-5-305(c) (allowing local assessors to ascertain the fair market value of any property not already appearing on the county digest except for property returned to the Commissioner); and O.C.G.A. § 48-5-313 (stating that no part of the Revenue Code setting forth the powers of local assessors shall apply to those persons required to file returns directly with the Commissioner). The court determined that the legislature's intent to retain valuation of public utility property at the state level was demonstrated by the preceding statutes because three of the statutes were expressly retained in the 1988 amendment and one was enacted three years later.

3. Oconee County Bd. of Tax Assessors v. Thomas, 651 S.E.2d 45 (Ga. 2007)

The Georgia Supreme Court addressed the issue of whether a taxpayer was entitled to appeal a Georgia property tax penalty assessment for a breach of a conservation use covenant to the Oconee County Board of Equalization ("BOE"). The Georgia Supreme Court affirmed the Court of Appeals decision and held a taxpayer was entitled to appeal a Georgia property tax penalty assessment for a breach of a conservation use covenant to the BOE.

The Oconee County Board of Tax Assessors ("BOA") assessed a penalty against Thomas for failing to apply for a continuation of the current use assessment with respect to property that she was awarded in a divorce. Thomas sought to appeal the penalty to the BOE but her efforts to appeal were denied by the BOA.

The relevant statute, O.C.G.A. § 48-5-311(e)(1)(A) (the "Statute") permitted taxpayers to "appeal from an assessment by the county board of tax assessors to the county board of equalization ... as to matters of taxability, uniformity of assessment, and value, and, for residents, as to denials of homestead exemptions." The BOA contended that the statute did not apply because the assessment it made was not an "assessment" within the meaning of the statute. However, the Georgia Supreme Court disagreed with the BOA.

The Georgia Supreme Court first noted that the event triggering Thomas's effort to begin an appellate process was not the BOA's determination of a breach of the conservation use covenant, but its assessment against her of a penalty for the alleged breach. As a result, the court determined that, on its face, the Statute appeared to authorize the appeal. The Georgia Supreme Court then rejected the BOA's contention that "assessment of a penalty for an alleged breach of the conservation use covenant was not an assessment within the meaning of [the Statute] because the meaning of the word 'assessment,' as used in the Code, is limited to a determination of value." The court determined that the term "assessment" involved much more than valuation and that its primary meaning was "imposition of a tax or fine," which the Statute permits a taxpayer to appeal to the BOE.

The BOA also contended that its assessment of a penalty was not appealable to the BOE because the BOE is given jurisdiction to appeal only one aspect of conservation use covenants (the denial of an application for such use). The BOA cited O.C.G.A. § 48-5-7.4(j)(1) in support of its argument. The Georgia Supreme Court

rejected the BOA's argument and concluded that the subsection cited by the BOA was concerned only with applications for conservation use covenants and did not purport to cover the entire subject of appeals in conservation use matters. The court determined that appeals in matters other than applications for conservation use covenants were covered elsewhere, including the provision in O.C.G.A. § 48-5-311 for appeal from assessments.

4. Buckler v. DeKalb County Bd. of Tax Assessors, 2007 Ga. App. LEXIS 1995 (Ga. Ct. App. 2007)

The Georgia Court of Appeals addressed the issue of whether a taxpayer was entitled to an award of reasonable attorneys fees incurred in appealing a first jury verdict under O.C.G.A. § 48-5-311(g)(4)(B)(ii) (the "Statute"). The Georgia Court of Appeals reversed the trial court's decision in part and held that the taxpayers were entitled to an award of reasonable attorneys fees incurred in appealing a first jury verdict under the Statute.

The Statute authorized the recovery of such fees "incurred in the [taxpayer's] action." The Georgia Court of Appeals determined that the issue was whether the legislature's use of the word "action" was intended to limit the recovery of attorney fees to those incurred in the trial court. The court looked to the Georgia Civil Practice Act, which defined the term "action" broadly as the "means of enforcing a right." The Georgia Court of Appeals concluded that the right of appeal was a judicial means of enforcing a right and that, therefore, the taxpayers were entitled to an award of reasonable attorneys fees incurred in appealing a first jury verdict under the Statute.

5. Clayton County v. HealthSouth Holdings, Inc., 654 S.E.2d 143 (Ga. Ct. App. 2007)

The Georgia Court of Appeals addressed the issue of whether O.C.G.A. § 48-5-380 permitted a taxpayer to claim a property tax refund that allegedly was assigned to it by an affiliated company. The Georgia Court of Appeals held that O.C.G.A. § 48-5-380 did not permit the taxpayers to claim a property tax refund as an assignee.

The appeal was a consolidated appeal of several cases that involved the same issue. In the first two cases, HealthSouth Holdings ("HSH") applied to Fayette County for a refund of property taxes that allegedly had been overpaid and asserted that it was entitled to a refund under O.C.G.A. § 48-5-380. In the third case, HSH and Diagnostic Health Corporation ("DHC") applied to Clayton County for a refund of property taxes that allegedly had been overpaid and asserted that they were entitled to a refund under O.C.G.A. § 48-5-380.

In each of the cases, the entity that actually filed the tax property returns with the county was HealthSouth Corporation ("HSC"). As a result, the Georgia Court of Appeals determined that, in each case, HSC was the taxpayer. Therefore, in the first two cases, the court determined that HSH was claiming the refund as an assignee of HSC and, in the third case, determined that HSH and DHC were claiming the refunds as assignees of HSC.

The relevant statute, O.C.G.A. § 48-5-380(b), provided that "[n]o refund provided for in this Code section shall be assignable." Therefore, the Georgia Court of Appeals concluded that, pursuant to O.C.G.A. § 48-5-380(b), no refund is assignable and determined that only HSC, the taxpayer, could claim a refund. Accordingly, the court held that, in the first two cases, HSH could not claim a refund under O.C.G.A. § 48-5-380 and that, in the third case, HSH and DHC could not claim refunds under O.C.G.A. § 48-5-380.

6. Clayton County Bd. of Tax Assessors v. City of Atlanta, 648 S.E. 701 (Ga. Ct. App. 2007)

The Georgia Court of Appeals reviewed several cases that had been consolidated for appeal. In the first two cases, the Court of Appeals addressed the issue of whether property located in Clayton County (the “County”) but owned by the City of Atlanta (“Atlanta”) and leased by Atlanta to the United States Postal Services (“USPS”) was exempt from property tax because it was used for a public or governmental purpose (i.e., to facilitate effective operation of an airport). On the basis of collateral estoppel resulting from a prior decision of the court, the Court of Appeals found that Atlanta was not acting in its governmental capacity but in its proprietary capacity in that it was leasing the property for the purpose of generating revenue. As a result, the Court of Appeals held that Atlanta’s property was subject to County property tax.

In the other two cases, the Court of Appeals addressed the issue of whether property located in the County that had been owned by a tax exempt development authority (the College Park Business and Industrial Development Authority) but sold to a non-exempt entity (Atlanta) remained exempt from County property

tax. Atlanta purchased property from the College Park Business and Industrial Development Authority and then leased the property to the City of College Park, which subleased a portion of the property to Sheraton Hotels. Atlanta’s first contention was that property owned by a tax-exempt development authority remains exempt when the property is sold to a non-exempt entity. The Court of Appeals held that the property was not exempt from County property tax because Atlanta could not justify an exemption based on its own use of the property and, therefore, was not entitled to piggyback on the College Park Business and Industrial Development Authority’s exemption.

Atlanta’s second contention was that the property was exempt from property tax because Atlanta’s lease of the property was for a public or governmental purpose (i.e., the purposes described in the statute creating the College Park Business and Industrial Development Authority). The Court of Appeals held that Atlanta’s property was subject to County property tax because Atlanta entered into the lease in its proprietary capacity for the purpose of generating revenue.

7. City of Atlanta v. Clayton County Board of Tax Assessors, 645 S.E.2d 42 (Ga. Ct. App. 2007)

The Court of Appeals addressed the issue of whether property located in Clayton County (the “County”) but owned by the City of Atlanta (“Atlanta”) in conjunction with the Hartsfield-Jackson International Airport was exempt from County property tax. The property at issue was a 30 acre parcel that Atlanta purchased in connection with a planned fifth runway at the airport.

The Court of Appeals noted that, although public property is generally exempt from ad valorem taxation pursuant to O.C.G.A. § 48-5-41(a)(1)(A), property owned by one political subdivision outside its own territorial limits may be subject to taxation unless it falls within the exemptions set forth in O.C.G.A. § 48-5-41(a)(1)(B). The exemptions in O.C.G.A. § 48-5-41(a)(1)(B) provide that no public real property which is owned by a political subdivision of Georgia and which is situated outside the territorial limits of the political subdivision will be exempt from ad valorem taxation unless the property is either: 1) “developed by grading or other improvements to the extent of at least 25% of the total land area and facilities are located on the property which are actively used for a public or governmental purpose” (the “First Tax Exemption”); or 2) 300 acres or less in area (the “Second Tax Exemption”).

The primary issue before the Court of Appeals was whether the First Tax Exemption required that 25% of the particular parcel be developed and contain functioning airport facilities or whether it is sufficient that 25% of the airport property as a whole be developed and contain such facilities. The County argued that in determining whether that property qualified for the First Tax Exemption the court must consider only the parcel the County wished to tax and that in determining whether the property qualified for the Second Tax Exemption the court must consider the total aggregate land held by Atlanta in the County. However, Atlanta argued that, in determining whether the First Exemption applied, the parcel should be considered a part of all the land held in conjunction with the airport, 25% of which was developed and contained facilities actively used for a public purpose.

The Court of Appeals determined that the property was purchased by Atlanta for the statutorily authorized purpose of expanding, improving, maintaining and operating an airport and landing fields for the use of aircraft. The court also determined that property designated for an approved, ongoing airport expansion project is property actively and reasonably used to facilitate the effective operation of the airport. As a result, the Court of Appeals ruled that it was appropriate to consider the property in conjunction with Atlanta’s other airport related property in determining whether it was exempt from County property tax. Therefore, Court of Appeals held that the 30 acre parcel was exempt from County property tax because Atlanta had developed at least 25% of the total land held by it in connection with the airport.

8. International Auto Processing, Inc. v. Glynn County, 2007 WL 2482469 (Ga. Ct. App. 2007)

The Court of Appeals addressed the issue of whether International Auto Processing, Inc. (“IAP”) was entitled refund for four years' worth of property (ad valorem) taxes paid to Glynn County. IAP operated a business which was owned by the Georgia Ports Authority (the “Authority”). From 1993 to 1996, IAP owned buildings and other improvements on land it leased from the Authority. During those years, IAP paid property taxes on its leasehold and improvements. In 1996, IAP sold the improvements to the Authority for over $7 million. Thereafter, IAP leased back both the land and the improvements from the Authority for an annual rent of over $700,000. On March 31, 1997, IAP filed a property tax return indicating that in 1996 the buildings and improvements on the subject land were sold by IAP to the Authority and were to be leased back to IAP, along with the land. However, the blocks on the form for “market value” were left blank. The county continued to bill IAP for ad valorem taxes in approximately the same amount as before IAP sold the improvements to the Authority. IAP paid the taxes for 1997 through 2002 without protest. However, in

December 2002, IAP filed a claim for a refund pursuant to O.C.G.A. § 48-5-380, which allows taxpayers to claim a refund for taxes determined to have been “erroneously or illegally assessed and collected.”

IAP contended that the county followed illegal procedures after IAP filed its 1997 return. Specifically, IAP contended that after it filed a return that was silent as to the fair market value of the taxable property, the properties should have been taxed at the values ascribed in the return (zero value). IAP further contended that, if the board of assessors disagreed with IAP's valuation, the board should have reassessed the property and notified IAP so that it could availed itself of the assessment appeal procedure set out in O.C.G.A. § 48-5-311, which requires that an appeal be instituted with 45 days of a notice of assessment. Because the county failed to either tax the property at a zero value or reassess the property, IAP contended that the assessment was reached by the use of illegal procedures.

The Court of Appeals noted that under Georgia's ad valorem tax statutes, each property owner has a personal affirmative duty to return the fair market value of taxable property including any improvements and must do so annually, in writing, and under oath. The court concluded that, contrary to IAP's argument, returns must state the taxable property's fair market value and that, in the absence of any return by the taxpayer or other information available to the taxing authority showing that the existing assessment overvalues the taxable property, the tax bill may be based on the existing assessment. As a result, the Court of Appeals held that IAP was not entitled to a refund because the county had not used illegal procedures to assess and collect the tax. The court determined that IAP had not identified any evidence supporting an inference that the county lacked authority to impose the tax, committed a clerical error, or collected a wrongly assessed tax.

HAWAII STATE DEVELOPMENTS MIKI OKUMURA (mokumura@goodsill.com) GOODSILL ANDERSON QUINN & STIFEL LLP 1099 Alakea Street, Suite 1800 Honolulu, Hawaii 96813 Telephone: (808) 547-5758 Fax: (808) 547-5880 I. ADMINISTRATIVE

A. Qualified High Technology Business (QHTB). The Hawaii Department of Taxation (DOT) issued several

administrative announcements and tax information releases relating to QHTBs and their investors:

1. Tax Information Release No. 2007-04 (November 29, 2007) explains the DOT’s policies regarding credit ratios for the high technology business investment tax credit allowed under HRS § 235-110.9. QHTB investors are allowed to receive allocations of the high technology business investment tax credit in excess of the actual investment amounts made, but they must demonstrate that the investments satisfy the common law doctrines of economic substance and business purpose when credit ratios reach certain multiples. This TIR provides a safe harbor for eligible investments which have credit ratios of 2:1 or less and meet two tests: first, the credit claim is made ratably over the 5-year statutory payout period and second, the investor retains at least 50% of his prorata equity interest of the investment. Investors who meet the safe harbor tests do not have to substantiate economic substance or business purpose.

2. Tax Information Release No. 2007-05 (December 31, 2007) explains the DOT’s policies regarding

application of the “activity test” and the “gross income test” for the high technology business investment tax credit under HRS § 235-110.9, and the “activities test” under HRS § 235-7.3 for certain income tax exemptions, in cases involving a disregarded entity. For purposes of applying these QHTB tests, an entity that is considered a disregarded entity for income tax purposes may opt to be analyzed as separate and distinct from its parent-owner, or alternatively be disregarded so that its activities are attributed to its parent-owner.

3. DOT Announcement No. 2008-02 (March 5, 2008) explains the electronic annual survey filing

requirement added by Act 206 beginning with calendar year 2007. A QHTB that accepts a cash investment for which a credit may be claimed must file the electronic annual survey using Form N-317.

4. DOT Announcement No. 2008-03 (March 20, 2008) summarizes the applicable deadline and filing

requirements for certification of high technology business investment tax credits and research tax credits. A certified statement (Form N-318A) must be filed on or before March 30 following the close of the tax year in which the QHTB investment is made or the qualified research activity is conducted. The DOT has taken the position that it does not have legal authority to accept a late submitted Form N-318A for certification for the year in which the due date has passed. The DOT has been willing, however, to grant credit claims which have not been certified if the taxpayer shows reasonable cause for the late filing.

B. Renewable Energy Technologies Income Tax Credit. Tax Information Release No. 2007-02 (September 17,

2007) explains the Hawaii renewable energy technologies income tax credit under HRS § 235-12.5. Hawaii has offered this credit since 2003, with amendments over the past five years that have included increases in the credit amounts for qualifying solar thermal, wind-powered and photovoltaic energy systems installed and placed in service on single family residential or commercial properties. The credit is nonrefundable, calculated as a percentage of actual costs of the system, and subject to a cap, all as specified in the statute. TIR No. 2007-02 clarifies who may claim the credit and when, what will constitute a system, and what constitutes the types of property eligible for the credit. Since the credit is calculated based on actual costs of a system and subject to a cap, the TIR’s guidance as to when an installation constitutes the installation of more than one system is of particular note. The TIR states that a system will exist when all components necessary for the

conversion process are present, and that an addition to an existing system may qualify for the credit provided it is substantial and not merely repair and maintenance.

II. JUDICIAL

A. Jurisdiction of Tax Appeal Court. In In Re Tax Appeal of Director of Taxation v. Medical Underwriters,

115 Haw. 180, 166 P.3d 353 (2007), the taxpayer was a company which managed the Hawaii-based insurance operations of a foreign reciprocal insurance exchange as the foreign insurer’s attorney-in-fact. For licensing purposes, the Hawaii Insurance Division treated the taxpayer as part of the reciprocal insurance exchange. The taxpayer asserted that it was therefore exempt from the Hawaii general excise tax because it was an insurer. The Hawaii Supreme Court held that the taxpayer was not exempt and thus was subject to the 4% general excise tax rate on the management fees paid by the exchange, because the taxpayer was a separate legal entity and did not have any risk under the insurance contracts that were being sold. The Court also rejected the taxpayer’s alternative argument that it should only be subject to the .15% tax rate imposed on insurance agents, because it was not a licensed insurance agent.

IDAHO STATE DEVELOPMENTS Robert T. Manicke Kris J. Ormseth Eric J. Kodesch Stoel Rives LLP 900 SW Fifth Avenue, Suite 2600 Portland, Oregon 97204-1268 Ph: (503) 224-3380 Fax: (503.220.2480 rtmanicke@stoel.com kjormseth@stoel.com ejkodesch@stoel.com web: www.stoel.com

I. INCOME/FRANCHISE TAXES

A. Legislative Developments

2008 Legislative Session. The Idaho 2008 legislative session convened on January 7, 2008 and adjourned on April 2, 2008. During the session, several income tax laws were enacted. Among them:

• Simplified Employer Information Returns. HB 344, which was signed into law to be effective January 1, 2009, simplifies the year-end income tax withholding reports employers must file with the State Tax Commission, by combining the former separate filings made on January 31 and the last day of February each year into a single return due on the last day of February each year.

• No Repeal of Income Tax Credit for Research Activities. Section 63-3029G of the Idaho Code generally provides a nonrefundable income tax credit related to research activities. The Idaho legislature passed HB 664, which would have repealed the credit. On April 14, 2008, however, the governor vetoed the bill, preserving the credit.

• Reconnection to January 1, 2007. HB 342, which was signed into law effective January 1, 2008, generally reconnects Idaho tax law to federal tax law as amended and in effect on January 1, 2008. The prior reconnect date generally was January 1, 2007.

II. TRANSACTIONAL TAXES

A. Legislative Developments

2007 Legislative Session. During the 2008 legislative session, several sales tax laws were enacted. Among them:

• Addition of a New Affiliate Nexus Rules. HB 360, which was signed into law to be effective July 1, 2008, adds a new test nexus for sales tax purposes. The law provides that “substantial nexus” exists if (1) the retailer and an in-state business are related parties and (2) the retailer and the in-state business use an identical or substantially similar name, trade name, trademark or goodwill to develop, promote or maintain sales, or the in-state business provides services to, or that inure to the benefit of, the out-of-state business related to developing, promoting or maintaining the in-state market.

• No Sales Tax for Payments of Personal Property Tax. HB 469, which was signed into law to be effective July 1, 2008, ensures that payments to cover personal property tax made by a lessee are not subject to sales tax, if the lease is for a period of at least one year, and the property tax is separately stated.

• Exemption for Processing Materials for the Production of Energy. HB 561, which was signed into law to be effective July 1, 2008, ensures that the general sales and use tax exemption for tangible personal property consumed in or used for production of other tangible personal property applies to processing materials for use as a fuel in the production of energy. It appears that the legislature did not believe that the law would create a new exemption because it was expected that the law would be revenue-neutral.

III. PROPERTY TAXES

2008 Legislative Session. During the 2008 legislative session, several property tax laws were enacted. Among them:

A. Legislative Developments

• Up to $100,000 Exemption for Personal Property. HB 599, which was signed into law to be effective January 1, 2009, provides an exemption for up to $100,000 of personal property, located within a particular county, that is not operating property.

• Incentive for Large Capital Improvements. HB 562, with was signed into law effective January 1, 2008, creates a new property tax incentive. Pursuant to this incentive, the net taxable value of all property of a taxpayer in excess of four hundred million dollars ($400,000,000) located within a single county in Idaho is exempt from property tax, provided that the property is part of a new investment of at least one billion dollars ($1,000,000,000).

• Incentives for Economic Development. HB 550, which was signed into law effective January 1, 2008, provides an economic development incentive for new manufacturing facilities construction and development in designated rural development areas. The law generally grants the board of county commissioners authority to offer property tax exemptions for a maximum of five years to a taxpayer that spends a minimum of $3,000,000 for new manufacturing facilities in certain rural areas.

IV. OTHER TAXES – GROSS EARNINGS TAX

2008 Legislative Session.

A. Legislative Developments

• New Gross Earnings Tax for Geothermal Power. HB 529, which was signed into law effective January 1, 2008, expands the tax imposed by Section 63-3502B of the Idaho Code to include “gross geothermal energy earnings.” Prior to this expansion, Section 63-3502B applied only to “gross wind energy earnings.”

About the Authors Robert T. Manicke: Mr. Manicke heads the state and local tax practice at Stoel Rives. He regularly represents clients before state and local tax tribunals in cases involving unitary taxation, Public Law No. 86-272 and other business tax matters. He also has written tax legislation and advises businesses on state tax incentives. Mr. Manicke graduated summa cum laude from the University of Illinois College of Law in 1992 and is a member of the Oregon, California and Washington State Bars. Kris J. Ormseth: Mr. Ormseth is managing partner of the Stoel Rives Boise office. He regularly handles mergers and acquisitions, financing arrangements and other transactions for privately and publicly held clients in a variety of industries. He provides corporate counsel advice to clients on a wide range of legal and business issues. Mr. Ormseth received his B.A. from Stanford University and his J.D. from the University of California at Berkeley. He is a member of the Idaho Bar. Eric J. Kodesch: Mr. Kodesch is a member of the Stoel Rives Business Services Group. His practice focuses on state and federal income taxation. Mr. Kodesch graduated from the Columbia Law School in 2002 and is a member of the Oregon and New York State Bars.

IOWA STATE DEVELOPMENTS

ILLINOIS STATE DEVELOPMENTS Tom Donohoe Keith Staats Fred Ackerson Catherine Battin Page Scully McDermott Will & Emery LLP 227 West Monroe Street Chicago, Illinois 60606 (312) 372-2000 www.mwe.com

I. Income Tax/Franchise Taxes

A. Legislative Developments

1. Public Act 95-707, the Trailer Bill to Public Act 95-233

On January 11, 2008 the Governor signed Public Act 95-707, a “trailer bill” which modified several of the provisions of Public Act 95-233, the 2007 corporate income tax “loophole closer” expected to raise $200 million to $300 million of revenue per year. Public Act 95-233, among other changes (1) expanded the “addback” of interest and royalties or other costs related to intangible property paid, accrued or incurred to affiliates excluded from the taxpayer’s unitary business group under the “80/20” rule, to also addback those deductions paid to affiliates excluded from the taxpayer’s unitary business group by reason of the use of different apportionment formulae; (2) created a new addback for insurance premiums paid to affiliates excluded from the taxpayer’s unitary business group; (3) disallowed the dividends paid deduction for certain captive REITs; (4) modified the apportionment rules for services businesses, financial organizations and transportation companies; (5) required withholding by pass-through entities; (6) required the subtraction modification for exempt interest to be reduced by all related expenses; (7) required the reduction of net operating losses by certain discharged debt; and (8) required a corporate franchise tax amnesty program to be held during the period February 1 to March 15, 2008. Most of the provisions of Public Act 95-233 are effective for taxable years beginning January 1, 2008.

Public Act 95-707 made numerous amendments to these income tax changes, including the following:

Add-back Rule Clarifications. The trailer bill cleaned up a number of drafting errors in the expanded add-back provisions for interest and royalties, most importantly to provide that the exceptions to the add-back rules (e.g., for payments made to an affiliate subject to a net income tax in another state or foreign jurisdiction, payments made to an affiliate that makes corresponding interest or royalty payments to a third party, and interest payments made in arms’ length transactions) will apply whether the affiliate is domestic or foreign. The literal language of Public Act 95-233 permitted the exceptions to apply only where the affiliate receiving the payment is a foreign person (i.e., an 80/20 company).

Apportionment Formula Changes. Public Act 95-233 made substantial changes to the apportionment formulae for services businesses, financial organizations and transportation companies, and those changes were revised extensively by the trailer bill.

The general sales factor rule for service businesses was modified to provide that sales of services are sourced to Illinois if the services are “received” in Illinois, determining largely by the location of the customer’s fixed place of business (within the meaning of Internal Revenue Code Section 864). The sales factor for interest, net gains and income from other intangible assets (other than royalties from patents, copyrights, trademarks and similar intellectual property) by companies other than financial organizations was restored to a cost of performance test, except for dealers in those items of

intangible personal property within the meaning of Internal Revenue Code Section 475, who will treat such income as Illinois source if the income is received from a customer in Illinois.

The trailer bill enacted highly detailed rules governing the apportionment of telecommunications service revenues which were negotiated with the industry and enacted into the Income Tax Act, with a general rule that receipts from the sale of telecommunications services are sourced to Illinois if the customer’s service address is in Illinois.

Financial organizations will treat receipts from the performance of services (such as fiduciary, advisory and brokerage services) as Illinois source receipts if the services are “received” in Illinois, under the same test as described above for service revenues in general. The rules for sourcing receipts from investment activities of financial organizations was rewritten by the trailer bill.

The airline apportionment rule enacted by Public Act 95-233, based upon a weighted average of take-offs and landings, was repealed by the trailer bill and replaced by a revenue miles formula, where a revenue mile is defined to be the transportation of one passenger or on net ton of freight the distance of one mile.

The trailer bill also repealed the provisions of Public Act 95-233 which required separate apportionment of income of financial organizations not attributable to financial services, and of nontransportation income of transportation companies. These highly detailed changes to the sales factor and special apportionment rules are effective for taxable years ending on or after December 31, 2008.

Pass-Through Withholding. The new withholding rules for partnerships, S corporations and trusts were amended to provide that a pass-through entity will not be required to withhold Illinois tax on the income allocated to nonresidents (other than individuals) upon receipt of certificate stating that the nonresident will be subject to personal jurisdiction in Illinois and will file all required Illinois income tax returns and pay all taxes due. Investment partnerships also are exempted from the withholding rules.

Captive REITs. The new captive REIT rules were amended to clarify portions of the definition of captive real estate investment trust. Under the new captive REIT rules, captive REITs will be required to add-back any federal deduction for dividends paid for taxable years beginning after December 31, 2008. Under a pending bill (SB 2643), the definition of “captive REIT” would be further amended to exclude REITs controlled by foreign real estate companies substantially similar to domestic REITs that are organized in a country with which the United States has an income tax treaty and either publicly traded or lacking a 10 percent shareholder.

Exempt Income Expenses. The trailer bill repealed the provisions in Public Act 95-233 that required the subtraction modification for interest exempt from state income tax (by federal statute, treaty or federal or state constitutional law) to be reduced by expenses related to the exempt income, including interest expense on debt incurred to carry the bonds or other obligations. Accordingly, the subtraction modification for exempt interest will continue to be reduced only for bond premium amortization.

Tax Shelter Provisions. The trailer bill amended the Illinois tax shelter registration and investor list maintenance requirements to coordinate with corresponding federal rules and to provide that, for returns or lists that must be filed after January 1, 2008, these rules apply to reportable transactions having a nexus with the State, meaning that the transaction has one or more investors that is an Illinois taxpayer at the date the transaction is entered into. For returns or lists that were required to be filed prior to January 1, 2008, a tax shelter was considered to have a nexus with Illinois only if the tax shelter was organized in Illinois, doing business Illinois or deriving income from sources within Illinois. The trailer bill also amends the penalty provisions associated with the requirement to disclose reportable transactions and the tax shelter registration and investor list maintenance requirements, to provide that the penalties may not be rescinded for listed transactions, and may be rescinded for other reportable transaction only to promote compliance with the Income Tax Act and effective tax administration (apparently eliminating other grounds for rescinding the penalties,

including reasonable cause and good faith, absence of willful neglect or intent not to comply, and a taxpayer’s history of tax compliance).

Franchise Tax and License Fee Amnesty Act of 2007. As noted above, Public Act 95-233 required the Illinois Secretary of State to create an amnesty program for corporate franchise taxes payable by Illinois corporations and corresponding license fees payable by foreign corporations. The amnesty program was held during the period from February 1, 2008 through March 15, 2008. Amounts paid under amnesty were not subject to penalties or interest. To incentive taxpayers to utilize the amnesty program, Public Act 95-707 amended the franchise tax statute to provide that the rate of interest on delinquent payments, including payments due for prior periods, is now doubled from 1% per month to 2% per month.

2. Proposed Legislation to Amend Section 404 (HB 4454)

HB 4454 would amend Section 404, which grants the Director broad authority to adjust items of income and deduction and any factor taken into account in allocating income to Illinois, if he determines that an adjustment is reasonably required to determine the base income properly allocable to Illinois. In recent years, the Director has become aggressive in invoking Section 404, particularly to deny deductions for intercompany payments to affiliates that are excluded from the payor’s unitary business group (due to 80/20 status or use of different apportionment formulae), but the Department has never promulgated regulations or other administrative rules which establish standards to be used in invoking Section 404.

In 2007, a bill (HB 1558) that would have prevented the Director from invoking Section 404 until the Department adopted regulations setting standards for its use passed the legislature by unanimous votes in both chambers, but was vetoed.

HB 4454 takes a new approach by setting forth the standards for the Director’s use of Section 404 in the statute itself. HB 4454 would amend Section 404 to provide that, unless the principal purpose of an arrangement is tax avoidance, any adjustment must be made in accordance with IRC Section 482 and applicable federal rules. HB 4454 then provides for a rebuttable presumption of tax avoidance in the case of arrangements between members of a unitary group and certain related companies that would be members of the unitary group but for 80/20 status or use of different apportionment formulae and that have characteristics typically found in tax planning structures (i.e., the affiliate has “de minimis” real property, tangible personal property or payroll, earns a “substantially” higher return on its real and tangible personal property than the aggregate of the unitary business group, or conducts “substantially all” of its business activity with members of the unitary business group).

HB 4544 also would bar the Department from using Section 404 to adjust base income in a manner that has the same effect as retroactive application of the add-back rules and other statutory amendments made by Public Acts 93-840, 95-233 and 95-707. The amendment would also deprive the executive branch of rulemaking authority under Section 404 as amended, permitting the Governor to propose rules to the legislature to consider for enactment into statutory law. HB 4454 passed the House of Representatives by 109-0; as of May 1, 2008 it was before the Senate.

B. Income Tax – Judicial Developments

1. MeadWestvaco Corp. v. Illinois Department of Revenue, __ U.S. __, No. 06-1413 (Apr. 15, 2008)

In MeadWestvaco Corp. v. Illinois Department of Revenue, No. 06-1413 (Apr. 15, 2008), the United States Supreme Court held that the “operational function” test for apportionable income articulated in Allied-Signal must be applied narrowly to assets used in the taxpayer’s business and is not to be applied to the relationship between business entities or businesses.

The Illinois Circuit Court had ruled that Illinois could tax an apportioned share of Mead’s gain on the sale of its wholly owned Lexis/Nexis business division because Mead’s investment in Lexis/Nexis served an “operational purpose” in Mead’s business, even though Mead and Lexis/Nexis were not engaged in a unitary business The Illinois Appellate Court reached the same conclusion as to apportionability based on its determination that the Lexis/Nexis investment served an “operational purpose” within the meaning of Allied-Signal v. Director of Taxation, 504 U.S. 768 (1992). The Appellate Court found it unnecessary to examine whether Mead and Lexis/Nexis were

engaged in a unitary business based on its determination that Illinois could tax an apportioned share of Mead’s gain solely on ground that the operational function test was met.

The Supreme Court rejected the Illinois Appellate Court’s interpretation of Allied Signal and ruled that the lower court erred in considering the operational test rather than the unitary business test because the asset in question was another business. The operational test is not a separate basis for apportionment of income, but is instead intended to recognize that an asset can be part of a taxpayer’s unitary business even if a unitary relationship does not exist between the payor and payee. Thus, the operational test is to be applied to determine the apportionability of gain from the sale of an asset when there is no unitary relationship between the payor and payee and the asset is not another business. But when the asset is another business, the Court held, the existence of a unitary relationship is determined based on the “hallmarks” of a functional integration, centralized management, and economies of scale. MeadWestvaco, No. 06-1413, slip op. at 12. The Court did not specify, however, what constitutes an “asset” and what constitutes a “business,” for purposes of determining whether to apply the operational function test. Nevertheless, because the lower court had based its decision on the operational function test rather than the existence of a unitary relationship between Mead and Lexis/Nexis, the Supreme Court vacated the lower court’s judgment and remanded the case.

On remand the Illinois Appellate Court may take up the question of whether Mead and Lexis/Nexis are engaged in a unitary business, contrary to the trial court’s determination that they were not unitary. The trial court’s determination that there was no unitary relationship represents a mixed question of law and fact and should therefore be subject to a “clearly erroneous” standard of review. As such, the decision should be reversed only if the Appellate Court is left with a “definite and firm conviction” that a mistake has been made. Interestingly, this presents an unusual circumstance of the State facing the burden of overcoming the clearly erroneous standard when it is typically the taxpayer who must clear that daunting hurdle.

2. Exelon Corp. v. Illinois Department of Revenue, 376 Ill. App. 3d 918 (1st Dist. 2007)

The Illinois Supreme Court granted Exelon’s petition for leave to appeal in Exelon Corp. v. Illinois Department of Revenue, 376 Ill. App. 3d 918 (1st Dist. 2007). The Appellate Court held that a wholly-owned subsidiary of an electric utility was not entitled to the Replacement Income Tax credit for investments in “qualified property” under section 201(e). Exelon argued it was a “retailer” and thus qualified for the credit. The Appellate Court held that since electricity is not “tangible personal property,” Exelon was not engaged in “retailing.” In addition, the court held that section 201(e) does not violate the uniformity clause of the Illinois constitution under the reasonableness standard set forth for tax credits, deductions and other allowances and that the credit’s availability only to taxpayers engaged in mining, manufacturing and retailing was reasonably related to the legislature’s goal in enacting the credit. A decision from the Illinois Supreme Court is expected later this year.

C. Income Tax – Regulations

1. Business Income Amendments

The Department of Revenue has amended the business income provisions of its income tax regulations to implement the amendment in 2004 of the definition of “business income” to include all income which may be treated as apportionable income under the United States Constitution. Section 100.3010, 32 Ill. Reg. 6055 (April 11, 2008). The amendments to Section 100.3010 specifically provide that the “liquidating sale exception” recognized by the Illinois courts in cases such as Blessing/White, Inc. v. Zehnder, 329 Ill. App. 3d 714 (1st Dist. 2002) and American States Insurances v. Hamer, 352 Ill. App. 3d 521 (1st Dist. 2004) is no longer applicable in Illinois for transactions occurring on or after July 30, 2004.

The amendment to the business income regulation also appears to state that Hercules, Inc., v. Zehnder, 324 Ill. App. 3d 329 (1st Dist. 2001) was incorrectly decided and will not be followed by the Department, on grounds that the gain on sale of stock at issue in the case should be subject to apportionment under the operational function test of Allied-Signal v. Director, 504 U.S. 768 (1992). The validity of this portion of the regulation is highly doubtful, since the Hercules court held that there was no operational relationship, and in addition the MeadWestvaco decision discussed above

has curtailed the scope of the operational function test to apply to sales of assets but not to sales of investments in other businesses. MeadWestvaco was decided on April 15, 2008, after this regulation was published as final on April 11, 2008.

2. Partnerships and Unitary Business Groups (Proposed Regulations)

The Department of Revenue has proposed amendments to the partnership and unitary business provisions of its income tax regulations. Proposed Section 100.3380 and 100.9700, 32 Ill. Reg. 798 (January 18, 2008). Under the proposed regulations, a partnership may be included in a unitary business group if substantially all (defined to be more than 90 percent) of the interests in the partnership are owned or controlled by members of the same unitary business group. If a partnership is included in a unitary business group, intercompany transactions with member of the unitary business group are eliminated.

3. Other Income Tax Regulations

Several other income tax regulations have been finalized or proposed which affect corporate taxpayers.

Research and Development Credit Regulation. This regulation was amended to reflect the repeal of the research and development credit in Public Act 93-029 and its reenactment in Public Act 93-840, and to clarify the computation of the average qualifying expenditures for the base period. Section 100.2160, 32 Ill. Reg. 872 (January 18, 2008).

Investment Credit. The regulation concerning the Illinois investment credit was amended to broaden its application to river edge development zones. A section was also added to provide that IRC § 179 deductions reduce the basis on which the credit is claimed. Section 100.2110, 32 Ill. Reg. 872 (January 18, 2008).

Tax Shelter Registration and Investor Lists. Regulations were adopted to provide guidance to persons required to register a tax shelter or listed transaction under Section 1405.5 and to persons required to furnish an investor list with respect to a potentially abusive tax shelter or listed transaction under Section 1405.6. Sections 100.5070 and 100.5080, 32 Ill. Reg. 872 (January 18, 2008).

Definition of Adjusted Gross Income, Taxable Income and Other Terms. A new regulation was adopted to provide guidance on the proper computation of “adjusted gross income” or “taxable income” for the purposes of computing Illinois taxable income. The regulation also provides guidance for making addition and subtraction modifications to “adjusted gross income” or “taxable income” in computing net income subject to Illinois tax. Section 100.2405, 32 Ill. Reg. 6055 (April 11, 2008).

Apportionment Rules for Insurance Companies. A new regulation was promulgated to provide guidance on which taxpayers are required to apportion their business income using the formula for insurance companies contained in IITA Section 304(b) and on the application of that apportionment formula. Section 100.3420, 32 Ill. Reg. 6005 (April 11, 2008).

III. Transaction Taxes

A. Transaction Taxes – Regulations

1. Sales & Use Tax Treatment of Seminar Materials

The Department of Revenue recently proposed amendments to the Service Occupation Tax Rules to address the taxation of seminar materials like manuals and handouts distributed to seminar attendees as an incident to the presentation of a seminar. The proposed rules apply the general rules under the Illinois Service Occupation Tax. Depending on the cost of the materials, the seminar’s host will be required to either pay tax to the printers or other suppliers or to self-assess tax or to purchase the materials for resale and then charge tax to the seminar participants, depending on the particular fact

situation. These determinations are fact intensive and have the potential to create a substantial liability for the seminar presenter if not done correctly. Proposed 86 Ill. Admin. Code Section 140.129, 32 Ill. Reg. 5956 (April 11, 2008).

III. Other Taxes

A. Insurance Companies – Judicial Developments

1. Sun Life Assurance Co. of Canada v. Manna, 227 Ill. 2d 128, 879 N.E. 2d 320 (2007)

The Illinois Supreme Court analyzed the impact of the Illinois constitution’s uniformity clause on the application of the Illinois Retaliatory Insurance Tax to a Canadian insurance company in Sun Life Assurance Co. of Canada v. Manna, 227 Ill. 2d 128, 879 N.E. 2d 320 (2007). In addition to its tax on the privilege of conducting an insurance business, Illinois also imposes a retaliatory tax on foreign and alien insurance companies that is triggered when the foreign/alien insurer’s state of domicile imposes higher taxes on Illinois insurers than Illinois imposes on insurers from that state. This “retaliatory” tax puts downward pressure on nationwide insurance rates because every multistate insurer will pressure its home state legislators to avoid tax increases that will trigger retaliatory taxes against the home state insurers by virtually every other state. The U.S. Supreme Court has held that, although retaliatory taxes discriminate against insurers from foreign states, the discrimination is constitutionally permissible because the retaliatory taxes serve the valuable public purpose of promoting the domestic insurers’ ability to carry on an interstate business.

Sun Life is a Canadian insurance company which paid lower premium tax in Canada than in Illinois, and thus the Illinois retaliatory tax would not apply if the comparison was made between Illinois and Canadian tax. However, an alien insurer must select a “state of entry”; Sun Life used Michigan. Illinois calculated Sun Life’s retaliatory tax by applying Michigan law which resulted in a retaliatory tax liability.

Sun Life defended with the argument that application of the retaliatory tax to an alien insurer violated the Illinois uniformity clause. That clause requires that a tax classification must be based on a substantial difference between the classes that is related to a legitimate state purpose. Sun Life argued that the legitimate purpose that may justify the retaliatory tax’s application to a U.S. insurer – creating political pressure to encourage all U.S. states to keep rates low – did not apply when the insurer is from a foreign nation.

The Supreme Court found that the relevant classification was simply all alien insurers and not Illinois insurers vs. non-Illinois insurers. With the analysis confined to that classification, the court found that there was no discrimination because the tax applied equally to all alien insurers without discrimination based on the insurers’ home nation.

The court went on to hold that, even if there had been discrimination, the classification served a legitimate state purpose of equalizing burdens between Illinois and other states. It ignored Sun Life’s Canadian domicile and looked only at Michigan law. Since Sun Life elected Michigan as its state of entry, Illinois could legitimately try to influence Michigan law by retaliating against Michigan’s higher tax burden. The court did not address whether a Canadian insurer could reasonably be expected to assert any political influence in Michigan and thus whether the retaliatory tax served a legitimate purpose.

INDIANA STATE DEVELOPMENTS Francina A. Dlouhy Baker & Daniels LLP Indianapolis, Indiana (317) 237-0300 Francina.Dlouhy@bakerd.com

INDIANA ENACTS MAJOR PROPERTY TAX REFORM

a. Overview. On March 19, 2008, Indiana Governor Mitch Daniels signed into law House Enrolled Act 1001 ("HEA 1001"). In addition to property tax caps, HEA 1001 provides relief to homeowners with additional homestead credits over the next few years and additional deductions. The legislation eliminates several property tax levies and shifts certain local costs to the State. The State pays for these increased costs by an increase in the statewide sales and use tax rate from 6% to 7%, effective April 1, 2008.

b. Proposed Constitutional Amendment. Senate Enrolled Joint Resolution 1 ("SJ 1") begins the process to amend the Indiana Constitution to limit a property taxpayer's liability to a certain percentage of the gross assessed value of its property. Specifically, SJ 1 provides that property taxes first due and payable in 2012 on residential property cannot exceed 1% of the property's gross assessed value. Property taxes on other residential property and agricultural land is limited to 2% of the gross assessed value. For other real property (non-residential, commercial or industrial) and personal business property, the limit is 3% of the gross assessed value. In order for this constitutional amendment to take effect, it must be passed by a second, separately elected session of the General Assembly and approved in a referendum by Indiana voters. If passed by the next General Assembly, which will be elected in the fall of 2008 and will conduct sessions in 2009 and 2010, and thereafter approved by the voters, the constitutional caps on property taxes provided under SJ 1 are expected to effect for taxes payable in 2012.

c. Statutory Caps. HEA 1001 also provides caps intended to be applicable until the constitutional amendment can be enacted. Beginning with taxes first due and payable in 2008, HEA 1001 provides tax credits against property tax liabilities to the extent those liabilities exceed the statutory cap. Excluded from calculation of the credit are property taxes imposed in certain counties for the purpose of paying debt service or lease obligations on bonds or leases issued or entered into before July 2008. For pay 2009, the statutory caps will be as follows:

1.5% for homesteads;

2.5% for non-homestead residential property, agricultural land, and long-term care property; and

3.5% for non-residential (commercial or industrial) real property and for personal property.

For pay 2010 and thereafter, the statutory caps will be as follows:

1.0% for homesteads;

2.0% for non-homestead residential property, agricultural land, and long-term care property; and

3.0% for non-residential (commercial or industrial) real property and for personal property.

d. Elimination of Township Assessors. Effective July 1, 2008, county assessors will assume all property assessment duties formerly assigned to township assessors in townships with less than 15,000 real property parcels and the township assessor offices will be eliminated. A referendum also will be held during the 2008 general election in each township with 15,000 or more parcels to determine whether to transfer township assessor duties to the county assessors in those locations.

INCOME TAX DEVELOPMENTS

a. Riverboat Development, Inc. v. Ind. Dep't of State Revenue, Cause No. 49T10-0506-TA-52, held that because all of the income of Riverboat Development, Inc. ("RDI"), a Kentucky S-Corp, was from its minority membership in RDI/Caesars Riverboat Casino LLC ("Caesars"), the income was not adjusted gross income derived from sources in Indiana, and thus adjusted gross income tax ("AGIT") did not have to be withheld from income passed through to nonresident shareholders. RDI's only business during the period in question, 1998-02, was as a minority member of Caesars LLC. During the period, RDI had between 33 and 59 shareholders, no more than 3 of which were Indiana residents. IC § 6-3-14-3 requires that an S-Corp withhold tax from any nonresident shareholder's share of the corporation's taxable income. "Taxable income" is the adjusted gross income derived from sources within Indiana. IC § 6-3-2-1(b). As the result of an audit, the Department proposed assessments of $2.3M in withholding tax, reasoning that RDI derived its income from operation of a riverboat in Indiana, and thus had taxable income for which tax should have been withheld with respect to income passing to RDI's shareholders. Citing IC § 23-18-6-2 and Rhoade v. Indiana Dep't of Revenue, 774 N.E.2d 1044 (Ind. Tax Ct. 2002), the Court observed that the interest of a member in a LLC constitutes intangible personal property. RDI's receipts from its interest in Caesars LLC are treated as receipts in the form of dividends from investments, which are attributable to Indiana if the taxpayer's commercial domicile is in Indiana. Because RDI is not commercially domiciled in Indiana, and the income RDI received was solely as a result of its membership interest in Caesars LLC, RDI's income was not adjusted gross income derived from sources within Indiana. Therefore, RDI was not subject to withholding obligations under IC § 6-3-4-13 for income passed through to nonresident shareholders.

b. In Welch Packaging Group, Inc. v. Indiana Dept. of State Revenue, No. 49T10-0503-TA-21, slip op. (Ind. Tax Ct. Nov. 13, 2007), the taxpayer appealed the Department's assessment of adjusted gross income tax (AGIT) for the 1998 to 2000 tax years. The issue was whether taxpayer's sales to Michigan could be "thrown back" to Indiana for purposes of calculating the numerator of taxpayer's sales factor. Taxpayer claimed that it paid the Michigan Single Business Tax ("MSBT") and was therefore "taxable in the state of the purchaser" under IC § 6-3-2-2(e)(2)(B). Accordingly, taxpayer claimed that the sales could not be thrown back to Indiana under IC § 6-3-2-2(e)(2). The Department claimed that the MSBT was a value added tax and therefore was not "franchise tax." Because the MSBT was not a "franchise tax," the Department reasoned, the taxpayer was not "taxable in the state of the purchaser" and thus the Michigan sales should have been thrown back to Indiana. IC § 6-3-2-2(n)(1) provides that a taxpayer is deemed taxable in another state if the taxpayer is subject to, among other things, either a "franchise tax measured by net income" or a "franchise tax for the privilege of doing business." The Court relied upon the plain language of the statute and dictionary definition of "franchise tax" to hold that a "franchise tax" does not have to be measured by income (as argued by the Department) in order to deem the taxpayer as being taxable in Michigan. The Court held, "The MSBT is a franchise tax on the privilege of doing business in Michigan. Accordingly, [taxpayer] was not required to include its Michigan sales in the numerator of its sales factor during the years at issue."

c. Letter of Findings No. 02-20060511, issued January 30, 2008. The Department found that a taxpayer was entitled to deduct royalty fees paid to a related entity located in California. The audit had disallowed the claimed royalty expense deductions because the payment of the royalties to an affiliated company significantly reduced the amount of income subject to tax in Indiana. In its Letter of Findings, the Department found that it is "well settled that corporations are free to adopt the corporate form and to engage in activities they deem appropriate." Applying the "business purpose" doctrine, the Department found that the taxpayer had provided evidence indicating that the California entity was an operating company engaged in sales to third parties and had $25 million in salary costs. It was also significant to the Department that the California entity did not loan its royalties back to the taxpayer. The Department also stated that "the California entity does not return the royalties to taxpayer in the form of dividends." It was also significant to the Department that the royalties paid by the taxpayer to the California entity constituted only 4% of the California entity's royalty income.

d Letter of Findings 06-0377, issued December 26, 2007. The taxpayer's affiliate which purchased taxpayer's accounts receivable and then borrowed money using the accounts receivable as securitization for commercial paper in the short term market was not a financial institutions taxpayer. Even though the Department had ruled in August 2001 that such a receivables company is subject to the financial institutions tax, the Department held that the 2001 ruling is over 6 years old and therefore no longer has precedential value. The Department went on to note that even though the accounts receivable gave rise to a debt owed by the customer to the taxpayer, there was no extension of credit, there was no consumer or commercial loan and, in the Department's view, there was no loan arising in factoring in this situation.

e Letter of Findings No. 04-0262, issued December 26, 2007, held that although Indiana statutes and case law have not dealt with the situation, the federal law governing net operating losses and, in particular, the right to adjust the income for a closed year to determine the proper amount of net operating losses allowed to be carried over to an open year would be followed. In this Letter of Findings, the Department also excluded from a consolidated return a parent company which had 99 employees working in Indiana and had over $1 million in dividend income. The taxpayer argued that the parent company had nexus with Indiana and therefore it should be included in the return. The Department however ruled that it was not excluding the parent company on the grounds it had no nexus; rather, it excluded the parent company because the Department believed it is justified in requiring separate accounting for the parent's Indiana activities due to the distortion that including the parent company in a consolidated return caused.

f Letter of Findings No. 07-0391, issued December 26, 2007. The Department found that the taxpayer had wrongly classified an interest expense deduction as a non-business expense resulting in a non-business loss. The Department reclassified this interest expense deduction as a business expense. Taxpayer argued that it classified the expense as non-business on its income tax return because it was relying upon a letter it received from the Commissioner in 1985 and claiming that the letter was a "Departmental Ruling" that interprets a listed tax and requires the Department to follow the "removal of expired rules" procedure in IC § 6-8.1-3-3. The Department disagreed that the letter was a "Departmental Ruling" and interpreted the letter as merely giving taxpayer the choice to report its income or a "modified stacked method," meaning that it could combine its parent's 100% allocated Indiana income with its two subsidiaries' apportioned Indiana income. The Department further noted that taxpayer had not followed the letter as it had apportioned its parent's Indiana source income since 1990 and concluded that since taxpayer's Indiana source income should be apportioned, any Indiana source business income or expense (including the interest expense deduction at issue) is subject to apportionment.

SALES AND USE TAX DEVELOPMENTS

a. The statewide sales and use tax rate is increased from 6% to 7% effective April 1, 2008. b. In Horseshoe Hammond, LLC v. Indiana Department of State Revenue, 865 N.E.2d 725 (Ind. Tax Ct. 2007),

the court held that a) Horseshoe did not owe sales tax on the complimentary merchandise it provided to select patrons, and b) Horseshoe did not owe sales or use tax on the components it used to prepare complimentary meals for select patrons. The court noted that because Horseshoe did not receive consideration for the complimentary merchandise and meals, the offerings were not retail transactions subject to sales tax. In making its use tax findings, the court noted that IC § 6-2.5-5-20(a) exempts the use of meal components from the use tax. The court further found that, although Horseshoe owed use tax on the merchandise, its use tax liability was based on the price by which it acquired the merchandise from its suppliers. Thus, Horseshoe was entitled to a refund because it had paid the use tax based on the price by which it would have otherwise sold the merchandise.

c. Kitchen Hospitality, LLC v. Indiana Dep't of State Revenue, Cause No. 49T10-0604-TA-35, held that during the years at issue (2004 and 2005) utilities consumed in a hotel's guest rooms qualified for exemption from sales tax under IC § 6-2.5-5-35(2)(A), an exemption for property used up or otherwise consumed during the occupation of rooms or lodging by a guest. However, utilities consumed in the hotel's common areas did not qualify for exemption.

OTHER TAX DEVELOPMENTS

a. In Letter of Findings No. 07-243, issued December 5, 2007, the Department found that it was entitled to withhold interest on refunds of amounts under a newly amended code provision, which became effective Jan. 1, 2007. Under the new provision, the Department is required to pay interest on an excess tax payment accruing from the date the refund claim was filed - the former provision provided for interest to accrue from the date the tax payment was due or the date the tax was paid, whichever is later. Taxpayer also argued that it was entitled to interest on its excess tax payment under common law. However, the Department concluded that taxpayer did not have legal right to the refund amount until the audit was concluded and a proposed assessment issued. Therefore, because the Department issued a refund within the statutory period, no interest should be paid.

KANSAS STATE DEVELOPMENTS S. Lucky DeFries Coffman, DeFries & Nothern, P.A. 534 S. Kansas Ave., Suite 925 Topeka, KS 66603-3407 Phone: (785) 234-3461 Fax: (785) 234-3363 Email: ldefries@cdnlaw.com Company Website: cdnlaw.com I. INCOME/FRANCHISE TAXES

A. Legislative Changes

1. EITC and Social Security Benefit Exemption

Effective for the 2007 tax year, the Legislature expanded the state earned income tax credit from 15 percent to 17 percent of the federal credit and exempted Social Security benefits of recipients with state adjusted gross income of less than $50,000 from the Kansas income tax. Beginning in 2008, the adjusted gross income threshold increases so as to exempt Social Security benefits of recipients with incomes of $75,000 or less.

2. State Educational Institution Long-Term Infrastructure Maintenance Program

The Legislature authorized $82.5 million in tax credits for contributions to the state's institutions of higher education for deferred maintenance and capital improvements. The legislation creates the State Educational Institution Long-Term Infrastructure Maintenance Program, and provides for $90 million in funding for deferred maintenance projects at state universities between 2008 and 2012. In addition, the legislation authorizes tax credits for the same period for contributions made on and after July 1, 2008 to institutions of higher education for deferred maintenance, capital improvements, and the purchase of technology and equipment. Contributors will be able to claim the credits against the state income tax, the financial institutions privilege tax, and the insurance premiums tax. The credits will be equivalent to 50 percent of qualifying contributions to post-secondary institutions and 60 percent of qualifying contributions to community and technical colleges.

Credits for contributions to post-secondary institutions are non-refundable, but may be carried forward for up to three years. Credits for contributions to community and technical colleges are refundable. The credits are transferable and the program will be set up to ensure that all contributions also qualify for federal and state income tax deductions. The legislation limits the amount of 2008 tax credits available for each community and technical college to $78,125; to $156,250 for fiscal year 2009; and to $208,233.00 for fiscal years 2010 through 2013. In addition, a provision specifies that no more than 40 percent of a given year's annual credits may be applied to any single post-secondary institution. For post-secondary institutions, the overall cap is set at $5.625 million for 2008, $11.250 million for 2009, and $15 million for 2010 through 2013.

3. Biofuels Storage and Blending

The Legislature authorized income tax credits for the years 2007 through 2011 for investments in equipment used for storing biofuels and for blending biofuels with petroleum-based fuels. The credit is in an amount equal to 10 percent of the first $10 million invested, and 5 percent of any investment over $10 million. The credit may be taken in 10 equal annual installments beginning with the year that the equipment is first placed into service, and excess credits may be carried over against future tax liabilities for up to 14 years. Those applying for the credits are required to agree to operate the equipment for at least 10 years during the term of the tax credit. The legislation also

creates an income tax deduction based on accelerated depreciation for storage and blending equipment. The deduction is extend over a 10-year period, with 55 percent of the deduction available in the first year, and 5 percent in each of the succeeding years.

4. Renewable Electric Cogeneration

House Bill No. 2038 also creates tax credits similar to those for biofuels storage and blending to spur investment in new renewable electric cogeneration facilities. Facilities eligible for the credits include those built between 2007 and 2011 that generate electricity from renewable energy resources for use in industrial, commercial, or agricultural processes. The cogeneration facility and the process consuming the electricity must be owned by the same entity. The credit for renewable cogeneration facilities equals 10 percent of the first $50 million invested, and 5 percent of any excess investment. The credit is taken in 10 equal annual installments over a 10-year period beginning with the year that the equipment is placed into service and excess credits may be carried over against future tax liabilities for up to 14 years. In addition, applicants for the credit must agree to operate the equipment for at least 10 years during the term of the tax credit. Finally, the legislation also provides for a tax deduction based on accelerated depreciation. The deduction is extend over a 10-year period, with 55 percent of the deduction available in the first year, and 5 percent in each year thereafter.

5. Franchise Tax

House Bill No. 2264 phases out the franchise tax over five years. Beginning in tax year 2007, the

bill raised the exemption threshold of K.S.A. 2006 Supp. 79-5401 from $100,000 of net worth to $1 million of net worth. The rate is subsequently reduced in stages from $1.25 per $1,000 of shareholder equity or net worth in 2007 to $0.9375 in tax year 2008; $0.625 in tax year 2009; and $0.3125 in tax year 2010. The franchise tax is repealed altogether in 2011.

B. Case Law Developments

In In the Matter of the Appeal of Weisgerber, James P., From an Order of the Division of Taxation on Assessment of Income Tax, the Kansas Supreme Court addressed whether K.S.A. 79-32,117(b)(vi), which requires that certain employee contributions to KPERS be added back to adjusted gross income for purposes of Kansas income taxation, is facially unconstitutional.

The taxpayer, James P. Weisgerber, argued that K.S.A. 79-32,117(b)(vi) violated the Equal Protection Clause of the United States and Kansas Constitutions because it applies to some, but less than all, public employees to pay Kansas income tax on contributions to their retirement plans. Specifically, K.S.A. 79-32,117(b)(vi) requires that in determining adjusted gross income for Kansas income tax purposes, there be added to federal adjusted gross income “[a]ny amount of designated employee contributions picked-up by an employer pursuant to K.S.A. 12-5005, 20-2603, 74-4919, and 74-4965, and amendments to such sections.” The references in K.S.A. 79-32,117(b)(vi) to K.S.A. 12-5005, 20-2603, 74-4919 and 74-4965 requires that participants in certain local police and firemen pension plans, judges and other employees of certain participating governmental employers to include employee contributions to KPERS in determining their adjusted gross income for Kansas income tax purposes. In contrast, employees of Kansas City, Kansas, the Kansas Board of Public Utilities and the Kansas Board of Regents, none of whom participate in KPERS, are not required to add back to federal adjusted gross income contributions they may make to tax deferred retirement plan. For this reason, Mr. Weisgerber argued that the statute impermissibly discriminated against KPERS participants in violation of the Equal Protection Clauses of the United States and Kansas Constitutions.

The Court began its analysis by making note of a threshold requirement for stating a equal protection claim: the plaintiff must demonstrate that the challenged statute treats similarly situated persons differently. The Court then observed that Mr. Weisgerber sought to have K.S.A. 79-32,117(b)(vi) declared unconstitutional on the grounds it discriminated among government workers. On this point the Court ruled that “all

governmental workers” was too broad a class upon which to base an equal protection claim. Moreover, the overly broad proposed class of alleged similarly situated persons included employees who are eligible for different retirement plans under state law. Consequently, the Court concluded that Mr. Weisgerber was unable to demonstrate KPERS participants were similarly situated with “all governmental workers” and, for this reason, his equal protection claim failed.

In addition, however, the Court went on to state that even if KPERS participants were similarly situated with all other governmental employees, the distinction made by K.S.A. 79-32,117(b)(vi) is supported by a rationally based legitimate state interests. The Court first pointed out that the retirement plans of other, non-KPERS governmental workers were defined contribution plans, whereby the amount of contributions of each employee, together with earnings (if any), are held for the benefit of the employee until retirement. Defined contribution plans neither contribute to nor are paid from the State’s general fund. In contrast, KPERS is a defined benefit plan where the benefits paid to an employee are determined with reference to salary and years of service at separation from service, not with reference to the amount the employee contributed during his or her period of employment. Further, and because KPERS is a defined benefit plan, the benefits of which are paid from the State’s general fund, the taxation of employee contributions through the add-back mechanism of K.S.A. 79-32,117(b)(vi) serves to enhance the State’s general fund from which the KPERS retirement obligations will be paid. This, according to the Court, “is unquestionably a legitimate legislative purpose that survives equal protection scrutiny.”

C. Kansas Department of Revenue Rulings

There were no significant departmental rulings in this area for the period covered by this survey.

D. Trends/Outlook for 2008-2009

There has been considerable legislative discussion regarding the corporate income tax area during the last two years. During the current legislative session, there have been several initiatives considered by the legislature. There have been proposals that would add the functional test to the transactional test, which has been the benchmark in Kansas for many years. Legislation was proposed last year but was held over for discussion during the interim study committees. New proposals were made this year to add the functional test and also to amend our current statutory scheme to permit the department to avoid having to include the gain on investment of short-term working capital when calculating gross receipts as part of the sales factor. This issue had also arisen last year in response to the GM and Microsoft cases in California. This year the approach was to include the above-referenced revisions but only if an equal amount of corporate tax-rate reduction as part of the package. These tax issues, as well as many other matters, were held pending the resolution of a vigorous discussion regarding whether to build two new coal-fired generation facilities in Western Kansas.

As these materials are being finalized, these issues have still not been totally resolved, although a Conference Committee report providing for the addition of the functional test and language to address the gain on investment of short-term working capital has been embraced as part of negotiation between the House and the Senate. Additionally, that same agreement contemplates that the corporate tax rate will drop from 7.35% to 7% over a period of years. No written Conference Committee reports have been available, and the package has not been voted on. There is, however, a strong likelihood that these measures will pass.

There had also been discussions about amending our statutory scheme to permit the inclusion of financial institutions and insurance companies within a unitary group, but those discussions stalled earlier in the session. The Department of Revenue has indicated an intention to try and address those issues admin-istratively through the promulgation of regulations. Based on our existing statutory scheme, there are concerns about whether such regulations would be permissible. There were also bills introduced that would have permitted the utilization of High-Performance Incentive Program (HPIP) credits across the entire unitary group as opposed to being limited to the utilization of said credits in connection with the entity that made the subject investment. Those discussions bogged down based on concerns with respect to whether the legislation would be prospective or retroactive. At this point, no proposals regarding that issue are currently being debated.

A bill was also introduced which would amend K.S.A. 79-3279, which had been amended last year in an effort to help attract a major manufacturing facility for an existing Kansas taxpayer. That bill provided for a single sales factor formula for the apportionment of a taxpayer’s net income. In order to qualify for the formula, a taxpayer had to: 1) be a manufacturer identified by NAICS code; 2) make an investment of $100 million for construction in Kansas of a new business facility; 3) employ 100 or more new employees at such facility after July 1, 2000, and prior December 31, 2009; and 4) pay higher-than-average wages. Certain businesses currently considering new locations or expansions within Kansas had communicated that extending the date contained within this bill could have a significant impact on their decisions. Consequently, the current proposal would be to extend the December 31, 2009, date to December 31, 2014. Although the bill was assigned a zero fiscal note, it has been included in a bill involving the coal-fired generation facilities and its passage is in doubt as these materials are being finalized. Additional votes on the issue will take place, so taxpayers should check to see what the outcome of those votes will be to the extent this bill might be applicable to a particular project. Most of the discussions during the session were focused on trying to create packages that were revenue-neutral because of concerns regarding the state of the budget, and in particular what the budget will look like over the next few years. There will likely be continuing discussions regarding some of the issues referenced herein that are not passed this year.

There were also bills introduced during the session which would provide for “Universal Expensing.” These proposals arose out of discussions as part of a Kansas Inc. strategic planning process. Dr. Art Hall, an economist from Kansas University broached this issue, and it has gained some traction. However, once the bills were introduced, they seemed to raise a multitude of questions and the proposals seemed to lose momentum fairly quickly. Whether they re-emerge next session is difficult to predict.

II. TRANSACTIONAL TAXES

A. Legislative Changes

1. Retailer Liability

House Bill 2007 2171 provides that a retailer is relieved of liability when the retailer obtains a fully completed Exemption Certificate. This legislation became effective July 1, 2007.

2. Definitional Changes

2007 House Bill 2171 made certain definitional changes with respect to “delivery charges,” “sales or selling price,” “entity-based exemption,” “over-the-counter,” and various telecommunications terms.

3. Refunds and Statute of Limitations

With respect to refunds and statutes of limitations, 2007 House Bill 2171 provides that no refunds are allowed after three years from the due date of the return. Historically, taxpayers believed that the right answer was the date when the tax was paid, which can be considerably past the due date of the return.

4. Refund Claims

2007 House Bill 2171 essentially incorporates the provisions of an existing administrative regulation into this statute. The new legislation sets out the requirements associated with refund claims filed by retailers. The new legislation indicates that the refund claims shall be treated as amended returns and must include an explanation of why a refund is due, a schedule listing each invoice, and provide properly completed Exemption Certificates, amongst other criteria. This new statute is effective as of July 1, 2007. House Bill 2171 also includes the requirements for refund claims filed by consumers.

5. Incomplete Refund Claims

2007 House Bill 2171 does provide that incomplete refund claims will not be considered valid and will be returned to the applicant. The applicant will be notified in writing of the errors and/or omis-sions. The applicant will have 60 days to file a complete refund claim.

6. Interest

2007 House Bill 2171 also provides that with respect to the payment of interest, no interest will be paid if taxes are refunded by KDOR within 120 days of (a) the filing date of the return claiming the refund or (b) the date of payment of the tax, whichever is later. This new provision becomes effective July 1, 2007.

7. Not-for-Profit Exemptions

A variety of not-for-profit organizations are now provided exempt status. See House Bill 2171.

8. Greensburg Exemption

In response to the tornado which completely destroyed the City of Greensburg, an exemption was created with respect to the property and services associated with the constructing or reconstructing of a business facility damaged or destroyed by tornado in Kiowa County. The bill included a provi-sion for a project exemption certificate. The bill became effective upon publication in the Kansas Register. See House Bill 2540. House Bill 2540 also provided for certain job restoration assistance payments and investment assistance payments in connection with the rebuilding of Greensburg.

9. New Exemptions

A new exemption is provided for oxygen delivery equipment, kidney dialysis equipment, and enteral feeding systems. Additionally, the definition of farm machinery and equipment has been expanded to include precision farming equipment.

10. New Exemption

House Bill 2171 provides an exemption with Project Exemption Certificates for the State of Kansas Correctional Institution, including a privately constructed correctional institution contracted for State use and ownership. This provision became effective July 1, 2007.

11. Expanded Definition of “Original Construction”

House Bill 2240 provides for an expanded definition of “original construction.” The definition now includes “restoration, reconstruction, or replacement of a building, facility, or utility structure damaged by fire, flood, tornado, lightning, explosion, windstorm, ice loading, and attendant winds, terrorism, or earthquake.” The definition of “utility structure” shall mean “transmission and distribution lines owned by an independent transmission company or cooperative, the Kansas Electric Transmission Authority, or natural gas or electric public utility.” “Windstorm” shall mean “straight line winds of at least 80 miles per hour as determined by a recognized meteorological reporting agency or organization.” This new provision became effective July 1, 2007.

12. Revocation of Registration Certificates

House Bill 2171 provides for the revocation of Sales Tax Registration Certificates if one is at least 60 days past due on filing returns or payment of tax. KDOR must give 30 days notice with respect to a revocation hearing. One must have a valid Registration Certificate in order to do business.

13. Third Party Drop Shipments

House Bill 2171 provides that with respect to third party drop shipments, a third party vendor is not liable for Kansas sales tax on an item shipped to Kansas when the third party vendor takes a Resale Exemption Certificate regardless of the state of issuance.

14. House Bill 2762

This bill provided for certain refunds in connection with telecom sales. Significant time and effort was expended trying to negotiate the provisions of this bill. Unfortunately, it ultimately was linked with the legislation involving the coal-fired generation facilities, and as these materials are being finalized, its fate is uncertain. Votes on bills including these provisions will be taken before the Legislature adjourns, but the results of those votes are very uncertain.

B. Case Law Developments

1. In The Matter Of The Appeal Of Ward Kraft Forms, Inc. From An Order Of The Division Of

Taxation On Assessment Of Retail Sales Tax.

The Kansas Board of Tax Appeals, in response to a Motion For Summary Judgment filed by the Kansas Department of Revenue, held that there is no genuine dispute that the electricity at issue operated air conditioning machinery and equipment, which although required in the production process, was used for general plant cooling and humidity control, and as such, the electricity used by such equipment was taxable under Kansas law. The principal issue in this case involved whether the electricity consumed by air conditioning machinery and equipment used to control the temperature and humidity throughout Ward Kraft’s printing plant qualified as exempt tangible personal property consumed in the “production, manufacture, processing . . . refining or compounding” of tangible personal property under K.S.A. 79-3606(n). The taxpayer argued that because controlled temperature and humidity are essential and indispensable in the printing process, the electrical current driving the air conditioning equipment that cools its entire plant area should be exempted pursuant to K.S.A. 79-3606(n). The KDOR, on the other hand, contended that K.S.A. 79-3606(n) should not be, in itself, dispositive of the subject appeal. The KDOR contended that if the exemption were granted, any industry that utilized plant equipment that must be operated “above sub-zero and below heat wave temperatures would be tax exempt.” Such an interpretation, the KDOR suggested, would necessarily extend exempt status to all heating and cooling equipment used in plant areas, along with all electricity purchases consumed by that equipment. According to the KDOR, the taxpayer’s interpretation of the exemption statute would result in an unintended outcome that would be contrary to existing law.

Another significant issue in the case involved whether the provisions of K.S.A. 79-3606(kk) as amended in 2000 should be used in construing the intended scope of K.S.A. 79-3606(n). K.S.A. 79-3606(kk) provides an exemption for various “machinery and equipment” used in the “manufacturing, processing . . . of tangible personal property” in a variety of different situations. The KDOR contended that the exemption pursuant to K.S.A. 79-3606(n) should not be available unless the equipment being used would also qualify pursuant to K.S.A. 79-3606(kk). The taxpayer argued that there was no indication that the Kansas legislature intended for the provisions of K.S.A. 79-3606(kk) (which was amended subsequent to the adoption of K.S.A. 79-3606(n)) to be used in construing the intended scope of K.S.A. 79-3606(n).

Ultimately, the Board concluded that electricity consumption could not be examined without first examining the machinery and equipment upon which the electricity acts. Consequently, in order to determine whether the electricity in question is consumed in the “production, manufacture, processing . . . refining or compounding” of tangible personal property, the Board needed to first consider the character of the processes, equipment, and machinery consuming the electricity under the integrated plant theory. This reasoning ultimately led the Board to conclude that the KDOR’s Motion For Summary Judgment should be granted and that the taxpayer’s request for an exemption should be denied.

In a Per Curian decision handed down very recently, the Kansas Court of Appeals affirmed the Board of Tax Appeals decision. The decision which was not designated for publication held that “After thoroughly reviewing the record on appeal and the briefs submitted by the parties, we conclude that there has been no reversible error of law and that BOTA’s Memorandum Opinion adequately explained the decision. Accordingly, BOTA’s judgment is affirmed.”

The Court of Appeals decision was not appealed.

C. Trends/Outlooks for 2008-2009

There was relatively little activity within the sales tax area during this legislative session. As is always the case, there are a few additional not-for-profits that received exempt status or that will likely be receiving exempt status. There was little discussion regarding any SSTP issues during the session, and we are not presently aware of any major discussions involving sales tax issues that will likely be taking place during the interim study periods. At this time, we are not aware of any major initiatives within the sales tax arena that will be unfolding in the near future.

III. PROPERTY TAXES

A. Legislative Changes

1. Energy-Related Tax Exemptions (House Bill 2038)

The bill included several provisions that dealt with KCC powers concerning nuclear generation facilities as well as provisions dealing with income tax credits and deductions that will not be addressed as part of this section. The bill provides tax exemptions for:

a. New nuclear generation facility property; b. Waste heat utilization system property; c. New or expanded biomass-to-energy plant property; and d. Biofuel storage and blending equipment.

There are a variety of conditions that have to be met in order to avail oneself of the property tax

exemptions referenced herein.

2. Amendment to the Renewable Energy Electric Generation Cooperative Act (House Bill 2039)

This bill amended the Renewable Energy Electric Generation Cooperative Act to remove thermal resources or technologies as a renewable resource or technology under the Act. (See HB 2039 Section 1 amending K.S.A. 2006 Supp. 17-4652.) The bill also amended the statutes concerning the powers of the Kansas Corporation Commission relating to parallel generation services to remove thermal resources or technologies as a renewable resource or technology under the statutes. (See HB 2039 Section 2 amending K.S.A. 66-1, 184a.) Finally, the bill amended K.S.A. 2006 Supp. 79-201 Eleventh to remove thermal resources or technologies as a renewable resource or technology that qualifies for the property tax exemption. (See HB 2039 Section 3.)

3. Interlocal Cooperation Agreement to Jointly Promote Economic Development (House Bill 2044)

This bill provides the authority for two or more counties to enter into an interlocal cooperation agreement pursuant to K.S.A. 12-2901 et seq. to jointly promote economic development at any location or locations within the boundaries of the counties involved in the agreement in accordance with the provisions of K.S.A. 19-4101 et seq. The bill also amends the business telecommunications and railroad machinery and equipment “slider” provisions for reimbursing taxing subdivisions for property tax reductions created by the exemption of commercial and industrial telecommunications and railroad machinery and equipment. Additionally, the bill:

a. Provides authority for the Board of County Commissioners of Johnson County to cancel

certain uncollected real estate taxes and penalties;

b. Renews the 20 mill school levy for the 2007-2008 and 2008-2009 school years;

c. Provides for an exemption of certain real property transferred by the City of Olathe to the Kansas State University Foundation and all tangible personal property which is held, used, or operated for educational research purposes at the Kansas State University Olathe Innovation Campus located in Olathe;

d. Provides for an exemption for all storage structures designed and predominantly used for

storage of cellulose matter or other related agriculturally derived material to be used in the production of cellulosic, alcohol, and co-products;

e. Renews the $20,000 exemption of the appraised value of residential property from the state

school levy for tax years 2007 and 2008; and

f. Amends the notification requirements for the proration of the valuation of boats.

4. Carbon Dioxide Reduction Act (House Bill 2419)

This act provides for the Kansas Corporation Commission to adopt rules and regulations relating to procedures and standards for safe and secure injection of carbon dioxide and maintenance of underground storage of carbon dioxide. It also establishes the Carbon Dioxide Injection Well and Underground Storage Fund as part of the State Treasury. From the tax perspective, it provides for an exemption for any carbon dioxide capture and sequestration or utilization property as well as an exemption for any electric generation unit which captures and sequesters all carbon dioxide and other emissions. The bill also provides for certain income tax deductions with respect to the amortization of the amortizable costs of carbon dioxide capture, sequestration, or utilization machinery and equipment.

5. Homestead Property Tax Refund Act Amendments (House Bill 2476)

This bill provides for certain amendments to the Homestead Property Tax Refund Act. It creates an asset test for Homestead filers and provides that if a Homestead filer owes delinquent taxes on the homestead, any Homestead refund is sent to the County Treasurer for application to the delinquent taxes. It also provides that 50% of one’s social security income should be excluded from the definition of income. The renter’s refund percentage is reduced from 20% to 15%, but the maximum Homestead refund is increased to $700.

6. Amendments to the State Certified and Licensed Real Property Appraisers Act (Senate Bill 360)

The act was amended to allow individuals who have been issued a certificate or license to request that such certificate or license be placed on an inactive status. The bill also provides authority for the Real Estate Appraisal Board to apply to District Court for the issuance of subpoenas and amends the statute concerning assessment of costs with respect to conducting proceedings before the Real Estate Appraisal Board.

B. CASE LAW DEVELOPMENTS

1. In the Matter of the Appeal of the Director of Property Valuation from an Order of the Board of Tax

Appeals Exempting Stored Natural Gas from Property Taxation.

This case represented the third of three cases which have been presented to the Supreme Court involving the ad valorem property taxation of underground stored natural gas. The first case was

Colorado Interstate Gas Company v. Board of Morton County Commissioners, 247 Kan. 654 802 P2nd 584 (1990). The second of the three cases was In re Tax Exemption Application of Central Illinois Public Service Company, 276 Kan. 612 78 P3rd 419 (2003). In this most recent case, the Supreme Court ruled that out-of-state companies that store natural gas in Kansas for subsequent resale outside Kansas are not subject to Kansas property tax. The taxpayers in this particular case were public utilities, municipal utilities, and natural gas marketing companies located outside Kansas who purchased natural gas from various producers and marketers, delivered the gas for storage, or deferred delivery to interstate pipeline companies with storage facilities in Kansas and subsequently sold the gas outside Kansas. K.S.A. 79-5a01, which is the relevant statute, contemplated that in order to be taxed, the parties would have had to “own, control and hold for resale” the gas in question. Although the taxpayers contractually owned the rights to the stored gas, they did not control and hold the gas in Kansas, since tariffs issued by the Federal Energy Regulatory Commission establish control and possession of the gas with the interstate pipeline companies. Consequently, the taxpayers did not meet the statutory definition of a taxable Kansas “public utility” and the gas would of necessity have to be considered merchant’s inventory that is exempt from property tax.

While the existing legislation was passed in response to the Central Illinois decision referenced above, no remedial legislation was sought by the counties during this legislative session. It is possible that some additional legislation will be sought in the future.

2. In the Matter of the Appeal of Goddard from an Order of the Director of Taxation Denying

Application for Exemption from Ad Valorem Taxation in Cloud County. In a case decided very recently by the Kansas Court of Appeals, it was held that the subject

machinery and equipment used in a saw mill was not exempt from property tax as farm machinery and equipment. The subject taxpayers harvested cottonwood trees and operated a sawmill as part of cutting the harvested logs into rough boards for shipment to a manufacturer of pallets and wooden crates. Although the Court agreed that the harvesting of trees is a farming operation, they ultimately concluded that the cutting of the harvested logs into rough boards is part of the processing or manufacturing stage and not specifically related to farming. Consequently, to the extent the sawmill operations were found not to be related to farming, the subject equipment could not appropriately fit within the farm machinery and equipment exemption.

3. In The Matter Of The Application of Phillips Lighting Company for Exemption from Ad Valorem

Taxation in Saline County, Kansas.

This case involved an application for an economic development exemption pursuant to Article 11 Section 13 of the Kansas Constitution. The County recommended that the economic development exemption be granted. The significance of this case relates to the fact that the Board’s Order granted an additional two year construction period exemption in addition to the ten year period contemplated by the Constitution. The Board based its decision on its interpretation of K.S.A. 79-213, which does reference economic development exemptions and which does provide for up to a two year construction period exemption in addition to any other term provided for by law. The ruling is significant because the economic development exemption itself contemplates that the ten year exemption begins the year following the completion of the subject project. Consequently, by blending the provisions of K.S.A. 79-213 and Article 11 Section 13 of the Constitution, a taxpayer will receive an exemption for up to a two year construction period plus the ten year exemption contemplated by the Constitution.

C. Trends/Outlook for 2008-2009

There are no significant discussions going on at the present time with respect to the property tax arena.

IV. OTHER TAXES

A. Motor Fuels Tax

1. Kansas Department of Revenue Rulings

In Revenue Ruling 19-2007-1, the Kansas Department of Revenue ruled that notwithstanding the exemption in K.S.A. 79-3408 for sales of motor-vehicle and special fuels to the United States of America, motor vehicle fuel sold to or for the use by the Kansas National Guard, including the Kansas Army National Guard and Kansas Air National Guard, is not exempt from Kansas motor fuel tax, whether the purchase is paid for by U.S. Property and Fiscal Office or directly by the Kansas National Guard.

V. PROVIDER’S BRIEF BIOGRAPHY/RESUME

S. Lucky DeFries, of the law firm of Coffman, DeFries & Nothern, P.A., practices in the areas of state and local taxation, corporate law and real estate. In connection with his tax practice, Mr. DeFries practices regularly before the Kansas Board of Tax Appeals. He received his B.A. degree from Ottawa University and his J.D. degree from Washburn University. Mr. DeFries was staff attorney in charge of sales and use tax litigation from 1979 to 1983 for the Kansas Department of Revenue. He lectured on state and local taxation at Washburn University Law School from 1980 to 1982 and returned to teach its state and local tax course in 1993. He is also the co-author of the Tax Law Chapter of the Annual Survey of Kansas Law. Mr. DeFries is a frequent speaker on state and local tax matters. He is a member of the Topeka and American Bar Associations and has served as the president of the Taxation and Administrative Law Sections of the Kansas Bar Association. He is on the Executive Committee of the National Association of State Bar Tax Sections and has served as its Chairman. Mr. DeFries is listed in the Best Lawyers in America and was included in the 2005, 2006, and 2007 editions of the Missouri/Kansas Super Lawyers. He currently serves on the Secretary of Revenue’s Advisory Council. Mr. DeFries has also served as chairman of the Greater Topeka Chamber of Commerce and as a member of the Board of the Kansas Chamber of Commerce and Industry.

KENTUCKY STATE DEVELOPMENTS Mark F. Sommer (mfs@gdm.com) Jennifer S. Smart (jss3@gdm.com) GREENEBAUM DOLL & MCDONALD, PLLC GREENEBAUM DOLL & MCDONALD, PLLC 3500 National City Tower 300 West Vine Street 101 S. Fifth Street Suite 1100 Louisville, Kentucky 40202 Lexington, Kentucky 40507 Telephone: (502) 587-3570 Telephone: (859) 288-4672 Facsimile: (502) 540-2165 Facsimile: (859) 367-3851 Web: www.greenebaum.com Web: www.greenebaum.com Email: mfs@gdm.com Email: jss3@gdm.com

I. INCOME/FRANCHISE TAXES

A. Legislative Developments

The General Assembly has recently concluded its 2008 legislative session and enacted comparatively few pieces of significant income/franchise tax legislation.

The change with probably the broadest impact on taxpayers was to the computation of interest. Beginning May 1, 2008, the interest rate charged by the Commonwealth on tax assessments will be set at the prime rate plus 2% and on refunds at prime minus 2%, a change originally proposed in H.B. 693 and enacted in H.B. 704. Previously, the rates for both assessments and overpayments were the same; however, this change creates a four percentage point spread to the detriment of taxpayers.

Also, retroactively effective for refunds issued after the effective date of H.B. 704, April 24, 2008, the accrual of interest begins after the latest of a tax return’s original due date, extended due date, actual filing date, date of payment, or amended return filing date, a change originally proposed in H.B. 568. Given that many taxpayers often file amended returns months or years after the original return, this will result in a retroactive loss of interest to taxpayers with outstanding refund claims. H.B. 704 also made what appears to be a technical correction to the definition of an “overpayment” for purposes of the general statute of limitations for refunds.

H.B. 258 generally provides that the receipts factor of the apportionment formula includes the overall net gain from treasury function transactions involving liquid assets. It also provides that a passenger airline computes the numerator of its property, payroll and receipts factor by multiplying the total of each by the revenue passenger miles ratio.

H.B. 2 provides for nonrefundable credits against the income tax or the limited liability tax for the purchase of certain energy-efficient products installed in buildings located in the Commonwealth, with item by item limits and a general limit of $1,000. It also provides for nonrefundable credits against the limited liability entity tax or the corporation income tax for the construction of an ENERGY STAR home built in the Commonwealth ($800) or sale of an ENERGY STAR manufactured home to be used as a principal place of residence in the Commonwealth ($400).

B. Judicial Developments

1. Davis v. Department of Revenue, 197 S.W.3d 557 (Ky. App. 2006) cert. granted (May 21, 2007). The United States Supreme Court granted the Kentucky Finance and Administration Cabinet’s Petition for a Writ of Certiorari to consider whether Kentucky’s income tax system of exempting interest earned from bonds issued by the state and its political subdivisions, while taxing interest income earned from bonds issued by other states and their political subdivisions, violates the United States Commerce Clause.

The Davises challenged Kentucky’s income taxation of interest they received on out-of-state bonds, while exempting interest earned on Kentucky bonds as violating the Commerce Clause. Kentucky is among 38 states whose laws exempt from income tax interest earned on their own bonds while taxing interest earned on out-of-state bonds.

The Kentucky Court of Appeals struck down in 2006 Kentucky’s system of exempting Kentucky bond interest while taxing out-of-state bond interest, holding that it violated the Commerce Clause because it gave more favorable treatment to in-state bonds than extra-territorially issued bonds. The Court reasoned that Kentucky’s exemption of its own bonds, while taxing those of its sister states, caused investors to reject investment in out-of-state bonds in favor of investment in Kentucky Bonds.

The Cabinet sought discretionary review of the appellate decision with the Kentucky Supreme Court, which was denied, and it then sought review with the U.S. Supreme Court, which was granted on May 21, 2007. Numerous amicus curia briefs have been filed in the case, including briefs filed by the National Association of State Treasurers, the Multistate Tax Commission, the State of North Carolina, the Securities and Financial Markets Association, and several private mutual fund companies. Oral argument was on November 5, 2007, at 10:00 a.m., but no decision has been issued to date.

2. Revenue Cabinet (n/k/a Finance and Administration Cabinet, Department of Revenue) v. Asworth Corp. (n/k/a Asworth, LLC), et al. No. 06-CI-00288 (Franklin Cir. Ct., Div. II, Jun. 14, 2007). The Franklin Circuit Court held that Kentucky’s corporation income tax statutory scheme imposed tax upon non-resident corporate partners, even though their only connection with Kentucky was receiving income from investment interests in partnerships located in Kentucky. The Court did not address the Appellees’ contention that Kentucky’s imposition of corporate income tax on the non-resident corporate partners violated the United States Commerce Clause and the Due Process Clause.

The Court held that Asworth Corporation (n/k/a Asworth, LLC), HT-Forum, Inc. (n/k/a HTF, LLC) and D Aviation Services, Inc. (n/k/a D Aviation Services, LLC) (collectively, the “Appellees”), all non-Kentucky corporations, had nexus with Kentucky based on the Court’s interpretation of Kentucky’s corporation income tax statutes. The parties stipulated that during the periods at issue, the Appellees did not own or lease property in Kentucky, and that they did not have any employees who received compensation in Kentucky. The parties also stipulated that the Appellees’ sole connection with Kentucky was the receipt of their distributive share of income from partnerships doing business in Kentucky during the taxable periods.

During the tax years at issue, KRS 141.040 had a “physical presence” test, and imposed corporation income tax on foreign corporations owning or leasing property in Kentucky or having one or more employees receiving compensation in Kentucky. During the involved tax years Kentucky did not impose corporate income tax on partnerships, but imposed tax on partners; distributive share of income from partnerships. The Kentucky Board of Tax Appeals (“KBTA”) held in favor of the Appellees, and held that because the Appellees had no physical presence in Kentucky they had no nexus with Kentucky for corporation income tax purposes. The KBTA noted in its Decision and Order that KRS 141.206 simply provides the mechanics of the administration of corporate income tax to a non-resident corporate partner, and only applies if the corporate partner is first determined to have physical presence in Kentucky under KRS 141.040.

The KBTA determined that because the Appellees did not have physical presence in Kentucky based on the language of KRS 141.040, it was not necessary that it reach the Appellees’ argument that they did not have nexus under the Commerce Clause or the Due Process Clause. The KBTA further held that it was not necessary that it address the Appellees’ alternative argument that if the Appellees had nexus with Kentucky, they were entitled to use standard three-factor apportionment methodology based on property, payroll and sales, rather than a single-factor apportionment based on sales, as utilized by the Revenue Cabinet (now known as the Finance and Administrative Cabinet, Department of Revenue) (“Department”).

The Department argued before the KBTA and the Court that KRS 141.206 was a tax imposition statute and that KRS 141.040 was not applicable to non-resident corporate partners, such as the Appellees. The Department also argued that physical presence was not required for Kentucky to impose the corporation income tax on the Appellees, and that the Appellees’ receipt of income from partnerships doing business in Kentucky satisfied the Commerce Clauses’ “substantial nexus” test. The Department further argued that the Appellees were required to use a single-factor apportionment method based on gross receipts.

The Appellees contended that because they had no property or payroll in Kentucky, they were not subject to Kentucky corporation income tax based on the clear language of KRS 141.040. The Appellees further argued that KRS 141.206 merely provided filing mechanics once a non-resident corporate partner was determined to be subject to tax under KRS 141.040. The Appellees also contended that even if the Court held that they had nexus on statutory grounds, they had no nexus on constitutional grounds because they had no physical presence in Kentucky. The Appellees further contended that they were entitled to receive interest on all overpayments, including paid-in taxes, penalties and interest. Finally, the Appellees contended that they were entitled to the immediate payment of refunds.

The Court first determined that the issues involved were questions of law because no factual issues were in dispute. The Court then held that the KBTA’s determination that the Appellees did not have nexus with Kentucky pursuant to KRA 141.040 ignored the existence of KRS 141.206. The Court held that if a corporation has no property or payroll in Kentucky, but is a partner in a partnership located in Kentucky, KRS 141.206 governs and imposes corporation income tax on the non-resident partner. The Court therefore concluded that the Appellees had nexus with Kentucky for corporation income tax purposes on purely statutory grounds.

Significantly, the Court did not address the Appellees’ argument that they did not have nexus with Kentucky because physical presence is required under the Commerce Clause before a non-resident may be subjected to corporation income tax. The Court did not address the Appellees’ Due Process argument either.

Instead, after concluding that the Appellees had statutory nexus, the Court addressed the Appellees’ alternative argument regarding apportionment methodology. The Court held that because it had found that the Appellees had “minimum nexus,” the traditional three-factor method of apportionment was proper in order to tax only the income that bore a reasonable relationship to the Appellees’ activities conducted in Kentucky.

The Court then addressed the Appellees’ argument that they were entitled to payment of interest on paid-in interest and penalties, as well as on tax overpayments. The Court reviewed a number of provisions including KRS 141.235 (requiring interest to be paid on tax refunds), KRS 134.580(2) (providing for the payment of interest on any overpayment of tax or any payment where no tax is due) and KRS 131.183 (providing for the payment of interest on any overpayment).

The Court held that the language contained in KRS 134.580(2) contemplates that interest must be paid on assessed penalties and interest, and that the intent of the Kentucky General Assembly in enacting KRS 134.580 and KRS 131.183 was to compensate taxpayers for the use of their money. The Court noted that its determination was consistent with federal interest provisions, which provide for the payment of interest on refunds of tax, penalties and interest. The Court therefore agreed with the Appellees, and held that interest was due on their refunds of tax, penalties and interest to be paid by the Department.

The Court then remanded the case to the KBTA for the calculation of the amount of the tax and interest refund due to the Appellees. The Appellees filed a Motion To Alter, Amend or Vacate the Order because it did not address: (1) whether Kentucky’s imposition of tax on the Appellees with no physical presence in Kentucky violated the Commerce Clause or the Due Process Clause; and (2) whether the Appellees are entitled to the immediate payment of tax refunds and interest prior to the final appellate disposition of the case. The Appellees also sought amendment or vacating of the Order because it did not contain finality language as required by CR 54.02 (stating that the Order was final and acceptable). The Appellees’ Motion also urged the Court to reconsider its holding and conclude that the Appellees do not have nexus under KRS 141.040, the threshold statute that previously required physical presence of a corporation for imposition of Kentucky corporation income tax. On December 4, 2007, the Court granted the Motion in part, reversed the Order of the KBTA, and held that Kentucky’s corporation income tax statutory scheme imposed tax upon non-resident corporate partners, even though their only connection with Kentucky was receiving income from investment interests in partnerships located in Kentucky.

The Court also addressed and rejected Appellees’ United States Commerce Clause and Due Process Clause arguments that Kentucky’s imposition of corporate income on the non-resident corporate partners violated same, held that the Appellees’ income should be apportioned based upon a standard three-factor apportionment formula, and ordered that refunds be paid within 15 days of the Order. The Court also ordered that if either party appealed the Order, the Appellees must post a bond in the amount of the refunds within 15 days of payment of the refunds.

On its de novo review of the KBTA’s Order, the Court held that the Appellees were subject to and owed Kentucky corporation income tax. In this regard, the Court observed that, “KRS 141.206 recognizes the flow-thru nature of partnerships, and accordingly, states that the income tax is not owed by the partnership, but rather imposes the income tax upon the partners.”

Regarding the constitutional issues, the Court held that the Appellees’ derivation of income from a partnership interest in partnership(s) doing business, both within and without Kentucky, satisfied the Commerce Clause’s substantial nexus requirement. It further held that the minimum connection required by the Due Process Clause was supplied by Appellees’ interest in partnerships that were doing business both within and without Kentucky. Accordingly, the Court held that Appellees were, “constitutionally subject to Kentucky corporation income tax on their distributive share income.”

Addressing the proper apportionment method, the Court, citing Complete Auto Transit, Inc., v. Brady, 430 U.S. 274 (1977), held that the three-factor apportionment formula of KRS 141.120(8) applies to the Appellees because they were multi-state corporations based outside of Kentucky and that method was logical and fairly reflected the income that bore a reasonable relationship to Kentucky. The Court then ordered the immediate payment of the refunds sought by the Appellees using the three-factor apportionment method, and ordered the posting of a bond by the Appellees in the amount of the refunds if either party appealed the Order.

The Department appealed the decision to the Kentucky Court of Appeals on the apportionment issue and the Appellees filed a cross-appeal on the nexus issue. The case is currently being briefed. The authors’ law firm represents the Appellees.

3. Marquette Transportation Co., Inc. v. Department of Revenue, No. 05-CI-00793 (McCracken Cir. Ct., Dec. 6, 2006; Franklin Cir. Ct., July 26, 2007). The McCracken Circuit Court held that the compensation of captain/pilots not performing “some” services in Kentucky could not be included in the payroll numerator of Marquette Transportation Company, Inc. (“Marquette”), and in so doing, reversed the KBTA to the extent that it included the compensation of same in Marquette’s payroll factor numerator and did not order Revenue to pay Marquette refunds on certain tax years.

Initially, the Court acknowledged that it acquired jurisdiction of the subject matter underlying this case when Marquette was aggrieved by the KBTA’s Order which ruled in part for the Revenue Cabinet (now known as the Department of Revenue) timely filed its Petition for Judicial Review with the Court. It also acknowledged that the KBTA Order also ruled in part for Marquette, as the KBTA ruled that Marquette’s towboat crew members should be excluded from the determination of Kentucky wages for corporation income and license tax purposes, and awarded Marquette its 2001 refund claims.

The Court then acknowledged that Marquette had appealed two aspects of the KBTA Order:

Specifically, Marquette appealed the KBTA’s failure to clearly hold that the wages of Marquette’s captain/pilot’s (like the towboat crew members) should be excluded from the numerator (which represents Kentucky wages) of Marquette’s payroll factor. Marquette also appealed the KBTA’s failure to order Revenue to pay Marquette its 1995 and 1996 refund claims.

The Court then held that the KBTA’s Order is reversed insofar as those two aspects of the KBTA Order were concerned.

The Court then discussed the procedural background of this case. Notably, the Department also filed an appeal to the KBTA’s Order; however, it filed its appeal in Franklin Circuit Court.

The Court then discussed the underlying facts of the case which were not in dispute. Marquette is a Delaware corporation, headquartered in Paducah, Kentucky in the business of providing inland waterway services, primarily upon the Upper and Lower Mississippi River and also on the Illinois River. It uses towboats and barges to accomplish these services.

The Court then observed that Kentucky does not own any part of the upper Mississippi or Illinois Rivers; however, Kentucky does own half of a 63 mile segment of the lower Mississippi River, which makes up approximately 1.5% of Marquette’s total route miles. The Court also observed that Marquette had no customers in Kentucky and that its boats never stop in Kentucky. Marquette sends vehicles to pick up its towboat employees from their homes in over 20 different states, take them to its towboats on which they work and live for 30 days. Marquette then sends vehicles to pick up the towboat employees and take them back to their homes where they are off from work for 15 days. Then, the process repeats.

Regarding the towboat employees, the Court observed that towboat employees perform all their job functions as towboat crew members and captains/pilots on the towboat and all towboat employees are paid by the day, including travel time to and from the towboats. Each towboat operates with ten people: a crew, a pilot and a captain. The Court further observed that the captain and pilot operate autonomously and run each towboat under their command to deliver barges to locations designated by Marquette’s customers. They work with the Paducah office together to pick up and move Marquette’s customers’ barges.

The Court then determined that the proper standard of judicial review of the KBTA decision here was de novo as a key evidentiary facts of the case were not disputed. Thus, the conclusions of the KBTA were ones of law, not fact, and fully reviewable by the Court.

The Court then discussed the payroll factor of the Kentucky corporation income and license taxes which have virtually identical statutory language and were taken almost verbatim from UDITPA. The Court noted that the payroll factor statutes take an all-or-nothing approach that attributes either all or none of the compensation of a taxpayer’s employee to Kentucky. Here, Revenue sought to attribute to Kentucky all (100%) of the compensation of the captain/pilots who are only present in Kentucky when passing through the 63 mile portion of the lower Mississippi River (half by Kentucky) which constitutes a mere 1.5% of their total route on their way to destinations not in Kentucky. In contrast, Marquette asserted that the payroll factor statute attributed none (0%) of such compensation to Kentucky.

The Court determined that the compensation of the captain/pilots could only be assigned to Kentucky when at least “some” of their services were performed in Kentucky. The Court then held that the captain/pilots (like the towboat crew members) provide no services in Kentucky, and are clearly not performing services in Kentucky that rises to the level of “some” services as required by KRS 141.120(8)(b)(3).

The Court further held that Revenue’s assignment to Kentucky of Marquette’s compensation paid to captain/pilots violates the Commerce Clause of the United State Constitution in that the Department’s assignment of 100% of such compensation unfairly distorts the extent of Marquette’s business activity in Kentucky.

The Court further held that although the KBTA held that the base of operations of the towboat employees was in Kentucky, the Court observed that the base of operations of all the towboat employees appears to be their out-of-state residences and it further observed that even if that were not the case, the towboats would be their base of operations. Moreover, although the KBTA held that the towboat employees were directed and controlled by Marquette’s corporate headquarters in Kentucky, the Court observed that the source of direction and control was that of immediately supervisory authority and, as such, the captains and pilots directed and controlled the crew (including themselves). The Department has appealed that decision to the Court of Appeals.

The Franklin Circuit Court has also affirmed the Order of the KBTA that Marquette’s towboat employees performed no services in Kentucky and thus their compensation was excluded from the Kentucky numerator of Marquette’s payroll factor.

Initially, the Court addressed a couple of procedural issues. By way of background, Marquette had filed an appeal of the same KBTA Order in the McCracken Circuit Court a few days prior to Revenue filing its appeal in Franklin Circuit Court. The Court noted that it had rejected Marquette’s argument that once Marquette filed its appeal in McCracken Circuit Court, the Department was required to file a compulsory counterclaim asserting any claims it had arising out of the same transaction or occurrence, and allowed the Department’s appeal to go forward on the merits. The Court also determined that the McCracken Circuit Court’s decision regarding the involved KBTA Order had no preclusive effect on the Department’s appeal.

Regarding the factual background, the Department had asserted that “Marquette was required, under the applicable statutory formulas, to include in the numerator of its payroll factor, all Marquette towboat employees who do not reside in Kentucky or report to work in Kentucky, but who are alleged…to have performed services in Kentucky solely by virtue of the fact that the towboats on which they work traverse the 63 mile portion of the Mississippi River which borders Kentucky.” (footnotes omitted).

The Court observed that Kentucky’s statutory scheme is modeled on the Uniform Division of Income for Tax Purposes Act (“UDITPA”), which allocates an employee’s compensation on an all-or-nothing basis. It then noted that Kentucky’s payroll factor apportionment statute is a tax statute, which when ambiguous, is construed in favor of the taxpayer.

Regarding the primary issue in dispute, i.e., whether “some” of the services of the towboat employees were performed in Kentucky, the Department argued that the KBTA erred in finding no services were performed in Kentucky because there was no evidence in the record that the boats stayed in non-Kentucky territory on the Mississippi River. However, in rejecting this argument, the Court noted that Kentucky law allows the burden of proving a negative to be discharged by proof which renders probable the existence of a negative fact, and thus it was unnecessary for Marquette to prove that is boats never utilized the Kentucky side of the river. Moreover, it appeared to the Court that the burden of proof should be allocated to the Department to establish the threshold jurisdictional fact that the towboat employees engaged in work activity within the jurisdictional borders of Kentucky. Accordingly, the KBTA acted reasonably in holding that the lack of proof on this issue should be construed in favor of Marquette and against the Department.

Further, the Court found that even if the involved towboats crossed over into the Kentucky side of the river along the 63 mile border, “such minimal contact is insufficient to provide a basis to include the towboat employees’ entire salary in the formula for the tax at issue here.” Specifically, the record demonstrated that Marquette had no Kentucky customers and made no Kentucky stops. The Court went on to note that the legislature did not use the terminology “any” services, which it could have chosen. It appeared to the Court that the extremely limited activity of the towboat employees met the very definition of de minimis contact with Kentucky. Moreover, the Court, citing Complete Auto Transport, Inc. v. Brady, 430 U.S. 274 (1979), held that “it is hard to see how inclusion of such wages could be ‘fairly apportioned’ or ‘fairly related to services provided by the state’ as required by the U.S. Supreme Court in commerce clause challenges to state taxation.”

Finally, the Court remanded consideration of one of the refund claims to the Department, directing it to complete its review and issue a Final Ruling applying the principles as set forth in the Court’s Opinion. The Department appealed to the Court of Appeals, and Marquette filed a Cross-Appeal. The parties moved to consolidate the appeal from the Franklin Circuit Court with the appeal from the McCracken Circuit Court. The Court granted the Motion and held that the cases were consolidated for all purposes, including briefing. However, the Department then filed two briefs – one in support of each of its appeals.

Marquette filed a Motion to Strike the Briefs, contending that per the Court’s Order, only one brief should have been filed. In the alternative, Marquette moved for dismissal of the appeals due to the Department’s violation of the Court’s consolidated Order. The Court granted Marquette’s Motion To Strike and denied its Motion to Dismiss. The Court ordered that the Department must file only one brief within 20 days of its Order, and that Marquette must file a response brief within 60 days of the filing of the Department’s brief. The authors’ law firm represents Marquette in this matter.

4. Johnson Controls, Inc. v. Rudolph, Nos. 2006-SC-00416 and 2004-CA-001566-MR (Ky. App., May 5, 2006). The Kentucky Court of Appeals held that H.B. 541, enacted in 2000 as KRS 141.200 (9)–(10), was unconstitutional on Due Process grounds. The Court therefore reversed the Franklin Circuit Court’s granting of the Department of Revenue’s Motion for Summary Judgment.

H.B. 541 prohibited corporate income tax refund claims originally filed as separate returns, but amended and filed as unitary returns after December 22, 1994 for tax years ending on or before December 31, 1995 (December 22, 1994 was the date of the decision in GTE v. Revenue Cabinet, 889 S.W.2d 788 (Ky. 1994) upholding unitary filings). The Court first reviewed the propriety of dual administrative and declaratory judgment proceedings. The Court indicated its concern that the taxpayers had filed their declaratory judgment actions while their administrative claims for tax refunds were pending before the Department. Ultimately, the Court determined that since the Department and the KBTA lack the power to declare a statute unconstitutional, the exhaustion of administrative remedies doctrine was inapplicable because it would have been futile to attempt to exhaust their administrative remedies before filing the declaratory judgment actions.

The Court then considered whether H.B. 541 constituted special legislation prohibited by Section 59 of the Kentucky Constitution. The Court held that H.B. 541 was not special legislation because a valid connection existed between the classifications created by H.B. 541 and the legislation’s purpose to avoid a “massive” loss of state revenue. The amount of projected lost revenue was not discussed in the Court’s opinion, but it has been projected in public proceedings to exceed $100 million.

The Court then considered the taxpayers’ argument that H.B. 541 violated Due Process principles. The Court relied upon the Supreme Court’s decision in United States v. Carlton, 512 U.S. 26 (1994), holding that the first prong to be applied to retroactive tax legislation to determine its constitutionality is the rational basis test. The Court determined that H.B. 541 had a rational basis because its purpose was to avoid a massive loss of state revenue resulting from the use of unitary returns for tax years prior to 1995. However, the Court held that H.B. 541 failed the second prong of Carlton, which was whether it was promptly enacted and “established only a modest period of retroactivity.” The Court concluded that H.B. 541 violated Carlton’s requirements because it was not enacted promptly following the GTE decision in 1994, and the period of retroactivity of five to nine years was not “modest.”

The Court then rejected the Department’s contention that the doctrine of sovereign immunity prohibited the taxpayers’ refund claims. The Court relied upon McKesson Corp. v. Div. of Alcoholic Beverages and Tobacco, 496 U.S. 18 (1990) to hold that “… a taxing authority must provide a post-deprivation remedy for a taxpayer aggrieved by an unconstitutional statute.” Slip Op. at 19.

The Court next considered and rejected the taxpayers’ argument that H.B. 541 violated the Equal Protection Clause because it had denied their refund claims, while paying refunds to other similarly situated taxpayers. Again applying a rational basis test, the Court held that protecting against a “massive” loss of tax revenue was a legitimate state purpose, so that Equal Protection principles were not violated.

The Court also considered the taxpayers’ argument that H.B. 541 violated Separation of Powers set forth in Sections 27 and 28 of the Kentucky Constitution. The taxpayers contended that the General Assembly, in enacting H.B. 541, legislatively overruled the GTE decision and improperly invaded the province of the judicial system. The Court rejected the taxpayers’ argument on this issue, and held that the General Assembly had the “unquestioned right to take action in response to decisions of Kentucky courts.” Slip Op. at 21-22.

The Court declined to opine on the taxpayers’ argument that H.B. 541 was an unlawful taking of private property for public use without just compensation under the federal and state Takings Clauses. The Court also expressed no opinion on the taxpayers’ argument that H.B. 541 violated Section 51 of the Kentucky Constitution, which requires the republication of any previously enacted legislation amended by a new statute. The Court indicated that this issue was not cognizable on appeal because it was not raised before the circuit court.

The Court concluded by stating that it was not stating that the taxpayers were entitled to payment of their refund claims, and stated it was simply holding that they were “entitled to receive a full, final, and prompt resolution of those claims

on the merits.” Slip Op. at 23. This holding means that the Department must issue determinations as to whether each taxpayer is unitary or not. The taxpayers will then have the opportunity to file appeals to the KBTA for a hearing on the merits of each claim of unitariness.

The Department filed a Petition for Discretionary Review of the Court’s decision with the Kentucky Supreme Court (No. 2006-SC-000416), which was granted on October 24, 2007. The taxpayers filed a Cross-Petition for Discretionary Review, (No. 2007-SC-000819) which was granted on December 12, 2007. The case is currently being briefed.

5. AT&T Corporation and Subsidiaries v. Finance and Administration Cabinet, Department of Revenue, File No. K01-R-18, Order No. K-19978 (KBTA Jan. 4, 2008). The KBTA held that the Department correctly interpreted and applied KRS 141.200 (effective generally for elections made during tax years 1995 through 2004) to AT&T Corporation and Subsidiaries (“AT&T”).

AT&T Corporation and its hundreds of Subsidiaries were all organized under the laws of states other than Kentucky, and neither AT&T Corporation nor the Subsidiaries were domiciled in Kentucky, nor have they ever been, such that they were all foreign corporations. And of the total, only AT&T Corporation and certain Subsidiaries (approximately twenty or so) had property or payroll in Kentucky during the years at issue (the “Kentucky Group”).

The KBTA found that AT&T filed a Kentucky Corporation Income Tax return, pursuant to the consolidated filing provisions of KRS 141.200, which included the entire AT&T group for the 1995 and 1996 tax years. Subsequently, AT&T filed a Corporation Income Tax Return which included only the Kentucky Group via amended returns for 1995 and 1996 and an original return for 1997 tax years.

The KBTA found that none of AT&T’s affiliates or subsidiaries fell within KRS 141.040(1)(i), which is sometimes referred to as the “printer nexus” provision. It also found that the Department had agreed at the hearing before the KBTA to adjust the returns to exclude an insurance company which was exempt from corporation income tax pursuant to KRS 141.040(1)(f).

The KBTA concluded that, “The clear legislative intent of the General Assembly, is that a consolidated return pursuant to KRS 141.200(3) is not limited to a nexus consolidated return, but instead includes all members of the affiliated group, other than those entities that are exempt from tax under KRS 141.040.” The KBTA went on to conclude that, “The phrase, ‘exempt from taxation under KRS 141.040,’ as used in KRS 141.200(3), means corporations exempted from Kentucky corporation income tax pursuant to KRS 141.040(1)(a) through (i).”

The KBTA also concluded that AT&T, by making the consolidated return election, had a “physical presence” in Kentucky and that various provisions of KRS 141.200 do not conflict with other statutes in KRS Chapter 141. Additionally, it found that AT&T lacked standing to challenge the regulation on the basis of KRS 141.040(1)(i), as it had no affiliates or subsidiaries that satisfy same, and that AT&T failed to prove that it was entitled to relief under either KRS 141.010(10)(a) or KRS 141.120(9).

The KBTA did not reach AT&T’s constitutional claims as it found that it did not have subject matter jurisdiction over same and held that the Board of Claims has exclusive jurisdiction over AT&T’s Taxpayer Bill of Rights claim. AT&T has appealed to the Jefferson Circuit Court. The authors’ law firm represents AT&T.

6. Dept. of Revenue v. Slagel, 2007-CA-000495 (Ky. App. April 24, 2008). The Kentucky Court of Appeals held that Peter Slagel (“Slagel”) was domiciled in Kentucky and was subject to Kentucky individual income tax, reversing the circuit court’s decision to the contrary.

The Department adjusted the individual income tax returns of Peter and Linda Slagel for tax years 1996 through 2000 to include wages earned by Slagel while working in Venezuela. The Court first discussed the standard of review when an administrative agency’s action is involved. The Court noted that “[w]here an administrative agency’s decision is to deny relief to the party with the burden of proof or persuasion, as was the case here, the issue on appeal is whether the evidence in that party’s favor is so compelling that no reasonable person could have failed to be persuaded by it.” (Italics in original, citations omitted). The Court also reiterated the long standing rule of law that as a finder of fact, an administrative agency is afforded great latitude in its evaluation of the evidence heard and the credibility of witnesses, including its findings and conclusions of fact. Upon review the Court determined that it could not say that the evidence was so compellingly in favor of Slagel that no reasonable person could have failed to be persuaded by it.

The Court reviewed the following facts that it held established domicile in Kentucky: (1) voter registration in Kentucky and exercise of that right for two years; (2) holding both Kentucky and Venezuela drivers licenses; (3) owning property in Kentucky, maintaining bank accounts in Kentucky and owning an incorporated business in Kentucky; (4) having a passport listing Kentucky as his “abode” and (5) having a will and power of attorney indicating that he was “of Fayette County Kentucky.” Finally, the Court noted that Slagel’s wife and children lived in Lexington, Kentucky, and in light of that fact it seemed likely that Slagel had the intention of returning to Kentucky with no present intention to move from the Commonwealth.

Accordingly, the Court held that the Department’s decision that Slagel was domiciled in Kentucky was not arbitrary or capricious. The Court therefore concluded that the circuit court had erred in substituting its judgment for the judgment of the Department regarding its factual determinations that Slagel was domiciled in Kentucky. The Court therefore reversed the circuit court’s Order and remanded the case for proceedings consistent with its opinion.

7. Department of Revenue v. AutoZone Development Corporation, No. 2006-CA-002175-MR (Ky. App., Oct. 12, 2007). The Kentucky Court of Appeals held that the deduction for dividends paid by a real estate investment trust (“REIT”), as provided in Internal Revenue Code of 1986, as amended (“Code”), is the functional equivalent of an allowable deduction from gross income for Kentucky income tax purposes.

AutoZone Development Corporation (“AutoZone”) is a federally qualified REIT pursuant to the Code. For the tax years 1995 through 1997, AutoZone claimed a deduction from gross income for dividends paid to its shareholders on its Kentucky corporate income tax returns. This effectively sheltered 95% of AutoZone’s REIT income from Kentucky’s corporate income tax.

The Department of Revenue disallowed the deduction for the years in question and assessed additional income tax liability. AutoZone appealed the ruling to the KBTA. The KBTA determined that the deduction for dividends paid to AutoZone’s shareholders was an allowable deduction under KRS 141.010(13). The Department appealed and the Circuit Court affirmed the ruling of the KBTA.

On appeal to the Court of Appeals, the Department argued that the KBTA erroneously determined that the dividends paid deduction was an allowable deduction. The Department contended that the dividends paid deduction is an adjustment to taxable income under the Code, and not a deduction from gross income. The Department argued that KRS 141.010(13) limited allowable deductions to those taken from the gross income of a corporation. As the dividends paid deduction is an adjustment to taxable income rather than a deduction from gross income, the Department contended this deduction was not allowed under KRS 141.010(13).

Although the Court of Appeals agreed with the Department that the dividends paid deduction was technically an adjustment to taxable income, the Court determined that the inquiry did not end there. The Court then applied the functional equivalency analysis from Revenue Cabinet v. General Motors Corporation, 794 S.W.2d 178 (Ky. App. 1990) to determine if the dividends paid deduction was a proper deduction under KRS 141.010(13). According to the Court, under the functional equivalency analysis, the “character of any tax must be determined by its operation and effect.” In rejecting the Department’s hyper-technical reading of KRS 141.010(13), the Court determined that the dividends paid deduction is taken from taxable income and the deduction’s ultimate function is to arrive at the REIT’s taxable income. According to the Court, the dividends paid deduction was functionally utilized to arrive at the REIT’s taxable income and effectively operates to reduce the REIT’s taxable income for federal taxation purposes. As taxable income is the equivalent of net income, the Court held that the deduction for dividends paid is the functional equivalent of an allowable deduction from gross income under KRS 141.010(13). Thus, the Court affirmed the KBTA’s decision that AutoZone properly claimed a deduction for dividends paid to shareholders on its 1995 through 1997 Kentucky income tax returns. The Department filed a Petition for Discretionary Review with the Kentucky Supreme Court on November 13, 2007.

II. TRANSACTIONAL TAXES

A. Legislative Developments

H.B. 538 limits the so-called reimbursement allowed to a taxpayer that collects and remits sales and use tax to $1,500 per monthly reporting period. It also provides for an exemption for over-the-counter drugs for people; however, the new exemption does not include grooming or hygiene products.

Also of general applicability in the sales and use tax area, the General Assembly has, via H.B. 629, consolidated most of the sales and use tax definitional provisions in KRS Chapter 139, without material modification, from their own stand-alone

statutes into one definitional statute, which is similar to the structure in other areas of Kentucky tax laws, the income tax laws of KRS Chapter 141 being the prime example. The provisions pertaining to the exemption for industrial machinery and the motion picture company refundable credit were also consolidated into one statute for each. This is significant in that it is a huge reshuffling of KRS Chapter 139 that changes numerous statutory references which have been in place for many years.

H.B. 629 also made two changes to the statutes which comprise the Uniform Sales and Use Tax Administration Act which was enacted as a part of the implementation of the Streamlined Sales and Use Tax Agreement (“SSUTA”) in Kentucky. It provides for a definition for a “taxability matrix,” a requirement of participation in the SSUTA. It also generally relieves a one-time purchaser from penalties and interest when the involved purchaser, seller or certified service provider has relied on information provided by the Department of Revenue. The legislation also made a rather narrow change by providing for a definition of repair and replacement parts for durable medical equipment, which is excluded from the KRS 139.472 exemption.

B. Judicial Developments

1. Revenue Cabinet v. GTE South, Inc. n/k/a Verizon South, Inc. Nos. 2003-CA-000773 and 2005-SC-000223-DG (Ky., Aug. 23, 2007). The Kentucky Supreme Court held that the Department of Revenue’s sales tax assessment issued to GTE South, Inc. (“GTE”) was both timely and sufficient under applicable Kentucky law.

By way of background, the Department conducted two sales tax audits of GTE from 1987 through 1996. Significant sales tax deficiencies were assessed for both periods. While GTE protested portions of both assessments, only a portion of the tax assessed during the second audit period was the subject of this case. The Department then sent two separate notification letters concerning the tax deficiency, including an assessment letter and a notice letter. Although GTE received both letters, it contended that neither of the letters were timely mailed pursuant to KRS 139.620.

KRS 139.620 requires that sales tax assessments must be issued within four years of the filing of the returns unless fraud or a failure to file returns is involved (and if so, the assessments may be issued at any time). Although the notice was sent after the deadline, and was on its face untimely, the Department contended that the first item, the assessment letter, which was dated prior to the deadline, was nonetheless timely mailed. Although GTE was able to produce the envelope in which the notice was mailed, GTE could not produce the envelope that contained the assessment letter. However, GTE later provided a “Post-it” note bearing an employee’s signature indicating the period of time in which he received the assessment letter. The “Post-it” note, which was not discovered until two weeks before the hearing, was the only evidence GTE presented substantiating a date of receipt for the assessment letter. GTE had retained and produced at the hearing a postmarked envelope containing the notice, as well as the envelopes for the assessment letter and notice concerning the first audit.

The KBTA held in favor of GTE, primarily based on the testimony of an employee regarding the date of receipt of an assessment letter related to one of the periods. On appeal, the Franklin Circuit Court overturned the KBTA’s factual finding that the assessment letter was not timely mailed, holding that its conclusion was not supported by substantial evidence. However, the Franklin Circuit Court held in favor of GTE on the issue of whether the notice was sufficient, and the Court of Appeals affirmed. The Supreme Court of Kentucky granted the Department’s Petition for Discretionary Review.

The issue before the Court was whether the Department’s initial notice of GTE’s sales tax deficiency was timely, and if so, whether the notice was sufficient to toll the applicable statute of limitations. Upon review, the Court determined that the sole evidence relied upon by the KBTA to determine the timeliness of the mailing was the “Post-it” note. The Court determined that the “Post-it” note did not constitute substantial evidence to support the KBTA’s conclusions. The Court further determined that it was significant that GTE had retained the postmark bearing envelopes for all of the other correspondence from the Department related to the audit periods, except for the one in question.

Additionally, the Court indicated that the KBTA appeared to have placed the initial burden of proof on the Department, or alternatively, improperly shifted the burden to the Department to establish it had a regular scheme or system of mailing. The Court noted that this burden of proof is generally utilized to create a presumption that a document was properly mailed in situations where the intended recipient denies receipt. However, the Court reasoned that there was no question that GTE received the assessment letter here, and that the only issue was the determination of the date that it was mailed. Because the assessment notice letter was timely dated, the burden was on GTE to provide conclusive proof that it was not timely mailed, according to the Court. The Court concluded that where correspondence bearing a date has been actually received, a party who disputes the timely mailing of the correspondence bears the burden of proof with respect to the issue of timeliness.

GTE also argued that the assessment letter was insufficient to toll the statute of limitations regarding sales tax assessments because it did not contain the necessary information required by KRS 131.081(8). KRS 131.081(8) requires that timely notice be sent to taxpayers, and that such notice must provide a description of the basis and amount of tax, penalty and

interest, a copy of the audit report, and copies of the auditor’s work papers. GTE asserted that there must be notice of all five requirements enunciated in KRS 131.081(8), and that such notice must be given prior to the expiration of the time period set forth in KRS 139.620(1). According to GTE, the Department’s failure to give notice of interest and penalties prior to the expiration of the limitations rendered the entire assessment null and void.

The Court disagreed with GTE, and noted that although a taxpayer is entitled to information specified in KRS 131.081(8), the statute of limitations provision contained in KRS 139.620(1), “merely required the Department to send notice to a taxpayer of any excess tax assessed as a result of an audit.” The Court determined that under the plain language of KRS 139.620(1), the Department’s obligation was simply to mail the notice of assessment within four years of the date the return was filed. The Court also noted that KRS 139.620 does not contain language indicating that the notice of assessment must comply with the provisions of KRS 131.081(8).

The Court further held that a taxpayer is adequately protected by KRS 131.110(1), which provides 45 days from the date of the notice of assessment to either protest or pay the tax. The Court concluded that the Kentucky General Assembly has therefore provided a specific remedy for violations of KRS 131.081(8). The Court determined that it would be illogical to presume that the General Assembly created another remedy for non-compliance with KRS 131.080(8), if there were already a remedy in place to handle such violations.

Finally, the Court analogized the statute of limitations with regard to taxes to those concerning lawsuits in general. The Court indicated that a party that files a notice of a claim in a general lawsuit within the formal statute of limitations period does not have to provide all theories or proof supporting such claim prior to the statute of limitations expiration date. The Court noted that timely filed claims may be amended and supplemented subsequent to the expiration date, provided the original notice was timely, and that such amendments relate back to the original filing. Accordingly, the Court saw no reason why a different result should be compelled where a taxpayer has been given timely notice that the Department is issuing an assessment against him for tax deficiencies. Thus, the Court held that the Department’s initial letter notifying GTE of the assessment and the amount of the tax assessed was sufficient under the four-year statute of limitations period set forth in KRS 139.620(1).

2. Revenue Cabinet v. King Drugs, Inc. and King Home Care, Inc., No. 2005-SC-000789 (Ky. April 14, 2008). The Kentucky Supreme Court held that prosthetic devices and physical aids prescribed by a physician are exempt from sales and use tax pursuant to the prosthetic device and physical aids exemption set forth in KRS 139.472. The Court reversed the Court of Appeals and circuit court decisions holding that an artificial device was only exempt if it was prescribed by a physician “for the use of a crippled person so as to become a brace, support, supplement, correction or substitute for the bodily structure including the extremities of the individual. In so doing, the Court affirmed the Order of the KBTA that such items were exempt from sales and use tax.

The Department audited King Drugs, Inc. and King Home Care, Inc. (collectively, “King”) and issued a sales and use tax assessment relating to the various medical supplies for which King claimed tax-exempt status under KRS 139.472. After the Department rendered a Final Ruling upholding its assessment, King appealed to the KBTA which overruled the Department’s Final Ruling and interpreted KRS 139.472 to encompass the various medical supplies and devices at issue. Challenging the KBTA’s interpretation of KRS 139.472(2), the Department thereafter appealed to the Franklin Circuit Court, which reversed the KBTA’s holding that the transactions were exempt and remanded the Summary Judgment Order with directions that the Department’s Final Ruling with respect to application of KRS 139.472(2) be affirmed and that the Department’s sales and use tax assessments against King be reinstated.

The sole issue before the Court was the interpretation of KRS 139.472(2), which allows an exemption for “prosthetic devices and physical aids,” and prior to its amendment effective July 1, 2004, provided:

Prosthetic devices and physical aids” for the purpose of this section shall mean and include artificial devices prescribed by a licensed physician, or individually designed, constructed, or altered solely for the use of a particular crippled person so as to become a brace, support, supplement, correction, or substitute for the bodily structure including the extremities of the individual; artificial limbs, artificial eyes, hearing aids described by a licensed physician, or individually designed, constructed, or altered solely for the use of a particular disabled person; crutches, walkers, hospital beds, wheelchairs, wheelchair repair and replacement parts, and wheelchair lifting devices for the use of invalids and crippled persons; colostomy supplies, urostomy supplies, ileostomy supplies, insulin and diabetic supplies, such as hypodermic syringes and needles, and sugar (urine and blood) testing materials purchased for use by diabetics.

The Court reaffirmed its previous decision in Stephenson v. Woodward, 182 S.W.3d, (Ky. 2005) holding that the rule of statutory construction that tax exemption statutes are to be narrowly construed against exemption only applies if the statute in question is ambiguous or otherwise frustrates a plain meaning. The Court noted that if “[o]n the contrary, a plain reading of the statute yields a reasonable legislative intent, then that reading is decisive and must be given effect regardless of the canons of construction and regardless of the Court’s estimate of the statute’s wisdom.” The Court concluded “[w]e agree with the Board of Tax Appeals that the 1986 version of KRS 139.472 is neither ambiguous nor absurd and that it provides an exemption, parallel to the exemption for sales of prescription medicines, for all sales of ‘artificial devices prescribed by a licensed physician.’” The Court further stated that “it is reasonably clear, in sum, that the General Assembly intended an exemption for sales of ‘artificial devices prescribed by a licensed physician,’ and the courts below erred by reading into that exemption limitations not supported by the statutory language.” Accordingly, the Court reversed both the Court of Appeals and the circuit court’s Opinion, and remanded the matter to the circuit court for entry of an Order affirming the KBTA’s decision.

3. Department of Revenue v. DuPont Performance Elastomers L.L.C., No. 2007-CA-000685-MR (Ky. App. Mar. 21, 2008). The Court of Appeals held in an unpublished decision that such items as gaskets, gauges, screws, scrapers, washers, fittings, valves, fasteners, and similar items that were used in the process of producing elastomers at Dupont’s Louisville, Kentucky manufacturing plant were exempt from use tax. During the period in question Dupont’s plant was located within an enterprise zone and subject to the sales and use tax exemption authorized by KRS 154.45-09, which exempts all “new or used equipment or machinery purchased and used by qualified business within an enterprise zone.”

Although the Court held that certain sales and use tax exemptions do not apply to repair and replacement parts, it determined no such limitation in the exemption for new or used equipment or machinery purchased and used by a qualified business within an enterprise zone. Certain items such as fasteners and gaskets, which attach to or are used in producing elastomers, qualified for the exemption for machinery for new and expanded industry because the definition of machinery used by the Department included the working parts of machines. Finally, the Court held that Scotch-Brite pads, mineral jelly used as a lubricant and scrapers qualified for the exemption for industrial supplies or tools.

4. Phone-Tech, Inc. v. Department of Revenue, File No. K05-R-33, Order No. K-19648 (KBTA Nov. 13, 2006). The KBTA held that when Phone-Tech, Inc. (“Phone-Tech”) makes available to a customer a dialing mechanism to allow the customer the opportunity to direct the signal of their voice to another specific location, a device which can both transmit and receive voice communications, and an outlet for the dial tone that allows such, it provides a service directly related to and inextricably connected with both intrastate telephone communications and the furnishing of communication services, which are transactions subject to Kentucky Sales and Use Tax.

Phone-Tech operates pay phones. It collects money from customers who deposit coins in its equipment, from long distance providers and from dial tone providers for “dial around” long distance calls and “operator assisted” calls. The KBTA found that in each instance, Phone-Tech received income in exchange for providing a service.

The KBTA observed that the parties agreed that the determination as to whether Kentucky Sales and Use Tax applies to these services at issue rests on the interpretation of KRS 139.100 which applied the Kentucky Sales and Use Tax to: “intrastate telephonic and telegraphic communications and services” for the period of 1998 through 2001, and “the furnishing of communications services to a service address in this state,…when the communications service…originates in this state.” The KBTA then observed that “much of the parties[‘] efforts have been directed at dissecting the equipment and the individual components of a telephone call. In our opinion the attempt to split wires in this case is splitting hairs.”

The KBTA concluded that Phone-Tech provides services which qualify as intrastate telephonic communications and the furnishing of communication services. Moreover, the KBTA rejected Phone-Tech’s arguments that the Kentucky and United States Constitutions as well as federal law prohibit the application of Kentucky Sales and Use Tax on the transactions at issue. Further, the KBTA refused to waive fees and penalties, which the Department upheld in its Final Ruling. Accordingly, the KBTA affirmed the Department’s Final Ruling. Phone-Tech has appealed the KBTA’s decision to the Franklin Circuit Court.

5. Rohm and Haas Co. v. Department of Revenue, No. 07-CI-00435 (Franklin Cir. Ct. Dec. 3, 2007). The Franklin Circuit Court reversed the KBTA’s denial of Rohm and Haas Company’s (“Rohm and Haas”) refund claim for sales tax it paid for energy consumed during the manufacture of Plexiglas, plastic additives, and other products.

Rohm and Haas operated a manufacturing facility in Louisville, Kentucky. A component of many of the products manufactured at the location was raw, undistilled Methyl Methacrylate (“MMA”). Rohm and Haas produced distilled MMA, which was used primarily on site in the production of other products, including Plexiglas, plastic additives and emulsions.

Rohm and Haas sought a refund of taxes paid on energy consumed in the manufacturing of the Plexiglas and emulsions based upon the application of KRS 139.480. KRS 139.480 provides a sales and use tax exemption for energy or energy producing fuels used in the course of manufacturing or refining which exceed three percent of the “cost of production.” Rohm and Haas based its refund claim upon the decision in Revenue Cabinet v. James B. Beam Distilling Co., 798 S.W.2d 134 (Ky. 1990).

In Beam, the distiller had sought a sales and use tax exemption for the fuels used in distilling liquor. The Department argued that the exemption should be denied because Beam failed to include in the cost of production of the alcohol the cost of warehousing and bottling such liquor. However, Beam sought the exemption on the distillery process alone. In granting the exemption in Beam the Kentucky Supreme Court held that the cost of bottling and warehousing were downstream processes and wholly unrelated to the cost of producing the liquor.

Rohm and Haas argued that similar to Beam, its operations were separate and distinct because they were on different parts of the work site, used separate chains of command, and were managed as separate accounts. Rohm and Haas therefore contended it had created “separate and complete” operations, and was thus entitled to a sales and use tax exemption on energy used in the production of Plexiglas and emulsions because the cost of that energy exceeded three percent of the “cost of production” in those operations. However, in making its calculation, Rohm and Haas did not include or account for the “cost” of the distilled MMA, which was an integral raw material used in making the products at issue.

The Court agreed with Rohm and Haas’ argument, and reversed the KBTA’s ruling. The Court held “it is clear from Jim Beam that of great import to the Kentucky Supreme Court was the existence of a real, external market for the finished products of the ‘separate and distinct’ operations. The record clearly indicates that an active and competitive market for distilled MMA exists. In fact, Rohm and Haas sells up to 5% of its distilled MMA each year to other companies. The existence of an active and competitive market indicates that other operations at the Louisville facility are not dependent upon Rohm and Haas’ distillation of MMA on site. Should Rohm and Haas choose to cease its distillation operation tomorrow, it could easily purchase the distilled MMA (rather than raw MMA) from some other entity.”

The Court also held that the Department’s position that a portion of the costs of the raw MMA should be allocated to the other separate operations at the Louisville facility was faulty and distortive. The Court therefore concluded that the energy exemption was applicable, and that Rohm and Haas was entitled to payment of its refund claims.

6. Department of Revenue v. Duplicator Sales & Service, Inc., No. 2006-CA-001783-MR (Ky. App., Aug. 17, 2007). The Kentucky Court of Appeals held in an unpublished decision, that parts supplied pursuant to maintenance agreements were not subject to sales and use tax.

Duplicator Sales & Service, Inc. (“Duplicator”) sells and leases, at retail, copiers, fax machines, and other types of office equipment in Kentucky, as well as provides parts, supplies, and maintenance for such equipment under warranty or other maintenance agreements. For a service fee, Duplicator provides parts and certain supplies, such as toner, at no additional charge beyond the service or maintenance fee.

The Kentucky Department of Revenue assessed use tax against Duplicator on the parts and supplies used to fulfill the maintenance and warranty agreements. Duplicator appealed the Department’s determination to the KBTA, which reversed the Department’s assessment. The Department appealed the decision to the Franklin Circuit Court, which affirmed the KBTA’s determination.

On appeal to the Kentucky Court of Appeals, the Court held that Duplicator was not liable for use tax on the materials supplied in furtherance of the maintenance agreements as the parts at issue were not consumed by Duplicator in the performance of the maintenance contracts, and therefore were not subject to assessment of use tax. The Court determined that Duplicator was engaged in the retail sale of parts and supplies that it transferred under the maintenance agreements as Duplicator did not consume the parts it installed, or supplies it transferred. The fee paid to Duplicator for the warranty or maintenance contract represented a pre-payment or payment over time for the parts and supplies that Duplicator provided, and was in consideration for the transfer of the tangible personal property. Accordingly, Duplicator’s customers were required to pay sales tax on the parts and supplies provided. As the customers in question were tax exempt, the appeals court determined that the transactions at issue were exempt from sales tax.

7. SKPR KY-2, LLC, d/b/a Ashland Plaza Hotel v. Department of Revenue, File No. K-06-R-23, Order No. K-19860 (KBTA, June 25, 2007), the KBTA abated all taxes, penalties and interest assessed against SKPR KY-2, LLC (the “Purchaser”) regarding its purchase of the Ashland Plaza Hotel, which was located in an “Enterprise Zone.” The purchase was made pursuant to a written contract in which the Commonwealth of Kentucky, the seller, obligated itself to assist the Purchaser in obtaining Enterprise Zone qualification, and a tax exemption for the personal property in the involved transaction.

The KBTA found that the underlying facts were not in dispute. The Purchaser and the Commonwealth of Kentucky executed a sale and purchase contract on June 13, 2002 in which transfer of ownership of the Ashland Plaza Hotel, took place on June 27, 2002.

Negotiations for the transaction proceeded very quickly, and the closing was to take place before June 30, 2002. The Commonwealth, as the seller, obligated itself to assist the Purchaser in obtaining Enterprise Zone qualification. The Purchaser specifically requested the exemption for the sale of the involved personal property, and the Commonwealth assured the Purchaser that it would be granted tax exempt status.

Because the Purchaser was informed that a meeting regarding authorization of Enterprise Zone status would not be held until July 12, 2002, the Purchaser did not file its application for Enterprise Zone status until July 11, 2002, according to hearing testimony before the KBTA. Although the Order is silent in this regard, the Department of Revenue apparently alleged that the tax exemption did not apply because the Enterprise Zone certification was not in place until after the sales transaction.

Based on these facts, the KBTA concluded, “Balancing all of the interests in this matter, it seems to the KBTA that when individuals do business with the Commonwealth, they should be entitled to trust that what the Commonwealth says is reliable.” The KBTA continued, “To permit one department to tax a citizen after another department has assured him that if he does business with the Commonwealth he will not be taxed, would establish a precedent that calls into question the trustworthiness of state government. We are not inclined to set that precedent.”

Accordingly, the KBTA held: “It would be unconscionable to…permit another branch of our state government to effectively renege on this promise not to tax the Appellant, and collect interest and penalties on top of that.”

The Department appealed to the Franklin Circuit Court, which reversed the KBTA’s decision on January 16, 2008. The Purchaser has appealed the decision to the Court of Appeals.

III. PROPERTY TAXES

A. Judicial Developments

1. St. Andrew Orthodox Church, Inc. v. Thompson, Nos. 2006-CA-000305-MR & 2006-CA-000458-MR (Ky. App., Aug. 10, 2007). The Kentucky Court of Appeals in an Opinion designated to be published, held that real property owned and used by St. Andrew Orthodox Church (“St. Andrew”) for church purposes was exempt from property tax pursuant to Kentucky Constitution Section 170, which exempts real property from taxation if “owned and occupied” by “institutions of religion.”

St. Andrew purchased two five-acre lots, each with a single-family house on it located in Jassamine County, Kentucky. St. Andrew plans to build a new, larger church on the property to replace its current smaller church located in Lexington, Kentucky. To help pay the mortgage on the property, St. Andrew leased the houses to various individuals. All of the rental payments were used to pay the mortgage on the property in question. Although the lease agreements provided that the tenants should maintain the properties, church members often did so. Further, St. Andrew used some of the property for outdoor games such as volleyball, soccer, horseshoes, and softball. St. Andrew set aside a portion of one lot for a prayer and meditation area. That area included a prayer bench and large wooden cross. St. Andrew also stored some equipment in the basement of one of the houses, and conducted various church activities, including picnics, on the property. Although no development has yet begun on the property, there is a large sign on the property announcing St. Andrew’s plans to build a church.

The Jessamine County Property Valuation Administrator (“PVA”) assessed real property tax on St. Andrew’s property for the 2003 and 2004 tax years. St. Andrew sought an exemption from tax under Section 170, because it was a religious institution that owned and occupied the property and because it was a purely public charity. However, the Board of Assessment Appeals denied both requests. St. Andrew appealed to the KBTA, which sustained the BAA’s denial of the exemption. St. Andrew then appealed to the Jessamine Circuit Court, which entered an Opinion affirming in part and reversing in part the KBTA decision. The Circuit Court affirmed the tax assessment on the two houses and their curtilage, but reversed the assessment for the remainder of the church property, and held that that portion of the property was exempt from tax because it was owned and occupied by a religious institution.

The Court reviewed the case de novo as it involved pure issues of law, and there were no factual issues in dispute. The Court first observed that in 1990, Section 170 was amended to exempt “real property owned and occupied by…institutions of religion.” The Court then noted that prior to the 1990 amendment, “use” rather than “ownership” was the controlling factor.

The Court then observed that in 1991, the Kentucky Attorney General opined that “a proper interpretation [of Section 170] should reject the imposition of conditions such as the requirement that the property be used for religious purposes, or that the property be occupied exclusively by the institution of religion, or that the institution of religion be in current rather than future occupation.” (citing Ky. OAG 91-216). The Court held that it may give “great weight” to the reasoning expressed in an Opinion of the Attorney General.

The Court held that “Section 170, as amended in 1990, clearly broadens the class of properties which may be held by a religious institution and not subject to an ad valorem tax. By narrowly construing the words ‘owned and occupied,’ the KBTA and circuit court have thwarted the intentions of the people as well as the drafters of the amendment to Section 170.” The Court then cited Black’s Law Dictionary and observed that the “definition of ‘occupancy’ or ‘to occupy’ is much broader than found by the KBTA.”

The Court recited the traditional rule that tax exemptions are strictly construed against the taxpayer, and are generally disfavored in the law. However, the Court held that it was apparent that St. Andrew intended to use all of the property for a future church, and that it used the property for prayer, meditation, family, social and related church activities. Further, the Court observed that “the attempt to fashion different degrees of occupancy would create a Gordian knot…[and s]uch a system would actually rewrite Section 170 to the extent that former acreage restrictions would be revived.”

The Court concluded that the KBTA Order was without substantial evidence on the whole record because there was no evidence that St. Andrew intended to use the property for investment purposes or to construct anything other than a church, and that the KBTA’s interpretation of “occupied” was contrary to the intent of Section 170. Because the Court ruled in St. Andrew’s favor on the religious institution exemption, it did not reach its argument that it was exempt because it was a purely public charity. The Department filed a Petition for Discretionary Review with the Supreme Court of Kentucky, which is pending. The authors’ law firm represents St. Andrew on a pro bono basis.

2. Jim Beam Brands Co. v. Finance and Administration Cabinet, No. 05-CI-1634 (Franklin Cir. Ct., Div. II, Sep. 26, 2006). The Franklin Circuit Court reversed the KBTA, and has held that Jim Beam’s distilled spirits stored in a warehouse for shipment within six months are exempt from ad valorem state property tax under KRS 132.097, and are subject to a reduced local ad valorem property tax rate under KRS 132.099.

The Court also held that Jim Beam’s in-process liquor is exempt from property tax under KRS 132.200 -- a statute that provides many property tax exemptions, including one for products in the course of manufacture. The Court further remanded to the KBTA the issue of the applicability of KRS 132.200 to white oak barrels used by Jim Beam to produce bourbon.

The Court determined that the facts were not in dispute and that Jim Beam “manufactures, imports, stores and distributes a host of various distilled spirits in Kentucky.” Because the issues before the Court were issues of law (that is, statutory construction), the court determined that it should review the KBTA’s order de novo. The Court then began what it characterized as the “sobering task” of “clarifying a muddied legislative intent.”

The Court observed that Jim Beam’s argument “can be distilled into one idea: the statute did not create any exceptions to the exemptions; therefore, distilled spirits must be included.” In contrast, the Court noted that the Finance and Administration Cabinet had argued that KRS 132.130 through KRS 132.180 -- specifically KRS 132.150, the statute governing the property taxation of liquor -- supersede the general exemption statutes at issue here.

In an exhibition of judicial humor, the Court characterized the question as “intoxicatingly close.” However, it held that the broad tax exemptions for personal property (KRS 132.097, KRS 132.099, and KRS 132.200) applied to Jim Beam’s personal property in the form of distilled spirits and raw distillate.

Further, the Court remanded the question of the applicability of KRS 132.200 to Jim Beam’s white oak barrels used to produce bourbon, which are resold. Because the Court found that the General Assembly did not intend to treat alcohol differently from other personal property, the Court did not reach the question of the constitutionality of a distinction in tax treatment between alcohol and other personal property. The Department of Revenue appealed the Court’s decision to the Kentucky Court of Appeals, where briefing is under way.

B. Administrative Developments

The Kentucky Department of Revenue has promulgated several new Regulations related to the property and ad valorem taxation of machinery actually used in the manufacturing of coal, crushed stone, sand and gravel, and hot mix asphalt. For purposes of Kentucky’s property taxation, machinery actually engaged in manufacturing subject to a state tax of Fifteen

Cents ($0.15) on each Hundred Dollars ($100.00) of value and is exempt from property taxation by any county, city, school, or other taxing district in which it has a taxable situs.

103 KAR 8:130. Ad Valorem taxation of machinery actually engaged in the manufacturing of coal

This Regulation determines that only machinery actually used in the crushing, sizing, blending, chemical treating and washing of coal is manufacturing machinery. Machinery used in the extraction, severance, dredging or mining of coal is not manufacturing machinery for purposes of KRS Chapter 132.

The Regulation provides that coal manufacturing begins when machinery and equipment is used to convey the raw coal into the crushing, sizing, blending and washing facilities and includes machinery and equipment utilized in moving the coal between manufacturing processes within the processing area. Manufacturing ends with the loading of coal for the final transportation to the end user. In addition, machinery whose purpose is to move, stage or load the coal when it is utilized subsequent to receiving or dumping of the coal into one of these processes and prior to the completion of the sizing, crushing, blending or washing processes constitutes manufacturing machinery.

103 KAR 8:140. Ad Valorem taxation of machinery actually used in the manufacturing of crushed stone, sand and gravel

This Regulation determines that only machinery actually used in the conveying, crushing, screening, washing, drying, blending and stockpiling of stone, sand, or gravel to a product of the appropriate gradation and specification required for sale or final use is manufacturing equipment. This includes machinery equipment actually used to size, crush, screen, blend, de-dust or wash the stone, sand, or gravel, including all necessary housing, electrical and support systems.

Manufacturing of crushed stone, sand and gravel commences with the initial sizing of the stone, sand or gravel after it has been removed from its natural deposit, and continues with the loading, hauling, pumping or conveying to the primary crusher or screen. This manufacturing process includes the sizing, classifying, crushing, screening, blending, de-dusting and washing of the stone, sand, or gravel. Manufacturing of such stone, sand or gravel ends when the product meets and maintains the appropriate gradation, specifications or blends. The loading process for final transportation to the end customer is only manufacturing if blending occurs during the loading process.

103 KAR 8:150. Ad Valorem taxation of machinery actually used in the manufacturing of hot mix asphalt

This Regulation determines that the following constitutes manufacturing machinery: (1) machinery actually used in the loading of raw material into an asphalt plant’s cold feed bins (including the cold feed bins); (2) machinery actually used in the blending of aggregates; (3) the movement of material across screen decks, and into dryers or drums (including the dryer and drums); and (4) machinery actually used in surge facilities, silos and load control systems.

In addition, machinery and equipment actually used to heat, dry, mix and blend the aggregates with liquid asphalt, including all necessary housing, electrical, controls, liquid asphalt tanks and energy supply systems, as well as equipment used to load, adhere, remix, place and compact hot mix asphalt constitute manufacturing equipment.

Manufacturing of hot mix asphalt commences with the loading of raw materials to cold feed bins and continues with the blending of aggregates on conveyor belts, through the flow of material across the screen decks, and into the dryer or drum for further blending or mixing. The manufacturing process continues with the surge facilities, silos, and load control systems. The manufacturing process of hot asphalt ends when either the hot mix asphalt is loaded for delivery to a retail customer or when the hot mix asphalt is placed and compacted as directed by the customer. Loading of hot asphalt for final transportation to the customer is only considered to be manufacturing if blending occurs during the loading process.

IV. MISCELLANEOUS TAXES

A. Judicial Developments

1. DirecTV, Inc. v. Treesh, 487 F.3d 471, (6th Cir. 2007). The United States District Court of Appeals for the Sixth Circuit held that Kentucky’s newly enacted tax on multi-channel video programming did not discriminate against interstate commerce in violation of the Commerce Clause of the United States Constitution.

DirecTV, Inc. and EchoStar Satellite, LLC (collectively, “Satellite Companies”), both headquartered outside of Kentucky, provide multi-channel video programming to subscribers via satellites stationed above the earth. The Federal

Government grants Satellite Companies the right to transmit programming signals from satellites located in orbit which are received by a subscriber by means of a small satellite dish mounted on or near their house.

Cable television operators (“Cable Companies”) also provide multi-channel video programming; however, they do so by means of cable networks located in Kentucky. Cable Companies receive programming in Kentucky and transmit such to Kentucky subscribers by way of cables laid in the Commonwealth and connected to their subscribers’ television sets in set top boxes. The three largest Cable Companies in Kentucky are headquartered in states other than Kentucky. Cable Companies must obtain permission from local governments in order to lay or string cable which is granted by means of franchise agreements and permits and typically pay a franchise fee of 5% of gross revenue to the applicable local government.

Satellite Companies compete with Cable Companies in the market for multi-channel video programming distribution as both sell various packages of television channels including local television stations and cable programming. Prior to the 2005 legislation, which was the subject of Satellite Companies’ Complaint, Cable Companies were typically subject to a local franchise fee of 5% of gross revenue. The 2005 legislation, 2005 Ky. H.B. 272 – a part of what is commonly known as Kentucky Tax Modernization – created two new taxes on multi-channel video programming services: [1] a new excise tax of 3% on multi-channel video programming services, which the provider must collect from the purchaser; and [2] a new gross revenue tax of 2.4% on a multi-channel video programming service provider’s gross revenues which may not be collected from a purchaser.

The 2005 legislation also created a fund into which all revenues from the gross revenue and excise tax must be deposited. The money in the fund is allocated among the Commonwealth and its political subdivisions, school districts and special districts. A portion of the fund is distributed to local governments according to the local historical percentage.

Importantly, KRS 136.660 prohibits a local government from levying a franchise fee or tax on a multi-channel video programming service, whether charged to a provider or purchaser. If such a franchise fee or tax is levied, the statute prohibits the local government from sharing in the proceeds of the excise and gross receipts taxes and provides a credit in the amount of the franchise fee or tax imposed against the local franchise tax or fee imposed against the state-levied excise and gross receipts taxes.

The Satellite Companies contended that the 2005 legislation, which affords Cable Companies credits against the state excise and gross revenue taxes and relief from franchise fees, was discriminatory of interstate commerce in violation of the Dormant Commerce Clause. The Court characterized the Satellite Companies’ argument as follows: the Cable Companies receive relief from a portion of their operating costs (i.e., the local franchise fees or taxes) in return for paying the new taxes; conversely, Satellite Companies pay new taxes but receive no relief from their operating costs. As such, Satellite Companies argue that this constitutes discrimination because Satellite Companies which employ out-of-state facilities to distribute television service are burdened, and Cable Companies which employ in-state facilities to distribute television service are benefited by the 2005 legislation.

The Court briefly reviewed the Satellite Companies’ challenges to the District Court’s findings of fact. Although the Court of Appeals identified errors on the part of the District Court, it nonetheless determined that the District Court had a reasonable basis for the dismissal of the Complaint. The Court then turned to a review of the Dormant Commerce Clause, which prohibits discrimination against interstate commerce and may be implicated where in-state economic interests are favored over out-of-state competitors.

Initially, the Court indicated that, had Kentucky imposed an equal state tax on both the Satellite Companies and Cable Companies, without providing the credit for the franchise fee or banning those fees altogether, the new taxes would not be violative of the Commerce Clause. Further, the Court determined that had Kentucky solely banned local governments from imposing the franchise fees on Cable Companies, that too, would not have done violence to the Commerce Clause. The Court noted that state and local governments are not required to charge for the use of local rights-of-way. Likewise, the provision of access to a state infrastructure, without charge, is an option freely exercisable by the state.

The Satellite Companies argued that Kentucky’s new tax structure is similar to one found to violate the Dormant Commerce Clause in West Lynn Creamery v. Healy, 512 U.S. 186 (1994). In West Lynn Creamery, Massachusetts required milk dealers in the state to contribute to a price equalization fund, regardless of where they bought their products, and then distributed the proceeds of the fund solely to in-state dairy producers. The U.S. Supreme Court found that such a structure violated the Commerce Clause.

The Court distinguished the current case from West Lynn Creamery in several important respects. First, in the instant case, the challenged subsidy is not a direct monetary subsidy, but only a beneficial right to conduct business and use local

rights-of-way without local taxation and fees. Second, in West Lynn Creamery, the purpose and effect of the tax and subsidy was to divert market share from out-of-state goods to an in-state competitive group. However, in the case of multi-channel programming the goods are distinct with two very different means of delivery and broadcast. Lastly, the Court determined that the purpose of the 2005 amendments included non-market share related goals, such as simplification of the tax fees related to Cable Companies and also how to best collect taxes from the Satellite Companies.

The Court found that the Satellite Companies’ allegations were insufficient to demonstrate the 2005 amendments created the functional equivalent of a protective tariff. The State, in enacting the amendment, merely sought to simplify the tax structure and provide a more uniform state taxation scheme. The Court of Appeals therefore affirmed the District Court’s granting of the Defendant’s Motion to Dismiss. The Satellite Companies filed a Petition for Certiorari with the U.S. Supreme Court on January 31, 2008, which was denied on April 14, 2008.

2. Episcopal Church Home and Infirmary v. Department of Revenue, No. 03-CI-547 (Franklin Cir. Ct., Div II, Jun. 13, 2007). The Franklin Circuit Court held that the Episcopal Church Home and Infirmary (“Episcopal Church Home”) was subject to Healthcare Provider Tax (“Provider Tax”).

The Episcopal Church Home is a non-profit 501(c)(3) organization that provides nursing and assisted living services to the elderly residents of its facility. In 1993, the Kentucky General Assembly enacted the Provider Tax in order to comply with newly amended federal requirements related to the ability of states to receive federal Medicaid money. The Provider Tax imposed a two to two and one half percent (2-2.5%) tax on the gross revenue of all inpatient and outpatient hospitals, nursing homes, physicians, home healthcare services, HMO services, and other immediate care facilities for the mentally retarded. The constitutionality of the Provider Tax was upheld in Revenue Cabinet v. Smith, 875 S.W.2d 873 (Ky. 1994). Subsequent to the passage of the Provider Tax, the General Assembly amended it in 1994 and again in 1996 to phase out the taxation of physicians and pharmacies. Notwithstanding such amendments, the other entities providing healthcare services remain subject to the Provider Tax.

The Episcopal Church Home contended that it should be exempt from the Provider Tax for several reasons. First, the Episcopal Church Home argued that the amendments constituted special legislation prohibited by Section 59 of the Kentucky Constitution, and that they violated the Equal Protection Clauses of both the United States and Kentucky Constitutions, and were invalid. Next, the Episcopal Church Home argued that it was an institution of purely public charity and an institution of religion, and was therefore exempt from the Provider Tax under Section 170 of the Kentucky Constitution. Likewise, the Episcopal Church Home claimed that its 1872 Charter from the General Assembly prohibited taxation of its property.

The Court began with a review of the Episcopal Church Home’s Section 59 argument. The Court indicated that the test for whether a tax constituted special legislation was outlined by the Kentucky Supreme Court in Shoo v. Rose, 270 S.W.2d 940 (Ky. 1954). Under the Shoo test, the tax must: (1) apply equally to all in a class, and (2) there must be distinctive and natural reasons inducing and supporting the classification.

The Court indicated that the legislative history provided that the class in this particular case consisted of all medical providers required to be taxed in order to qualify for federal matching funds in the Commonwealth’s Medicaid program, with the primary goal of obtaining such federal funds. Therefore, the Court determined that the class should be comprised of all healthcare providers that must be taxed in order for Kentucky to qualify for federal matching money, including nursing homes.

With regard to the second prong of the Shoo test, the Court determined that there were natural and distinctive reasons for the classification, including the need to comport with the requirements outlined in federal law which were the basis for the Provider Tax in the first place. The Court therefore held that the Legislature had not acted arbitrarily with regard to the amendments to the Provider Tax excluding physicians and pharmacies from the tax.

The Court also dismissed the Episcopal Church Home’s argument related to Section 170 of the Kentucky Constitution. Section 170 exempts from property tax property owned and occupied by religious institutions and property owned by purely public charities. The Episcopal Church Home’s position was that since the Provider Tax liability was paid from its endowment funds, it constituted a property tax, and the tax therefore violated Section 170 of the Kentucky Constitution. The Court held that a taxpayer cannot change the nature of a tax by selecting the account from which it chooses to pay the tax, and concluded that because the Provider Tax is not a property tax, Section 170 was not applicable. The Episcopal Church Home has filed a Motion To Alter, Amend or Vacate the Court’s decision.

3. American Express Travel Related Services, Inc. v. Jonathan Miller, No. 06-CI-1151 (Franklin Cir. Ct., Div. II, Jan. 31, 2007). The Franklin Circuit Court declared Section 39 of 2006 House Bill 380 (“HB 380”), the biennial budget bill for Kentucky, unconstitutional as violating Ky. Const. §51.

Section 39 of HB 380 shortened the period of time under KRS 393.060 that a holder of a traveler’s check can retain it before it is presumed abandoned and escheats to the State. Prior to the enactment of HB 380, the escheat period for traveler’s check was fifteen years. HB 380 shortened that period to seven years.

American Express Travel Related Services, Inc. (“American Express”) challenged the statute on several substantive and procedural bases. In particular, American Express argued that Kentucky Constitution Section 51 prohibits the General Assembly from passing laws related to more than one subject, as well as passage of any revision, amendment, or extension to a law, “by reference to its title only.” Section 51 requires that any such revision, amendment, or extension, be enacted by publishing the law, complete with deletions, additions, and creations. The Court determined that Section 51 was intended to enable members of the General Assembly to better understand the change in the law and to know what they are voting for or against.

American Express also argued that the proper constitutional process regarding the escheat provision was not followed. The Kentucky Department of Treasury argued that Section 39 represented merely a suspension of KRS 393.060 for the two year biennium period. Under that analysis, no republication of KRS 393.060, with the proposed changes, would be necessary for the statute to pass constitutional muster.

The issue before the Court was whether Section 39 was an amendment, revision, or extension, or just a suspension or modification of KRS 393.060. The Court analyzed the difference between suspensions and modifications versus amendments, revisions, or extensions, and concluded that the distinction between the two types of alternatives to legislation involved the permanency, or lack thereof, to a law. In furtherance of this analysis, the Court reviewed Armstrong v. Collins, 709 S.W.2d 433 (Ky. 1986), where the court upheld the suspension of certain appropriations as necessary to fulfill the General Assembly’s primary obligation - balancing the budget. In Armstrong, the Legislature suspended the operation of certain statutes until the money appropriated for certain programs was reduced.

The Department of Treasury, in the instant case, cited no financial emergency to necessitate the change in the statute affecting American Express. Further, the Legislature did nothing to alter or suspend appropriations but, rather, altered the operation of law governing the escheat of property due to the State as a way to raise revenue. The Court determined that the suspension of appropriations versus a change in the law as a revenue raising mechanism is a crucial element in determining whether there is a suspension or modification versus a revision or an amendment.

4. Department of Revenue v. Combs, No. 2007-CA-001134-0A (Ky. App. Sept. 19, 2007). The Court of Appeals denied a Petition for relief in the nature of a writ of prohibition or mandamus pursuant to CR 76.36 sought by the Kentucky Department of Revenue against Pike Circuit Court Judge Combs.

The Department petitioned the Court either to prohibit the Pike Circuit Court from exercising jurisdiction or to direct the Circuit Court to grant the Department’s Motion to Dismiss. The real party in interest in the Circuit Court action styled SouthEast Telephone, Inc. v. Commonwealth, Civil Action No. 07-CI-00299 (Pike Cir. Ct., Div. II) SouthEast Telephone, Inc. (“SouthEast”) responded to the Department’s Petition. In the Circuit Court action, SouthEast has sought a declaration that certain Budget Bill amendments to KRS 139.505, a sales and use tax refund statute, are facially unconstitutional. Arguing, inter alia, failure to exhaust administrative remedies, the Department moved for the dismissal of the action; however, the Circuit Court denied the motion.

The Court denied the extraordinary relief sought “based on its determination that Petitioner [the Department]…failed to demonstrate any entitlement to it.” The Court further determined that “it is clear that the Trial Court does not lack jurisdiction over the action because of the well-established exception to the requirement of exhaustion of administrative remedies.” That is, it is unnecessary to exhaust administrative remedies when attacking a statute’s constitutionality as facially void because an administrative agency cannot decide constitutional issues, and so, such an exercise would be futile.

The Court went on to hold that the Department failed to make a showing that it had no adequate remedy by appeal or otherwise, and that great injustice and irreparable injury would result if its Petition was not granted. The authors’ law firm represents the real party in interest.

The Court held that there was no impending financial emergency motivating the legislation and concluded that because the legislation changed the rules in order to raise revenue, rather than suspend appropriations, the General Assembly’s effort to raise revenue by changing the operation of the statute was an amendment to, and not a suspension of, the statute. The Court held that the General Assembly was required “…to follow the constitutional and statutory procedures that have been created to protect Kentucky’s citizens from stealth legislation.” Because the General Assembly failed to follow the dictates of

Kentucky Constitution Section 51, the Court concluded that Section 39 was unconstitutional and, therefore unenforceable. The authors’ law firm represents the taxpayer, South East Telephone, Inc.

5. North Atlantic Operating Co., Inc. v. Commonwealth ex rel. Dept. of Revenue, Civil Action No. 07-CI-00517 (Franklin Cir. Ct., Div. II), the Franklin Circuit Court held that a provision imposing an excise tax on cigarette papers violated Section 51 of the Kentucky Constitution because it was set forth in 2006 H.B. 380, the Biennial Budget for the Commonwealth of Kentucky.

The 2006 General Assembly enacted H.B. 380, the Biennial Budget for the Commonwealth, which in its over 600 pages, purported to amend Kentucky’s general cigarette tax statute to impose an excise tax on cigarette papers. Cigarette papers were previously not taxed in Kentucky. The Plaintiffs challenging the provision alleged numerous violations of the Kentucky Constitution as well as a statutory provision.

Although the Court noted that it had previously decided a similar case involving the same Budget Bill [American Express Travel Related Services, Inc. v. Commonwealth, Case No. 06-CI-1151 (Franklin Cir. Ct. Div. II)], the Court addressed the specific issues and facts presented in the case. The Court explained that Section 51 of the Kentucky Constitution prohibits the General Assembly from passing laws related to more than one subject, as well as passing a revision, amendment or extension to a law by reference to its title only. The Court indicated that Section 51’s purpose is to prevent logrolling legislation and acts as a prohibition against omnibus legislation. The Court then held that H.B. 380 plainly embraced multiple constitutionally distinct subjects, both in its title and its text, i.e., that “Revenue” and “Appropriations” are two distinct subjects. In so holding, the Court observed that “We believe this is the very evil the framers sought to prohibit when drafting Section 51.”

The Court went on to hold that the legitimate purpose of a Biennial Budget Bill is limited to making appropriations; however, the tax provision at issue was in no way related to making appropriations. Rather, the provision at issue was a new revenue generating measure which purported to tax cigarette papers. Because the Court concluded that the provision violated Section 51, it permanently enjoined enforcement of the tax at issue. The Department has appealed the circuit court’s decision to the Court of Appeals.

LOUISIANA STATE TAX DEVELOPMENTS1 William M. Backstrom, Jr.2 Jones Walker Law Firm 201 St. Charles Ave., Suite 5100, New Orleans, LA 70170-5100 Phone: 504-582-8228 Fax: 504-589-8228 Email: bbackstrom@joneswalker.com Company Website: www.joneswalker.com I. INCOME/FRANCHISE TAXES

A. Legislative Developments

1. General Comments

a. Governor Bobby Jindal was inaugurated in January 2008. Governor Jindal immediately called two special sessions of the Louisiana Legislature – one to deal with ethics issues and one to deal with other issues, including various tax-related matters. Tax-related developments from the two special sessions are discussed in this outline.

b. In addition, the 2008 Regular Session of the Louisiana Legislature is in session from March 31, 2008 to June 23, 2008. The 2008 Regular Session is a non-fiscal session, which means that most tax-related matters are not germane to the session.

c. Nevertheless, there are several state and local tax issues to watch during the 2008 Regular Session, namely bills to require centralized collection of local sales/use taxes, prohibit contingent fee auditors in state and local tax matters, prohibit contingent fee attorneys in state and local tax matters and eliminate the statutory requirement that a losing taxpayer pay up to 10% of the tax collector’s attorneys’ fees. Even though the likelihood of adopting centralized collection of local sales/use taxes is not very high for this session, proponents of the bill are hopeful that there will be some debate on the issue that could lead to the adoption of some of the other initiatives and lead to further developments in future legislative sessions. The bills to outlaw contingent fees auditors and attorneys in state and local tax cases and repeal the 10% attorneys’ fee penalty have some momentum, but proponents need all the support they can muster. COST is active in supporting the Louisiana Association of Business and Industry (“LABI”) in its efforts to have these initiatives enacted into law. Members of COST that have experienced the joy of working on state and local tax matters in Louisiana should be fighting to get to the table to support these initiatives! Information on these bills can be found on the COST and LABI web sites. The address for the LABI web site is http://www.labi.org.

2. Act No. 4 (H.B. 9) of the 2008 2nd Extraordinary Session amends La. R.S. 47:6016 relative to the Louisiana New Markets Tax Credit as follows: (i) the credit is expanded to include an additional $50 million cap ($25 million in 2008, $12.5 million in 2009, and $12.5 million in 2010), and (ii) the credit is now limited to $5 million cap per project, rather than the prior $15M cap, unless the project is in an approved targeted industry.

3. Act No. 10 (S.B. 10) of the 2008 2nd Extraordinary Session amends La. R.S. 47:602 and La. R.S.

47:603 to accelerate the current phase-out of all borrowed capital from the determination of the corporate franchise tax. Prior to this Act, the borrowed capital phase-out was due to be completed after 2011. Now it will be fully phased-out for years after 2010.

B. Judicial Developments

1 This outline covers selected Louisiana state and local tax developments from September 2007 through April 2008. 2 The author gratefully acknowledges the contributions provided by the following members of the Jones Walker State and Local Tax team: Louis S. Nunes III (Partner, New Orleans), Jonathan R. Katz (Associate, New Orleans) and Kathryn S. Friel (Associate, New Orleans).

1. The Louisiana 1st Circuit Court of Appeal rendered a decision on February 8, 2008 in Bridges v. Geoffrey, Inc., No. 2007 CA 1063 (La. 1st Cir., 2008), affirming the trial court’s decision in Bridges v. Geoffrey, Inc., No. 502,769 (19th J.D.C. filed 01/30/07). The Louisiana Supreme Court denied Geoffrey’s writ of certiorari on April 25, 2008. See Bridges v. Geoffrey, Inc., No. 2008-0547 (La. 04/25/08). The court of appeal held that Geoffrey, Inc. (“Geoffrey”), a Delaware Corporation, was subject to Louisiana corporate income tax on the royalties it earned from its affiliate’s use of Geoffrey’s trademarks and trade names. Geoffrey, as an intangible holding company for Toys-R-Us and other affiliates, had no physical presence within or contacts with Louisiana except those contacts established through its affiliate’s use of the intangibles. Geoffrey argued that the Department’s assessment of corporate income tax was in violation of the Commerce Clause of the U.S. Constitution. The appellate court’s decision primarily focused on whether the court was going apply the U.S. Supreme Court’s holding in Quill v. North Dakota to Louisiana corporate income and franchise tax matters. Relying on decision from other courts around the country, the Louisiana appellate court held that the Supreme Court’s decision in Quill was limited to sales and use tax.

Although the 1st Circuit did not address the issue directly, the trial court also held that Geoffrey’s intangible property was used in Louisiana in such a way as to become an integral part of a business carried on in Louisiana. As a result, the trial court held that Geoffrey’s intangible property had acquired a business situs in Louisiana that was subject to income and franchise taxation. Irrespective of each court’s rational, both the trial court and appellate court concluded that the use of the trademarks in Louisiana by the affiliate and the significant royalty income generated therefrom was sufficient to establish a substantial nexus with Louisiana.

In addition to tagging Geoffrey with the taxes and interest due, the 1st Circuit also upheld the Department’s claim for a 25% negligence penalty. The court noted that Geoffrey knew about the decision in the South Carolina Geoffrey and presumably should have known that it was subject to Louisiana income and franchise tax. This is a very curious ruling given that South Carolina case law has no precedential value in Louisiana and, prior to the Louisiana Geoffrey case, there was no Louisiana jurisprudence regarding the nexus issue for companies with no physical presence in Louisiana.

C. Administrative Developments

1. Revenue Rulings and Revenue Information Bulletins (“RIB”)

a. RIB No. 07-025 (September 13, 2007) (Wind Energy System or Solar Energy System Tax Credit). Act No. 371 (S.B. 90) of the 2007 Regular Session created two new tax credits, one of which is the credit for wind energy systems and solar energy systems. This RIB provides that credits for such systems will only be issued for costs of purchase and installations of such systems incurred on or after January 1, 2008.

b. Revenue Ruling 08-001 (Jan. 9, 2008) (Hurricane Recovery Benefits and Insurance Settlement Proceeds). This Revenue Ruling discusses whether hurricane recovery benefits can be deducted from individual and corporate income tax and whether insurance settlement proceeds receive similar treatment. The Department concludes that insurance settlement proceeds do not fall within the provisions of Act 247 of the 2007 Regular Session, and, as such, do not receive the same treatment as hurricane recovery benefits and cannot be deducted for Louisiana individual income tax and corporate income tax purposes. If the taxpayer receives both hurricane recovery benefits and insurance settlement proceeds, the hurricane recovery benefits would be considered as having been included in income for federal tax purposes prior to the inclusion of the insurance settlement proceeds.

Act 247 provided a corporate and individual income tax deduction for hurricane recovery benefits. The legislation indicated that hurricane recovery benefits include any gratuitous grant, loan, or other benefit directly or indirectly provided to a taxpayer by a hurricane recovery entity. The deduction would be allowed to the extent that the hurricane recovery benefit was included in federal adjusted gross income. The legislation defined a "hurricane recovery entity" as being the Road Home Corporation, the Louisiana Recovery Authority, or the Louisiana Family Recovery Corps. The Revenue Ruling also provides several

examples of computations concerning the deduction and the effects of the receipt of hurricane recovery benefits and insurance settlement proceeds.

c. RIB No. 08-006 (January 29, 2008) (New Market Tax Credits). Act No. 379 (S.B. 188) of the 2007 Regular Session amended La. RS. 47:6016 to increase the cap on New Market Tax Credits to $50 million. However, the program was so successful that the cap was reached by the end of January 2008. This RIB notified the public that the cap had been reached. However, Act No. 4 (H.B. 9) of the 2008 2nd Extraordinary Session (discussed above) amended La. RS. 47:6016 again to provide for additional caps to be spread over 2008, 2009 and 2010.

2. Private Letter Rulings (“PLR”)

a. PLR 08-007 (March 12, 2008) (Whether or Not a Member of an Affiliated Group will be Subject to Louisiana Corporation Income or Franchise Taxes). This PLR addresses whether certain corporations in an affiliated group of corporations are subject to Louisiana corporation income tax and corporation franchise tax. Two of the affiliated group’s major U.S. affiliates are (i) Company A, a manufacturer and distributor of tangible personal property, and (ii) Company B, a corporation that finances wholesale and retail purchases of the affiliated group’s products. Company A sells property to a network of independent dealers which maintain physical locations in Louisiana and Company B owns property in Louisiana. Therefore, both Companies A and B determined they had sufficient nexus with Louisiana, and accordingly, have filed Louisiana corporate income and franchise tax returns.

The PLR relates only to the wholly-owned subsidiaries of Company B. These subsidiaries are Delaware corporations formed to facilitate the securitization of Company B’s loans. This securitization process is structured to allow Company B to raise capital without reference to its credit rating restrictions and to provide for a lower cost of financing. In other words, there is an apparent business reason for this structure.

The subsidiaries represented that they do not exercise their charters or transact business within Louisiana, they do not have employees within Louisiana, they don not have physical, intangible or other property within Louisiana, and they do not derive revenue from Louisiana sources. However, they do outsource the administration of their loan portfolios to Company B for a fee. Company B, in turn, conducts the loan servicing activities, principally outside of Louisiana.

Notwithstanding the connections of Company A and Company B with Louisiana and the connections between Company B and the subsidiaries, the Department ruled that under the facts provided, the subsidiaries do not “appear” to owe any Louisiana corporation income or franchise tax. The PLR noted that the Department reserved its right to require “consolidated reports” for the affiliates pursuant to the provisions of La. R.S. 47:287.480.

3. Adopted Rules [None to Report]

4. Notices of Intent to Adopt Rules [None to Report]

II. TRANSACTIONAL/SALES AND USE TAXES

A. Legislative Developments

1. Act No. 1 (H.B. 1) of the 2008 2nd Extraordinary Session decreases the state sales tax rate on electricity and natural gas to 2.3% and steam and water to 2.8% effective July 1, 2008. The remaining 2.3% and 2.8% is scheduled to expire on June 30, 2009, leaving business purchases of electricity, natural gas, steam and water exempt from state sales tax after June 30, 2009. The Act also excludes other fuels or gases, including but not limited to propane and butane, sold for non-residential uses from the current 4% state sales tax.

2. Act No. 9 (S.B. 7) of the 2008 2nd Extraordinary Session corrects current law regarding the manufacturing machinery and equipment exclusion to include persons who or which do have to register with the Louisiana Department of Labor, as well as those who or which do not. Thus, for example, an entity that has no employees of its own, but still qualifies as a “manufacturer,” will be able to take advantage of the exclusion if it otherwise satisfies the provisions of the exclusion. The Act also extends the manufacturing machinery and equipment exclusion to apply to newspaper publishers within Sector 511110 of the 2002 NAICS Codes.

3. Act No. 12 (S.B. 12) of the 2008 2nd Extraordinary Session accelerates the phase-in of the exclusion of manufacturing machinery and equipment to fully exclude manufacturing machinery and equipment from state sales tax in fiscal year 2009-2010. Local tax recipient bodies in Louisiana have the local option to enact a similar manufacturing machinery and equipment exclusion.

B. Judicial Developments

1. International Paper, Inc. v. Cynthia Bridges, Secretary, Department of Revenue, State of Louisiana, No. 07-C-1151 (La. 01/16/08).

a. Summary. The Louisiana Supreme Court held that purchases by International Paper, Inc. (“IP”) of three chemicals (the “raw materials”) used in the manufacturing process of white paper were excluded from Louisiana sales and use taxes under the “further processing exclusion.” The Court reaffirmed the three-part test for applying the further processing exclusion, which applies if raw materials (1) become recognizable and identifiable components of the end products, (2) are beneficial to the end products, and (3) are material for further processing and are purchased with the purpose of inclusion in the end products. The Court rejected the Department’s argument that the raw materials themselves must be present in the end products and that the further processing of the raw materials must be the primary purpose for purchasing the raw materials.

b. Facts. IP manufactures light-weight grades of paper from wood chips. The wood chips were converted into wood pulp through a cooking process in which a great portion of the lignin in the wood chips was removed/ dissolved while a majority of the cellulose materials of the chips remained in the pulp. The small percentage of lignin that remained gave the pulp a brown color. The pulp was bleached to remove the color from the pulp and sent to paper machines for pressing into white paper products for sale to customers. The raw materials at issue in the case were used in the bleaching process. The raw materials served two purposes (i) they dissolved some of the remaining lignin molecules and (ii) they oxidized (i.e., bleached) the lignin that remained by “giving” an oxygen atom to the lignin.

c. History. The case began at the Louisiana Board of Tax Appeals, which held that the materials at issue were excluded from sales/use tax pursuant to the further processing exclusion. The Louisiana Department of Revenue then appealed the decision to the district court which affirmed the Board of Tax Appeals’ decision. The Louisiana Second Circuit Court of Appeal, however, reversed the district court’s decision. The Second Circuit stated that in order for further processing to apply, four requirements must be met, namely: (i) the material itself must be processed into tangible personal property for sale at retail; (ii) the material must become a recognizable, integral part of the end product; (iii) the presence of the material as a component of the end product must be of benefit to the end product; and (iv) the primary purpose for the purchase of the material must be to process it into the end product. The court noted that the “primary purpose” test was of “jurisprudential origin.”

d. Supreme Court Decision. The Department argued that none of the raw material purchases were excluded because: (i) not all of the materials could be identified in the finished products and; (ii) none of the raw materials were purchased for the primary purpose of further processing them into the finished products. IP, on the other hand, argued that each of the materials was excluded from sales/use taxes because the purchases satisfied the long-standing, three-part test in the Department’s own regulations, La. Admin. Code, Title 61, Part I, § 4301, Retail Sale or Sale at Retail (d)(2006)(“LAC 61:I.4301”). The Court quoted from the Board’s decision regarding the application of the three-part test as follows:

The Secretary’s regulation, LAC 61:I.4301(10) and the case law provides that in order to be “material for further processing,” as contemplated by the above statute, the raw materials or their component molecular parts must meet three criteria: (1) the must be of benefit to the end product; (2) they must be a recognizable and identifiable component of the end product, and (3) they must have been purchased for the purpose of reprocessing into the end product. [cite omitted].

The Court began its decision by reviewing prior decisions of the Court regarding the further processing exclusion, Traigle v. PPG Industries, Inc., 332 So. 2d 777 (La. 1976), and Vulcan Foundry, Inc. v. McNamara, 414 So. 2d 1193 (La. 1982). The Court noted that the Traigle Court “recognized that the ‘further processing exclusion’ applied to those raw materials purposefully incorporated within the final products (i.e., not incidentally/accidentally incorporated within the final products), such that said incorporation resulted in the raw materials providing integral and beneficial parts to the final products produced.” The Court in International Paper noted that the Traigle Court “recognized the significance of the DOR’s administrative rule with regard to the proper interpretation of the ‘further processing exclusion.”

The Louisiana Supreme Court agreed with the lower court that the further processing exclusion applies to raw materials that become recognizable and integral parts of the end products and that are beneficial to the end products. The Court disagreed, however, with other aspects of the lower court’s decision. Specifically, the Court held that based on the law and jurisprudence there is no requirement “that the raw materials themselves (i.e., the exact chemical/physical compositions of the raw materials) must appear in the end products . . . .” Further, the Court held that there is no primary purpose component of the test.

Having reached these conclusions, the Court reaffirmed the long-recognized, three-part test as follows:

From this rule [LAC 61:I.4301], we recognize that raw materials “further processed” into end products are excluded from the sales and use tax provisions when: (1) the raw materials become recognizable and identifiable components of the end products; (2) the raw materials are beneficial to the end products; and (3) the raw materials are material for further processing, and as such, are purchased with the purpose of inclusion in the end products.

The Court also rejected the “primary purpose” portion of the test that the lower court added to its analysis. The Court held that purchases of raw materials are excluded from sales/use tax pursuant to the further processing exclusion if the raw materials are purchased for the purpose of incorporation into the end products.

e. Commentary. This long overdue clarification of the further processing exclusion is an extremely important development to the many manufacturers in Louisiana that have grappled with the application of the exclusion. The Court’s decision brings clarity to the exclusion. The Department obviously will follow the Court’s decision and is in the process of reviewing pending audits, deficiency cases and refund cases in light of the decision.

2. Bridges v. Production Operators, Inc., No. 2007-0648 (La. App. 4th Cir. 12/12/07), addressed a gas compression transaction.

a. Summary. The Louisiana Fourth Circuit Court of Appeal found a taxable barter transaction imbedded in a gas compression contract and remanded the case to the district court to determine the sales price of the gas.

b. Facts. Production Operators, Inc. (“POI”) was a provider of gas compression services to companies engaged in the exploration and production of natural resources in Louisiana. POI’s services were provided pursuant to a form gas compression contract with its

customers pursuant to which the customer was required to provide compressor fuel at no cost to POI to power POI’s compressors. The Department sued POI seeking to recover sales taxes on the customer-supplied fuel.

c. History. The district court granted POI’s motion for summary judgment relying on the reasoning of the Louisiana Third Circuit Court of Appeal in Hanover Compressor Co. v. Department of Revenue, No. 02-0925 (La. App. 3d Cir. 2/5/03), 838 So. 2d 876, which held on nearly identical facts that even if a “sale” was found, there was no sales price or value for the compressor fuel, and thus no tax imposed.

d. Decision. The Louisiana Fourth Circuit Court of Appeal reversed and held that POI’s customers transferred possession of the fuel to POI in a barter transaction. The court also found that the consideration that POI received in exchange for its compression services included the value of the gas used. The court stated that a contrary finding would imply that the transfer of the possession of the gas would have been a gift or gratuitous transfer, a type of transaction that businesses typically do not engage in. The court of appeal did not reach the issue of the value of that gas, remanding the case to the district court to determine that fact.

3. Enterprise Leasing v. Curtis, No. 2007-0354 (La. App. 1st Cir. 11/02/07).

a. Summary. The Louisiana First Circuit Court of Appeal held that payments for a collision damage waiver were part of the gross proceeds of the lease of an automobile that were subject to lease tax; and that penalties for the late payment of tax were mandatory. With respect to attorney fees, the court found that they were also mandatory, but subject to a judicial review of reasonableness.

b. Facts. Enterprise Leasing Company was engaged in the business of leasing automobiles. Enterprise’s customers had the option to accept responsibility for damages to the automobile or to purchase a collision damage waiver (“CDW”). The Livingston Parish School Board assessed sales taxes on the CDW payments. Enterprise paid the assessed taxes under protest and filed a refund suit. Enterprise asserted that the sale of the CDW was a purely optional purchase that was not part of the rental transaction, but rather was the sale of an intangible right that was not subject to taxation.

c. District Court. The district court held that the gross proceeds derived from the lease of the automobiles included any amount collected for CDW payments.

d. Court of Appeal. The court found that the real object of the transaction was the lease of the autos and that the CDW cannot be separated from the lease of the auto. Integral to the court’s ruling was the fact that the customers could not purchase the CDW from anyone other than Enterprise.

Enterprise also contended that it should not be liable for penalties because it timely paid the taxes shown as due in good faith (Enterprise had been audited by several other taxing jurisdictions which concluded that the charges for the CDW were not taxable). The school board asserted that the penalties were mandatory. The court found that the penalties were mandatory and upheld their assessment.

The court also upheld the award of attorney fees to the school board. Although the court stated that attorney fees are subject to a judicial review for reasonableness, the parties had stipulated that the attorney fees awarded were not unreasonable.

4. Firestone Polymers v. Calcasieu Parish, No. 2007-0501 (La. App. 3d Cir. 10/31/07).

a. Summary. The Louisiana Third Circuit Court of Appeals ruled that the lease of shipping containers from an out-of-state company was subject to the Calcasieu Parish lease tax, even though the containers were used primarily in interstate commerce.

b. Facts. Firestone Polymers (“Firestone”) produced synthetic rubber at its Calcasieu Parish plant for shipment to tire manufacturers outside Louisiana. Firestone leased shipping containers from lessors located outside Louisiana. The lessors shipped empty containers to Firestone at its Calcasieu Parish plant where the containers were stored and maintained by Firestone Polymers. As rubber was manufactured, Firestone filled the containers with rubber and shipped the filled containers to customers outside of Louisiana. Empty containers were then shipped back to Firestone’s plant in Calcasieu Parish for reuse. The parish school board asserted that the lease payments paid by Firestone were subject to the local lease tax. Firestone argued that the leases were exempt from the Calcasieu Parish lease tax because the containers were used exclusively in interstate commerce under the local equivalent of the interstate commerce exclusion of La. R.S. 47:305(E). Firestone argued that a “lease is a continuing transaction with the tax due on each lease payment, such that one cannot take a snapshot of a moment in time during a lease transaction and have that moment determinative of the tax consequences for the entire lease.” In essence, Firestone argued (i) that the lease follows the property leased such that the property never comes to rest in Calcasieu Parish, and in the alternative, (ii) the lease payments attributable to periods when the leased property was actually moving in interstate commerce should not be taxable in Calcasieu Parish. In support of its position, Firestone Polymers cited Louisiana Administrative Code (“LAC”) 61:I.4303(B)(2), which states that “lease tax is not due on the lease of tangible personal property for those periods of time that it is used in bona fide interstate commerce, whether the use in bona fide interstate commerce is in Louisiana or outside Louisiana.”

c. History. The District Court granted summary judgment in favor of the school board.

The Third Circuit, citing Word of Life Christian Ctr. v. West, 04-1484 (La. 2006), held that (i) the containers left interstate commerce when they were delivered to Firestone in Calcasieu Parish, (ii) came to rest in Calcasieu Parish, (iii) were used in Calcasieu Parish and (iv) became part of the mass of property in Calcasieu Parish.

The court concluded that the “fact that owners used goods for travel across state lines does not necessarily classify the goods as part of bona fide interstate commerce as used in La. R.S. 47:305(E).” Therefore, the taxable moment for the entire lease transaction was deemed to occur at the moment the containers were delivered to Firestone in Calcasieu Parish and the local lease tax applied to all lease payments accordingly.

The Third Circuit dismissed these arguments and held that (i) “a contract of lease is not a series of transactions but a single transaction” and, (ii) citing LAC 61:I.4303(B)(3), “the tax on the initial lease or rental period is due where the transfer or possession (delivery) of the leased property occurs, and that for subsequent lease periods, when there is no additional transfer of possession, the tax is due to the local taxing jurisdiction where the property is primarily located.” Because the situs of the leases at issue was in Calcasieu Parish and delivery under the leases occurred at the moment the containers came to rest in Calcasieu Parish, the court held that the leases were taxable in Calcasieu Parish.

5. School Board of the Parish of St. Charles v. Shell Oil No. 04-2511 (E.D. La. 06/06/07).

a. Summary. The Federal District Court for the Eastern District of Louisiana enumerated the following principals: (i) a sale in form is not necessarily a sale in substance; (ii) if there is no market for an asset (i.e., no willing independent third party buyer for an asset), the asset does not have a market value; and (iii) waste gases, in certain circumstances, are exempt from use tax as byproducts even though there may be some level of further processing and fabrication prior to their use as fuel.

b. Facts. The case involved Shell Chemical Company (“Chemical”), Shell Norco Refining Company (“Refining”), and Shell Oil Company’s polypropylene unit, all of which shared facilities at a manufacturing and refining plant in St. Charles Parish, Louisiana. Chemical and Refining each produced waste gases which were routed to a Fuel Gas System. The Fuel Gas System, co-owned by Chemical and Refining, is a series of pipes used to gather and distribute the waste gas streams for use as fuel for boilers and furnaces throughout the

Refining and Chemical complexes. Because the waste gases are not sufficient enough alone to provide the required fuel, Chemical, as operator of the Fuel Gas System, purchases natural gas on behalf of both owners and homogenizes and lowers the velocity of the gases in the Blend Drum to allow for safer and more consistent burning of the blended fuel. As operator of the Fuel Gas System, Chemical allocates the fuel costs between itself and Refining on a neutral basis, that is to say, neither derives a profit from the other from the operation or the contents of the Fuel Gas System. Each is credited for the amount of waste gas it deposits into the Fuel Gas System, and each is charged for its use of the blended fuel coming out of the system. In order to facilitate the accounting of each facility’s energy use, all waste gases provided to the Fuel Gas System are assigned the same cost as a similar unit of natural gas. During later periods, Refining and Chemical went as far as to account for the costs of the Fuel Gas System using invoices and cash payments to settle credits and debts (i.e., sales). The primary issue presented was whether any gas was “sold” by one legal entity to another.

c. Decision. The District Court, under diversity jurisdiction, held that the alleged sales were not subject to St. Charles Parish sales or use taxation because the “sales” were not sales for sales tax purposes. The court reasoned that although the accounting system used by the parties provided the appearance of a sale, in substance it functioned to track waste gas in and out of the Fuel Gas System and to allocate the costs of operating the Fuel Gas System. No new product was fabricated and no consideration was provided from one party to the other. Therefore, in substance there were no sales, so no sales tax could be imposed on the accounting.

The District Court also held that the waste gas was not subject to use tax because the waste gas had no value, thus, it had no “cost price” for which to determine the tax. Although, the parties assigned a value to the waste gases equal to the value of natural gas, it was only for accounting purposes. Further, the waste gases could not be sold or transported through the U.S. natural gas pipeline system. Because the court found that there was no willing third party buyer for the waste gases, there was no market for waste gases. Even though the waste gas has utility and value for Chemical and Refining, the District Court, citing Louisiana case law, held that value in use is not indicative of the market value. Considering all these facts, the Court held that the waste gases did not have a market value, and as a result, were not subject to a use tax.

The District Court went on to alternatively hold, that even if the waste gases were found to have a market value for use tax purposes, the waste gases were exempt under La. R.S. 47:305(g) and (h) as residues or byproducts of the processing of raw materials into articles for sale. Generally, this exemption is not applicable if the byproduct is subject to further processing. However, the District Court held that when the waste gases pass through the Blend Drum “the streams are not fabricated into a new product for sale.” Therefore, the exemption would apply.

The Court did find an underpayment of sales taxes on certain other transaction between other affiliates.

6. School Board of the Parish of St. Charles v. Shell Oil No. 04-2511 (E.D. La. 04/10/08).

a. Summary. This case is a follow-up to the case described in the previous paragraph. The District Court held that the taxpayer was not entitled to a refund or a credit for non-protested taxes paid on the waste gas.

b. Facts. Shell Oil Company (“Shell”) had been paying parish sales taxes on the waste gas under the terms of a 1986 agreement with the School Board that secured certain bonded indebtedness. When the bonds expired in 1999, Shell’s obligations under the contract expired. However, Shell continued to pay sales taxes on the waste gas. As discussed in the paragraph above, the District Court found that no taxes were due on the waste gas. However, Shell had not paid these taxes under protest. Shell had paid approximately $2.4 million in taxes on the gas. The District Court also found that Shell had underpaid taxes on

other transactions in the amount of $458,734. Shell argued that it should be entitled to a credit for the taxes paid on the waste gas against the amount of taxes that it owed.

c. Court. The District Court disagreed, finding that a credit is allowed only in situations where a refund of non-protested taxes is allowed; that a refund of non-protested taxes is allowed when a mistake of fact has been made, and that this case did not involve a mistake of fact. The Court found that the payment of taxes pursuant to an agreement that had expired was not a mistake of fact because the taxing authority believed those transactions to be taxable.

The District Court was not persuaded by Shell’s argument that since the school board had initiated the action by filing suit, it was the party that had to prove damages. Shell argued that the school board could not prove any damages because of the overpayment of taxes on the waste gas. The Court stated that actions involving the payment of taxes do not follow the same rules as other types of actions.

C. Administrative Developments

1. Revenue Rulings

a. Revenue Ruling No. 07-003 (Sept. 6, 2007) (Sales Tax Applicable to Long-term Occupancy of Hotel and Motel Rooms). This revenue ruling addresses an issue that probably has been more prevalent in the wake of Hurricanes Katrina and Rita. This ruling also supersedes Revenue Ruling No. 03-007. The ruling provides that the taxability of hotel accommodations depends on the character of use and not the time or method of payment. According to the Department, if the use of accommodations is as a hotel, then the character of use is transient and not taxable. On the other hand, if the purpose of use is as a permanent resident, then the user is considered permanent. Further, the Department notes that fulfillment of several factors including, but not limited to physical presence, long term use, the contractual nature of the arrangement, and the permanency of the habitation are essential components to establishing the character of the use as that of permanent residence or home. Only the use of a hotel as a permanent residence or home by a natural person is excluded from payment of sales tax. The ruling also reviews the regulations at LAC 61:I.4301(C)(b).

b. Revenue Ruling 07-004 (August 20, 2007) (Taxation of Outdoor Signage). The ruling addresses the tax treatment of various transactions involving the manufacturing and/or sale of outdoor signs. The primary issue addressed is whether the signs are component parts of an other construction. In general, things are considered permanently attached to an “other construction”, and therefore immovable property, if they cannot be removed without substantial damage to themselves or to the other construction.

i. Signs Affixed to Buildings:

(a) A sign affixed to a building that can be removed without materially defacing the building is classified as movable property. The sale of the sign is subject to sales tax.

(b) Most signs, though affixed to a building with screws or compounds are considered moveable. Halo Lit signs and Neon Channel signs are also capable of being removed without substantial damage to the building, and are changed whenever a new enterprise occupies and makes use of the structure to which they are affixed. Therefore, these signs are not considered immovable and are subject to the sales tax.

ii. Signs Placed on Pylons – Billboard Signs

(a) Signs placed on pylons as part of a sign package or as an individual sign are subject to sales taxes. The column support of the pylon is permanently attached to the ground.

(b) Transactions involving the pylon typically are not taxable.

(c) Because the signs typically may be removed from its pylon at will, transactions involving the sign are taxable.

iii. Permanent Signs on Fixed Foundations

(a) These signs are created and intended to be permanent and are constructed on a fixed foundation. They are often referred to as monument signs.

(b) The Department acknowledged that these signs present a more difficult question. While the sign might be changed and replaced from the underground foundation if it is merely bolted and not welded, the attachment underground suggests that the sign is permanently attached to the “construction” (foundation).

(c) The Ruling holds that whether or not a monument sign is an immovable turns on the specific facts. If the sign could be readily unbolted and carried away, than the sign would be movable.

iv. Delivered Manufactured Signs

(a) The ruling holds that a manufactured sign destined for building wall installations, pylon or monument installation is picked up by the customer at a manufacturing facility, that sign is movable by its nature, regardless of the type of installation it is to become.

v. Free-Standing or Movable Signs

(a) The sale of “free-standing” signs are subject to sales taxes.

(b) Any sign attached in any manner to a movable device is characterized as movable property.

(c) The free-standing movable structure supporting the sign is subject to sales or lease tax, as the case requires.

vi. Sign Manufacturers.

(a) The ruling reiterates the rule that the contractor of an immovable must pay sales taxes on the materials that are incorporated into the construction of the immovable. Though a sign manufacturer can be sub-contracted by a construction contractor to fabricate a sign that will be installed on or into the building under contract, for purposes of sales tax law, the sign manufacturer is the contractor for construction of the sign, and must pay sales taxes on materials used in the construction of the sign.

(b) In all other circumstances where the sign is considered tangible personal property, the purchaser pays sales taxes on the sale of the sign. The retail sales price of the sign incorporates the materials used in its construction.

(c) If the sign is movable, repairs thereto are taxable.

vii. Installation charges, if separately stated on invoices, are not subject to sales taxes.

c. Revenue Ruling No. 07-005 (Sept. 19, 2007) (Sales and Use Taxation of Transactions Involving for the Furnishing of Scaffolding. This revenue ruling discusses the sales/use tax aspects of transactions involving the furnishing of scaffolding. The Department opines that transactions for the furnishing of the possession or use of scaffolding without the transfer of

title will be taxed as leases or rental of tangible personal property. According to the Department’s understanding of the scaffolding business, “[s]caffolding is a type of property that, when set in place, does not require operation by human presence. The customer’s possession and use of the scaffolding is the essence of the transaction, and is certainly not an inconsequential element of a service transaction.” Therefore, the Department will apply sales tax to the daily or other periodic rate for the furnishing of scaffolding.

The Department also opines that at this time it will not apply sales tax to any separately stated charges for the delivery and pick up of leased or rented property, including scaffolding. Similarly, the Department will not apply sales tax to separately-stated, additional charges for the set-up and tear-down of the scaffolding and for the on-site presence of owner personnel who advise lessees in the proper and safe use of the scaffolding, provided that these additional services are optional to the customer and the periodic lease or rental rates for the scaffolding are not affected by the customer’s decision to purchase or decline the additional,, optional services. If the additional services are included in a single charge for the furnishing of the scaffolding, or if the purchaser does not have the option of purchasing or declining the additional services, the entire charge to the customer will be considered a taxable lease or rental.

Scaffolding and other durable tangible personal property purchased by scaffolding providers for the exclusive purpose of leasing or renting the scaffolding as tangible personal property are excluded from sales/use tax as provided in La. R.S. 47:301(10(a)(iii).

Because of apparent uncertainty in the industry, the revenue ruling provides that the revenue ruling will be applied only on a prospective basis from the date of issuance for dealers “who have not collected the sales tax on these transactions, but who themselves paid the sale or use tax on the scaffolding as property being used in rendering non-taxable services ….” Dealers that elect to apply the ruling on a prospective basis “…will not be recognized as eligible to have made tax-free purchases or importations of scaffolding, as provided by La. Rev. Stat. Ann. §47:301(10)(a)(iii).” From the effective day forward, according to the Department, all dealers will be required to collect state sales/use tax on leases or rentals of scaffolding regardless whether the sales/use tax was paid on particular units of property that are leased or rented after the effective date of the ruling.

Taxpayers should read this revenue ruling together with Revenue Ruling No. 06-012 (commercial trash containers and trash collection services) and Revenue Ruling No. 06-013 (portable toilet facilities). Taxpayers may find it hard to reconcile the three rulings.

d. Revenue Ruling No. 07-006 (October 15, 2007) (Taxability of Transactions Involving the Copying of Medical Records). This ruling addresses two situations. Situation 1 addresses the furnishing of copies of medical records by a medical provider (or member of such provider’s staff) to a patient. The ruling concludes that the transaction is excluded from the sales tax under the work product exclusion because the patient is requesting the copies from a person who is in the business of rendering professional medical services.

Situation 2 addresses a provider of health care information services that contracts with a hospital or medical provider to make copies of medical records for a fee over a period of time. Some copies are made for the internal use of the hospital and some are made to fulfill the requests of patients. The Department first notes that, in this situation, the work product exclusion does not apply because the medical provider is not making the copies for its patients. Analyzing this set of facts, the ruling makes a distinction between billing methods.

If the provider charges a flat fee where the copies stay in house or where the healthcare provider is obligated to provide those copies to another party without billing), then there is no sale of property. In this case, the provider is providing a taxable service to the provider that is sourced to the location where the copies were made. If the copies are invoiced with

fees charged per copy/reproduced image, the transaction is treated as a taxable sale of tangible personal property that is sourced to where the copies are delivered.

The ruling holds that the following charges must be included in the tax base: (a) Retrieval Fee – a mandatory flat fee charged for locating the records to be

copied.

(b) Quickview Fees – a fee to electronically access and view the copies via the internet.

(c) Per-page Fee – a mandatory fee for each page of the medical record scanned or copied.

(d) Handling Fee – a mandatory fee for costs “associated” with the mailing of the copies (compare to postage fee).

The ruling also holds that the following charges are not included in the tax base if separately stated on the invoice:

(a) Postage Fees – If two conditions are met: (i) the fees are separately stated and represent charges for actual delivery or transportation of the property; and (ii) the place of the sale and the fact that the transportation is rendered subsequent to the sale and purchase for the buyer’s account is clearly determinable from the invoice.

(b) E-Disclosure Fee – Fee to track and confirm the status of the information being delivered.

(c) Certification Fee, Notarization Fee and Deposition Fee – Fees to certify information, fee to notarize the information, and to affirm that the information is suitable to be utilized in a legal deposition. The ruling holds that these services are optional professional services and are not part of the sales price.

(d) Docustore Fee – A fee to electronically store information.

e. Revenue Ruling No. 07-007 (October 15, 2007) (Furnishing of Construction Barricades

and Associated Lighting Equipment). The ruling holds that the furnishing of construction barricades, lighting, and fencing (typically found at construction sites) are taxable as leases. The tax base includes the charges for the lease as well as any charges for bulb replacement or other maintenance of the property while the property is in service. Separately stated charges for delivery and pick up of the property by the lessor are not included in the tax base.

f. Revenue Ruling No. 07-008 (October 15, 2007) (Federal Credit Card Purchases). The United States Government is exempt from state sales taxes under the Supremacy Clause of the United States Government. A variety of banks issue federal credit cards, the charges on which are billed directly to the federal government. The federal government issues these cards to its employees. The ruling addresses the issue of whether federal government employees can purchase goods and services exempt from sales tax without providing a tax exemption certificate if the purchase is made with a centrally billed government credit card. The ruling holds that merchants are allowed to accept a federal credit card that is billed directly to the federal government in lieu of a sales tax exemption certificate. The merchant must require identification establishing the person’s identity and status as a U.S. Government employee, such as an employee photo identification card, and the merchant must note the government employees’ identification number and agency on the merchant copy of the sales receipt and retain that receipt for its records. The ruling also notes that

federal credit card transactions that are billed to the employee are generally not exempt from sales taxes.

g. Revenue Ruling No. 07-009 (October 25, 2007) (Taxability of Manufactured Homes Immobilized by Dealers). The facts of the ruling are: dealer purchases a manufactured home from the manufacturer; places the new manufactured home on a tract of land owned by the dealer and files an act of immobilization. The dealer then sells the manufactured home with the land to a customer as immovable property. The ruling concludes that the dealer owes sales tax on its purchase of the new manufactured home. Under current Louisiana law, 46% of the sales price of the sales price of a new manufactured or mobile home is subject to tax and 54% is excluded from tax. The Department concluded that the dealer was transforming an item of tangible personal property into real property when the dealer filed the act of immobilization. By doing that, the Department found that the dealer was taking on the responsibilities of a contractor, and that contractors are treated as the ultimate consumer of materials incorporated into the immovable and is taxed on the purchase of those materials. As the dealer is “using” the manufactured home, it is not “reselling” the home to its customer.

h. Revenue Ruling No. 07-002A (October 22, 2007) (Additional Information Concerning Prospective Application of Word of Life Case). In this ruling, the Department clarifies certain aspects of Revenue Ruling No. 07-002 (May 22, 2007), which provided guidance regarding the Department’s interpretation and application of Word of Life Christian Center v. West, 936 So.2d 1226 (La. 2006). In Revenue Ruling No. 07-002A, the Department provides that it will apply the decision in Word of Life prospectively from July 1, 2007, with regard to the Louisiana use tax liability for owners of airplanes that are imported into Louisiana. The addendum clarifies certain questions that arose with regard to the prospective application of the case. In the addendum, the Department opines that it will apply the less restrictive interpretation of “bona fide interstate commerce” to airplanes that were imported into Louisiana before July 1, 2007, and that remained in the state after that date. Thus, aircraft that qualified for the use tax exemption under the law prior to the Word of Life case will continue to qualify for the use tax exemption on original aircraft using the less stringent standards under prior case law. The ruling also notes that the standards established by the Louisiana Supreme Court in Word of Life will be applied with respect to airplanes imported into Louisiana on or after July 1, 2007, and on replacement parts or additions to aircraft made after July 1, 2007, to aircraft that arrived in the state prior to July 1, 2007.

i. Revenue Ruling No. 08-002 (January 29, 2008) (Sales Tax Applicable to Country Clubs). This ruling holds that dues paid to a tax-exempt, private country club are subject to sales tax as a sale of admissions to places of amusement, to athletic entertainment other than that of schools, colleges, and universities, and recreational events, and the furnishing, for dues, fees, or other consideration of the privilege of access to clubs or the privilege of having access to or the use of amusement, entertainment, athletic, or recreational facilities. The Department rejected the club’s argument that it was a non-profit civic organization because the club does not make its facilities open to all members of the public. The ruling also holds that the club is not exempt from sales taxes on materials purchased for use in repair or renovations of real property.

j. Revenue Ruling No. 08-003 (February 4, 2008) (Sales Tax Exemption as Medical Drug for

Dermal Filer Substances). “Dermal fillers,” such as Botox, are held to be “drugs,” the sale of which is not subject to the state sales tax.

k. Revenue Ruling No. 08-006 (March 26, 2008) (Definitions for State Sales Tax Holiday on Purchases of Hurricane-Preparedness Items). Act 429 of the 2007 Regular Session provided for an annual state sales tax holiday on the last Saturday and Sunday of each May for purchases of hurricane-preparedness items. Sales of otherwise eligible hurricane-preparedness items are not eligible for exemption when sold at certain types of businesses, including airports, public lodging establishments or hotels, convenience stores or

entertainment complexes. This revenue ruling provides the Department’s interpretation of what constitutes an airport, a public lodging establishment, a hotel, a convenience stores and an entertainment complex.

2. Revenue Information Bulletins (“RIB”)

a. RIB No. 07-024 (September 17, 2007). This RIB explains the exemption for off-road vehicles purchased by certain buyers domiciled in other states.

b. RIB No. 07-026 (September 20, 2007). Act 173 enacts La. R.S. 47:301(14)(iii))(aa) and (bb) to provide that taxable “sales of services” shall not include labor, or sale of materials, services, and supplies, used for repairing, renovating or converting of any drilling rig, or machinery and equipment which are component parts thereof, which is used exclusively for the exploration or development of minerals outside the territorial limits of the state in Outer Continental Shelf waters. For purposes of the new exclusion, the term “drilling rig” is defined as any unit or structure, along with its component parts, that is used primarily for drilling, work over, intervention, or remediation of wells used for exploration or development of minerals. “Component parts” means any machinery or equipment necessary for a drilling rig to perform its exclusive function of exploration or development of minerals.

This provision is the enactment as an exclusion of a similar provision that already existed as an exemption that has been fully since July 11, 2005. Additional details concerning the earlier exemption are addressed in RIB No. 07-016, which can be accessed from the Department’s web site at http://www.revenue.louisiana.gov/forms/lawspolicies

Act 173 amends R.S. 47:301(14)(g)(i)(bb) relative to the sales tax exclusion on repair services rendered in Louisiana when the repaired property is delivered to customers outside the state. This exclusion continues to be mandated to apply to state sales taxes on repair transactions, and continues to be optional and allowable at the discretion of local sales tax authorities in 63 of the state’s 64 parishes. Act 173 provides, however, that the exclusion will apply to tax levies in parishes with populations between 21,300 and 21,450 according to the most recent federal decennial census. According to the 2000 federal census, the only parish in that population range is East Feliciana.

La. R.S. 47:337.10(L) permits, but does not require, authorities in parishes with populations between 45,000 and 48,250, according to the most recent federal decennial census, to conduct sales tax holidays at the same time and in the same manner as the state sales tax holiday authorized by Senate Bill No. 3 of the 2007 regular session of the Legislature, or by any other Act of the 2007 regular session or any other session that provides for annual sales tax holidays. According to the 2000 federal census, the only parish within this population range is St. Charles.

c. RIB No. 07-028 (September 20, 2007). This RIB explains the major changes to the advance sales tax provide by Act 393 of the 2007 regular session of the Louisiana legislature.

d. RIB No. 07-030 (September 20, 2007). This RIB explains Act 209 of the 2007 Regular Session of the Louisiana Legislature, which amended and reenacted La. R.S. 47:305.50 relative to the sales tax exemption for trucks operating in interstate commerce. The Act became effective June 29, 2007. The Act retained the existing exemption from sales tax for trucks with a gross weight of 26,000 pounds or more and associated trailers if the trucks and trailers are used at least 80% of the time in interstate commerce, and their activities are subject to the jurisdiction of the United States Department of Transportation. Language was added to the existing exemption to provide that the determination of whether a truck is used at least 80% of the time in interstate commerce is based solely on the actual mileage of each truck, and that no truck shall have more than twenty percent Louisiana intrastate mileage.

In order for a truck to be a qualifying truck, it must meet the following provisions specified by Act 209: i. Be registered as a Class 1 vehicle as defined in La. R.S. 47:462 and shall have a

registered gross weight as defined in La. R.S. 47:451 of at least eighty thousand pounds;

ii. Be subject to the jurisdiction of the United States Department of Transportation; and

iii. (Will be registered or is registered with apportioned plates through the International Registration Plan or will be issued or is issued a special permit according to the provisions of La. R.S. 32:387(J) from the Louisiana Department of Transportation and Development.

The Act provides that a “qualifying trailer”, for purposes of the additional exemption added to La. R.S. 47:305.50, shall be a trailer which is subject to the jurisdiction of the United States Department of Transportation.

e. RIB No. 08-013 (March 27, 2008). This RIB addresses certain issues regarding which supplies qualify for the sales tax exemption as hurricane preparedness supplies, storm shutters, and return filing procedures for such sales.

3. Private Letter Rulings

a. PLR 07-015 (December 4, 2007) (What is the Applicability of Sales or Use Tax to a Replacement Vehicle under the Louisiana “Lemon” Law or Through Manufacturer’s Warranty)? Louisiana’s “lemon law” provides for certain remedies if the manufacturer of passenger motor vehicles, its agents or authorized Louisiana dealers do not conform the vehicle to an express warranty by repairing or correcting any defect or condition that substantially impairs the use and value of the motor vehicle to the consumer. Those remedies include replacement of the vehicle with a new vehicle, or accept the return of the vehicle from the consumer and refund the full purchase price. The Department addressed certain sales and use tax issues that arise in connection with these transactions.

The Department ruled that it will not consider a substitution of a vehicle under these circumstances as a “return” and “sale” to the original customer. As long as the substitute vehicle is the value of the original vehicle and the substitution is a bona fide replacement under the warranty or lemon law, the replacement does not trigger a sales tax.

If the original vehicle had been used so that an additional sum is due by the purchaser to the dealer, that sum is taxable as a new transaction. If the purchaser upgrades the vehicle in the replacement, the cost of the upgrade or additional purchased options are a separate sales tax transaction and sales tax is due by the purchaser.

The service provided by the dealer and compensated for by the manufacturer in facilitating the substitution of the vehicle is not a taxable service.

The Department has no specific form for documentation purposes. However, the dealer must retain documentation that shows that the vehicle substitution is triggered by causes sufficient to require the dealer or manufacturer to accept the first vehicle and substitute the second vehicle in fulfillment of warranty requirements.

4. Notices of Intent to Adopt Rules

a. Rule LAC 61:I.4351 (Sept. 21, 2007) (Returns and Payment of Tax). This rule provides guidance to taxpayers concerning the filing of sales tax returns. The Department has traditionally approved applications of dealers to combine the sales tax filing data from several locations of the same legal entity into a single monthly or quarterly sales tax return, and will continue to do so.

The proposed rule provides that when a dealer operates a location within the boundaries of a tax increment financing district, the Department might require that the sales tax data for the location within the district be reported on a separate return. The Department may also require a dealer to file a separate return in any other instance where tax data is required for an individual sales location.

The proposed rule also provides rules with respect to the filing of quarterly sales tax returns and for the filing with the Department of returns for periods other than a calendar month or quarter. The filing of quarterly sales tax returns with political subdivisions of the state is not affected by the proposed rule.

III. TAX PROCEDURES AND OTHER ADMINISTRATIVE DEVELOPMENTS

A. Legislative Developments [None to Report]

B. Judicial Developments

1. Bridges v. Hertz Equipment Rental Corp., No. 07-717 (La. App. 5th Cir. 01/22/08). The Louisiana Department of Revenue filed suit against Hertz Equipment Rental Corp. (“Hertz”) to collect estimated sales and use taxed for the tax periods January 1, 1999 through December 31, 2003. Relying on prescription waivers signed by a former employee of Hertz, Mr. Cordova, the Department claimed its suit was timely filed. Hertz disagreed, providing evidence that the waivers were invalid because Mr. Cordova was not authorized by the corporation to waive Hertz’s right to prescription. The Department countered with evidence that Mr. Cordova had apparent authority to act on behalf of Hertz with respect to the waivers: Mr. Cordova held himself out to the Department as the Director of Tax Audits for Hertz, which title he used in signing the prescription waivers, he was the Department’s only contact person at Hertz, he informed the Department that all waivers were to be directed to him, and he had represented Hertz at a Board of Tax Appeals hearing on a previous audit involving Hertz.

The trial court determined that Mr. Cordova did not have the authority to execute a binding waiver of prescription on behalf of Hertz and that consequently, the Department’s claim had prescribed. The Louisiana Fifth Circuit Court of Appeal found no manifest error with this determination and provided further support for it by applying the case of Bridges v. X Communications, Inc., 03-441 (La. App. 5 Cir. 11/12/03), 862 So.2d 592, writ denied, 03-3431 (La. 2/2/04), 866 So.2d 830, in which the court held that the authority to act on behalf of a corporation in executing a prescription waiver could only be conferred by the charter, bylaws, or by resolution of the board of directors. Reliance by the Department on perceived apparent authority was not sufficient to bind the taxpayer to a waiver of prescription.

In accordance with X Communications, Inc., the Fifth Circuit found that although Mr. Cordova may have had perceived apparent authority to bind Hertz to the prescription waivers, he did have the express power to do so, as he was not an officer or director of Hertz, nor authorized to act on behalf of Hertz pursuant to Hertz’s charter, bylaws, or by corporate resolution. Therefore, the prescription waiver was invalid, and consequently, the Department's claims were prescribed.

PRACTICE TIP: In the wake of the two cases discussed above, the Department is strictly enforcing all aspects of RIB No. 07-011 (April 3, 2007) (Signatures Required to Execute Binding Agreements).3 Non-individual taxpayers should take the necessary steps to make sure that a person signing an agreement with the Department has the requisite authority to sign the agreement and bind the entity. This applies to settlement agreements, agreements to abide by pending cases and waivers of prescription, just to name a few.

LEGISLATIVE ACTION: Thankfully, there is a bill pending in the Louisiana Legislature that would clarify the law in this area and relive both taxpayers and the Department from the administrative burdens resulting from the two cases discussed above. House Bill No. 1188, 2008 Reg. Sess. by Rep. Greene will amend the law to provide for the authority for persons to

3 This RIB originally was issued on March 27, 2007, and was updated on April 3, 2007, to include the Voluntary Disclosure Coordinator as one of the Secretary’s delegates who can sign agreements to bind the Department.

sign tax returns and agreements with the Department. This bill is a joint effort of the Department and the business community.

C. Administrative Developments

1. Revenue Information Bulletins

a. RIB No. 07-032 (October 12, 2007). Tax Relief for Victims of Tropical Storm Erin in Texas. This RIB provides tax relief for taxpayers in the Texas Presidential Disaster Area that was struck by Tropical Storm Erin on August 14, 2007. The disaster area consists of Bexar, Harris, Jones, Kendall, Medina and Taylor counties. The relief is available to individuals who live and businesses whose principal place of business is located in the covered disaster area and taxpayers not in the covered disaster area, but whose books, records, or tax professionals’ offices are in the covered disaster area. Deadlines for affected taxpayers to file returns and pay taxes from August 14, 2007, through December 3, 2007, will be postponed until December 3, 2007, and delinquent penalties assessed during this period will be abated. In addition, delinquent penalties for employee withholding payments due August 14, 2007, through August 29, 2007, will be abated as long as the payments were made by August 29, 2007.

b. RIB No. 07-033 (October 15, 2007) Acceptance of Faxed or Emailed Signatures. The Louisiana Uniform Electronic Transactions Act, La. R.S. 9:2601 et seq., provides for the use and acceptance of electronic signatures by governmental agencies. Section 2602 defines “electronic signature” to mean an electronic sound, symbol, or process attached to or logically associated with a record and executed or adopted by a person with the intent to sign the record.

This RIB also lists examples of signed documents the Department will accept by fax or email as having valid signatures to include:

i. Initial Taxpayer Inquiry Regarding Refund;

ii. Claim for Refund of Taxes Paid;

iii. Request for Waiver of Penalty for Delinquency;

iv. Abatement of Interest Request;

v. Individual Income Tax Name and Address Change Form;

vi. Business Taxes Address Change Form;

vii. Application for Extension to file Partnership and Fiduciary;

viii. Extension for Composite Partnership, NR Professional Athlete, or NR Team Composite;

ix. Request for Louisiana Tax Assessment and Lien Payoff;

x. Offer in Compromise;

xi. Requests for Installment Agreements;

xii. Tax Information Authorization;

xiii. Authorization Agreement for Electronic Funds Transfer;

xiv. Central Registration Application (Form CR-1).

c. RIB No. 08-001 (January 1, 2008) (2008 Interest Rate Collected on Unpaid Taxes). This RIB sets the interest rate on unpaid taxes at 12.5% for the calendar year 2008.

d. RIB No. 08-002 (January 1, 2008) (2008 Judicial Interest Rate to Be Paid on Refunds). This RIB sets the interest rate to be paid on refunds and credits at 8.5% for the calendar year 2008.

2. Adopted Rules

a. Adopted Rule LAC 61:III.1501 (November 19, 2007) (Compensated Tax Preparers to Submit Certain Returns Electronically). This rule requires tax preparers to file certain individual income tax returns electronically beginning in 2008. Act 452 of the 2006 Regular Session of the Legislature amended La. R.S. 47:1520(A) to authorize the Secretary of the Department to require certain tax preparers to file returns electronically under certain circumstances and to require that the electronic filing requirements be implemented by administrative rule in accordance with the Administrative Procedure Act.

Individual income tax returns prepared by a tax preparer that prepares more than 100 Louisiana individual income tax returns during any calendar year are required to be filed electronically in accordance with the following requirements. For returns due on or after January 1, 2008, 30% of the authorized individual income tax returns must be file electronically. For returns due on or after January 1, 2010, 60% of the authorized individual income tax returns must be filed electronically. For returns due on or after January 1, 2012, 90% of the authorized individual income tax returns must be filed electronically.

a. Adopted Rule LAC 61:III.1532 (April 20, 2008) (Payment of Taxes by Credit or Debit Cards). This Emergency Rule, effective December 12, 2007, provides special provisions for payment of taxes by credit or debit cards. Specifically, this Emergency Rule provides that when a credit or debit card is accepted as a method of payment of taxes, matters concerning the payment are subject to the applicable error resolution procedures of the Truth in Lending Act, the Electronic Fund Transfer Act, or similar provisions of state law, only for the purpose of resolving errors relating to the credit card or debit card account, but not for resolving any errors, disputes, or adjustments relating to the underlying tax liability. This Emergency Rule also provides the limited purposes and activities for which information relating to payment, or processing of payment, of taxes by credit and debit card may be used or disclosed by card issuers, financial institutions, and other persons involved in the transaction. This Rule remains in effect for a period of 120 days from enactment or until effective through the normal promulgation process, whichever comes first.

IV. TRENDS/OUTLOOK FOR 2007/2008

A. Louisiana State and Local Taxpayers Bill of Rights

It has been several years since the business community sought to add some teeth to the taxpayers’ bill of rights in Louisiana. The time has come for the business community to rise up and once again demand a real taxpayers’ bill of rights with some teeth. Business taxpayers continue to grapple with rampart, arbitrary assessments by the Department and local tax collectors, law suits by the Department and local tax collectors even before an audit has began or been completed, multiple audits by multiple parishes using multiple contract audit firms, referrals of state and local tax cases to outside counsel who are entitled to attorneys’ fees of up to 10% of the amount due if the government is successful, aggressive claims by tax collectors that have little basis in fact or law without the ability of a winning taxpayer to get a reimbursement for its attorneys’ fees, just to name a few. It is time to reconsider an effort to seek the enactment of a state and local taxpayer’s bill of rights with teeth! As discussed at the beginning of this outline, the legislature will address measures to rid the world of contingency fee auditors and lawyers in tax matters. In addition, there is proposed legislation to get rid of the 10% attorney fee penalty presently on the books. Taxpayers must get involved in the process to get these measures passed.

B. “Loophole” Legislation

Unlike many states, the Louisiana Legislature has not been too aggressive in pushing for the so-called “loophole closing legislation” that we have seen in other states. Although the Louisiana Legislature previously has considered combined reporting, there seems to be no current initiative to enact combined reporting in Louisiana. Nevertheless, as discussed above, the Department continues its efforts to “force combination” in certain cases based on its perceived authority in La. R.S. 47:287.480. The scope of the Department’s authority under current law will be tested in litigation.

V. PROVIDER’S BRIEF BIOGRAPHY/RESUME

Bill Backstrom leads Jones Walker’s State and Local Tax Practice team. Bill has over 26 years of experience in state and local tax matters both in Louisiana and on a multistate basis. Bill’s pertinent contact information is as follows:

William M. Backstrom, Jr. Jones Walker Law Firm 201 St. Charles Ave., Suite 5100 New Orleans, LA 70170-5100 Telephone: 504-582-8228 E-Mail: bbackstrom@joneswalker.com Web site: www.joneswalker.com

MASSACHUSETTS STATE DEVELOPMENTS Kathleen King Parker Choate, Hall & Stewart LLP Two International Place Boston, MA 02110 Tel: 617-248-5018 Fax: 617-248-4000 Email: kparker@choate.com Web: www.choate.com I. INCOME/FRANCHISE TAXES A. Legislative Developments

Update on Legislation. It is almost certain that the Legislature will pass two major parts of the Governor’s corporate tax reform proposals: full conformity to the federal check-the-box rules and mandatory combined reporting. Mandatory combined reporting has raised several important issues in public debate and behind-the-scenes maneuvering. The business community and the Massachusetts Department of Revenue (“MDOR”) disagree about whether a consolidated return election should be allowed; whether U.S.-incorporated companies with more than 80% of their property, payroll and receipts outside the U.S. should be exempt; how combined apportionment should actually be calculated where financial institutions are in a group with non-financial institutions; and whether a new deduction for changes in deferred tax assets or liabilities should be allowed. They also are debating the less technical issue of how much discretion the MDOR should be given in the regulations they will need to issue to implement combined reporting. In the course of these debates, MDOR has noted that combined reporting will generate $200 - $300 million in new tax revenue, and more than half of which is attributable to 20 to 40 large multinational corporations. For good reason, COST is following this legislation closely. B. Judicial Developments REIT Dividends. The Massachusetts Appellate Tax Board (“ATB”) upheld MDOR’s disallowance of the dividends-paid deductions of two Massachusetts REITs, because the deductions were the result of a sophisticated state-tax savings plan and thus lacked economic substance and business purpose. Fleet Funding v. Commissioner of Revenue, ATB Docket No. C271862-63 (2008). Although the taxpayer showed that it also intended to use the structure as a vehicle to raise capital and so did have a business purpose, the ATB refused to accept this. The taxpayers have appealed. Nexus. The ATB ruled that a California corporation that sold its products to Massachusetts customers did not prove that its Massachusetts activities were within the protection of P.L. 86-272. Advanced Logic Research, Inc. v. Commissioner of Revenue, ATB Docket No. C271740, C271871 (2008). The taxpayer had filed corporate excise tax returns for the periods at issue but decided later that it did not have nexus and sought abatement accordingly. According to the ATB, the taxpayer’s witnesses did not demonstrate enough knowledge of taxpayer’s activities in Massachusetts to overcome the fact that the taxpayer actually had filed tax returns. To the ATB, the filing of those returns showed that the taxpayer thought it had nexus at the time. C. Administrative Developments Voluntary Disclosure. Since 1996 MDOR has had a Voluntary Disclosure Agreement program under which, generally, a taxpayer that voluntarily discloses past due filing obligations is subject to a three-year lookback period and possibly waiver of penalties, while a taxpayer that MDOR finds is subject to a seven-year lookback period. MDOR has now changed these terms for two kinds of taxpayers because it believes those taxpayers should not have had any reasonable doubt as to their Massachusetts filing obligations. TIR 08-4 (March 24, 2008). The affected taxpayers are those whose facts are similar to those in two cases that MDOR has won in the last year, Geoffrey, Inc. v. Commissioner of Revenue, ATB Docket No. C271816 (2007), and Capital One Bank v. Commissioner, ATB Docket No. C262391, et al. (2007), both of which cases are on appeal to the Supreme Judicial Court. Thus intangible holding companies and financial institutions with credit card customers in Massachusetts are the taxpayers in MDOR’s sights for the new harsher VDA policy. The new terms for these taxpayers are a five-year lookback period, unlikely waiver of penalties, and taxpayers must identify themselves and notify MDOR by September 30, 2008, that they wish to participate in this voluntary disclosure and file returns and pay all tax interest and penalties by December 31, 2008. The TIR does not explain exactly what happens to affected taxpayers that do not comply, but the implication is that it will be unfavorable.

D. Trends/Outlook for 2008/2009 II. TRANSACTIONAL TAXES A. Legislative Developments Update on Legislation. The Governor’s tax reform proposal originally contained a provision that would have eliminated the sales/use tax exemption on airplanes and airplane repairs. It appears now that the exemption will survive, though that is not certain until some legislation actually passes. If plans include purchase of an airplane for use in Massachusetts, it is advisable to check on the status of this exemption. B. Judicial Developments Services. The ATB decision that mail room services are subject to sales tax has been reversed by the Massachusetts Appeals Court. Pitney Bowes Management Services v. Commissioner of Revenue, Dkt. No. 06-P-2020 (12/17/2007) (unpublished). The ATB had found that because taxable tangible personal property and non-taxable services had been billed together on the same invoice, they were inseparable, which caused the services to be taxable. The Appeals Court disagreed and found that where the taxpayer was able to show how much of the amount billed was services, that was sufficient regardless of the terms of the invoice. C. Administrative Developments D. Trends/Outlook for 2008/2009 III. PROPERTY TAXES A. Legislative Developments Update. Still in play is a proposal that would eliminate the local property tax exemptions on certain personal property of telephone companies. The telecommunications companies have opposed the bill, but cities and towns are desperately seeking new sources of funds. It is not known how this will turn out. B. Judicial Developments Wireless Telephone Services. The Supreme Judicial Court has ruled that a provider of wireless cellular telecommunications services is not a telephone company for purposes of a statute requiring central valuation of personal property of telephone companies. Bell Atlantic Mobile of Massachusetts Corporation v. Commissioner of Revenue, _____ Mass. _____ (April 28, 2008). This means that each city and town in which a cellular service provider has property will value the property and tax it. The decision also means that a property tax exemption available to other telephone service providers is not available to cellular service providers. Other Telephone Company Changes. The ATB has issued two more decisions changing the property taxation of telephone company property. In In re Verizon New England, ATB Docket No. C273560 (2008), the Board held that telecommunications companies are subject to tax on poles and wires erected on public ways, even though for many years this property was treated as exempt. In In re MCI Valuation Appeals, ATB Docket No. C269462 (2008), the Board ruled that construction work in progress is property subject to tax, even though this property too had for many years been treated as exempt. C. Administrative Developments D. Trends/Outlook for 2008/2009 IV. PROVIDER’S BIOGRAPHY Kathleen King Parker, partner, is a member of Choate’s Tax Group. Ms. Parker’s practice concentrates on state tax matters and state tax litigation. She also has significant experience in federal and local tax matters, including multi-state tax planning.

Before joining Choate, Ms. Parker served in state government as an Assistant Attorney General, Assistant District Attorney, and Chief of the Rulings and Regulations Bureau of the Massachusetts Department of Revenue. Ms. Parker is past Chair of the National Association of State Bar Tax Sections, past Chair of the Tax Section of the Boston Bar Association and past Chair of its State Tax Committee. Ms. Parker is active in the State and Local Tax Committee of the Taxation Section of the American Bar Association, Author of the Massachusetts Chapter of the ABA Sales & Use Tax Desk Book, and an editor of The State and Local Tax Lawyer. In addition, she is a Trustee of the Massachusetts Taxpayers Foundation. She speaks and writes frequently on tax law and related subjects.

MARYLAND STATE DEVELOPMENTS KURT J. FISCHER MELISSA L. MACKIEWICZ DLA PIPER US LLP 6225 Smith Avenue Baltimore, Maryland 21209 410-580-3000 410-580-3001 facsimile kurt.fischer@dlapiper.com melissa.mackiewicz@dlapiper.com website: http://www.dlapiper.com I. INCOME/FRANCHISE TAXES

A. LEGISLATIVE DEVELOPMENTS Chapter 3 of the Laws of the 2007 Special Session of the Maryland General Assembly (the “Maryland Tax Reform

Act of 2007”) amends § 2-106 (f) of the Tax-General Article to provide that the required withholding on wages for all tax years beginning after December 31, 2007 is to be calculated without regard to the marginal State income tax rates less than 4.75 %.

The Maryland Tax Reform Act of 2007 revises state income tax rates for all tax years beginning after December 31, 2007 under § 10-105 of the Tax-General Article for individuals, spouses filing jointly, and a surviving spouse or head of household. Additionally, the Maryland Tax Reform Act of 2007 amends § 10-912 of the Tax-General Article to provide that in a sale or transfer of real estate and associated personal property owned by a nonresident or nonresident entity, the instrument effecting the change of ownership cannot be recorded without payment of either (1) the sum of the rate of the tax imposed under § 10-106.1 and the top marginal state tax rate for individuals, applied to the total payment to a nonresident, or (2) the rate of the tax for a corporation under § 10-105(b) of the total payment to a nonresident entity. This amendment is applicable to all tax years beginning after December 31, 2007. The Maryland Tax Reform Act of 2007 also amends § 11-105 of the Tax General Article to provide that from January 3, 2008, through June 30, 2011, the credit available to vendors for the expense of collecting the sales and use tax may not exceed $500 for each return, and for a consolidated return the total maximum credit that the vendor is allowed for all returns for any period is $500. The Maryland Tax Reform Act of 2007 raises the State income tax rate for a corporation, under § 10-105 (b) of the Tax General Article, to 8.25% of Maryland taxable income. This amendment is applicable to all tax years beginning after December 31, 2007. The Maryland Tax Reform Act of 2007 amends § 10-804 of the Tax-General Article to require that as of January 1, 2008, an individual who reports income or loss from a sole proprietorship or income or loss from real estate and royalties, partnerships and S corporations, estates and trusts, or real estate mortgage investment conduits, must attach a copy of the federal income tax return to its state income tax return. The section also adds the requirement that a corporation must attach to its income tax return, the statements required under § 10.804.1 of the Tax-General Article. Finally, the Maryland Tax Reform Act of 2007 adds § 10-804.1 to the Tax-General Article and provides reporting requirements for publicly traded corporations and corporations that are members of a corporate group as of January 1, 2008. If a publicly traded corporation is the member of a corporate group and the worldwide gross receipts of the group for the taxable year exceed $100,000,000, the statements required must also include, among other information, the difference in Maryland income tax that would be owed if the corporation were required to use combined reporting using the “water’s edge” method and the difference in tax that would be owed if the corporation were required to allocate 100% of the nonapportionable income to Maryland. The statements required under this provision must be filed annually for all taxable years beginning after December 31, 2005. The members of a corporate group must submit one combined report.

Chapter 10 of the 2008 Laws of Maryland, the “Budget Financing Act,” repeals the sales tax on computer services, enacted as part of the Maryland Tax Reform Act of 2007, and provided in § 11-101 of the Tax General Article. Tax provisions relating to the exemption of computer services which were in the effect prior to the 2007 Special Session of the Maryland General Assembly are thus restored.

Chapter 10 of the 2008 Laws of Maryland, amends § 10-105 of the Tax-General Article, to provide that for tax years 2008 through 2010, the income tax rate for taxable income between $500,000 and $1,000,000 is 5.5%. For taxable income in excess of $1,000,000, the taxable rate is 6.25%. B. ADMINISTRATIVE DEVELOPMENTS

In Classic Chicago Inc. v. Comptroller of the Treasury, 2008 WL 1724237 (Md. Tax Ct. April 11, 2008), Talbots, Inc., a parent corporation, and its wholly owned subsidiary, Classic Chicago, Inc. appealed tax assessments and penalties for royalty income received by the subsidiary from its parent over a period of ten years. Talbots, Inc. is a Delaware corporation with its principal place of business and commercial domicile during the taxable period in Hingham, Massachusetts. Classic Chicago, Inc. is a Delaware corporation with its principal place of business and commercial domicile in Chicago, Illinois throughout the taxable period. The petitioners asserted that no constitutional nexus with Maryland existed to permit Maryland to tax the royalty income paid by Talbots to Classic Chicago. The Maryland Tax Court disagreed and held that a constitutional nexus with a parent corporation in Maryland exists where an out-of-state affiliate has no real economic substance as a separate business entity. The Tax Court in Classic Chicago found that the subsidiary corporation had no economic substance as a separate business entity and therefore the activities of the subsidiary must be viewed through the activities of the operating parent corporation. The Tax Court found that the subsidiary had minimal operating expenses, little or no expenses for compensation of employees, and minimum expenditures for travel, maintenance, professional services, rent, etc. The royalty income paid to the subsidiary resulted entirely from transactions by the parent corporation. Furthermore, although the parent corporation made significant royalty payments to the subsidiary, the subsidiary thereafter made a substantial repayment to the parent corporation in the form of a dividend.

II. TRANSACTION TAXES

A. LEGISLATIVE DEVELOPMENTS

Chapter 6 of the Laws of the 2007 Special Session of the Maryland General Assembly (the “Transportation and State Investment Act”) amends § 11-104 of the Tax-General Article, modifying the sales and use tax for a taxable price of less than a dollar and for $1 or more. The amendments to § 11-104 also alter the sales and use tax for vending machine sales, so that such sales are taxed at 6% applied to 94.5% of the gross receipts. This amendment took effect on January 3, 2008.

The Transportation and State Investment Act amends § 11-302 of the Tax-General Article. Prior to this change which

became effective on January 3, 2008, this provision required that in a retail sale the sales and use tax be stated and charged separately from the sale price. Deleting the language, “and charged,” the provision requires only that the sales and use tax be stated separately from the sale price.

The Transportation and State Investment Act amends § 11-402 of the Tax-General Article, permitting a vendor as of

January 3, 2008 to assume or absorb all or any part of the sales and use tax imposed on a retail sale, and pay that sales tax on behalf of the buyer. The corresponding revision of § 11-601 of the Tax-General Article further requires that where a vendor assumes or absorbs the sale and use tax for a sale, the vendor must pay the sales and use tax on that sale with the return for the period in which the vendor made the sale.

Chapter 97 of the 2008 Laws of Maryland amends § 9-603 of the Political Subdivision Article to provide that as of

July 1, 2008, the Washington Suburban Sanitary Commission in Prince George’s County is not exempt from sales and use tax on energy or fuel used in Prince George’s County.

B. JUDICIAL DEVELOPMENTS

In Mayor and City Council of Baltimore v. Vonage America, Inc., 2008 WL 1757753 (D. Md., April 16, 2008), the City of Baltimore sought to impose the City’s Telecommunications Tax upon the Digital Voice services provided by Vonage to Maryland subscribers. The issue ultimately before the United States District Court was whether, by the language of the Telecommunications Tax statute, Vonage “leases, licenses, or sells a [wired or wireless connection … to an exchange, wireless, or other telecommunications service] … for wired service.” Art. 28, §§ 25-1(e), 25-2. In all calls other than those between two Vonage subscribers, a wired connection is required to complete the call. Vonage contended that the wired connection required for these calls is provided by third party providers, and not by Vonage. The District Court found that although these third parties provide the wired connections, these wired connections are included as necessary components of the Vonage service. Because Vonage is selling a service that includes the use of a “telecommunications line” within the definition of the City’s Telecommunications Tax, except as to calls between two Vonage customers, Vonage “leases, licenses, or sells a

communications line” within the meaning of Art. 28, § 25-2. Thus, Vonage is required to pay the City’s Telecommunications Tax.

III. PROPERTY TAXES

A. LEGISLATIVE DEVELOPMENTS Chapter 2 of the Laws of the 2007 Special Session of the Maryland General Assembly (the “Budget Reconciliation

Act”) enacts § 7-514 of the Tax-Property Article providing, when, and at what amount the governing body of a county may increase the percent of the assessment the personal property described in § 7-237 of the Tax Property Article. The provision permits a governing body of the county to enter into an agreement with the owner of a facility that generates electricity for a negotiated payment in lieu of taxes on the facility. The provision is applicable to all taxable years beginning after June 30, 2008. The Tax Reform Act of 2007 adds § 12-117 to the Tax-Property Article, which provides for the imposition of a recordation tax on the transfer of a controlling interest in a real property entity. This provision takes effect on July 1, 2008, and is applicable to all transfers of a controlling interest by a real property entity that occur after June 30, 2008. The Tax Reform Act of 2007 adds § 13-103 to the Tax-Property Article, which provides for transfer taxes imposed on the consideration payable for the transfer of a controlling interest in a real property entity, or on the value of the real property owned by the entity. This provision takes effect on July 1, 2008, and is applicable to all transfers of a controlling interest by a real property entity that occur after June 30, 2008. Chapter 75 of the 2008 Laws of Maryland, revises § 9-320 of the Tax-Property Article which permits St. Mary’s County to extend a property tax credit for any county property tax imposed on real property subject to a land preservation program operated by either the state or county. Prior to the revision, this subsection applied only specifically to real property subject to the Maryland Agricultural Land Preservation District Program or the St. Mary’s County Agricultural Land Preservation District 5-Year Program. This revision is applicable to tax years beginning after June 30, 2008. Senate Bill 465 of 2008 amends § 14-512 of the Tax-Property Article to decrease the time within which the Maryland Tax Court must hear and decide residential property tax assessment appeals. The prior time period of 120 days has been reduced to 90 days, unless the Court grants an extension at a party’s request. This amendment becomes effective on July 1, 2008. Chapters 334 and 335 of the 2008 Laws of Maryland revise numerous provisions of Title 14 of the Tax-Property Article to alter the tax sale process in Maryland. Title 14 was revised to increase the minimum total tax owed on a property, from $100 to $250, which permits the collector to withhold the property from tax sale. The changes require the collector to send notice to a specified person within 60 days of the tax sale. The revisions also alter the manner and terms by which a person redeeming a property shall pay the collector’s expenses, and provides that amounts required to stabilize and maintain a property become part of the redemption amount. Senate Bill 297 of 2008 creates § 10-711 of the Tax-General Article which reestablishes a program terminated in 2004, where an employer may claim a tax credit for 15% of the wages paid to secondary or postsecondary students between 16 and 23 years old who participate in approved work-based learning. The act takes effect July 1, 2008 and applies to all taxable years beginning after December 31, 2008. Senate Bill 597 of 2008 revises § 12-108 of the Tax-Property Article as of July 1, 2008 to exempt a transfer of property between two domestic partners and former domestic partners from the recordation tax and State and county transfer taxes. Specific evidence of the relationship, including an affidavit to prove the existence of the partnership is required to establish eligibility for this exemption. B. JUDICIAL DEVELOPMENTS In F.D.R. Srour Partnership v. Montgomery County, 2008 WL 821032 (Md. App., March 27, 2008), a developer challenged an assessment by Montgomery County of certain development impact taxes on the construction of warehouses on the developer’s property. Prior to July 1, 2002, the effective date of the impact tax codified in § 52-47, et seq. of the Montgomery County Code (2004), the developer had submitted an application for a permit to build a retaining wall on the subject property, and no impact tax was assessed. The developer subsequently submitted permit applications on

December 1, 2003 and March 23, 2004 for additional development on the subject property after the effective date of the impact tax. The developer argued that because its first permit application was submitted on June 6, 2002, which was before the impact tax effective date, its “development” began before the effective date. Thus, the developer argued that it acquired a vested right not to have its property taxes changed. The Tax Court, the Circuit Court, and the Maryland Court of Special Appeals rejected this argument. The Court of Special Appeals held that the impact tax applies to any developments for which a building permit is sought after the effective date of July 1, 2002, and that the filing of the first permit less than one month before the effective date of the impact tax did not grant the developer any vested rights that would exempt all subsequent permits from the impact tax. Stellar GT v. Supervisor of Assessments, 178 Md. App. 624 (2008), involved the issue of when the Supervisor of Assessments for Montgomery County is authorized by statute to revalue a property during the three-year period between regular valuations. In Stellar, an apartment building was assessed at roughly $52 million dollars in January 2004. The assessors neglected to thoroughly evaluate the property, and failed to consider existing improvements to the property, which led to a substantially undervalued assessment. In March 2004, the property sold for $89 million dollars. The Court of Special Appeals found that the disparity in the sale price so soon after the assessment brought the property to the attention of the Supervisor and prompted the Supervisor to reassess the property. Section 8-104(c) of the Tax-Property Article permits revaluation within the three-year period upon the occurrence of any of six enumerated events. The Supervisor argued that § 8-104(c)(iii) demands reassessment within the regular three-year assessment period where substantial improvements have increased the value of the property by more than $50,000. The Court of Special Appeals determined, however, that the Supervisor reassessed the property because of the sales price, and only later attempted to justify the mid-cycle reassessment on the basis on an increased value of improvements. The Court held that the Supervisor was not permitted under the statute to use the sale price of a property as a retroactive justification for a mid-cycle reassessment based on improvements that existed at the time of the regular three-year assessment. In Howard County v. Heartwood 88, LLC, 178 Md. App. 491 (2008), the Maryland Court of Special Appeals held that where the contractual terms of a tax sale permit, a tax collector can declare a tax sale void when an action to foreclose a right of redemption in a property is pending in circuit court and the local government that held the tax sale learns that the unpaid taxes for which the property was sold were never assessable. There, the State Department of Assessments and Taxation mistakenly assessed taxes against a property located in Howard County, Maryland. After the erroneously assessed taxes remained unpaid for two years, Howard County instituted a tax sale. The contractual terms of the tax sale provided that in the event the sale is voided, reimbursement was to be limited to the amount paid by the purchaser at the tax sale. The tax sale purchaser argued that Howard County did not have the authority to invalidate the tax sale. Rather, only the Circuit Court for Howard County had such power pursuant § 14-848 of the Tax Property Article. The purchaser sought to obtain payment of interest in addition to reimbursement of the purchase price under § 14-848. Howard County responded that under the contractual terms of the tax sale, it had the right to reimburse only the purchase price. The Court of Special Appeals agreed with Howard County finding that, by its plain terms, § 14-848 does not apply to a tax sale that is void from its inception due to an error in improperly assessing taxes where none are owed. The section only applies to cover a tax sale that was procedurally invalid or erroneous but correctable. In McPhail v. Comptroller of Maryland, 178 Md. App. 115 (2008), the appellant submitted a request to the Comptroller under the Maryland Public Information Act (“MPIA”) seeking a Maryland Real Estate Tax Return filed by her late mother’s estate. The Comptroller denied the request and stated that the MPIA contains has a mandatory exception which prohibits disclosure of tax information without a proper judicial or legislative order. The Court of Special Appeals held that the information in a Maryland real estate tax return falls within the definition of “tax information” and thus, may not be disclosed by the Comptroller’s Office under § 13-202 of the Tax-General Article. V. BRIEF BIOGRAPHY/RESUME OF PROVIDERS A. KURT J. FISCHER (B.A., magna cum laude, Phi Beta Kappa, Washington and Lee University, 1980; J.D.,

magna cum laude, Order of the Coif, Washington and Lee University Law School, 1982) is a partner with the Baltimore office of DLA PIPER US LLP.

B. MELISSA L. MACKIEWICZ (B.A., Florida International University, 1998; M.S, The University of Baltimore,

2002; J.D., The University of Baltimore, 2002) is an associate with the Baltimore office of DLA PIPER US LLP.

MAINE STATE DEVELOPMENTS Sarah H. Beard, Esq. PIERCE ATWOOD LLP One Monument Square Portland, Maine 04101 sbeard@pierceatwood.com (207) 791-1378 I. INCOME TAX/FRANCHISE TAX A. Legislative Developments Net Operating Losses Previously, Maine had disallowed the carryback of certain net operating losses (“NOLs”) that arose during tax years beginning on or after January 1, 1989 but before January 1, 1993 and those arising from tax years beginning on or after January 1, 2002. Carrybacks were also disallowed for NOLS arising in a tax year beginning or ending in 2001 for which federal taxable income was increased under the federal Job Creation and Worker Assistance Act of 2002. These NOLs may, however, be carried forward and subtracted from a taxpayer’s federal taxable income in future years to determine that taxpayer’s Maine taxable income. Under the new budget (PL 2007, c. 539, the “budget bill”), corporate income taxpayers may not claim a carryforward deduction of more than $100,000 per year of those disallowed carrybacks in tax years beginning in 2008. The intent is that taxpayers will be able to carryforward the excess above $100,000 to future tax years within the allowable federal period for carry-over. The $100,000 cap only applies to carryforwards of NOL carrybacks that were previously disallowed for Maine purposes. Under a separate enactment, beginning in 2008, corporate taxpayers must increase their income for state tax purposes by 10% of the value in excess of $100,000 of any net operating loss (NOL) carried over for federal income tax purposes to the taxable year. Also, during the allowable federal period for carryover of the loss plus one year, a corporate taxpayer may reduce its income for state tax purposes by the amount of a prior year’s NOL addition, provided that amount has not been previously used as a modification and the taxpayer’s income is not reduced below zero. See PL 2007, c. 700. Bonus Depreciation in Federal Economic Stimulus Package

Also as part of the budget bill, Maine has chosen not to allow the 50% bonus depreciation deduction that is available for federal income tax under the Economic Stimulus Act of 2008, primarily due to budget concerns. As a result, for the 2008 tax year, Maine taxpayers will need to increase their federal taxable income by an amount equaling the net increase in depreciation deductions attributable to bonus federal depreciation deduction for property placed in service during the tax year. For tax years starting on or after January 1, 2009, Maine taxpayers will be able to reduce their federal taxable income by an amount equal to the allowable depreciation deductions as if the bonus depreciations contained in the Economic Stimulus Act had never been enacted. New Credit for Rehabilitation of Historic Properties The budget bill provides a credit for rehabilitation of certified historic structures in Maine, provided that the credit may not be claimed for expenditures incurred before January 1, 2008 or after December 31, 2013. The credit equals 25% of the taxpayer’s qualified expenditures for which a credit is claimed under Internal Revenue Code Section 47 (to a maximum of $5 million for each project), or 25% of qualified expenditures equal or greater than $50,000 and up to $250,000 with respect to which no federal credit is claimed. The credit is increased to 30% if the project is also an affordable housing project. The credit is fully refundable and is to be claimed 25% in the taxable year in which the certified historic structure is placed in service and 25% in each of the next three taxable years. The bill provides for several additional limitations and a recapture provision. The bill also provides that the existing historic structures credit may not be claimed for expenditures incurred after December 31, 2007. New Amended Return Requirement for Partnerships and S Corps

Under PL 2007, c. 693, partnerships and S corporations that must file information returns in Maine are now required to file an amended Maine return whenever they file an amended federal return affecting their net income or the amount of the distributive share of any partner or shareholder. B. Judicial Developments Members of an LLC Cannot Claim Credit Against Maine Liability for Taxes LLC paid to New Hampshire

Maine’s Supreme Judicial Court, in an evenly split decision, has upheld a Superior Court ruling that individual Maine taxpayer’s may not claim as a credit any taxes their pass-through business entities pay to other states.

In a per curiam decision Maine’s Supreme Judicial Court has affirmed the Superior Court’s decision in Day v. State Tax Assessor, 2006 Me. Super. LEXIS 284. The Superior Court had held that Maine residents who were members of a New Hampshire LLC could not take a credit against their Maine individual income taxes for the business profits and business enterprise taxes the LLC had paid to New Hampshire. The Superior Court noted that under 36 M.R.S.A. § 5217-A, an individual Maine taxpayer may take a credit against the income tax he or she owes for the amount of tax imposed on that individual by another state. Because New Hampshire had taxed the LLC at the entity level the individual members could not take a credit for the taxes it had paid to that state.

On review, the Supreme Judicial Court was evenly divided, and therefore upheld the Superior Court’s ruling. Without a majority opinion resolving this issue, the question of whether Maine residents may obtain tax credits for taxes their business entities pay to other states is likely to produce more litigation in the future.

Day v. State Tax Assessor, 2008 Me. LEXIS 42 (March 4, 2008).

C. Administrative Developments Economic Nexus

Maine Revenue Services formally announced in a February, 2008 Maine Tax Alert that it considers taxpayers who have only an economic nexus with Maine, with no actual physical presence in the state, to be subject to Maine income tax. According to MRS, economic nexus exists when a taxpayer purposefully directs business activities into the state. Courts in other states have found that this, by itself, may be a sufficient basis for subjecting a taxpayer to their state’s income tax. MRS is following this trend, and notes that Rule 808 allows it to assert Maine’s tax jurisdiction to the full extent permitted by the Constitution and laws of the United States. MRS evidently believes that using economic nexus as a basis for imposing income tax on taxpayers is constitutionally permissible. Apportionment of Income

MRS has adopted a revised version of Rule 801, “Apportionment of Income.” The revisions primarily reflect the recent statutory change to require businesses to apportion their income between Maine and other states where they do business based solely on the sales factor. There is also new language on sourcing receipts from: (1) the performance of services; (2) the sale of patents, copyrights and trademarks; (3) the sale, lease or rental of real property; (4) the lease or rental of tangible personal property; (5) the sale of partnership interests; and (6) financial services provided by entities that do not fall within the Financial Institution Franchise Tax. The revised rule also allows the Assessor, in certain situations, to require a taxpayer to apportion its income by other methods, including the use of the property and payroll factors. Withholding Reports and Payments

Rule 803, “Withholding Tax Reports and Payments,” has been revised to incorporate the enactment of Rule 104 and the revision of Rule 102. New references to the thresholds for being required to file returns electronically or remit payment via EFT are found in sections 4(8) and 5(5).

Unitary Business Taxable Income and Combined Reports and Returns

MRS has also adopted a revised version of Rule 810, “Maine Unitary Business Taxable Income, Combined Reports and Tax Returns.” As with the changes to Rule 801, the revisions to Rule 810 primarily concern Maine’s switch to apportioning income based solely on the sales factor. New Rule on Claiming the Educational Opportunity Credit

The Maine Department of Education has adopted a new rule governing how to qualify for and obtain the Educational Opportunity Credit, which may claimed by a qualified college graduate or the graduate’s employer if certain conditions are met. To be eligible for the credit, a student must sign an Opportunity Contract as soon as possible after enrollment in an associate’s or bachelor’s degree program at a Maine college or university. In doing so, the student will certify that he or she is a Maine resident who agrees to live in Maine while pursuing a degree. Students are eligible for the credit after receiving their degrees. D. Trends/Outlooks

Audit Focus. Maine Revenue has been increasingly aggressive in asserting nexus on audit, in particular in examining whether foreign corporations that have claimed 86-272 protection have established nexus by hiring unrelated entities in Maine to perform services, apparently without regard to whether the services are related to the establishment or maintenance of a market in Maine. Maine Revenue’s publication of its position on economic nexus in February suggests that it will be asserting nexus against taxpayers engaged in sales of services or intangibles even more broadly.

II. SALES AND USE TAX/ SERVICE PROVIDER TAX

A. Legislative Developments Exemptions for Nonresidents Narrowed to Individuals Only

Under Maine Revenue Services’ “Technical Changes” bill, PL 2007, Ch. 438, exemptions for sales and leases to nonresidents of vehicles, aircraft, watercraft and certain other items was narrowed to nonresident individuals. Formerly, these exemptions also were specifically applicable to any nonresident legal entity such as a partnership, association or corporation. This change became effective September 20, 2007.

Exemption from use tax for property delivered outside of Maine is Narrowed

Under a subsequent “Technical Changes” bill, PL 2007, c. 627, the exemption from use tax for property delivered outside of Maine was amended to state that it does not apply to the subsequent use of that property within Maine. (This amendment was proposed by Maine Revenue in response to arguments made by aircraft owners that this exemption applied to aircraft that had been both purchased and delivered outside of Maine and subsequently brought into the state.)

Several Changes Made to Tax on Telecommunications Services

Also under PL 2007, c. 627, several definitions were amended and added to the Service Provider Tax relating to telecommunications services. Specifically, the new definition of telecommunications services reads as follows:

"Telecommunications services" means the electronic transmission, conveyance or routing of voice, data, audio, video or any other information or signals to a point or between or among points. "Telecommunications services" includes transmission, conveyance or routing in which computer processing applications are used to act on the form, code or protocol of the content for purposes of transmission, conveyance or routing without regard to whether the service is referred to as "Voice over Internet Protocol" services or is classified by the Federal Communications Commission as enhanced or value added. "Telecommunications services" does not include:

A. Data processing and information services that allow data to be generated, acquired, stored, processed or retrieved and delivered by an electronic transmission to a purchaser when the purchaser's primary purpose for the underlying transaction is to obtain the processed data or information;

B. Installation or maintenance of wiring or equipment on a customer's premises;

C. Tangible personal property; D. Advertising, including, but not limited to, directory advertising; E. Billing and collection services provided to 3rd parties; F. Internet access service; G. Radio and television audio and video programming services, regardless of the medium, including the

furnishing of transmission, conveyance and routing of those services by the programming service provider. Radio and television audio and video programming services include, but are not limited to, cable service as defined in 47 United States Code, Section 522(6) and audio and video programming services delivered by commercial mobile radio service providers as defined in 47 Code of Federal Regulations, Section 20.3;

H. Ancillary services; or I. Digital products delivered electronically, including, but not limited to, software, music, video, reading

materials or ringtones.

Prepaid calling services, international telecommunications services and interstate telecommunications services were excluded from the tax. Ancillary services that are associated with or incidental to the provision of telecommunications services will be subject to the Service Provider Tax.

Exclusion of Sales for Resale from “Retail Sale” Is Limited

Previously, “retail sale” subject to tax excluded sales for resale. Under PL 2007, c. 693, sales for resale are excluded only if the sale is to a retailer that has been issued a resale certificate, or to a retailer that is not required to register as a seller to collect sales and use taxes, for resale outside of Maine. Another provision of the same legislation, however, provides that “the presumption that a sale was not for resale may be overcome during an audit or upon reconsideration if the seller proves that the purchaser was the holder of a currently valid resale certificate at the time of the sale or proves through other means that the property purchased was purchased for resale by the purchaser in the ordinary course of business. Notwithstanding section 1752, subsection 11, paragraph B, if the seller satisfies the seller's burden of proof, the sale is not considered a retail sale.” Emphasis added.

Refund for Sales Tax Paid on Parts and Supplies Used in Harvest-Related Transport of Forest Products Maine has put in place emergency legislation, PL 2007 c. 658, to allow for the refund of sales tax paid on parts and supplies used in the repair and maintenance of motor vehicles and trailers used directly and primarily in the harvest-related transport of “forest products.” To qualify for the refund, purchases must be made on or after April 1, 2008 and before October 1, 2008. Taxpayers must submit an application for a refund within 36 months of the date of purchase. Alternatively, Taxpayers may obtain a certificate stating that they are engaged in the harvest-related transport of forest products authorizing them to purchase covered parts and supplies without paying sales tax. Bill on Use of Sampling Defeated

The Joint Standing Committee on Taxation rejected a section of L.D. 2151, “An Act to Make Minor Substantive Changes to the Tax Laws,” that would have given MRS the ability to mandate the use of statistical sampling in sales and use tax audits. Currently, MRS uses sampling only after coming to an agreement with a taxpayer about doing so. Under the proposal in L.D. 2151, MRS could have unilaterally determined that statistical sampling would be used in an audit, and then dictated what type of sampling would be employed. Aircraft Used for Emergency Transportation

Under PL 2007, c. 691, when determining whether an aircraft has been present in Maine more than 20 days, making it subject to sales and use tax, a day must be disregarded if at any time during that day:

[T]he aircraft is used to provide free emergency or compassionate air transportation arranged by an incorporated non-profit organization providing free air transportation in private aircraft by volunteer pilots so children and adults may access life-saving medical care.

This statute applies to days an aircraft has spent in Maine on or after July 1, 2008. B. Judicial Developments In John T. Cyr & Sons, Inc. v. State Tax Assessor, 2008 Me. Super. LEXIS 56 (January 16, 2008), the Maine Superior Court determined that, under the Maine Supreme Judicial Court’s decision in Brent Leasing Co., Inc. v. State Tax Assessor, 2001 ME 90, 773 A. 2d 457, it was constrained to construe the exemption for instrumentalities of interstate commerce (36 M.R.S.A. §1760(41)) very narrowly, to exempt from tax only sales or use of instrumentalities with respect to which imposition of tax

would violate the Commerce Clause of the United States Constitution. The Brent Leasing case concerned vessels used for whale watching expeditions that departed from and returned to Maine ports, which the taxpayer contended were engaged in foreign commerce. At issue in Cyr are buses used to transport cruise ship passengers on round-trip excursions from ships at port in Portland or Bar Harbor to various locations in Maine. The Superior Court noted that:

The payload here, as opposed to Brent Leasing Co., originated outside of Maine. This would be relevant to interpretation of “instrumentalities of interstate commerce” and a meaningful distinction were this court not bound to limit the extension of 36 M.R.S.A. §1760(41) to only those situations in which not doing so would result in a tax that violates the commerce clause.

Emphasis added. Taxpayers had been hoping that Brent Leasing Co., a split decision, would be limited to its facts. The Superior Court in Cyr clearly felt that it could not do so. Cyr has been appealed. If Cyr is upheld on appeal, it is likely that many taxpayers that have traditionally used this exemption will be unable to do so.

C. Administrative Developments

Service Stations and Auto Repair Shops

Sales Tax Instructional Bulletin Number 1, “Service Stations and Auto Repair Shops,” has been revised to incorporate recent legislative changes. Section 2(e) now states that after September 20, 2007, the sale of an extended service warranty on an automobile which entitles the buyer to specific service benefits for a specific period of time is taxable. Parts used in repair work conducted under such warranties, however, are not taxable to either the service station or making the repairs or the customer. Section 5 describes the tax treatment of the oil change premium that has been imposed on the retail sale of motor vehicle oil changes as of October 1, 2007. For the purpose of calculating sales tax, the premium is considered a part of the sale price of the oil change on which it is imposed. The premium must be collected even if the customer is otherwise exempt from sales tax. Section 5 also describes what services are subject to the oil change premium, including engine oil and transmission fluid changes, and which are not, such as brake fluid changes. Leases and Rentals

Sales Tax Instructional Bulletin Number 20, “Lease and Rental Transactions” has also been revised. The bulletin now specifies that “rent-to own” businesses must apply the service provider tax to the rental of audio tapes, audio equipment and furniture. The rental of video media, including tapes and DVD’s, is also subject to the service provider tax. The tax must be applied to each rental payment as the payment is made. Providers may pass the tax on to their customers, as long as it is separately stated. If a customer elects to purchase the item being rented, sales tax must be collected on the buy-out price at the time of the sale. D. Trends/Outlook

Use Tax Assessments on Aircraft Landing in Maine

Maine Revenue continues to assess use tax on aircraft owned by nonresidents that have landed in Maine and spend more than 20 days in Maine during the first year of ownership. Several of these assessments are being challenged in Maine Superior Court. Broadcasters

Maine Revenue Services is in the process of developing guidance on the exemption set forth in 36 M.R.S.A. § 1760(31) for

machinery and equipment used directly and primarily in the generation of a broadcast signal, which became effective in July of

2007, with input from industry. Like the development of instructional bulletins for printers and publishers, and manufacturers

generally, this should be a lively discussion.

III. PROPERTY TAX

A. Legislative Developments.

Business Equipment Tax Exemption

The Business Equipment Tax Exemption (“BETE”), enacted last year, is available for “eligible business equipment” first subject to assessment on or after April 1, 2008. The term “eligible business equipment” does not include property “located at a retail sales facility and used primarily in a retail sales activity.” A retail sale activity is an activity “associated with the selection and purchase of goods or services or the rental of tangible personal property.” A retail sales facility is a “structure used to serve customers who are physically present at the facility for the purpose of selecting and purchasing goods or services at retail or for renting tangible personal property.” B. Judicial Developments Unannounced Visit by County Commissioner was Improper

The Maine Superior Court has determined that an unannounced visit by a single York County Commissioner to inspect property which was the subject of an appeal before the Commission was improper. The plaintiff’s property was assessed by the Town of Newfield at $224,008 in 2005 and at $1,105,900 in 2006. In making the 2006 assessment, the Town’s assessor had used methodology that did not appear to reflect market data and ignored the valuations given to similarly situated properties in neighboring towns. The plaintiff sought an abatement from the Town, and when this was denied, appealed the denial to the York County Commissioners, which upheld the Town’s decision. Although the individual Commissioners’ positions were not clear, the minutes of their meeting reflected a 3-1 vote for upholding the town’s denial of the plaintiff’s request for an abatement. On appeal, the Superior Court noted that one of the Commissioners had made an unannounced visit to view the plaintiff’s property, and had then lead the discussion of that property at the Commissioners’ meeting. The Court ruled that although this visit was well-intended, it was improper for being made without notice, because the plaintiff could not be present or provide a response to evidence gathered during the visit. The Court could not find that the visit was harmless, because the minutes showed that it was important to at least one of the Commissioners, and perhaps others as well. Such unscheduled visits were normally grounds for remanding the proceedings to the Commission for a new hearing. The Court also found that the town’s methodology for property valuation was not well explained in the record, and produced a result that was not related to market data. There were no instances of properties similar to the plaintiff’s selling for over $1,000,000 and the numbers used by the assessor did not appear to be related to actual value in this case. As a result, the Court remanded the proceedings to the Commission, which was to remand them to the Town with instructions to grant the requested abatement. Spickschen v. Town of Newfield, 2007 Me. Super. LEXIS 218 (October 29, 2007). C. Administrative Developments

Business Equipment Tax Exemption

There has been a good deal of confusion as to what types of business equipment are primarily used in connection with a retail sales activity at a retail facility and therefore ineligible for the Business Equipment Tax Exemption (“BETE”). MRS has issued a guidance document that lists some examples of what does and does not constitute eligible business equipment, but the document is not comprehensive and the status of many types of business equipment will likely need to be determined on a case-by-case basis.

D. Trends/Outook Business Equipment Tax Exemption Municipal assessors appear to differ in how they plan to interpret BETE, and it is likely that Maine Revenue will be called upon to provide additional guidance. Meanwhile, business taxpayers are well advised to question feedback provided by local authorities and to seek independent advice.

IV. OTHER

A. Legislative Developments.

Excise Taxes on Beverages, and Tax on Insurance Claims.

Several new broad-based, regressive taxes were passed on the last night of the session to fund the Dirigo Health program. These include new excise taxes on beer and wine, new excise taxes on soft drinks and soft drink syrup and powder, and a new 1.8% tax on health insurance claims. This came in via an amendment and there was no public hearing or opportunity for public input on these tax increases. A people’s veto effort is likely to be forthcoming.

Certificate of Excuse for LLCs

A new provision in Maine’s partnerships and associations law, 36 M.R.S.A. § 757(4) has been enacted to allow limited liability companies that have ceased to transact business to apply for a certificate of excuse. LLCs holding these certificates will not be required to file annual reports with the Secretary of State, so long as they continue not to transact any business. The fee for applying for a certificate is $140. B. Judicial Developments Notice Provided Under 36 M.R.S.A. § 111(2) Meets the Constitutional Requirements for Due Process

The Maine Superior Court has found that notice provided by the Assessor pursuant to 36 M.R.S.A. § 111(2) meets the requirements for providing taxpayers with constitutional due process. As required by 36 M.R.S.A. § 111(2), on January 27, 2002 the Assessor sent the defendant, who owed $159,190.14 in unpaid taxes, a notice and a demand for filing returns for the 1996-1997 tax years. This notice was sent via certified mail to the defendant’s last known address and was returned unclaimed. The Assessor then, as directed by § 111(2), re-sent the notice via first-class mail. On November 11, 2002, the Assessor also sent the defendant notice and a demand for filing returns for the 1998-1999 tax years via certified mail to the defendant’s last known address. This certified mailing was signed for by someone other than the defendant on November 12, 2002. The defendant argued that he never received these notices and that he had not signed for them. He then alleged that 36 M.R.S.A. § 111(2) did not meet the requirements of the Due Process Clause of the U.S. Constitution because rather than requiring actual notice, it allows the use of certified mail, followed up by first-class mail, to constitute adequate notice to a taxpayer. The Court found that the Due Process Clause did not require the Assessor to ensure that the notices he sent the defendant were physically delivered into the defendant’s hands. Instead, the Assessor was only required to provide notice in a way that was reasonably calculated to apprise the defendant of the action and afford him a chance to present his objections. Sending a notice via certified mail, followed by resending the notice via first-class mail when the certified mail was returned unclaimed, met this standard. The defendant had therefore received notice that was statutorily and constitutionally adequate. Maine v. Thompson, 2007 Me. Super. LEXIS 268 (September 19, 2007). Audit Plans and Audit Letters are Confidential and not Public Records

The Maine Superior Court has ruled that under 36 M.R.S.A. § 191 (confidentiality of tax records), MRS is not required to provide a requesting party with copies of the agency’s audit plans and audit letters.

According to the plaintiff, because 36 M.R.S.A. § 191(1) prohibits the disclosure of information that is “provided” pursuant to Maine’s tax laws, it only prohibits the disclosure of information provided by taxpayers to MRS. She, therefore, claimed that audit letters, which are sent from MRS to taxpayers, are not confidential. The Court found that § 191 focuses on information rather then the document it might be contained in. It is clear that all taxpayer related information is intended to be kept confidential under the statute, whether being sent to or by MRS. Audit letters and audit plans are thus confidential under § 191 and not public documents that could be disclosed by MRS. Ptak v. State of Maine, 2007 Me. Super. LEXIS 263 (November 27, 2007). C. Administrative Developments

Real Estate Transfers

Rule 207, “Real Estate Transfers,” has been revised to clarify the exceptions to the requirement that the taxpayer identification numbers of the grantor and grantee be provided when filing a transfer tax return and declaration of value. These exceptions include transfers where there is no consideration and transfers of unimproved land where the consideration is less than $25,000 or transfers of improved land where the consideration is less than $50,000 when a satisfactory explanation for failure to include the taxpayer identification numbers is attached.

Electronic Funds Transfer

Rule 102, “Electronic Funds Transfer,” has been revised to incorporate new thresholds at which the payment of tax liabilities by the electronic transfer of funds (“EFT”) becomes mandatory. As of January 1, 2008, persons or certain entities with a combined tax liability of $100,000 must now remit payment of those liabilities by EFT. This threshold decreases to a $50,000 combined liability as of January 1, 2009 and a $25,000 combined liability as of January 1, 2010. Record Keeping

Rule 103, “Recordkeeping and Retention,” has been amended to clarify several portions of the rule that deal with electronic recordkeeping. In particular, this includes the fact that electronic records must be stored for as long as required under 36 M.R.S.A. § 135, which is 6 years for records pertaining to most taxes. Records pertaining to income tax must be stored for as long as required under federal statutes and regulations.

Electronic Filing of Returns

MRS has adopted Rule 104, “Electronic Filing of Maine Tax Returns.” Effective as of February 11, 2008, the new rule mandates the electronic filing of individual income tax returns, income tax withholding returns and sales, use and service provider tax returns when certain thresholds are met.

• Individual Income Tax Returns - Tax preparers who filed 200 or more individual income tax returns in 2007 that were eligible for electronic filing must now electronically file all individual returns eligible for electronic filing. As of January 1, 2009, the electronic filing threshold is reduced to 100 returns prepared in 2008, and for subsequent years is reduced to 50 returns prepared in the previous calendar year.

• Income Tax Withholding Returns- All employers with 75 employees or more in 2008 must electronically file their

quarterly and annual returns for income tax withholding. The same is true for third party filers or payroll processors: (1) who prepare withholding returns for employers with 75 employees; or (2) have 75 clients or more who are required to file withholding returns.

• Sales, Use and Service Provider Tax Returns - Electronic returns must be filed by taxpayers having a sales, use or

service provider tax liability of $200,000 or more for the 12-month period ending September 30, 2007. For 2009, the threshold for the electronic filing requirement is reduced to $100,000 and is then further reduced to $25,000 for subsequent years.

MICHIGAN STATE DEVELOPMENTS

Patrick R. Van Tiflin, Esq. The Phoenix Building, Suite 400 Honigman Miller Schwartz and Cohn LLP 222 North Washington Square E-Mail: pvantiflin@honigman.com Lansing, MI 48933-1800 Telephone: (517) 377-0702 Fax: (517) 364-9502 I. MICHIGAN BUSINESS TAX

A. Legislative Developments

Deduction created for deferred tax liabilities – A portion of the book-tax differences arising from the transition of Michigan’s business tax system from a Single Business Tax to a Michigan Business Tax is provided by 2007 Public Act 90 effective January 1, 2008. The amount of the deduction cannot exceed the amount required to offset the net deferred tax liability computed under generally accepted accounting principles which would arise if the deduction were not otherwise allowed.

B. Judicial Developments

Single Business Tax. Newark Morning Ledger v Michigan Dep’t of Treasury, Court of Claims No. 00-17603-CM. The Michigan Court of Claims has ruled that amounts paid by Newark’s eight Michigan newspapers to the Associated Press and other news gathering organizations and to feature syndicates for feature items constitute royalties for Single Business Tax purposes and the payments must be added back to federal taxable income in arriving at a Single Business Tax base. The Court of Claims also rejected a constitutional challenge to the differential treatment of print media and other forms of media as well as differential treatment of news content arising within the State of Michigan, and news content arising outside the state of Michigan, and transmitted into Michigan through news gathering organization exchanges and feature services transmissions. Newark has appealed to the Michigan Court of Appeals.

C. Administrative Developments

1. Revenue Administrative Bulletin 2007-5 discusses the preparation and submission of the final Single Business Tax Return for a fiscal year taxpayer.

2. Revenue Administrative Bulletin 2007-6 defines the term “actively solicits” for purposes of the Michigan Business Tax. This Revenue Administrative Bulletin embraces a full-fledged economic nexus standard.

3. Frequently Asked Questions and Answers

The Department of Treasury website (michigan.gov/treasury) contains over 100 Michigan Business Tax frequently asked questions and Treasury’s answers to those questions intended to provide guidance on various issues currently arising under the Michigan Business Tax.

4. A tax estimator for the Michigan Business Tax is available on the Michigan Department of Treasury website but it provides only unofficial estimates and the results have no legal bearing on a taxpayer’s actual Michigan Business Tax liability.

II. TRANSACTIONAL TAXES—USE TAX A. Legislative Developments The Michigan Use Tax on services was repealed within hours of its effective date by 2007 Public Act 145. The legislation allows a person who paid use tax on a taxable service to apply for a refund of the tax. A person who collected Michigan Use Tax on services may return the tax to the person that received the service and paid the tax or pay it over to the Department of Treasury so that the person who received the service and paid the tax may apply for a refund of the tax.

B. Judicial Developments 1. Escanaba Paper Company v Michigan Dep’t of Treasury, Court of Claims Docket No. 04-227-MT. Escanaba Paper Company operates a paper mill in Escanaba, Michigan and claimed an industrial processing exemption from Michigan Use Tax for costs incurred in the treatment and processing of wastewater generated by its paper making process. The Michigan Court of claims ruled that although Escanaba Paper Company was an industrial processor with regard to its paper, it was not engaged in industrial processing when it

treated and processed wastewater in order to place it in a condition so that it could be returned to the public waterways as required by federal and state laws. Escanaba Paper Company has appealed to the Michigan Court of Appeals. III. OTHER TAX DEVELOPMENTS A. Judicial Developments 1. Tyson Foods, Inc. v Michigan Dep’t of Treasury, Court of Appeals Docket No. 272929. The Court of Appeals determined that the Michigan Department of Treasury had authority to issue more than one assessment under the Revenue Act where the second assessment is premised upon obtaining information indicating a taxpayer’s true tax liability. In this case, taxpayer failed to file Single Business Tax Returns. The Department issued an estimated assessment which the taxpayer paid. The Department later conducted a field audit and issued a second assessment based upon the actual liability of the taxpayer giving credit for the tax previously paid. The court determined that the legislature plainly intended to permit Treasury to issue a second assessment to a taxpayer for the same tax period if necessary for Treasury to collect the entire amount of taxes lawfully due from the taxpayer for the taxpayer at issue. The Michigan Supreme Court denied an Application for Leave to Appeal. 2. NSK Corporation v Michigan Dep’t of Treasury, Court of Appeals Docket No. 274633. The taxpayer was entitled under the Michigan Department of Revenue Act to receive interest on overpayments of Single Business Tax discovered during a field audit by the Michigan Department of Treasury. The Court of Claims had ordered interest commencing 45 days after the due date for the return for each of the tax years for which an overpayment was determined. The appellate court modified the trial court decision by determining that interest begins accruing 45 days after a claim was filed. The Court of Appeals gave the term “claimed” a liberal construction and determined that it was the date on which the Department was made aware of the taxpayer’s overpayment. Under the facts of this case, interest began to accrue 45 days from the date of the audit determination letter issued by the Department of Treasury. The Court of Appeals’ ruled the letter functioned as a claim. The case was remanded to the trial court to determine the exact date of the audit determination letter. A delayed Application for Leave to Appeal has been filed with the Michigan Supreme Court. B. Administrative Developments Revenue Administrative Bulletin 2007-4 establishes the annual rate of interest due on Michigan tax deficiencies and refunds for the period January 1, 2008 through June 30, 2008 at 9.2%. The rate for the prior six months was 9.25%. The interest rate on tax deficiencies and refund claims is established by the Treasurer once every six months based upon the adjusted prime rate charged by three large commercial banks to their largest customers. IV. PROVIDER’S BIOGRAPHY

Patrick R. Van Tiflin is a partner with the law firm of Honigman Miller Schwartz and Cohn LLP. He received a Bachelor of Arts degree in business administration and accounting from Michigan State University. He received his law degree from the University of Notre Dame Law School. He has served as Chair of the State and Local Taxation Committee of the State Bar of Michigan Taxation Section, and as a member of the Taxation Section Council. He is listed in Best Lawyers in America 2007-2008, and Michigan Super Lawyers 2007-2008. Mr. Van Tiflin has written on state tax topics for the BNA Multistate Tax Report, CCH's State Income Tax Alert, State Tax Review and Sales and Use Tax Alert, Journal of Multistate Taxation, RIA's State & Local Taxes Weekly, Michigan Tax Lawyer and Michigan Bar Journal. He is the General Editor of the Lexis Nexis Michigan Tax Practice Insights series and the author of many of the insights on single business, sales and use taxes. He has spoken on state tax topics at conferences sponsored by the Council on State Taxation, Tax Executives Institute, New York University, the Chicago Tax Club, Georgetown University Law Center, Michigan Association of Certified Public Accountants, and the State Bar of Michigan.

MISSOURI STATE DEVELOPMENTS Janette Lohman, Esq. jlohman@thompsoncoburn.com P: 314.552.6161 F: 314.552.7161 M: 314.602.6161 Thompson Coburn LLP One US Bank Plaza St. Louis, Missouri 63101 www.thompsoncoburn.com I. INCOME/FRANCHISE TAXES.

A. Legislative Developments (2007 Regular and Special Sessions – May 2007). 1. All attempts to eliminate and/or reduce Missouri’s income tax and franchise taxes died in

Committee during the 2007 regular legislative session. Similar attacks are occurring during the 2008 General Session which will end in May 2008 after the due date of this summary.

2. House Bill 444 (L. 2007).

a. Phased-Out Elimination of the Taxation of Social Security Benefits. This legislation

will gradually eliminate Missouri’s taxation of social security benefits for approximately 220,000 “middle class” seniors. Under the final version of the bill, Missourians who are at least 62 years old are entitled to a phased-in deduction for social security benefits, to the extent that their total income does not exceed $85,000 (for all filing statuses other than joint) and does not exceed $100,000 for joint returns. To the extent that these income levels are exceeded, the relevant taxpayers must reduce their benefit, dollar for dollar, for each dollar in excess of the limit. Exemptions are also provided to those public employees who opt out of receiving social security benefits, such as veterans, educators, disabled individuals and the police. House Bill 444 will cost Missouri taxpayers $27 million in 2007 (for a 20% exemption the first year of the phase-in) up to approximately $154 million when the exemption is fully implemented. Each year the maximum deduction is tied to the maximum social security benefit available to the taxpayer; if the federal benefit goes up, so does Missouri’s deduction. Individuals receiving social security disability benefits are also entitled to these deductions, regardless of their age.

b. Deduction for Health Insurance Premiums. House Bill 444 provides an additional deduction from Missouri taxable income for certain health insurance premiums for taxpayers and their immediate family members (so long as they were included in the individuals’ federal adjusted gross income). The taxpayers are required to show proof of payment to the Department of Revenue.

c. Elimination of Non-Resident’s Deduction for Non-Missouri Property Taxes. House Bill 444 also contains a tax hike for non-residents – effective for calendar year 2007, the elimination of a non-resident’s deduction for non-Missouri property taxes (if the non-resident deducted such property taxes on his or her federal return) is anticipated to raise an annual $11 million. Question, class – could this new law possibly violate the Commerce Clause????? Smart money says that certain Kansas residents who work in Missouri may challenge it.

d. New Refund Donation Option. Finally, House Bill 444 permits taxpayers to donate all or part of their refunds to the “After-School Retreat Reading and Assessment Grant Program.” If the taxpayer has a balance due but would like to make a contribution to this program, the taxpayer can include a second check or other negotiable instrument in the amount of the donation along with his or her tax return.

3. HB 453 (L. 2007).

a. Income Tax Credit for Donations to Local Food Pantries. Effective January 1, 2007, taxpayers may receive an income tax credit equal to 50% of the value of cash or food that they donate to any local food pantries. The maximum credit cannot exceed $2,500 per taxpayer. This credit is non-transferable and non-refundable but has a three-year carryforward. The state will only award $2 million of credit per year. This new program will expire in four years.

b. Amendments to the Residential Treatment Agency Tax Credit. HB 453 amended this existing program to qualify cash, public securities and real estate for the credit.

4. SCS HCS HB 1 (L. 2007).

a. Effective January 1, 2008, the New Law Creates the Distressed Areas Land Assemblage Tax Credit Act (New § 99.1205). This new transferable tax credit is equal to 50% of the acquisition/maintenance costs and all acquisition interest paid for acquiring eligible property. The applicant can receive the credits for up to five years after purchase and the credits have a six-year carryforward. The eligible land must be in an eligible redevelopment area, must meet numerous other program restrictions and must be purchased prior to beginning any condemnation proceedings. Funds raised from the credits must be used to develop the project. The program has a $10 million per year credit limitation (which will carryforward to future years if not used) and a $95 million overall credit limitation for the program. Applicants must comply with the 2004 Tax Credit Accountability Act.

b. Tax Credit for Qualified Beef (New §135.679). This credit program is established for a period beginning January 1, 2009 through December 31, 2016 and provides a credit of ten cents per pound for certain cattle that weigh at least 200 pounds and are born in Missouri after August 28, 2008. The weight requirement can be waived by the Agricultural and Small Business Development Authority under certain circumstances. There is a $3 million per year program cap and the credit has a 3-year carryback provision and a 5-year carryforward provision.

c. New Markets Qualified Equity Investment Tax Credit (New § 135.680). This new

program establishes a tax credit program that is similar to the federal New Market Tax Credit Program. It provides to the issuer a tax credit of 8% of a qualified equity investment for the third year (0% for the first two years) and 7% for the next three years. There is an annual program cap of $15 million. The program sunsets in 2010 and contains recapture provisions.

d. Modifications to Missouri’s Film Production Credits. Commencing in 2008, the

General Assembly lowered the minimum budget expenditures to $50,000 for films that are less than half an hour and to $100,000 for projects that are longer. The annual program cap has been increased to $4.5 million, and the amount of the credit will be equal to 35% of the qualifying costs.

e. Modifications to Missouri’s Enhanced Enterprise Zones. This law changes some of the

definitions applicable to this program and also prohibits certain tax-exempt organizations from participating in the program (except for headquarters or administrative offices projects). The annual program cap for the tax credits was doubled to $14 million in credits and more program restrictions were added.

f. Modifications to the Quality Jobs Program. The new law adds some new definitions,

adds some additional qualifications and restrictions, expands the types of programs that can qualify and permits the tax credits to offset the financial institutions tax in addition to the income tax. The annual program cap was increased from $12 million to $40 million.

B. Judicial Developments. 1. Method of Calculating Interest Decided. Kidde America, Inc. and Subsidiaries v. Director of Revenue, 242 S.W.3d 709 (January 15, 2008). Interest that results from an income tax refund attributable to an amended return is computed using the applicable Missouri Treasury rates under Sections 32.068 and 32.069, RSMo that were newly enacted by S.B. 1248 (L. 2002).

C. Administrative Developments. N/A.

D. Trends/Outlook for the Rest of 2008. 1. Election Year Slow-Down. Because 2008 is an election year, there probably will not be any earth-

shattering legislation involving income tax in the coming year, although (as noted above) the tax credits are under what is becoming an annual attack.

2. Departmental Changes. Omar Davis, Esq., has resigned his position as the Director for the

Department of Labor and Industrial Relations and is now Missouri’s Director of Revenue. Mr. Davis is a former General Counsel for the Department of Revenue. Effective last winter, the new General Counsel for the Department of Revenue is Rochelle Reeves, Esq. Rod Chapel, Esq., formerly the Department of Revenue’s General Counsel, was sworn in on October 1, 2007 as the newest Commissioner for the Missouri Administrative Hearing Commission. This is good news for taxpayers

because Mr. Chapel has an LL.M. in Taxation, is a former General Counsel for the Department and has much practical experience in handling tax matters in both the public and private sectors.

3. Future Departmental Changes. Come November 2008, however, Missouri will have a new

Governor and the Director of Revenue and the Department’s General Counsel will probably change, regardless of which party wins. The current Governor is a Republican, Matt Blunt, who decided not to run for a second term.

MINNESOTA STATE DEVELOPMENTS Jerome A. Geis∗

JERRY GEIS BRIGGS AND MORGAN, P.A. W-2200 FIRST NATIONAL BANK BUILDING SAINT PAUL, MINNESOTA 55101 (651) 808-6409 jgeis@briggs.com

I. TAX LAWS ENACTED IN 2008 LEGISLATURE SESSION.

A. Transportation Finance: H.F. 2800 - Lieder (DFL) Taxes (Codified as Chapter 152). This Bill makes several changes to transportation finance by approximately $6.6 billion for transportation, transit, and bridges and $1.8 for bonding of highway construction, and funds the appropriation by new taxes, which are set forth below:

H.F. 2800 was vetoed by the Governor but overridden by the House and Senate on February 25, 2008. It is codified as Chapter 152.

1. Tax Increases:

• Gas Tax. Phasing-in a five cent gas tax increase (by two cents on the first of the month after enactment (April 1, 2008), and three cents on October 1, 2008), and raising the tax on other motor fuels proportionally;

• Gas Tax. Establishing a gas tax debt service surcharge of up to 3.5 cents, based on the amount needed to repay trunk highway bonds, effective August 1, 2008;

• Motor Vehicle Registration. Amending the motor vehicle registration tax to (1) eliminate the tax caps (the tax paid is based on the vehicle's value up to current caps of $189 per year on the renewal and $99 per year on subsequent renewals), and (2) to accelerate the yearly decrease in a vehicle's taxable value;4

• Low-income Credit. Creating a low-income motor fuels tax credit of $12.50 for single filers and $25 for married filers, starting for calendar year 2009 tax returns;

• Motor Vehicle Rental Fee. Increasing the short-term motor vehicle rental fee from 3 percent to 5 percent, effective July 1, 2008;5

• Metro Sales Tax. Authorizing metropolitan counties to impose a metropolitan transportation sales tax of 0.25 percent and a motor vehicle excise tax of $20 under a joint powers agreement, and specifying powers and revenue uses without voter approval, effective July 1, 20086;

• Outstate Sales Tax. Authorizing counties in greater Minnesota to impose a local transportation sales tax of 0.5 percent and a motor vehicle sales excise tax of $20 with voter approval, effective July 1, 2008;

* Jerome A. Geis (B.A., Saint John's University, 1968, J.D. University of Notre Dame, 1973; LLM (taxation), New York University, 1975). He is an attorney with the St. Paul office of Briggs and Morgan, P.A. 4 This provision is applicable to any additional tax for registration period that begins on or after September 1, 2008 through and including August: 31, 2009. 5 The rental motor vehicle fee applies to rentals of passenger automobiles for up to 28 days, and is imposed in addition to a 6.2% rental motor vehicle tax. 6 Counties must take individual votes to impose the sales tax. If they impose the tax by April 1, sales tax collection would begin July 1 and the first payment to counties could be made September 10. If the counties impose the tax after April 1 but before July 1, sales tax collection would begin October 1, and those counties would receive their first money on December 10.

2. Transportation Expenditures:

• Appropriation. Appropriating $290.2 million to the Department of Transportation and the Department of Public Safety for transportation;

• Bonding. Authorizing $1.8 billion in trunk highway bonds for fiscal years 2009 to 2018, $60 million in bonding for local roads and bridges, and funding several transportation projects (gas tax debt service surcharge will fund the bonds);

• Dedications. Allocating motor vehicle lease sales tax revenue, starting in fiscal year 2010, so that in fiscal year 2012 (after a phase-in), the revenue will first go to the motor fuels tax credit, with the remainder allocated: 50 percent to greater Minnesota transit, 25 percent to metropolitan area transit, 17.25 percent to county state-aid highways, and 7.75 percent to municipal state-aid streets;

• Bridge Repair. Establishing a new trunk highway bridge improvement program for repair and replacement of bridges, which is funded through trunk highway bonds;

• Highway Aids. Amending the county State-aid highway fund allocation formula; and

• Other. Making other changes related to transportation finance, including amending allocation requirements for funds in the flexible highway account.

B. Constitutional Amendment to Raise Minnesota's Sales Tax Cleared for Voters. The Legislature passed H.F. 2285 that would increase the sales tax from 6.5 percent to 6.875 percent for the next 25 years. The voters would have a choice on the Constitutional Amendment on the November 2008 ballot. Revenues from the tax increase would be dedicated to the State's natural resources and cultural programs. Specifically, the sales tax increase would be constitutionally dedicated as follows:

• Wildlife Lands. 33 percent to an outdoor heritage fund to restore, enhance, and protect wetlands, prairies, forests, and habitats for fish, game, and wildlife;

• Clean Water. 33 percent to a clean water fund to protect, enhance, and restore water quality of lakes, rivers, and streams and protect groundwater from degradation, with at least five percent of the revenues dedicated to protecting drinking water sources;

• Parks. 14.25 percent to a parks and trails fund; and

• Arts. 19.75 percent to an arts and cultural heritage fund to increase arts, arts access, arts education and to preserve Minnesota's history and cultural heritage. The tax increase would become effective July 1, 2009, and expire in 2034. It is estimated that the tax increase would generate about $276 million in new revenues each year. H.F. 2285 is available on the Minnesota Legislature's website at: http://www.revisor.leg.state.mn.us/bin/bldbill/php?bill=ccrhf2285.html&session=ls85.

The following question will now be placed on the election ballot this Fall: 2008

"Shall the Minnesota Constitution be amended to dedicate funding to protect our drinking water sources; to protect, enhance, and restore our wetlands, prairies, forests, and fish, game, and wildlife habitat; to preserve our arts and cultural heritage; to support our parks and trails; and to protect, enhance, and restore our lakes, rivers, streams, and groundwater by increasing the sales and use tax rate beginning July 1, 2009, by three-eighths of one percent on taxable sales until the year 2034?"

C. First Omnibus Tax Bill. H.F. 3201 (Lenczewski, DFL and Simpson, R) and S.F. 2935 (Bakk, DFL) (Codified as Chapter 154). In 2007, the Governor vetoed the entire 319-page 2007 Omnibus Tax Bill due to a few controversial provisions. A revised, 230-page version of that 2007 Bill, H.F. 3201 was introduced in February 2008. The Bill is the product of negotiations between the House and Senate tax chairs and the Governor. The new Bill has eliminated not only those objectionable provisions that drew the Governor's veto last year, but it also has removed the largest revenue and spending increases, including:

• The inflation adjustment to expenditures for the budget forecast.

• The $70 million local government aid ("LGA") appropriation increase;

• $32 million in an enhanced property tax relief for homeowners;

• The foreign operating corporation ("FOC") tax change that would have funded most of last years tax initiatives.

• Eliminated public utility personal property class rate increases.

• Aid for the Mall of America expansion.

• Authorization for local deed taxes.

• Eliminates most local option sales tax requests.

It was passed and signed by the Governor on March 7, 2008 and is codified at Chapter 154.

Enacted Provisions In 2008 Tax Bill of H.F. 3201 and S.F. 2935 (Chapter 154).

1. Article 2: Property Taxes.

a. Exclusion for Homesteads of Disabled Veterans. Provides a full or partial valuation exclusion for homesteads of disabled veterans with a disability rating of 70 percent or greater, effective for assessment year 2008, taxes payable in 2009, and thereafter.

b. Reduced Property Classification Rate for VFW, American Legions, Etc. Authorizes a reduced property classification rate for qualifying nonprofit community service-oriented organizations (VFWs, American Legions, etc.), effective for the 2008 assessment and thereafter, taxes payable in 2009, and thereafter.

c. Expansion of Class 4d Low-Income Apartment Property. Changes requirements for class 4d low-income apartment property, allowing more properties to qualify, effective for taxes payable in 2009, and thereafter, effective for taxes payable in 2009 and thereafter.

d. First-Tier Classification of Class 1c Homestead Resorts Increased. Increases the market value eligible for the first-tier classification of class 1c homestead resorts from $500,000 to $600,000 and reduces the class rate from 0.55 percent to 0.5 percent, effective for taxes payable in 2009 and thereafter.

e. Compression of Joint Truth In-Taxation Public Advertisements. Allows for joint truth-in-taxation public advertisements and hearings involving all taxing authorities within a county (Greater Minnesota only), effective for hearings held in 2008 and thereafter.

f. "60-Day Rule" Clarified. Amends 60-Day Rule to clarify what specific information is required to be given to the County Assessor in cases where a taxpayer contests the valuation of income-producing property. Effective for petitions filed beginning July 1, 2008.

2. Article 3: Income Taxes.

a. Overview. Provides with the following:

• Eliminates the exclusion from taxable income for wages that were earned when the taxpayer was a Minnesota resident and received when the taxpayer was not a Minnesota resident.

• Requires construction contractors to withhold 2% of payments to independent contractors who are individuals.

• Provides that the income tax exclusion for out-of-State military service applies to National Guard Service under Title 32 of the U.S. Code.

• Required inclusion of fines, fees, and penalties in taxable income.

b. Information Reporting. Requires payers who Federal law requires to file Form 1099 information for contractor payments with the IRS to also file a copy of the return with the Commissioner. This applies if the payments were made to a Minnesota resident or if the services were performed in Minnesota. The Commissioner may require the information to be filed electronically. Present law gives the Commissioner authority to require this information to be filed by Notice and Demand to the taxpayer.

Effective beginning with tax year 2010.

c. National Guard Income Included in Subtraction from Income. Clarifies that the income tax subtraction for out-of-state military service applies to National Guard service under Title 32 of the U.S. Code. Minn. Stat. §§ 290.01, Subd. 19b(11, 12, 13, 17).

Out-of-state military service by National Guard. Clarifies that the 2005 enactment that exempts from State taxation a filer's earnings for out-of-state military service applies to National Guard personnel in the same manner that it is currently being applied to other Military Reservists.

Federal law defines the term active duty for military Reservists other than the National Guard in Title 10 of United States Code, but for National Guard personnel in Title 32 of Federal code (in nearly identical language).

This section clarifies that both of these Federal definitions apply to the subtraction for active duty pay for service outside Minnesota and, thus, that National Guard members, like Reservists, qualify for this Minnesota tax deduction on all out-of-state military earnings.

This would extend the subtraction to

• basic training at out-of-state military facilities • special training and annual training at out-of-state military facilities • Mexican border patrol duty

Effective beginning in tax year 2008.

d. Military Credit – Surviving Spouse/Heirs.

Also allows the estate or heirs at law of a deceased member of the military to retroactively claim the credit for combat service that occurred before January 1, 2006.

Current law allows only a surviving spouse or dependent to claim the credit on behalf of individuals who died before January 1, 2006, and only if the member of the military died as a result of combat zone activity.

Current law also allows for the credit to be claimed on a deceased individual's final return for individuals who die on or after January 1, 2006.

This change will allow the credit to be claimed for all combat zone service since September 11, 2001, by the estate or heirs at law of deceased members of the military who do not have a surviving spouse or dependent, and who died before January 1, 2006.

Effective retroactively for tax years beginning after December 31, 2005.

Effective retroactively for tax years beginning after December 31, 2005.

e. Stock Options/Deferred Compensation Exclusion Repealed. Eliminates the exclusion from taxable income for wages that were earned when the taxpayer was a Minnesota resident and received when the taxpayer was not a Minnesota resident. Minn. Stat. § 290.17, Subd. 2.

Under present law, an individual is not subject to Minnesota income tax on wages for work performed while a Minnesota resident that are not received until the individual is a resident of another state.

Examples include:

• individuals on contract whose contracts provide for them to continue to be paid for some time period after they complete the work required under the contract,

• individuals who receive nonqualified deferred compensation, and

• individuals who receive stock options while performing work as a Minnesota resident, but do not exercise the options until they have moved to another state.

This section would not apply to individuals participating in qualified plans (such as a regular defined benefit pension, 401(k), 403(b), IRAs, and 457 plans) while Minnesota residents and making withdrawals once they are nonresidents, since Federal law prohibits state taxation of withdrawals from these plans by nonresidents.

Effective Date: Beginning in tax year 2008, except withholding tax does not apply to payments made before April 1, 2008.

f. Withholding on Construction Contractors For Payments to Independent Contractors. Requires construction contractors to withhold 2 percent of payments to individuals (other than employees) who perform contract work for them as Minnesota withholding tax, if total payments to the individual during the year exceed $600.

This requirement applies (based on North American Industry Classification System codes) to the following types of businesses engaged in the:

• Construction of buildings

• Heavy and civil engineering construction

• Specialty trade contractors

The requirement applies to payments that are subject Federal information reporting (IRS Form 1099). In applying the withholding tax, the individual is treated as an employee. Recipients must furnish the contractor with the names, addresses, and social security numbers. (Federal law imposes a similar requirement to permit 1099 information reporting.) Withholding would not apply to payments made to entities (corporations, partnerships, LLCs, and so forth). Minn. Stat. §§ 289A.12, Subd. 4 and 290.92, Subd. 3.

Effective Date: For payments made after December 31, 2008.

Also requires payers, who Federal law requires to file Form 1099 information with the IRS for contractor payments, to also file a copy of the return with DOR. This applies if the payments either were made to a Minnesota resident or if the services were performed in the Minnesota. The Commissioner may require the information to be filed electronically.

Present law gives the Commissioner authority to require this information to be filed by notice and demand to the payer.

Effective Date: Beginning with tax year 2010.

Requires the Commissioner to conduct a random sample audit of construction contracting withholding returns and to report to the Legislature by February 1, 2011, on the audit.

The report must also include the total number and amount of withholding payments received under the new law, and the types of contractors making payments, grouped by specialty skills categories under the North American Industry Classification System codes.

g. Disallowance of Fines and Penalties. Requires inclusion of fines, fees, and penalties in taxable income. Minn. Stat. § 290.10.

Adds a subdivision to Section 290.10 that provides that amounts paid to a government entity, or to a specified "nongovernmental entity" associated with a violation of a law are not deductible business expenses whether characterized as fines, penalties, or the investigation or inquiry into a potential violation of any law, legal fees or expenses.

These payments are not deductible when paid under a criminal or civil court order, an administrative action, a plea agreement, or settlement agreement. Defines "nongovernmental entity" as an entity that exercises self-regulatory powers, including imposing sanctions, specifically

• a qualified board or exchange as defined under the Internal Revenue Code 1256(g)(7), such as a National securities exchange or a domestic board of trade or

• a nongovernment entity that performs an essential government function to the extent provided in Federal regulations.

• Damages or restitution are specifically excepted from the new provisions.

• Four (4) different types of fines and penalties that appear to now be covered that were not previously are:

1. payments to settle SEC charges without admitting liability;

2. civil tax penalties;

3. payments to settle investigation by EPA or PCA; and

4. the States' tobacco litigation (this is a one-time event that would not be covered because of the effective date, but if it happened now, might disallow the payments).

Effective Date. This section is effective for taxable years beginning after December 31, 2007, and for fines, fees, and penalties assessed after the date of enactment.

3. Article 4: Federal Update. Conforms Minnesota individual income tax and corporate franchise tax to most Federal changes enacted since May 18, 2006 through and including February 13, 2008. These include:

• Heroes Earned Retirement Opportunities Act, Public Law 109-227, May 29, 2006.

• Pension Protection Act of 2006, Public Law 109-280, August 17, 2006.

• Tax Relief and Health Care Act of 2006, Public Law 109-432, December 20, 2006. The bill includes additions to income for tax year to two provisions: the deduction for tuition and the deduction for educator expenses.

• Small Business and Work Opportunity Tax Act of 2007, Public Law 110-28, May 25, 2007.

• Clean Renewable Energy and Conversation Act of 2007, Public Law 110-140, December 19, 2007.

• Mortgage Forgiveness Debt Relief Act of 2007, Public Law 110-142, Dec. 20, 2007.

• Economic Stimulus Act of 2008, Public Law 110-185, Feb. 13, 2008.

The principal Federal changes that Minnesota would conform to are:

• Allowance of IRA contributions by members of the military with income primarily from nontaxable combat pay;

• Allowance of direct transfers to charities from traditional IRAs and Roth IRAs;

• Exclusion of $3,000 of distributions from governmental pension plans to pay various health insurance premiums for public safety retirees;

• Various limits on charitable contributions;

• Making permanent the increases in contribution limits to various retirement plans (IRAs, 401(k)s, and so forth) that were increased on a temporary basis in earlier Federal laws (this article would conform for the tax year 2007 only);

• Provides a new itemized deduction for mortgage insurance premiums;

• Allows a one-time rollover to a health savings account, and reduces limitations on contributions to health savings accounts;

• Excludes from gross income discharges of indebtedness on principal residences;

• Annually excludes from gross income up to $360 of payments to volunteer firefighters and emergency medical technicians.

Federal changes that Minnesota would not conform to are:

• Deduction for higher education tuition expenses for tax year 2007 (save $19 million);

• Deduction for teacher classroom expenses for tax year 2007 (save $1 million);

• Increase in "Section 179 expensing" for tax years 2007 and 2008 (to be handled like 2002 and 2003 limitations);

• Allowance of 50 percent bonus depreciation for tax years 2008 and 2009 (to be handled like the 2002 and 2003. Claim 20% of bonus deprecation in the first year of purchase and the remaining 80% can be claimed in equal amounts in each of the five following years. That is, claiming all the depreciation in six years instead of one).

• Enhanced deduction for computer technology charitable to the extent the enhancement exceeds costs of computer property for 2007.

4. Article 5: Sales and Use Tax. The major provisions include:

• Clarifies taxing of modular and manufactured homes.

• Allows the following local taxes, which were all part of the vetoed 2007 Omnibus Tax Bill:

-- Increases the Duluth food and beverage tax;

a. Manufactured and Modular Housing. Provides that sales of manufactured homes and modular housing sales shall be sourced to the site where the housing is first installed or erected for purposes of calculating sales taxes. Usually the manufacturer or dealer delivers this type of housing directly to the site and in those cases the sale is currently sourced to the site. This covers situations when a purchaser or contractor picks up the housing at the dealer's location and transports it to the site.

Effective Date: for Purchases Made After June 30, 2008.

b. Duluth: Food and Beverage Tax. Allows the city of Duluth to increase its food and beverage tax from one and one-half percent to two and one-quarter percent. The increase does not require voter approval. The extra three quarters of one percent tax must be used to help pay off the $40 million in debt issued for building a new ice arena and related improvements to the Duluth Entertainment and Convention Center. This portion of the tax will expire when sufficient revenues are raised from this and other revenue sources to pay these bonds.

Revenues from the current tax are being used to repay $8 million of bonds for capital improvements to the Duluth Entertainment and Convention Center and $5 million for the Great Lakes Aquarium. Current law requires that this portion of the tax will be reduced from one and one-half to one percent when these debts are repaid.

c. City of Bemidji. Allows the city of Bemidji to expand the projects that it may fund from its existing local sales tax revenues to include a regional event center, based on voter approval received at the November 2006 general election. The revenues currently are earmarked for parks and trail within the city. The bill would allow the city to pay the city's share of constructing a regional events center, not to exceed $40 million for construction costs plus all other associated costs. It also allows the city to issue up to $40 million in bonds for construction costs of the center, based on the 2006 referendum. The tax would now expire at the earlier of (1) when bonds for both projects are paid off, or (2) when revenues sufficient to pay the $9.8 million of bonds for the parks and trails have been raised, plus 30 years.

d. Article 6: June Accelerated Tax Payments. Increases Sales and Use Tax (June Accelerated Payments) and other excise taxes. Increases the percent of June Sales and Use Tax, tobacco excise tax, and alcohol excise tax receipts that must be paid by larger tax collectors in June from 78% to 80%. Minn. Stat. § 289A.60, Subd. 15, etc.

Effective Date: Beginning With June 2009 Sales Tax, Tobacco Excise, and Alcohol Excise Tax Receipts.

5. Article 10: Department Income and Franchise Taxes.

a. Date of Birth on Returns. Requires that individuals provide their date of birth on their individual income tax returns.

Effective beginning with the tax year 2008 returns.

b. Electronic Filing of Withholding Tax Returns. Requires employers who are required to withhold Minnesota individual income taxes for more than 100 of their employees to submit their Minnesota W-2 filings to the Commissioner by electronic means.

Effective for wages paid in tax year 2008. Decreases the 100 employee threshold to 50 for tax year 2009, to 25 for tax year 2010 and after, the threshold is reduced to 10.

c. 1099 Returns Required of Mutual Funds Paying Federally Tax-Exempt Interest Dividends. Requires mutual funds that pay Federally tax exempt dividends to Minnesota residents to file a copy of the 1099 return currently sent to the shareholders of the fund to the commissioner by March 15th of the year following the year the dividends were paid.

Current law allows the Commissioner to demand copies of 1099 returns after which the mutual fund has 60 days to provide the returns without penalty.

Effective for tax years beginning after December 31, 2007.

d. Penalty: Failure to Provide Identification Number for Partner or Shareholder. Imposes a $50 penalty for each time a partnership or S corporation provides an incorrect tax identification number of an owner the entity reports in their Minnesota return, if the partnership or S corporation was previously notified by the Commissioner that the number is incorrect.

Effective for returns filed after December 31, 2008.

e. Penalty: Negligence In Filing a Property Tax Refund Return. Changes the penalty for negligence in filing a property tax refund return from one based on 10 percent of the property tax refund allowed to a penalty of 10 percent of the claimed amount that is not allowed.

Effective for property tax refund claims filed on or after July 1, 2008.

f. Penalty: Tax Preparers Failing to Include Preparer Number. Requires tax preparers who prepare Minnesota individual income tax returns to provide their Federal preparer number on Minnesota individual income tax returns. Imposes a $50 penalty for each instance of failure to provide the number on a return.

Effective for returns prepared for tax years beginning after December 31, 2007.

6. Article 12: Department Sales and Use Taxes.

Overview.

Makes a number of language changes to comply with the Streamlined Sales and Use Tax Agreement ("SSTA") without changing the tax status of the items. The major SSTA changes include:

• Changing the definitions of "telecommunication services" and related services

• Clarifying the treatment of "bundled transactions"

• Eliminates the separate gross receipts tax on fur clothing and subjects fur clothing to the sales tax

• Adding language to continue the exemption for kidney dialysis equipment

• "Sales Price" definition when consideration is received by the Seller from third parties amended.

• Repeals the multiple points of use exemption certificate provision.

• Revises exemption certificate provisions.

Effective for sales and purchases on or after January 1, 2007.

7. Miscellaneous. A number of provisions in H.F. 3201 and S.F. 2935 are of interest and are set forth below.

a. Utility Values Are Recommended Rather Than Ordered Values for Pipelines, Transmission Lines, and Electrical Companies. Clarifies that the values of property of pipelines, transmission lines, electric utilities, etc. listed and assessed by the Commissioner shall be provided by Order to the City or County Assessor. All values not required by statute to be listed and assessed by the Commissioner are recommended values.

This section is effective the day following final enactment.

b. Tax Refunds Not Subject to Attachment or Garnishment. Amends Minn. Stat. § 270C, by adding a new Minn. Stat. § 270C.435, to technically clarify longstanding administrative procedure that tax refunds are not assignable or subject to attachment, garnishment, or other legal process except as provided by law.

Effective the day following enactment.

c. Publication of Tax Preparers Who Knowingly File False Returns. Requires the Commissioner to publish the name of tax preparers, who have been assessed over $1,000 of penalties for willfully prepared Minnesota returns that understate the Minnesota tax or overstate a claim or refund. Does not apply to preparers who are challenging the penalty assessment.

Effective for penalties on returns filed after December 31, 2008.

d. Expansion of Penalties. Makes taxes imposed under Chapters 295 (MinnesotaCare Tax), 296A (motor fuels tax), 297A (sales and use tax), 297F (cigarette and tobacco tax), 297G (alcoholic beverage tax), and Sections 290.92 (income tax withholding) and 297E.02 (lawfully gambling taxes) subject to applicable penalties in current law for nonpayment, e.g., personal liability.

Effective for personal liability assessments made after the day of final enactment.

e. Liens and Period of Limitations. Amends the law dealing with tax liens to provide that a notice of lien filed by the Commissioner at the Office of Secretary of State may be transcribed to any County within ten years after the date of its filing, but the transcription does not extend the period during which the lien is enforceable.

Effective for liens transcribed after the day of final enactment.

f. Valuation of Assets for Estate Tax. Allows the Commissioner to challenge an estate's valuation of assets included in an estate rather than being bound by valuations accepted by the Internal Revenue Service. However, values agreed to by the IRS govern, if the IRS reviews reappraised value or proposes a change in the value reported by the estate.

This provision will allow the Commissioner to challenge valuations of estates with values above the Minnesota's exemption amount, but below the Federal exemption.

Effective retroactively for estates of decedents dying after December 31, 2006.

II. Cases in 2007-2008.

A. Income and Franchise Taxation.

Municipal Bond Income: Unconstitutionality and Discrimination Against Out-Of-State Interest. Minnesota municipal bond interest is exempt from Minnesota taxation if issued in Minnesota. Minnesota taxes the interest from other state's municipal bond obligations. Most bond prospectus note that issuers make no provision for the redemption of the bonds, or for an increase of the interest rate on the bonds, in the event that interest on the bonds becomes subject the United States or State of Minnesota income taxation, retroactive to the date of issuance. In 1995, the Minnesota Legislature enacted a statement of intent that interest on obligations of Minnesota governmental units and Indian tribes be included in net income of individuals, estates and trusts for Minnesota income tax purposes if a Court determines that a Minnesota's exemption of such interest unlawfully discriminates against interstate commerce because interest on obligations of governmental issuers located in other states is so included. This provision applies to taxable years that begin during or after the calendar year in which such Court decision becomes final, irrespective of the date on which the obligations were issued. See Minn. Stat. § 289A.50, Subd. 10 (2006): Shaper v. Tracy, 647 N.E.2d 550 (1994) cert. denied, 516 US 907 (1995). Prior to 2006, there had not been a reported state court decision holding that the exempting of interest of tax-exempt bonds issued by any state or its political subdivisions

while taxing the interest from tax-exempt bonds issued by other states discriminated against Interstate Commerce in violation of the Commerce Clause. However, that is not true anymore. The recently decided case of Davis v Department of Revenue, Docket No. 2004 – CA–001940-MR, 2006 WL 29215, 197 S.W.3d 577 (Ky. App. January 6, 2006) held that Kentucky's taxation of income from other state's bonds, while exempting income from Kentucky bonds, discriminated against interstate commerce in violation of the Commerce Clause. The Court in Davis held that the taxation program in Kentucky "[c]learly" was "facially" discriminatory because "it affords more favorable treatment to in-state bonds than it does to extraterritorially issued bonds." Id. In its opinion, the Kentucky Court dismissed cases from other jurisdictions which had found the discrimination permissible and distinguished Supreme Court cases to find that the Commerce Clause was implicated and violated unconstitutionally. In the event the rule of Davis is recognized as the "law of the land," Minnesota will be required to tax all state and local interest income. Many purchasers would be whipsawed and shocked by that result. The Supreme Court in Kentucky refused to accept the case on appeal and the U.S. Supreme Court accepted the case for certiorari in Kentucky Dept. of Rev. v. Davis, Docket No. 00-666 (November 9, 2006). The language of the Minnesota Statute likely would not be triggered by a decision in Davis, but may require a decision invalidating the Minnesota tax exemption itself. See "Kentucky v. Davis: Implications for State Tax Policy and the Dormant Commerce Clause" by Joel Michael, State Tax Notes, pages 753-763 (September 17, 2007). Thus, the Legislature might have to act to minimize the amount of refunds to be paid, if it still intends to tax all bond interest. Id. For the tax year 2007, Minnesota is estimated to collect about $13 million from taxing out-of-state bonds.7 Assuming most taxpayers have four open years, this suggests a maximum tax refund exposure of about $50 million, plus accrued interest.8

Corporate Franchise Tax: Minnesota's Treatment of IRC Section 338(h)(10)9. In Myron J. and Alice B. Nadler v. Commissioner of Revenue, Docket No. 7736-R, 2006 WL 1084260 (Minn. T. Ct. April 21, 2006), the Minnesota Tax Court held that a Federal election under IRC Code § 338(h)(10) should be respected for Minnesota purposes and that the deemed sale of assets by the S Corporation 2001 should be treated as nonbusiness income and allocated to Florida. Lastly, the Court held that the deemed liquidation of the installment sale note and cash by the S corporation to its Shareholders should be treated as attributable to a sale of stock, and therefore, not subject to taxation in Minnesota. The issues in this case were: (1) whether the shareholder's IRC Code § 338 election to treat the sale of their corporation's stock as a sale of corporate assets governs the determination of the corporation's Minnesota taxable income; (2) whether gain from the sale of the corporation's assets is business or non-business income; (3) whether the amount of Minnesota-source gain allocable to goodwill is limited to taxpayer's share of the corporation's 2000 Minnesota apportioned net income; and (4) whether the corporation's distribution of the installment note that was part of the consideration for the sale resulted in gain recognized by the corporation which, in turn, flowed through to the taxpayers. The taxpayers were residents of Florida, who held stock through grantor trusts in certain restaurants owned by an S corporation. The shareholders including the taxpayers of the S Corporation sold their stock and the S corporation made a Federal election under IRC § 338(h)(10) to treat the sale of stock as a "deemed" asset transaction. The sales price of the stock was $53 million and generated $28 million in gain of which $8 million was allocated to the taxpayers. The Court held that the Federal election carried through for Minnesota tax also. The Court rejected the Commissioner's argument that Minnesota's apportionment rules extend to all income that may be constitutionally taxed in this State. The Court felt that there were two types of nonbusiness income for the purposes of Minnesota statutory income tax law: (1) nonbusiness income that is income derived from a trade or business and (2) nonbusiness income that is not income derived from a trade or business. A black and white categorization of business and nonbusiness income was too broad with the Constitution only being the dividing line. The Court construed the ambiguity in Minn. Stat. § 290.17, Subd. 6 of "income of a trade or business" to be parallel to and construed as the phrase "income derived from the conduct of a trade or business" found in Minn. Stat. § 290.17, Subd. 2. The Minnesota statutes provide for a nonbusiness income short of the Constitution and the deemed sale of assets here was nonbusiness income under the tests of Hercules, Inc. v. Commissioner of Revenue, 575 N.W.2d 111 (Minn. 1998) and Firstar v Commissioner, 575 N.W.2d 835 (Minn. 1998). The deemed sale of assets was an isolated transaction in the S corporation's history, the income was not reinvested in the ongoing business, and this result was supported by similar statutes and case law in other jurisdictions. The Court concluded that the deemed sale of asset gain should be allocated in accordance with Minn. Stat. § 290.17, Subd. 2 since the gain was not "income of the trade or business." Therefore, the amount of the Minnesota-source gain allocable to goodwill was limited to the taxpayer's share of the S corporation's 2000 Minnesota apportioned income and not the 2000 ratio of apportionment factors. The language found in Minn. Stat. § 290.17, Subd. 2(c) did not refer to the ratio of factors but to "income." Lastly, the Court concluded that the installment sale distribution to the

7 Id. Joel Michael article at page 756 footnote 24, State Tax Notes (September 17, 2007). 8 Id. Joel Michael article at pages 756-757, State Tax Notes (September 17, 2007). 9 The IRC Section 338(h)(10) election recharacterizes a sale of stock by the S corporation shareholders as a sale of assets by the S corporation (Old Target) to New Target. Old Target then distributes the consideration that it receives in exchange for its assets to its shareholders. Reg. Section 1.338(h)(10)-1(d)(4) states that the transfer of consideration received on the sale of its assets is generally transferred to its shareholders in complete liquidation of Old Target. Reg. Section 1.338(h)(10)-1(d)(8) states that when "an installment note is received by Old Target in exchange for its assets" Old Target will be treated as distributing the New Target installment note to the deemed liquidation of Old Target to the S corporation shareholders.

shareholders should be treated under the Federal election as a fiction and as recasted, was a sale or exchange of stock, and therefore, allocable to Florida. There was no appeal; therefore the decision is final.

Income Tax and Other Taxes: JOBZ Program Is Constitutional. Alec G. Olson v. State of Minnesota, Ramsey County District Court File C8-05-2727. On March 17, 2005, a lawsuit was filed in Ramsey County District Court asking that the JOBZ and Biotech Zone programs be scrapped as unconstitutional. These programs grant income, sales or property tax exemptions to companies for up to 12 years in return for relocating or expanding in designated areas. The lawsuit claims that JOBZ and the similar BioScience program violate the State's constitution by surrendering the legislative power of taxation to state and local economic development officials. The lawsuit also claims that the programs violate the U.S. Constitution's Interstate Commerce Clause by granting tax exemptions to induce businesses to expand in Minnesota rather than in some other states. Similar lawsuits are popping-up around the country challenging the proliferating practice of states competing with each other for tax breaks. A ground-breaking case in Ohio (Cuno) found in September of 2004 that tax breaks Ohio gave Daimler Chrysler for a Jeep assembly plant in Toledo, Ohio were unconstitutional and violated the Interstate Commerce Clause; subsequently the U.S. Supreme Court reversed, finding no standing and not reaching the substantive issue. Stipulation of facts was prepared and Motions for Summary Judgment were heard on August 7, 2006. On October 8, 2006, the Court ruled that the plaintiffs lacked standing to challenge the program and dismissed the case. The Court cited case law saying such suits are usually dismissed unless they can "show some damage or injury to the individual who is special or peculiar." In Alec G. Olson v. State of Minnesota, et al., Docket No. A06-2324, 742 N.W.2d 681 (Ct. App. December 18, 2007), the Minnesota Court of Appeals affirmed a Ramsey County District Court decision that taxpayers' challenging JOBZ program lacked standing to challenge the constitutionality of the program since they could not show "actual injury-in-fact." To establish standing, a taxpayer must have a sufficient personal stake in the controversy, which exists if the taxpayer has suffered an "injury-in-fact." That is, taxpayer suits in the public interest are generally dismissed unless the taxpayers can show some damage or injury to the individual bringing the action which is special or peculiar and different from damage or injury sustained by the general public. Here the taxpayers challenged the JOBZ solely on their status as taxpayers. They had neither applied for nor been rejected in the program. Taxpayers without personal or direct injury may still have standing, but only to maintain an action that restrains the "unlawful disbursements of public money or illegal action on the part of public officials." However, a party seeking to challenge a law on the basis of its status as a taxpayer must show more than a disagreement with the discretionary decision in order to invoke standing where the taxpayer perceives to be an illegal expenditure or waste of tax monies. Rather, the proper party to challenge an exemption on behalf of the public and in the public's interest is a governmental official not a private citizen.

Income Tax: Failure to Timely Appeal to Minnesota Tax Court. In Thomas P. and Mary Ann O'Meara v. Commissioner of Revenue, Docket No. 7943, 2008 WL 696928 (Minn. T. Ct. March 13, 2008), the Minnesota Tax Court dismissed a pro se taxpayer's appeal for failure to timely meet deadlines. The taxpayer was issued an Order on May 10, 2007 and timely requested a 30-day extension from the Court, which was granted until July 9, 2007. However, it was not until August 10, 2007, that taxpayers filed the Notice of Appeal. In holding that the taxpayer did not have a timely appeal by August 8, 2007, the Court reiterated that Minn. Stat. § 271.6.06, Subd. 2 requires a timely appeal within 60 days unless a 30-day extension is obtained and that necessitates actual receipt of the appeal within the 60 or 90-day period.

B. Sales and Use Taxation.

Excise Tax—Unemployment Benefits: "Experience—Rating Transfer." In Spherion Pacific Workforce, LLC v. Commissioner of Employment and Economic Development, Docket No. A05-1391, 2006 WL 146023 (Minn. App. Ct. May 30, 2006), the Minnesota Court of Appeals held that the Commissioner of Employment and Economic Development did not error in transferring the old experience rating of a reorganized affiliate to the new subsidiary. A previous popular technique was to take an existing business and reorganize it so that its experience ratio would be less than presently operated. In an effort to stop the erosion of the tax base, Congress mandated new federal "employment tax dumping" rules. This case was decided under the existing Minnesota Statute, Minn. Stat. § 268.051, Subd. 4(i), which empowers the Commissioner to provide the old experience ratio upon "transfer [of] all or a part of the experience rating" without requiring a determination of successorship if "the Commissioner finds that a transaction was done, in whole or in part, to avoid an experience rating or the transfer of an experience rating." (Emphasis supplied) The taxpayer, a temporary staffing business, reorganized. One subsidiary acquired 81.1% of the predecessors affiliate's employees and the other subsidiary acquired all of predecessor's assets and continued all of its employment positions. Both affiliates were owned by the taxpayer after the reorganization. The Court found that the Commissioner did not error in transferring to the new subsidiary the experience rating of the affiliate based on a finding, which was supported by the record, that the transaction was done in whole or in part to avoid the affiliate's higher experience rating. The Court specifically rejected the taxpayer's argument that the phrase "in part" in Subd. 4(i) should be construed to mean a "principal or substantial" purpose. That construction of the existing language would add something that does not appear in the statute and is prohibited. Therefore, the previous experience rating of the old company carried-over.

Excise Tax – Unemployment Benefits: "Experience-Rating Transfer." In Kforce Flexible Solutions, LLC v. Commissioner of Minnesota Department of Employment and Economic Development, Docket No. 7660 05, Order of Affirmation, the Minnesota Department of Employment and Economic Development held that Kforce Flexible Solutions, to

whom certain temporary employees were transferred from its parent Kforce, Inc. but without transfer of physical assets, carried over the experience rating of Kforce, Inc. The Department originally accepted the notification of change in successor but two years later indicated that it had made an error and that successorship in the experience rating of the parent Kforce would apply. The hearing examiner rejected the arguments of the taxpayer that the determination of successorship had become final and the Department was precluded from reopening it two years later after it had become final; that Kforce did not substantially transfer all of its assets to solutions since it had made an error in that the listed 87% of its assets was for the transfer of the temporary employee staffing and not for hard assets; and the Department was estopped from changing Kforce Solution's succession determination after it became final. On direct appeal to the Minnesota Court of Appeals by a writ of certiorari, the Court of Appeals affirmed the Minnesota Department of Employment and Economic Development conclusion in Kforce Flexible Solutions, LLC v. Department of Employment and Economic Development, Docket No. A06-601, 2007 WL 656458 (Minn. Ct. App. March 6, 2007).

Sales Tax: Minnesota Sales Tax on Fuel is Discriminatory Tax Against Railway Carriers in Violation of "4-R Act." In Union Pacific Railroad Company & Soo Line Railroad Company v. Minnesota Department of Revenue, et al., Docket No. 06-3397, 507 F.3d 693 (8th Cir. Nov. 2007), the Eighth Circuit reversed the Federal District Court and held that Minnesota's sales and use tax on diesel fuel purchases used by railway carriers is a discriminatory tax against railway carriers in violation of 49 U.S.C. 11501(b)(4) (the "4-R Act"). In Burlington Northern, Santa Fe Railway Co. v. Lohman, 193 F.3rd 984, 985 (8th Cir. 1999), the Court held that the "competitive mode" comparison class, which is comprised of the railroad's direct competitors, was the proper comparison class for ascertaining whether a sales and use tax scheme violated the "4-R Act." A State's overall tax structure need not be examined under the "4-R Act." Relying on it's holding in Lohman, the Court held that only those taxes imposed upon the railroads are taken into account in determining whether those taxes are discriminatory. While recognizing, within the competitive mode, barges and ships were also subject to the same tax imposed upon the railroads, the fact that two other members of the competitive class – motor carriers and air carriers – were not, required a reversal based on the above precedent.

Sales Tax: Fuel Used by Pipeline Company Does Not Qualify as Exempt. In Great Lakes Transmission Limited Partnership v. Commissioner of Revenue, Docket No. C7-06-012756 (Ramsey D.Ct. December 13, 2007), the Ramsey County District Court held that the taxpayer pipeline company was not exempt from sales and use taxes on diverting some of shipper's gas from the pipeline and consuming it in its compressor engines in Minnesota and did not qualify for the industrial production exemption or the capital equipment refund. First, the Court concluded that the consumption of gas as compressor fuel met the three statutory requirements for imposing a use tax under Minn. Stat. § 297A.14, Subd. 1 (now Minn. Stat. § 297A.63, Subd. 1 (2006)). That is, the Court concluded that the gas was "used," that the pipeline company purchased the compressor fuel, and that the purchase was for consumption in the compressors located in Minnesota. Second, the Court held that the Commerce Clause was not limited to an interpretation that was frozen as of 1967 but rather the Constitutional exemption referred to the Federal law (and the current U.S. Supreme Court's interpretation of the Commerce Clause). See Minn. Stat. § 297A.67, Subd. 24 (2006). Third, the imposition of a use tax upon the compressor fuel did not violate the Commerce Clause since there was no risk of double taxation, no facts to demonstrate discrimination against Interstate Commerce, the tax was fairly apportioned, no other State could tax the same gas and therefore, there was no unfair apportionment, and there was a fair relationship between the tax and the benefits that Minnesota confers on the pipeline company. Fourth, the Court held that there was no discrimination under the Equal Protection Clause, although electrical utilities were exempt and pipelines were not, since there was a rational basis for the dividing line. Fifth, there was no Supremacy Clause violation since there was no conflict between the FERC and State laws. Sixth, the Court denied the pipeline's refund claims for the capital equipment refund since the equipment was not used "primarily" for the refining of the gas and thus did not qualify as "capital equipment" pursuant to Minn. Stat. § 297A.68, Subd. 5 (2006) nor would it qualify for refund on the basis even before the Legislature amended the capital equipment refund to expressly exclude pipeline companies in 2005. The case has been appealed to Minnesota Court out of Appeals.

Insurance Premium Tax: Title Insurance Premium Includes Amounts Retained By Insurance Agents. In Stewart Title Guaranty Company v. Commissioner of Revenue, Docket No. 7754, 2008 WL 126590 (Minn. T. Ct. January 9, 2008), the Minnesota Tax Court held that title insurance premiums paid to the title insurance company included amounts retained by its title insurance agents for the purposes of the insurance premium tax levied pursuant to Minn. Stat. § 297I.05. The Commissioner's determination that the premiums, including all of those payments retained by independent agents, were subject to the insurance premium tax was validated. The plain meaning of the statutes included the amounts received by the agents because they were for insurance and were not excluded by law and the premiums were determined by the rate filed with and approved by the Commissioner of Commerce as the cost of the insurance. The taxpayer's position that the only amount subject to the insurance premium tax was the portion of the premium it actually retained not the portion of the premiums paid to its agents since these amounts were for "due diligence" or non-insurance related services was rejected. The case has been appealed to the Minnesota Supreme Court.

Excise Tax: What Is Included In The "Sale Price" For Tobacco Products. In McLane Minnesota, Inc. v. Commissioner of Revenue, Docket No. 7801 (Minn. T. Ct. February 5, 2008), the Minnesota Tax Court determined that the proper "sale price" for purchases of tobacco by McLane as a distributor from its supplier was the "sales price" that it paid to the supplier and not

the manufacturer's price to the supplier. The case involved a construction of Minn. Stat. § 279F, etc., the tobacco products tax statute, which imposed a tax on a manufacturer or person distributing tobacco products in Minnesota and based on the "wholesale sale price of the tobacco products." Prior to the years at issue, 2002 through 2005, the manufacturers of smokeless tobacco products sold directly to McLane but subsequently reorganized and McLane purchased directly from an affiliate of the manufacturer. The price paid by the affiliate from the manufacturer differed from the price that the affiliate charged McLane and that was the crux of the issue. The Court determined that the proper price and person to look to was the affiliate rather than the manufacturer and therefore the price charged McLane by the affiliate was the base of the tax. McLane argued that the manufacturer was the proper party to focus on and should use its sales price charged to its affiliate. The Court also dismissed McLane's contention that the imposition of the tax upon the "sales price" of the affiliate to McLane was an unconstitutional violation of the Commerce Clause and the Equal Protection Clause. McLane argued that the imposition of the tax based upon the price paid by it to the affiliate was a discrimination against Interstate Commerce in violation of Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977) (the third prong of Complete Auto Transit). The Court found that there was no discrimination or burdening of Interstate Commerce since the tobacco tax was only imposed on in-state of Minnesota activities. The tax applied equally to in-state and out-of-state parties. Similarly, the Court found there was no violation of the Equal Protection Clause since all persons paid the same tax rate when engaging in a taxable event – bringing tobacco products or causing those products to be brought into the State of Minnesota. Any difference in the amount paid was due to the manufacturer's or seller's decision to reorganize, not the State's tobacco tax statute.

Sales and Use Tax: Ancillary Charges Made With Purchase of Ticket Sales. In Ticketmaster, LLC v. Commissioner of Revenue, Docket No. 7866 R, 2008 WL 650294 (Minn. T. Ct. March 6, 2008), the Minnesota Tax Court determined that a City entertainment tax and sales tax applied to certain charges and not for other fees charged by Ticketmaster as a reseller of tickets to its customers. Ticketmaster acted as an agent for entertainment event organizers, selling event tickets through retail outlets, by telephone, and over the Internet. The sponsors of the event also maintained box offices from which customers could purchase event tickets. Customers buying tickets through Ticketmaster's system paid a per-ticket "convenience charge," a per-transaction "processing fee," and an optional UPS/Courier fee. The "convenience charge" was imposed on a per ticket amount by Ticketmaster. The "processing fee" imposed by Ticketmaster was on those customers purchasing tickets via the Internet or by telephone and coordinating the box office "will call" in the case of "will call" tickets. No "processing fee" was charged when a ticket was directly purchased from the sponsor's own box office. Ticketmaster also charged a UPS/Courier fee when the purchaser selected expedited delivery and required physical delivery of the purchased ticket. Each of these extra charges was separately stated on the customer's bill. The Commissioner assessed Ticketmaster for (1) unpaid entertainment tax on the "convenience charge" and "processing fee," and (2) unpaid State and local sales taxes on the "Courier fee." The Commissioner assessed the taxpayer for (1) the "convenience charge" and "processing fee" as part of the consideration paid for the privilege of admission to places of amusement or athletic events, and therefore, was subject to Minneapolis Entertainment Tax as part of the "sale price" and (2) that Ticketmaster's UPS/Courier fee was a part of the "sale price" for which tangible property or services were sold to a ticket purchaser, and therefore, was subject to Minnesota and local sales taxes. Ticketmaster argued that the "convenience charge" and "processing fee" were not charges for admission, but were optional charges for services that ticket purchasers elected to pay for convenience. Since the customer could purchase tickets directly from the sponsor of the event and avoid the extra "processing fees," and since the fees were not tied to admission to any event (since even those who had not paid the fees were admitted to the underlying events), the Court held that the "convenience charges" and "processing fees" were not subject to the City's entertainment tax. Ticketmaster also contented that the "Courier fees" did not fall within the definition of "sale price" because only delivery charges made by a seller were included in the "sale price." Because Ticketmaster was an agent for the sponsor of the event, and not a seller, it argued that its courier charges were not subject to State and local sales tax. The Court held that Ticketmaster made sales of tangible personal property and was considered a seller. Thus, the "Courier fees" constituted delivery fees made by a seller and were not deductible from the "sale price." Consequently, the "Courier fees" that Ticketmaster charged its customers were subject to State and local sales tax. On the last point, the Court dismissed Ticketmaster's reliance on a Fact Sheet issued by the Commissioner stating that "[d]elivery services furnished and billed by a third party are not taxable," as a mere administrative interpretation and not in compliance with Minnesota law, and therefore, could be disregarded by the Court.

C. Procedure.

Procedure: Requirement of "Erie Transfer" and Adequate Preservation of E-Mail Records for Discovery. In Minnesota Sports Federation v. County of Anoka, Docket Nos. CX-05-4138 and C5-06-4090, 2007 WL 2820417 (Minn. T. Ct. September 25, 2007), the Court denied summary judgment on an unconstitutional determination issue since the jurisdictional "Erie Transfer" under Erie Mining Co. v. Commissioner of Revenue, 343 N.W.2d 261 (Minn. 1984) had not been done. Further, the Court warned the parties about not deleting any emails when a property tax petition is pending, even though they may be able to show adequate paper records contained the pertinent information. Here, the County was unable to determine whether the paper records were adequate, complete, or correct because the underlying data had been deleted from the taxpayer's computers, if it ever existed.

III. Administrative Developments.

A. Franchise Tax.

Income Tax: Alternative Allocation Method Petition Form. In Minnesota Department of Revenue Notice No. 04-07 (August 16, 2004), the Commissioner published a new form, Form ALT, Application for Alternative Methods of Allocation, to assist taxpayers to comply with Minn. Stat. § 290.20(1a). The form is for those taxpayers who select to petition for another method of allocation of income. Use of this form and filing the information required on such form will meet the requirements for filing a petition under Minn. Stat. § 290.20. The procedure set forth in the Form ensures that the taxpayer substantially complies with the requirements of Minn. R. § 8020.0100 and provides notice of the petition to the Commissioner.

Income Tax : Treatment of Partnership Income of Corporate Partners. In Revenue Notice 08-03 (February 19, 2008), the Commissioner revoked Revenue Notice 1992-16 and replaced it with this Notice, which in substance does not differ in result from the revoked Notice but merely deletes obsolete references to old corporate tax forms. The Notice sets forth how partnership income is included in the corporate partner's Minnesota income in one of two ways, depending on whether the partnership and the corporation are in a unitary business. If unitary, the corporation must include its partnership income and its apportionable business income and the pro-rata share of the partnership's payroll, property, and receipts/sales located within and outside Minnesota in the corporation's property, payroll, and sales/receipts numerator and denominator. If the entities are not engaged in a unitary business, the corporation must report its partnership income or loss as separately stated income or loss. If the partnership's business is conducted solely within Minnesota, all of the partnership income or loss must be assigned to Minnesota by the corporate partner. If the partnership's business is conducted wholly outside Minnesota, the corporate partner's share of income or loss must be assigned entirely outside Minnesota. If the partnership conducts its business both within and without Minnesota, the corporate partner's share of partnership income or loss is assigned to Minnesota based on the partnership's property, payroll, and sales/receipts apportionment factor.

Corporate Income Tax – Less Than Three Factors. In Minnesota Department of Revenue Notice No. 08-04 (February 25, 2008), the Commissioner explained when either the property or payroll factor does not exist, the taxpayer can elect to calculate its Minnesota Franchise (Income) Tax Apportionment Formula based upon a two-factor weighted formula without petitioning the Commissioner for use under Minn. Stat. § 290.20. Revenue Notice No. 02-06 was revoked and superceded because of changes made in Minn. Stat. § 290.191, which changed the apportionment percentages.

Business Activities Tax Study. In September, 2005, "A Business Activities Tax for Minnesota," a report, prepared for the Legislative Coordinating Commission, was authored by Professor Laura Kalambokidis, University of Minnesota and released to the public. The study was based on information from all types of businesses operating in Minnesota in 1999 and was patterned after Michigan's SBT and New Hampshire's BET. The report assumed a repeal of the corporate income tax and a 1999 revenue neutral approach utilizing the BAT and would have required a BAT on all businesses at a .71% rate. If the BAT was only imposed on corporations then that rate would have been 1.58%. The BAT would use only the sales factor to apportion the tax.

Minnesota Taxes Increasing or Not. When is a fee really a fee? Have State taxes gone up? These issues will be vetted in the upcoming legislative elections in November, 2006. Recent studies show that State taxes have not gone up. However, the fees Minnesotans pay for State government services are now about $446 million a year higher than in 2003 according to a report by the Minnesota Senate Fiscal Analysts. The portion of fees in the State's budget moved from 3.5% to 4.6% in three years. The bulk of the fee increases are from the 75-cents-a-pack cigarette fee, presently in litigation on its legality. The other fee increases range from increased fees for boiler inspections, trout and salmon fishing, cross country skiing, and beekeeping. It costs $3.00 more per parking ticket, a State surcharge on each traffic citation increased from $35.00 to $60.00. There is a 25-cent-month 911 fee increase on each telephone line. The rationale for fees is that people pay for a specific service. The fee is a more transparent way for citizens to gage the impact of government on their lives than tax increases. For a copy of the fee report go to the Senate web site at www.senate.leg.state.mn.us and click on Senate Office of Fiscal Policy Analysis and then Fiscal Tracking Documents. In addition, tax data from the Minnesota House Research staff predict local property taxes on a Statewide basis this year will total about $5 billion, up $1.3 billion from 2003.

Office of the Legislative Auditor Issues "Evaluation Report Tax Compliance." In March, 2006, the Office of the Legislative Auditor issued its "Evaluation Report Tax Compliance" on "tax cheaters" in the State of Minnesota and the collection activities of the Minnesota Department of Revenue. The income tax "tax gap" is $604 million and the sales and use tax "tax gap" deficiency totals $451 million. This $1 billion does not include tax balances due that taxpayers report on their tax returns, even if the balance due is not remitted on time. The full evaluation report, "Tax Compliance," including the Department of Revenue's response is available by calling (651) 296-4708 or at www.auditor.leg.state.mn.us/ped/206/taxcomp.htm.

DOR's Report On "Expanded Tax Compliance Initiatives" Fiscal Years 2006-2007. The DOR in March 2006 issued its Report "Expanded Tax Compliance Initiatives" for Fiscal Years 2006-2007 to the Minnesota Legislature in response to the $17.8 million appropriated by the Minnesota Legislature for tax audits and enforcement activities by the Department in 2006-2007 biennium. The expectation of the Legislature was that enforcement would generate $91 million in new revenue through stepped-up audit activities. As of December, 2005, DOR spent $2.4 million of the approximate $18 million appropriated and

collected $17 million, or 19% of the anticipated $91 million for the biennium. Based on the results to date, DOR believes it is on track to collect the estimated added revenue. A copy of the DOR Report to the Minnesota Legislature "Expanded Tax Compliance Initiatives" Fiscal Years 2006-2007 is on the Department of Revenue's web site.

Commissioner Issued His "Expanded Tax Compliance" Report for 2006-2007. In January 2007, the Commissioner issued his report on its "Expanded Tax Compliance Initiatives for the fiscal years 2006-2007." The Minnesota Legislature appropriated $17.8 million to the Commissioner for the 2006-2007 biennium to collect $90.7 million through expanded tax compliance activities (Laws of Minnesota 2005, Chapter 156, article 1, section 15, subdivision 2-3). This report summarizes the results the Commissioner achieved through the end of November 2006, and is the second of two reports for the biennium. During this period – with 71 percent of the biennium completed – the Commissioner has:

• collected and deposited in the general fund $74.6 million, or 82 percent, of the anticipated $90.7 million sought through the tax compliance initiatives;

• resolved a total of 20,024 non-compliant individual income tax cases;

• identified a total of 2,044 non-compliant sales and use tax payers and 1,011 non-compliant corporate tax payers; and

• spent $9.6 million and of the total $17.8 million appropriated.

To collect the $74.6 million to date, the Commissioner spent $9.6 million, or approximately $1 for every $8 collected. In the remaining months of the FY 2006-2007 biennium, the Commissioner expects to exceed the amount forecasted for the initiatives.

Commissioner Releases His 2007 "Tax Incidence Study." In March 2007, the Commissioner issued his "2007 Minnesota Tax Incidence Study." Conclusions of the research are:

• Of the total $19.3 billion in 2004 taxes, Minnesota residents paid 83.7 percent ($16.2 billion). The remaining $3.1 billion of tax burden was exported to nonresidents.

• In 2004, the state and local tax burden on Minnesota households averaged 11.6 percent of income, up from 11.3 percent in 2002.

• The local tax share of tax revenue rose from 24.6 percent in 2002 to 25.8 percent in 2004 and is projected to rise to 28.5 percent in 2009. The State tax share fell from 75.4 percent in 2002 to 74.2 percent in 2004 and is projected to fall to 71.5 percent in 2009.

• The share of State and local revenue derived from consumption taxes fell from 34.8 percent in 2002 to 33.7 percent in 2004 and is projected to fall to 30.8 percent in 2009. The shares of income taxes and property taxes are both rising.

• The business tax share of total tax revenue is projected to fall from 33.2 percent to 32.3 percent between 2004 and 2009.

• After allowing for the shifting of business taxes, the Minnesota tax system is 2004 was slightly regressive.

• Incomes are expected to grow by over 30 percent between 2004 and 2009. Tax receipts are forecast to grow at a slightly higher rate, raising the overall effective tax rate to 11.7 percent.

• The tax system is expected to become more regressive between 2004 and 2009.

The entire report may be found at: http://www.taxes.state.mn.us/reports/reports.html.

B. Sales Tax.

Sales & Use Tax: Served Taxable Food Sold to or by Airlines. In Minnesota Department of Revenue No. 93-07 (amended March 19, 2007), the Commissioner modified the Revenue Notice 1993 on when meals served on airlines are subject to sales and use tax. If an airline serves taxable food as part of its transportation service and no separate charge is made for the food, there is no sale of taxable food by the airline within the meaning of sales and use tax laws. The sale of taxable food to the airline in Minnesota is a taxable retail sale. If an airline purchases taxable food for sale to passengers, who are separately

charged for the food, the sale to the airline is exempt for the purposes of resale. The Commissioner then construes "sale price" to include any charge leading-up to the final taxable sale. Examples of includable fees and costs are sanitation or sterilization of food service equipment, dishwashing, storage, handling, delivery of taxable food to aircraft, tray set-up, and liquor and beverage set-up as being including.

Sales & Use Tax: Taxability of Returnable Skids and Pallets for Industrial Production Exemption. In Minnesota Department Revenue No. 07-3 (March 19, 2007), the Commissioner stated his position on the issue of whether returnable skids and pallets used for food and beverage products qualify for the industrial production exemption, as returnable containers used in packaging food and beverage products. Minn. Stat. § 297A.68, Subd. 2(a)(5) provides that "packaging materials" qualify for the exemption for materials used in the industrial production. Since pallets and skids are, by definition, portable platforms for handling, storing, or moving materials and packages (as in warehouses, factories, or vehicles), the skids and pallets are used primarily for storage and transportation in the industrial production process. Therefore, the skids and pallets are not containers as defined in Minn. Rul. 8130.5500, Subpart. 6, and thus do not qualify as exempt packaging.

Sales and Use Tax: Logging Equipment – Qualifying Equipment. In Minnesota Department of Revenue No. 98-25 (amended April 2, 2007), the Commissioner restated Revenue Notice 98-25 (December 14, 1998) to reflect changes in sales and use law from a reduced rate of taxation for logging equipment to a full exemption. Numerous examples are provided of qualifying logging equipment and ineligible logging equipment.

Sales & Use Tax: Patient Services – Massage Therapy. In Minnesota Department of Revenue No. 07-06 (April 30, 2007), the Commissioner revoked Revenue Notices 94-11 and 03-9 and stated its audit position on the sales tax and the Minnesota Care Tax on massage services. Massage therapy qualifies as a therapeutic service and is therefore subject to the MinnesotaCare if provided by a licensed or registered health care provider. Massage services are subject to the sales tax under Minn. Stat. § 297A.61, Subd. 3(g)(6)(vii) unless they are provided for treatment of illness, injury or disease by, or upon written referral of, a licensed health care facility or professional. Unlicensed massage therapists are subject to sales tax unless the massage is provided for the treatment of illness, injury, or disease upon a written referral by a licensed health care facility or professional. Massage therapy provided by licensed or registered health care providers is subject to the MinnesotaCare or the Minnesota sales tax. A massage therapist, who is also a licensed or registered health care provider, is required to collect the sales tax unless the massage is for the treatment of an illness, injury, or disease. If the massage is provided, as stated above, for the treatment of illness, injury, or disease, it is subject to the MinnesotaCare tax and not subject to the sales tax. All massage services are presumed to be subject to sales tax unless the massage therapist can show that the service was for treatment of illness, injury, or disease. Numerous examples are provided.

Sales & Use Tax: Direct Mail – Tax Rates and Delivery or Distribution Exemption. In Minnesota Department of Revenue No. 07-07 (April 30, 2007), the Commissioner explained his position on determining the appropriate sales tax rate to be imposed on charges to print direct mail and discusses the types of activities that the Commissioner feels are included within the exemption for the delivery or distribution of direct mail. Charges for printing direct mail pieces are generally taxable unless the purchaser provides either delivery information or a certification of sales tax exemption. If the purchaser provides delivery information to the seller, the delivery information must show the taxing jurisdiction where the direct mail will be delivered. If the purchaser provides a direct mail form, which is a fully completed Form ST3 Certification of Exemption, claiming the direct mail exemption or provides a direct pay number issued by the Commissioner, the Seller does not charge any sales tax. Charges for the delivery or distribution of direct mail are exempt under Minn. Stat. §297A.68, Subd. 36. "Delivery charges" are defined in Minn. Stat. §297A.61, Subd. 30. Separately stated fees for services that are performed primarily to provide direct mail for delivery or distribution qualifies for the exemption. The Revenue Notice sets forth a number of services that may be part of the nontaxable delivery charges for direct mail if they are separately stated and these include postage, boxing, folding, inserting, shrink wrapping, tabbing, etc.

Sales & Use Tax: Out-of-State Business Use Exemption. In Minnesota Department of Revenue No. 93-09 (amended May 7, 2007), the Commissioner updated the previous Notice issued in 1993 and set forth the Commissioner's position on where maintenance work must be performed in order for repair and replacement parts to be exempt from the sales tax. The Minnesota sales and use tax exemption for property purchased for business use outside Minnesota and used as a part of a maintenance contract applies if (1) the repair or replacement parts are shipped or transported outside Minnesota by the purchaser and (2) the repair or maintenance work is performed outside Minnesota. The exemption does not apply if the repair or maintenance work is performed in Minnesota, even if the property repaired or maintained will be shipped or transported by the purchaser for use outside Minnesota.

Sales and Use Taxes: Responsibility for Collection and Remittance of Sales Tax on Tickets Sold at Selling Events. In Minnesota Department of Revenue Notice 99-05 (amended June 18, 2007), the Commissioner updated his previous Notice under the same number to reflect changes in tax rates. The Notice explains the duties and responsibilities of a "operator" (a person who controls the renting or leasing of space to persons conducting business as a seller at an event) for collecting and remitting sales or use tax on total sales of tickets at events or the like are used for purchasing items or admissions. The sales and use tax should be calculated on the gross receipts of all tickets sold, not the amount redeemed. Numerous examples are provided to illustrate the cascading of the sales and use tax or alcoholic gross receipts tax, and local tax rates.

Sales and Use Taxes: Flee Markets. In Minnesota Department of Revenue Notice 07-09 (June 25, 2007), the Commissioner detailed what information the operator of a flee market, show, etc. must obtain from sellers who rent space at the event. The following information is required: evidence that the seller holds a valid sales tax permit; a written statement that no taxable items are being sold; or a written statement indicating (1) that the selling event is the only selling event that the seller will participate in for the calendar year, (2) the seller will participate in the event for no more than three (3) days; (3) the seller will have less than $500 in gross receipts during the calendar year; and (4) the seller's name, address, and telephone number.

Sales and Use Taxes: Revocation of Exempt Status. In Minnesota Department of Revenue Notice 07-12 (October 15, 2007), the Commissioner discussed what happens when the property tax exemption is lost and its implications for continued sales tax exemption. An organization may have its Minnesota sales and use tax exempt status revoked if there has been a final judicial determination that the nonprofit does not qualify as a charitable organization for property tax purposes. Minnesota courts have established an identical test to determine whether an organization qualifies as charitable for sales and use tax and property tax purposes. Therefore, an organization that does not qualify as a charitable organization for Minnesota property tax purposes also does not qualify for exemption as a charitable organization for Minnesota sales and use tax purposes.

Sales & Use Tax: Agricultural Production – Grain Drying. In Minnesota Department of Revenue Notice 08-01 (Feb. 4, 2008), the Commissioner stated his position on the consumption of electricity used and consumed in agricultural production. Exempt electricity used and consumed to dry grain in agricultural production includes the harvesting and continues until the grain reaches a saleable state or until it can be acceptably commingled with other grains. However, the Commissioner's position is that electricity used to prevent spoilage, control insects, or to reduce dust and sweating is not part of the agricultural production, and therefore, is subject to sales and use tax.

Sales & Use Tax: Internet Access Charges – Update. In Minnesota Department of Revenue Notice 08-02 (February 19, 2008), the Commissioner restated his position on the taxation of Internet access charges in light of Public Law No. 110-108 "Internet Moratorium Act" being extended from November 2, 2007 through November 1, 2014 and making Revenue Notice 05-01 obsolete. The Internet Extension preempted and now governs the issue of nontaxable Internet access charges that are aggregated with other taxable charges, which was the subject of Revenue Notice 05-01, which is now revoked.

Sales and Use Tax Regulations Proposed and Adopted. The Commissioner proposed to amend various regulations in the Sales and Use Tax in 2007 and 2008. These are set forth below:

• Minnesota Rules, Chapter 8130.9000 Final Rule on Soft Water Equipment and Service Dealers Amended. On June 25, 2007, the Commissioner adopted a sales and use tax rule (Rule 8130.9000) for soft water equipment and service dealers to reflect that the tax applies to charges for delivery and installation of rented equipment and tanks, including charges to replace or exchange such equipment and tanks, even if those charges are separately stated and if the installation is performed by the lessor of the equipment and tanks. Previously, the rule provided that certain installment and replacement charges related to water softening equipment were exempt as a personal service. In addition, a rule provision stating that sales of minerals, cells, chemicals, equipment, tanks, parts, and materials to water softener dealers are taxable when used in conjunction with a water softening service is repealed.

• DOR Adopts Rules on Sales of Food Sold With Eating Utensils Provided by The Seller. The DOR announced its intention to amend and adopt without a public hearing rules pertaining to sales of food sold with eating utensils provided by the seller, amending Minnesota Rules, Chapter 8130. 31 S.R. 1701 (May 21, 2007). Under Regulations Section 8130.4705, the sale of food with "eating utensils," including plates, bowls, knives, forks, spoons, chopsticks, glasses, cups, napkins, or straws, provided by the seller falls within the definition of prepared food. Food will be deemed to be sold with eating utensils provided by the seller if the seller's practice for the item is to physically give or hand a utensil to the customer with the food as part of the sales transaction. Therefore, food sold with eating utensils provided by the seller is generally taxable as prepared food. The rule explains the circumstances in which eating utensils are considered to be provided by the seller and provides examples. In addition, the rule requires sellers to annually determine a single prepared food sales percentage for all of the seller's establishments in Minnesota. The rule is intended to conform to the provisions of the Streamlined Sales and Use Tax Agreement. Rule 8130.4705 was adopted without a hearing, effective September 17, 2007. See 32 S.R. 461 (September 10, 2007).

• Minnesota Rules, Chapter 8130.5800 on "Isolated and Occasional Sales." On October 3, 2007, the Commissioner proposed adoption of the final rule on the law governing the sales and use tax exemption for isolated or occasional sales. The isolated and occasional sales law has been split into two provisions: Minn. Stat. § 297A.67, Subd. 1 deals with occasional sales by individuals and Minn. Stat. § 297A.68, Subd. 25 deals with the sale of tangible personal property primarily used in a trade or business, if the sale is not made in the ordinary course of business. The rule explains some of the provisions provided in the law, including the sale of farm machinery, farm auction sales, and the application sections of the Internal Revenue Code

under which certain sales of tangible personal property qualify as occasional sales. The rule also explains the meaning of some of the terms provided in the law, including "tangible personal property primarily used in a trade or business"; "substantially all"; and "normal course of business." It also deals with garage sales, sales by nonprofit organizations, flea markets, and sales of repossessed items. The Commissioner intends to adopt the rules without a public hearing unless 25 or more persons submit a written request for a hearing on the rules by 4:30 p.m. on Wednesday, November 21, 2007.

C. Procedure and Miscellaneous Taxes.

Interest Rates. In News Release (October 20, 2007), the Commissioner announced that the interest rate of the tax refunds and delinquent State taxes, other than property taxes, is eight percent (8%) for 2007. This is up from six percent (6%) for 2006.

Insurance Premiums Retaliatory Tax: Total Premiums Received by Agents Insurance Companies are Subject To Taxation. In Minnesota Department of Revenue Notice 06-01 "Special Taxes – Insurance Premiums Retaliatory Tax", the Commissioner stated his position that all premium payments whether received by the agent or the insurance company directly are subject to the premiums tax of two percent (2%) of all gross premiums under Minn. Stat. § 297I.05, Subd. 1. Similarly, for the retaliatory tax computation, a foreign state's tax treatment of a Minnesota company would be subject to tax on its total premium whether received by the insurance company, the agent, or any combination before applying tax computation of the foreign jurisdiction.

Procedure: Employment/Payroll Taxes. Employers may now submit their Minnesota Forms W-2 (and any 1099 with Minnesota withholding) electronically through e-File Minnesota at the same time they file the year-end withholding tax return. Employers with more than 250 employees are required to submit W-2s electronically or magnetically on CD or 3 ½" diskette (tax year 2006 was the last year magnetic media was allowed). Further, employers that withheld more than $10,000 in fiscal year 2006 (threshold down from $20,000) must make 2007 deposits electronically. Employers must also deposit withholding tax electronically if required to pay any other Minnesota business tax to the Commissioner electronically. Employers that are required to deposit electronically and do not are assessed a 5% penalty; even if a paper check is sent on time. Employers making supplemental payments to employees at a different time than regular wages are paid, should not use the tax tables provided for in the employer guide to determine how much to withhold on those payments. Instead, regardless of the number of withholding allowances the employee claimed, the employer should multiply the supplemental payment of 6.25% (.0625). The result is the amount to withhold. Additional information is available at: http://www.taxes.state.mn.us/taxes/withholding/index.shtml.

Procedure: Employment/Payroll Taxes. The 2008 Minnesota State unemployment insurance ("SUI") tax rates continue to range from 0.556% to 10.702%, including the 0.10% Workforce Enhancement Fee and 14% Additional Assessment. The total rate assigned to new employers for 2008 is 2.3572%, with the exception of new employers considered to be in high experience rating industries (generally construction). These new high-experience employers are assigned a total rate of 9.676% for 2008. The taxable wage base for 2008 increases to $25,000, up from $24,000 for 2007. Experience-rated employers whose accounts have been changed with unemployment benefits, and have no past due amounts pending on their accounts, may make a voluntary contribution (referred to by the Minnesota DEED as a "tax rate buydown") to pay all or a part of the benefits charged against their accounts back to the state and reduce their assigned tax rate. A 25% surcharge must be included in the voluntary contribution amount. A voluntary contribution may be made any time between January 1, 2008 and April 29, 2008.

Procedure: Revocation of Revenue Notices as Obsolete. In Revenue Notice No. 07-04 (April 16, 2007), the Commissioner revoked twenty previously issued Revenue Notices because they were deemed to be obsolete. The Revenue Notices that were revoked are listed below:

2004-02 Individual Income Tax – Employer Payments to National Guard and Reservists on Active Duty

2003-03 Individual Income Tax - Alternative Minimum Tax and Contributions to Non-Minnesota Charitable Organizations

2001-03 Clarification of Revenue Notice #01-02

2001-02 Tax Relief for Victims of the Terrorist Attack on the World Trade Center and the Pentagon

2001-01 Individual Income Tax and Corporate Franchise Tax – 2001 Estimated Tax Requirements of Shareholders of S Corporation Banks, and the Treatment of Estimated Tax Payments of S Corporation Banks Made Prior to the Repeal of the Corporate Franchise Tax on S Corporation Banks

1999-12 Sales and Use Tax – Food, Candy and Soft Drinks

1999-10 Special Taxes – Unfair Cigarette Sales Act

1997-02 MinnesotaCare – Sale of Medical Supplies to a Patient or Consumer

1996-03 Insurance Premium Tax – Bail Bonds

1994-24 Income Tax – 1993 Depreciation Modification

1994-05 Special Taxes – Minnesota Unfair Cigarette Sales Act – Meeting Competition

1993-26 MinnesotaCare – Medical Supplies, Appliances and Equipment – Sale, Rental and Repair

1993-06 MinnesotaCare – Exemptions for Medicare, Medical Assistance, General Assistance Medical Care and MinnesotaCare Payments

1993-05 MinnesotaCare – Gross Revenues Subject to Tax

1993-01 Special Taxes – Bad Debt Deduction on Cigarette and Tobacco Tax Products Tax Returns

1992-15 All Types – Administration and Compliance; Electronic Funds Transfer

1992-08 Lawful Gambling – Annual Audit of Licensed Organizations

1991-23 Sales and Use Tax – Clothing and Wearing Apparel Exemption

1991-14 Special Tax – Annual Audit of Organizations Licensed to Conduct Lawful Gambling

1991-05 Sales and Use Tax – Isolated or Occasional Sale of Services

IV. Minnesota Tax Cases on Appeal.

CASES ON APPEAL FROM TAX COURT TO MINNESOTA COURT OF APPEALS AND MINNESOTA SUPREME COURT.

Case Name Filing Date Issue Hearing Date HealthEast and University of Minnesota Physicians v. County of Ramsey, Docket Nos. C4-03-4664, C3-04-4505, and C5-05-4553, File No. A071086. (Supreme Court)

05/31/2007 Exemption for hospital as "public charity"

11/5/07

Kmart Corporation v. County of Dakota, Docket No. A07-2391

12/20/2007 Right of owner to intervene in property tax contest with tenant and discovery issues

Undetermined

Kmart Corporation v. County of Mower, Docket No. A07-1474. (Supreme Court)

07/30/2007 Violation of "60-Day Rule" 10/3/07 Dismissal Stipulation

Stewart Title Guaranty Company v. Commissioner of Revenue, Docket No. A08-0429. (Supreme Court)

03/07/2008 Insurance premiums retained by insurance agents

Undetermined

Carol Dreyling, et. al v. Commissisoner of Revenue, Docket No. A08-0274. (Supreme Court)

02/13/2008 Domicle Undetermined

V. Pending Cases.

A. Income.

Corporate Franchise Tax – Nexus. In Dell Marketing Corporation v. Commissioner of Revenue and five related cases, the taxpayers, six Dell entities, object from a determination that they are liable for franchise taxes stemming from Dell's sale of computers to Minnesota customers from out-of-state locations. Taxpayers principally contend that under Quill Corporation v. North Dakota, and its progeny, Minnesota's assessment of these taxes against taxpayers for the period in question (1993 and subsequent taxable years) violated the Federal Commerce Clause. The cases were settled.

Corporate Franchise Tax – What is a Royalty? Medtronic, Inc. v. Commissioner of Revenue, Tax Ct. No. 7621-R. The taxpayer appeals from the denial of its corporate franchise tax refund claims, totaling approximately $1.7 million, filed as amended returns for 1991-1996. The taxpayer alleges that during the years in issue it sold raw materials and components for medical devices to two wholly-owned Puerto Rican subsidiaries which qualify as foreign operating corporations (FOCs) under Minn. Stat. § 290.01(6b). Both FOCs allegedly utilized the taxpayer's technology, patents, trade secrets, know-how and other intangible assets in manufacturing various medical devices. The FOCs reimburse the taxpayer for the use of these intangible

assets under IRC § 936. The taxpayer alleges the reimbursements are "royalties, fees, or other like income," 80% of which should be subtracted from its federal taxable income under Minn. Stat. § 290.01(19(d)(11)). The Commissioner disallowed the subtraction on the basis that the payments do not qualify as royalties, fees, or other like income. The case is closed.

Corporate Income Tax - Nexus. Providian Financial Corp. v. Commissioner of Revenue, Ramsey County District Court File No. C3-03-10083. The general issue in this case is whether Plaintiffs (Providian), during the taxable years 1996 through 1999, were subject to imposition of the Minnesota corporate franchise tax. Providian has brought this action under Minn. Stat. § 289A.50(7(a)(2)) and (d), upon denial by Defendant (Commissioner) of Providian's claims for refund of taxes paid for the taxable years 1996, 1997, 1998, and 1999, in the amounts of $248,399, $417,513, $1,255,806, and $2,213,072, respectively. The specific issues in the case can be summarized as follows: (1) whether the Commissioner had authority under Minn. Stat. §290.015, to assess the corporate franchise tax against Providian; (2) whether Minn. Stat. §290.015(1(b)), on the facts of this case, violates the Commerce Clause of the United States Constitution (U.S. Const. art. 1, §8, cl. 3) and the Due Process Clauses of the United States and Minnesota Constitutions (U.S. Const. Amend. XIV, §1, and Minn. Const. art. 1, §7); and (3) whether the presumptions set forth in Minn. Stat. § 290.015(2(a)), violate the Equal Protection Clause of the United States Constitution (U.S. Const. amend. XIV, §1) and the Uniformity Clause of the Minnesota Constitution (Minn. Const. art. X, §1). Federal and Minnesota constitutions. This case is continued and settlement discussions are ongoing.

Corporate Franchise Tax: FOC Qualification and Disallowance of Expenses. In Polaris Industries, Inc. v. Commissioner of Revenue, Minn. T. Ct. Docket No. 7694-R:

Issue: 1. Whether approximately $58 million paid in the settlement of a lawsuit were business expenses subject to apportionment or non-business expenses allocable to Minnesota, taxpayer's domicile.

2. Whether, in the alternative, the settlement payments of the lawsuit were unitary income of taxpayer's trade or business or were expenses not definitively related to an item or class of income which, under Minnesota Statutes §290.17, Subd. 1(b) must be assigned to Polaris' domicile.

3. Whether, in the alternative, Polaris, which owns an FSC that qualifies as a foreign operating corporation within the meaning of Minnesota Statutes §290.01, Subd. 6(b), is entitled to deduct 80 percent of the deemed dividends paid from its FOC and, if not, whether it is contrary to the Foreign Commerce and Equal Protection Clauses of the U.S. Constitution and the Equal Protection and Uniformity Clauses of the Minnesota Constitution.

4. Whether, in the alternative, whether Polaris is entitled to a deduction equal to 80 percent of the fees it received or accrued from its FOC.

5. Whether, in the alternative, Polaris is able to deduct 80 percent of the fees received from its FOC (non-FSC) on its original and amended franchise income tax returns.

Years: 1997 through and including December 31, 2000 Amount: $6,114,426.34

Status: Case settled and closed out.

Corporate Franchise Tax: Public Law 86-272. In Biogen, Inc. v. Commissioner of Revenue, Minn. T. Ct. Docket No. 7740:

Issue: 1. Whether Biogen is protected from the Corporate Franchise Tax under P.L. 86-272 because its Minnesota activities were ancillary to the solicitation of order.

2. Whether, in the alternative, if Biogen's Minnesota activities exceed the solicitation of orders, such activities were de minimus.

3. Whether, in the alternative, if taxation of Biogen is precluded by P.L. 86-272, Biogen is also not subject to the corporate franchise tax pursuant to the Minn. Stat. § 290.015, Subd. 3(a).

4. Whether, in the alternative, Biogen is exempt from the corporate franchise tax pursuant to Minn. Stat. § 290.015, Subd. 4(b).

5. Whether imposition of the corporate franchise tax violates the Due Process and Commerce Clauses of the United States Constitution and the Due Process Clause of the Minnesota Constitution.

6. Whether, in the alternative, if it determined that Biogen is subject to the corporate franchise tax, the Commissioner incorrectly computed the tax due.

7. Whether, in the alternative, if it is determined that Biogen is subject to the corporate franchise tax, the Commissioner's disallowance of certain charitable contribution deductions is unconstitutional.

8. Whether, in the alternative, the Commissioner's Order improperly imposes penalties.

Years: 1996 through and including December 31, 2001 Amount: $1,322,040.97

Status: Settled and case closed.

Corporate Income Tax: Sales Factor Apportionment. In Merrill Lynch, Pierce Fenner & Smith v Commissioner of Revenue, Minn. T. Ct. Docket No. 7717:

Issue: 1. Whether the Commissioner violated Minnesota law in not allowing gross receipts in the sales factor component of the apportionment factor for corporate franchise and income taxes.

2. Whether the Commissioner erred in sourcing receipts from principal and commission transactions to Minnesota.

Years: 1992 Corporate Franchise and Income Tax Amount: $457,830.02

Status: The case is pending and a trial is scheduled for February 3, 2008, with Judge Ramstad.

Corporate Franchise Tax: FOC and Disallowance of Expenses. In St. Jude Medical, Inc. v. State of Minnesota, Ramsey County Docket No. C5-06-000086:

Issue: 1. Whether reimbursement allocations and payments by St. Jude Puerto Rico, an IRC Section 936 Corporation and a "foreign operating corporation" under Minn. Stat. § 290.01, Subd. 6b, to its parent, St. Jude Medical, for St. Jude Puerto Rico's use of certain intangibles were "royalties, fees, or like income" accrued or received by St. Jude Medical from a foreign operating corporation within the meaning of Minn. Stat. § 290.01, Subd. 19(d)(11) for the years 1989 through and including 1997.

2. Whether the State's denial of the refund claims of St. Jude Medical for tax periods 1989 through and including 1997 violates the Equal Protection, Commerce and Foreign Commerce Clauses of the United States Constitution and the Equal Protection and Due Process Clauses of the Minnesota Constitution.

Years: Refund claims for taxable periods 1989 through and including 1997. Amount: $1,943,884

Status: Case settled.

Corporate Franchise Tax: FOC and "Economic Substance." In HMN Financial, Inc. and Affiliates v. Commissioner of Revenue, Minnesota Tax Court Docket No. 7911:

Issue: 1. Whether transactions engaged in by the Bank, which operated retail banking facilities in Minnesota and Iowa, and which set up a REIT and then a FOC entity in Delaware and had the REIT purchase loans from the Minnesota Bank, which then paid dividends to the FOC should be disregarded because they "lacked economic substance" and the FOC and the REIT should be "ignored for purposes of determining the taxable income of the combined group."

2. Whether the FOC could be excluded from the combined report of the Bank and the REIT.

3. Whether the Commissioner "blatantly ignored" the holding in Hutchinson Technology, Inc. v. Commissioner of Revenue, 698 N.W.2d 116 (Minn. 2005) that a corporation can qualify as an FOC even if it is an "empty shell entity, existing solely to provide tax exemptions."

4. Whether, in the alternative, the Commissioner correctly determined in his Order that the FOC was not a qualifying FOC.

owns

owns

Years: Corporate franchise tax returns for the years 2000, 2003, and 2004.

Amount: $2,505,392.22

Status: Discovery.

TRANSACTIONS AND TAX CONSEQUENCES

Corporate Franchise Tax: FOC and "Economic Substance." In BNSF Railway Company and Affiliates v. Commissioner of Revenue, Minnesota Tax Court Docket No. 7920:

Issue: 1. Whether BNSF Railway, formerly known as The Burlington Northern & Santa Fe Railway Company, an operating railroad, could deduct interest paid to its two (2) foreign operating corporations, called BNSF Manitoba and BNSF British Columbia, for the tax periods ending 1997 through and including 1999.

2. Whether BNSF Railway is entitled to refunds of $3,994,142.40 for tax periods ending 1997 through and including 1999 for foreign operating corporation deductions.

3. Whether the Commissioner improperly invoked Minn. Stat. § 290.34, Subd. 1 and Minn. Rule § 8034.0100 because the transactions lacked a business purpose for establishing and transferring the notes to the foreign operating corporations.

4. Whether the Commissioner improperly ignored the plain language of Minn. Stat. § 290.17, Subd. 4(i), which expressly prohibits the Commissioner from disallowing interest deductions "otherwise allowable under this chapter that are connected with or allocable against . . . deemed dividends."

Years: Corporate Income Tax Years 1997 Through and Including 1994.

Amount: $3,994,142.40

Status: Trial April 23, 2008.

Income Tax and Other Taxes: JOBZ Program Constitutionality. In Interstate Motor Trucks, Inc., Osvold Company, et al. v. State of Minnesota, Commissioner of Revenue, et al., Ramsey County District Court (June 29, 2007):

Issue: 1. Whether the JOBZ program is unconstitutional under the Minnesota Constitution because:

a. Violates the provision of Article X, Section 1 of the Minnesota Constitution that "the power of taxation shall never be surrendered, suspended or contracted away" by delegating the power of taxation to employees of DEED and local economic development officials;

b. Violates the provision of Article X, Section 1 of the Minnesota Constitution that "the power of taxation shall never be surrendered, suspended or contracted away" by authorizing the execution of contracts with businesses

Bank

REIT

FOC

3. FOC pays dividends to its parent, which deducts 80% from its Minnesota taxes because it is an FOC.

1. Loan customers of Bank pay interest to the real estate trust.

2. The real estate trust pays dividends to the FOC. The FOC pays no state taxes. It is based in Delaware, which doesn't tax this type of income. The real estate trust pays no state tax because it is a qualified REIT under Federal law.

by which Minnesota State and local governments are banned from taxing the businesses in specified respects for a period of up to 12 years;

c. Violates the rights of Plaintiffs under Article I, Section 7 of the Minnesota Constitution to Due Process of law in the administration of the Minnesota tax system by arbitrarily exempting favored businesses from taxation while leaving Plaintiffs subject to taxes and the full coercive force of the government as it collects those taxes;

d. Violates the proscription of Article XII, Section 1 of the Minnesota Constitution against Local or Special Laws that exempt property from taxation or grant to any private corporation, association, or individual any special or exclusive privilege or immunity; and

e. Violates the provision of Article X, Section 1 of the Minnesota Constitution that mandates that "taxes shall be uniform on the same class of subjects" by providing to locally favored businesses arbitrary, locally determined exemptions from legislatively enacted Statewide taxes on income, sales, and business property.

Years: All years that Article One of the Omnibus Tax Act, First Sp., Ch. 21, Article 1, §§1-27 and Minnesota Statutes §§469.310 to 469.320 and Chapters 272, 290, 297A, and 297B (exemptions from property, income, sales, motor vehicle sales taxes, and a refundable jobs credit) are effective ab initio.

Amount: $(undetermined) Requests (i) Declaratory Judgment that the JOBZ Act is unconstitutional and, in the alternative, (ii) award a full refund for each and all of the State and local taxes paid by the plaintiffs from the commencement of the JOBZ program until Judgment.

Status: Discovery.

B. Sales Tax.

Sales Tax – Nexus. barnesandnoble.com, LLC v. Commissioner of Revenue, Tax Ct. No. 7690-R. Appellant in this case sells books and similar products to Minnesota residents from sources outside Minnesota over the Internet. The issue in this case is whether Appellant's contacts with Minnesota comprise sufficient nexus to enable Minnesota to require Appellant to collect sales taxes on these transactions. On March 25, 2005, the case was settled.

Sales Tax – Exemption from Use Tax. In Berger Transfer & Storage, Inc. v. Commissioner of Revenue, Minn. T. Ct. Docket No. 7759:

Issue: 1. Whether pads which Berger purchases from out of state vendors and which are used in transporting household goods in interstate commerce are in fact equipment subject to the use tax or are they exempt packing materials under Minn. Stat. § 297A.68, Subd. 14 and Subd. 16.

2. Whether the use tax is imposed on certain pads used in transportation and storage business of the taxpayer or do the exemptions in Minn. Stat. § 297A.68, Subd. 14 and Subd. 16 apply.

Years: January 1, 1999 – February 28, 2002 Amount: $104,669.52

Status: Case was settled.

Sales Tax – Equipment Refund. In Ameripride Services, Inc. v. Commissioner of Revenue, Minn. T. Ct. Docket No. 7971:

Issue: 1. Whether taxpayer is eligible for a capital equipment refund for equipment purchased for taxpayer's taxable services of laundering of uniforms.

2. Whether taxpayer is eligible for the capital equipment claim for the periods October 1, 2000 through and including July 31, 2003.

3. Whether the 2005 amendment to the capital equipment statute in Minn. Stat. § 297A.68(5)(c), excluding services from capital equipment, can be retroactively applied since it is a mere "clarification."

4. Whether taxpayer is providing a taxable service or engaged in the manufacture of tangible personal property for ultimate sale at retail.

Years: Sales and use tax returns for capital equipment October 1, 2000 through and including July 31, 2003

Amount: $ undetermined

Status: Trial on July 15, 2008.

Sales Tax – Scope of Cleaning Services. In Fabritain Enterprises, Inc. d/b/a COIT Services v. Commissioner of Revenue, Minn. T. Ct. Docket No. 7876:

Issue: 1. Whether Fabritain Enterprises, Inc. is liable for additional sales and use tax when it removes waste water from the customer's home after carpet cleaning for disposal at its facility. Taxpayer did not collect tax on the waste water surcharge.

2. Whether Taxpayer could rely on Commissioner's Fact Sheet 131 by analogy and as authority for its position that the disposal charges similar to disposal of oil in the automotive industry was not subject to sales tax.

3. Whether the Commissioner's Order is an erroneous determination that disposal of waste water away from the customer's site from the Taxpayer's carpet cleaning is a necessary part of the service, and cannot be separated, and therefore is subject to sales tax under Minn. Stat. § 297A.61, Subd. 7(a)(3). That is, whether the "sale price" includes "charges by the seller for any services necessary to complete the sale, other than delivery and installation charges". Id.

Years: Sales and Use Tax January 1, 2001 through and including December 31, 2003.

Amount: $30,692.37

Status: Case Settled.

Sales Tax: "What Is Included In The Sales Price?" In Northern X-Ray Co. v. Commissioner of Revenue, Minn. T. Ct. Docket No. 7945:

Issue: 1. Whether Commissioner's audit adjustment of the purchase price of x-ray consumables (such as film and barium products) to end users (such as hospital, clinics and medical imaging centers) was correct.

2. Whether the taxpayer's claim that the assessment for a change in computing sales tax on the actual price which Northern X-ray Co.'s customers paid Northern X-ray Co. for products to another price which includes in the taxable amount manufacturer and customer negotiated reductions for manufacturer's list prices was correct.

Years: Periods beginning March 1, 2003 through and including June 30, 2006 on sales and use tax

Amount: $854,405.05

Status: Trial on May 5, 2008.

Sales Tax – Rebates and "Buy-downs." Salem Tobacco v. Commissioner of Revenue, Minn. T. Ct. Docket No. 7760:

Issue: 1. Whether Salem Tobacco in Columbia Heights should charge sales tax for manufacture coupons and/or other "buy downs."

Years: April 1, 2001 through and including March 31, 2004 Amount: $202,915.15

Status: Case is closed.

Sales Tax – What Is Included Within The Scope of "Admissions?" In Bados & Bados, Inc. v. Commissioner of Revenue, Minn. T. Ct. Document No. 7926:

Issue: 1. Whether taxpayer should be charging a fee for admissions as required under Minn. Stat. § 297A.62, Subd. (g)(1) for the privilege of admission to places of amusement, etc. when it conducts various leagues of basketball, bowling, broomball, football, kickball, softball, soccer, and volleyball at public establishments.

2. Whether the services provided by Bados & Bados, Inc., in conjunction with its business, are or are not includable within the definition of services that are taxable under the privilege of admissions to places of amusement, recreational areas, or athletic events under Minn. Stat. § 297A.62, Subd. (g)(1).

3. Whether the fees charged by Bados & Bados, Inc. are a fee for admissions to a place of amusement, recreational areas, or athletic events as required under Minn. Stat. § 297A.62, Subd. (g)(1).

Years: Sales & use tax returns for the period beginning January 1, 2003 and ending December 31, 2006

Amount: $337,332.09

Status: Trial on May 15, 2008.

Sales Tax – Industrial Production Exemption for Packaging Services. Midwest Crating Unlimited Corp. v. Commissioner of Revenue, Minn. T. Ct. Docket No. 7767:

Issue: 1. Whether the taxpayer's materials purchased were used or consumed in industrial production of personal property when the taxpayer offers to its customers standard and custom packaging services by preparing crates or other containers to ship large machines or other bulky objects for delivery to their purchasers.

2. Whether the Commissioner erred in determining that certain out-of-state transactions were subject to sales tax when the tangible personal property involved in those transactions was shipped or transported outside of Minnesota.

3. Whether Midwest Crating Unlimited's customers are manufacturers and whether the items being crated or packaged are items being produced by that customer (manufacturer) for sale at retail.

4. Whether Midwest Crating Unlimited is providing customer packaging services or producing tangible personal property used in the industrial production process.

5. Whether the Commissioner under Minn. Stat. § 270.07 may abate a penalty if the late payment that gave rise to the penalty was due to "reasonable cause" based upon the accounting firm's advice that the items were exempt from sales and use tax.

Years: Sales and Use Tax for Calendar Years 1999, 2000, 2001, 2002 and the first three quarters of 2003 Amount: $26,569.30

Status: Case settled and dismissed.

Sales Tax: "What Is Included In The Sales Price." Avis Rent A Car System, Inc. v. Commissioner of Revenue, Minn. T. Ct. Docket No. 7790:

Issue: 1. Whether the Minneapolis-St. Paul Metropolitan Airports Commission's Rental Auto Facility Charge ("RAFC") on – Airport vehicle renters at a specified rate per vehicle per day is considered part of the sale price for Avis Rent A Car System's and gross receipts under Minn. Stat. §§ 297A.61, 297A.62, and 297A.64.

2. Whether the Rental Auto Facility Charge imposed by the Minneapolis-St. Paul Metropolitan Airports Commission was imposed on the customers leasing the car or on Avis. See U.S. Sprint Communications Company, Ltd. V. Commissioner, 578 N.W. 2d 752 (1998).

3. Whether the Rental Auto Facility Charge is Avis' property and revenue or is the MAC's property because of a lease agreement with the MAC, when Avis' book accounting excludes the RAFC from gross sales, and when for federal and Minnesota income tax purposes Avis does not include the RAFC in its gross sales or additions to gross sales.

4. Whether the RAFC is in violation of Minnesota Constitution, Article 10 (taxation), Section 1, which requires that all taxes be uniform since the RAFC does not apply to rental companies operating out of the Airport premises.

Years: September 1, 1999 through and including September 30, 2003 Amount: $907,708.68

Status: Closed – Case Dismissed on September 18, 2006.

C. Procedure.

Procedure: Statute of Limitations Applied to Capital Equipment Claims and Constitutional Arguments. AT&T Corp. v. Commissioner of Revenue, Minn. T. Ct. 7888:

Issue: 1. Whether AT&T Corp. is entitled to sales and use tax capital equipment refund claims for telecommunications equipment in the amount of $1,707,120.12 for the sales and use tax periods from June 1, 1998 through and including June 30, 20

2. Whether Lucent Technologies, Inc., properly acted as agent for AT&T in timely filing sales and use tax the capital equipment refund claims under Minn. Stat. §289A.40 and Section §289A.42.

3. Whether the extension of the statute of limitations (for all tax periods at issue) by Lucent and AT&T and the Commissioner allowed the two capital equipment refund claims to be properly filed.

4. Whether AT&T was the purchaser making the claim for refund of the capital equipment for Lucent Technologies, Inc.

5. Whether the Legislature's 2005 amendment under Minn. Stat. §289A.40 to provide that the statute of limitations would be 3.5 years from the 20th day of the month following the month of the invoice date, effective for claims filed after the date of the enactment (June 2, 2005), barred any of the capital equipment refund claims.

6. Whether if the 2005 Legislative amendment of Minn. Stat. §289A.40 barred AT&T from receiving refunds claimed, there was a violation of the Due Process Clause of the Fourteenth Amendment of the United States Constitution and the Due Process Clause of Article I, Section 7 of the Minnesota Constitution.

7. Whether if the 2005 legislative amendment of Minn. Stat. §289A.40 barred AT&T from receiving refunds claimed, was there a violation of Article I, Section 11 of the Minnesota Constitution, and Article I, Section, Clause 1 of the United States Constitution, which states that no law impairing the obligation of contracts shall be passed.

Years: Sales and use tax capital equipment refund claims for the periods June 1, 1998 through June 30, 2001

Amount: $1,707,120.12

Status: Case settled.

VI. Websites.

A. The Department of Revenue Website is:

www.taxes.state.mn.us

B. The Office of the Revisor of Statutes Website is:

http://www.house.leg.state.mn.us/

C. The Minnesota Tax Court Website is:

www.taxcourt.state.mn.us

D. Minnesota Department of Finance Website is:

http://www.finance.state.mn.us/

E. Minnesota Supreme Court Website is:

http://www.courts.state.mn.us

This will locate you at the homepage of the Minnesota Court System. An icon can be clicked that will take you to the Minnesota Supreme Court. Once on the homepage of the Supreme Court, you can also view Supreme Court oral arguments as streaming video at: http://www.tpt.org/courts/

F. Minnesota State Legislative Website is:

http://www.leg.state.mn.us/

VII. "Traps for the Unwary" or "Have They No Shame Provisions" in Minnesota Tax Laws.

A. Pro-taxpayer results in litigation prompts legislative "clarifying" actions by Department of Revenue.

B. Insufficient notice and lack of time to review and comment on DOR legislative technical and policy bills before introduction into Legislature.

C. Lack of interest netting: During the course of an audit, a taxpayer is found not to have accrued tax on certain purchases which are eligible for 100% capital equipment refund for sales tax purposes. The Commissioner's position is that interest is charged on the deficiency that is due up to the date of the audit report, but no interest is allowed on the capital equipment refund.

D. The uncertain status of "Protective Claims" in Minnesota and the non-payment of interest in some circumstances.

E. Buying assets of a business and picking-up the tax liabilities of the Seller: "successor liability" in Minnesota for purchasers.

F. Mandatory procurement of sales tax exemption certificates within 60-days after audit notice from DOR on penalty of loss of the resale exemption and too restrictive sampling techniques used in sales and use audits.

G. The procedures on filing claim for refunds was limited in 1995: Within 1-year from the date of Order, claimant needs (i) to pay and (ii) to file the claim and then (iii) the claim is restricted to the issues and the payment made with the Order.

H. Too many penalties and lack of independent appeal review for penalties: Penalty abatement procedure is in the Collections Division rather than in the Appeals Division like appeals for other taxes.

I. No prohibition on ex parte communications in Appeals Division among examination agents, Commissioner's attorneys, and appeals officers.

J. The evisceration of the "isolated sale" sales tax exemption.

K. Until complete phase-out, June "accelerated sales tax" payment and electronic filing.

MISSISSIPPI STATE DEVELOPMENTS J. Paul Varner Butler, Snow, O’Mara, Stevens & Cannada, PLLC P. O. Box 22567 Jackson, MS 39225-2567 tel. 601-985-4552 fax. 601-985-4500 e-mail: paul.varner@butlersnow.com web address: www.butlersnow.com I. INCOME/FRANCHISE TAXES

A. Legislative Developments.

1. New Markets Tax Credit. Mississippi law currently allows a credit against income tax and insurance premium tax liability for a qualified equity investment in a qualified community development entity or CDE. This credit, which is the Mississippi equivalent of the federal “new markets” tax credit, is to encourage investments in entities involved in developments in low- and moderate-income areas throughout the United States. Under current law, the income tax credit is 4%, and the insurance premium tax credit is 1-1/3%, of the amount of the investment in a CDE in each of the second through seventh years of the investment. A bill was enacted to amend Mississippi Code Section 57-105-1 to make various changes to this credit. It accelerates the benefit by allowing a credit equal to 8% of the investment in a CDE for each of the first through third years of the investment for both income tax and insurance premium tax purposes. The bill also makes it clear that tax credits earned by a partnership or other pass through entity may be allocated to the entity owners as they may agree pursuant to the terms of the operating agreement for such entity. The bill imposes a fee of $1,000 on the CDE for the privilege of applying for the credit. The fee is payable to the Mississippi Development Authority, which is the state agency that must allocate the credit. The maximum amount of an investment in a CDE that may qualify for the credit remains capped at $10 Million. (House Bill 1662, effective July 1, 2008).

2. Credit for Jobs Skills Training Costs. Mississippi law allows an income tax credit equal to 50% of the costs incurred by certain employers for providing basic skills training programs to its employees. A bill was passed to postpone the date of repeal of such credit from July 1, 2008 until July 1, 2012. (Senate Bill 2534, effective July 1, 2008).

3. Disregarded Entities; Reportable Transactions. A bill was passed to clarify the Mississippi income tax treatment of disregarded entities and to give the Chairman of the Tax Commission the authority to monitor reportable transactions. Various income tax statutes were amended to provide that trusts, partnerships and corporations that are required to include the financial activity of a disregarded entity on its tax return for federal income tax purposes are also required to do so for Mississippi income tax purposes. The bill also authorizes the Chairman of the Tax Commission to require taxpayers and their advisors, who are required to notify the IRS of certain “reportable transactions,” to also notify the State Tax Commission of such transactions. The bill further authorizes the Chairman of the Tax Commission to require tax advisors, who are required by federal income tax law to keep lists of certain “reportable transactions,” to also maintain such lists for Mississippi income tax purposes. (Senate Bill 2562, effective July 1, 2008).

B. Judicial Developments.

1. Barton v. Blount10 – Income Tax On September 4, 2007, the Mississippi Court of Appeals issued its opinion addressing the proper method to calculate depreciation recapture in connection with the sale of all assets by a corporation followed by a complete liquidation. The husband and wife taxpayers owned all of the stock of a corporation that operated a restaurant business in Mississippi. In 2000, the corporation sold all of its assets and liquidated.

Mississippi law generally imposes an income tax on gain resulting from the sale of assets. During the year in question, however, an exemption from the gain recognition requirement applied if (i) a corporation sold all or

10 Docket No. 2006-CA-00698-COA.

substantially all of its assets, (ii) the assets had been held for more than one year and (iii) the corporation was completely liquidated within one year from the date of sale. The exemption in question was repealed for transactions occurring after March 29, 2005.

The applicable gain exclusion statute did not apply to depreciation recapture "computed in the same manner as provided for in Section 1245 of the Internal Revenue Code." Upon audit of the taxpayers’ 2000 return, the taxpayers and the Tax Commission could not agree on the proper method of computing the taxable depreciation recapture from the sale.

The taxpayers and the buyer of the assets had agreed to an allocation of the total consideration among the assets in the transaction for purposes of calculating gain for the seller and basis for the buyer for each asset. The taxpayers asserted that they were required to recapture depreciation only to the extent of the lesser of the depreciation claimed on a given asset or the gain from the sale of that asset based on the agreed allocation.

The State Tax Commission took the position the allocation of the sales price among the assets that was agreed to by the taxpayers and the buyer was irrelevant to the depreciation recapture computation. It asserted that the proper method for computing the depreciation recapture was to include all prior depreciation on all assets sold so long as that amount did not exceed the total amount of sales proceeds.

The court held that because the statute required the depreciation recapture to be computed "in the same manner as provided for in Section 1245," and because Section 1245 requires depreciation recapture to be determined on an asset-by-asset basis, the Tax Commission's computation of the depreciation recapture on an aggregate basis was erroneous. The Court of Appeals reversed and remanded the case and instructed the Tax Commission to recalculate the proper amount of depreciation recapture in a manner that was consistent with its opinion.

This decision creates an income tax refund opportunity (subject to the applicable statute of limitations) for those taxpayers who filed returns prior to the repeal of this exemption that reported excessive depreciation recapture from a liquidating sale of assets.

C. Administrative Developments – No substantive changes.

II. TRANSACTIONAL TAXES

A. Legislative Developments

1. Sales Tax on Rebates Received by Retailers. It is a common practice for manufacturers of consumable products to pay rebates to retailers as an incentive for the retailer to offer the product for sale at a lower price. The Mississippi sales tax treatment of rebate payments received by retailers has been unclear. A bill was enacted to modify the definition of “gross proceeds of sales” for sales tax purposes to clarify this uncertainty. Pursuant to this change, a retailer will not be required to pay sales tax on a rebate payment unless (i) the payment is directly related to a discount on the product sold, (ii) the retailer is obligated to pass the discount through to the purchaser, (iii) the amount of the rebate that is attributable to the sale of each item of the product is fixed and determinable at the time of the sale, and (iv) the discount is either identified on the invoice received by the purchaser or on a coupon presented by the purchaser. (House Bill 1663, effective July 1, 2008).

2. Contractors’ Tax. Under Mississippi law, contractors are required to pay a 3.5% tax on the contract price for all non-residential construction projects in excess of $10,000. The tax must be paid to the Tax Commission prior to the commencement of work when the contractor applies for a Material Purchase Certificate (“MPC”). The MPC allows the contractor to purchase materials that are to become a component part of the structure free of sales tax. A bill was passed to amend Miss. Code Section 27-65-21 to provide that contractors who pay sales tax on the purchase of component materials may, after obtaining a MPC from the Tax Commission, claim a credit for any sales tax paid on such purchases. (House Bill 1663, effective July 1, 2008).

3. Software sold via the Internet. Mississippi law imposes sales tax on the revenue earned from certain specified services including “computer software sales and services.” Legislation was enacted to clarify that sales of software or software services transmitted by the internet to a destination outside of Mississippi where the first use by the purchaser occurs outside of Mississippi are exempt from sales tax. (Senate Bill 3173, effective July 1, 2008).

B. Judicial Developments.

1. Blount v. ECO Resources, Inc.11 – Contractor’s Tax. On November 20, 2007, the Mississippi Court of Appeals issued its opinion addressing whether a management company that operated water and sewer systems for municipalities was subject to contractor’s tax for its repairs to the water and sewer systems. The taxpayer contracted with municipalities to operate, manage and repair their water and sewer systems for a flat fee. The flat fee only covered repair work that did not exceed $2,000 per repair project.

Upon audit, the Tax Commission imposed the 3.5% contractor’s tax on that portion of the flat fee that was attributable to the repair work. Under Mississippi law, the contractor’s tax applies to the fee paid to contractors for the construction or repair of non-residential real property improvement projects in excess of $10,000.

The taxpayer claimed it was exempt from the contractor’s tax because all repairs it performed were to portions of the water and sewer system that were personal property. The Tax Commission argued that the personal property exemption from the contractor’s tax does not apply to repairs made to water and sewer systems.

The court recognized that underground water and sewer pipes lost their identity as personal property, but it held that other component parts of the system that could be easily removed retained their identity as personal property. After determining that 99.5% of the repair work was performed on the personal property components of the system, the court held that only .5% of the fee attributable to repair work was subject to the contractor’s tax.

2. Pursue Energy v. Tax Comm’n12 – Use Tax. On September 20, 2007, the Mississippi Supreme Court issued its opinion addressing whether the corporate owner of natural gas wells and a gas processing plant in Mississippi was subject to use tax on gas that it used and consumed in its operations. The taxpayer owned and operated a number of sour gas wells in Mississippi. Sour gas requires processing to remove hydrogen sulfide before it can be sold. The taxpayer also owned the plant that removed the hydrogen sulfide from the gas. Most of the processed or clean gas was sold by the taxpayer in the wholesale market. A portion of the processed gas, however, was used by the taxpayer to run the gas processing plant and to run its equipment at well sites.

Upon audit, the Tax Commission imposed use tax at the rate of 1.5% (the rate applicable to manufacturers) on the value of the gas used to run the processing plant and use tax at the rate of 7% (the rate applicable to retail sales) on the value of the gas used to run its well site equipment.

The taxpayer first argued that the fuel used in its operations was neither sold, nor placed in the market for sale, and therefore there is no transaction upon which to impose the tax. The court found that the only necessary requirement for the imposition of the use tax is a use or consumption of personal property in Mississippi.

The taxpayer then argued that because it was a wholesaler, the gas used at the plant was exempt from use tax under the wholesaler exemption. The court found that the wholesaler exemption did not apply to the gas used at the plant because it was not sold to other parties for resale.

Finally, the taxpayer argued that the use tax only applies to tangible personal property that is purchased outside of Mississippi and later used or consumed in Mississippi. The court rejected that argument finding that it was irrelevant whether the taxpayer's gas came from within Mississippi boarders or was brought into the state.

C. Administrative Developments – No substantive changes.

III. PROPERTY TAXES

A. Legislative Developments.

1. Ad valorem Exemptions for Certain Suppliers. In the third special legislative session of 2000, Mississippi Code Section 57-75-35 was enacted to allow a city or county to agree in advance to provide certain ad valorem exemptions to attract enterprises that would have a major economic impact as part of the Mississippi Major Economic Impact Act. A bill was passed to broaden the types of enterprises that may qualify for this exemption so

11 Docket No. 2006-CC-00673-COA. 12 Docket No. 2006-CA-01390-SCT.

that it will now cover certain major manufacturers that have recently been attracted to Mississippi for economic development purposes. (Senate Bill 2532, effective March 31, 2008).

2. Mineral Documentary Tax. Mississippi law has long provided an ad valorem exemption for non-producing oil, gas and mineral interests that are severed from the surface interest. However, the law required a “mineral documentary tax” to be paid upon the transfer of any non-producing mineral interests. The chancery clerk was required to collect the tax and to affix “mineral documentary tax stamps” to the deed evidencing the payment of such tax. A bill was passed to simplify to procedure for documenting the payment of such tax. The chancery clerk is no longer required to attach mineral documentary tax stamps to the deed transferring such interest. Rather the chancery clerk may note in writing on the face of such deed that the mineral documentary tax has been paid. (Senate Bill 2714, effective January 1, 2009).

B. Judicial Developments – No substantive changes.

C. Administrative Developments – No substantive changes.

IV. OTHER NOTES OF INTEREST

In Governor Barbour's state of the state address, which was delivered on January 21, he announced the appointment of a commission to conduct a comprehensive study of Mississippi's tax system, including how the combined federal and local tax structures affect Mississippi citizens and businesses.

The public-private commission will be chaired by Leland S. Speed, one of the state's long-time business leaders and the former Director of the Mississippi Development Authority. The 37 other members of the Commission come from business, legal, academic and legislative backgrounds. The members of the Commission include the Secretary of State, the State Treasurer and the Chair of the State Tax Commission. Governor Barbour asked the commission to provide a report on its findings by August 31, 2008.

V. PROVIDER’S BIO/RESUME

Please see the resume’ below for Paul Varner.

J. PAUL VARNER Butler, Snow, O'Mara, Stevens & Cannada, PLLC P. O. Box 22567 Jackson, MS 39225-2567 tel. 601-985-4552 fax. 601-985-4550 e-mail: paul.varner@butlersnow.com web address: www.butlersnow.com DISTINCTIONS Fellow, American College of Tax Counsel The Best Lawyers in America, Tax Law, Trusts and Estates Law Mid-South Super Lawyers, Tax Certified Public Accountant (Miss.) Mississippi Legal Correspondent, State Tax Notes AV-rated, Martindale-Hubbell

EDUCATION & HONORS New York University, LL.M., Taxation, 1984 University of Mississippi, J.D., 1982 Editorial Board, Mississippi Law Journal University of Mississippi, B.B.A., accounting, 1977

ASSOCIATIONS American Bar Association

Taxation Section State and Local Tax Committee

American Institute of Certified Public Accountants Mississippi Bar

Taxation Section Mississippi Tax Institute

Board of Trustees, 1993-1995 Mississippi Society of Certified Public Accountants

Board of Governors, 1987-89 and 1997-99 BAR ADMISSIONS Mississippi, 1982

MONTANA STATE DEVELOPMENTS NEBRASKA STATE DEVELOPMENTS NEVADA STATE DEVELOPMENTS NEW HAMPSHIRE STATE DEVELOPMENTS NEW MEXICO STATE DEVELOPMENTS

NEW JERSEY STATE DEVELOPMENTS Arthur R. Rosen Leah M. Samit McDermott Will & Emery LLP McDermott Will & Emery LLP 340 Madison Avenue 340 Madison Avenue New York, New York 10173 New York, New York 10173 (212) 547-5596 (212) 547-5342 arosen@mwe.com lsamit@mwe.com

CORPORATION BUSINESS TAX

A. Legislative and Regulatory Updates

Federal Stimulus Act. Because New Jersey does not follow federal treatment of depreciation, the depreciation-related business incentives contained in the Federal Economic Stimulus Act of 2008 are not adopted for New Jersey CBT purposes. Division of Taxation, Notice (Apr. 17, 2008).

S Corporation Retroactive Elections Permitted. The Director promulgated new regulation 18:7-20.3 outlining a procedure that enables a corporation and its shareholders to cure a defective New Jersey S Corporation election. The regulation requires that a Form CBT-2553-R be signed by all shareholders and be submitted along with a fee equal to $100 for each year of retroactivity requested. The corporation must be authorized to do business in New Jersey and must be registered with the Division of Taxation; all CBT returns must have been timely filed as if the election had been made; the request must be made before a final assessment is issued covering a year within the request period; there must not have been a notice issued by the Division denying a previous late filed S election request; and (this may be the tricky one!) all shareholders must have filed appropriate tax returns and paid their gross income tax in full when due as if the New Jersey S Corporation election had been timely made. The fee is not refundable.

B. Judicial Updates

Requirement of Regular Place of Business Outside of State Found to Be Internally Consistent; Home Office Does Not Qualify as Regular Place of Business Outside of State. New Jersey Natural Gas Co. v. Director, Division of Taxation, Tax Ct. Dkt. Nos. 000240-2005; 007284-2005 (Apr. 17, 2008). A corporation must have a regular place of business outside of New Jersey to apportion its income; otherwise, 100% of the corporation’s income is allocated to New Jersey. N.J.R.S. 54:10A-8. Taxpayers required to allocate 100% under this scheme may be eligible for a credit for taxes paid to other states, N.J. Admin. Code 18:7-8.3(b). Taxpayer, NJ Natural Gas, initially filed New Jersey returns allocating 100% of its income to New Jersey but then amended its returns seeking to apportion its income using three-factor apportionment. The Division did not allow apportionment on the basis that the taxpayer’s employee’s home office in Connecticut did not constitute a regular place of business outside New Jersey.

Presiding Judge Small determined that the employee’s home office in Connecticut was not a regular place of business because the taxpayer neither owned, leased, nor paid rent for the home office. The employee bore the expense of insurance, taxes, remodeling and alteration costs for the home and received no salary as payment in lieu of rent for use of her home. Further, Judge Small determined that the 100% allocation formula was internally consistent under Commerce Clause and Due Process Clause standards because the credit mechanism ensured that double taxation did not occur. The 100% allocation formula was externally consistent because the difference in taxes calculated using the Director’s 100% allocation with regulatory credits and the three-factor apportionment the taxpayer requested was between 4.18% and 15.66% during the years at issue. NJ Natural Gas failed to prove that this disparity fell “outside the constitutional margin of error.”

Nexus for Intangibles Holdings Companies; Penalties – Appeal Pending. Praxair Technology, Inc. v. Division of Taxation, Letter Decision Tax Ct. Dkt. No. 007445-05 (June 18, 2007). Judge Hayser determined that a company licensing patents, trade secrets, and know-how for use in New Jersey was subject to the CBT even though the company was not itself physically present in the State. The Judge held that tax could be imposed in years prior to 1996; previously, common opinion had been (and perhaps still is) that 1996 was a “cut off” date in IHC cases because New Jersey’s nexus regulation was amended in 1996 to include for the first time, as an example of nexus-generating activities, the licensing of intangibles for use in the State. Praxair is particularly noteworthy because the imposition of a 25% failure to file penalty was upheld on the basis that a sophisticated taxpayer could not have reasonably believed that it was not required to file. The decision did not address the fact that the Tax Court itself had previously opined that physical presence was required (Tax Court opinion in Lanco, reversed on appeal) and that the New Jersey Supreme Court acknowledged that there was a split among the states as to whether Quill’s physical presence requirement applied to income taxes. Appeal is currently pending.

Business/Non-Business Income: Gain from Deemed Asset Sale is Nonoperational Income – Appeal Pending. McKesson Water Products Co. v. Division of Taxation, Tax Court Dkt. No. 000156-2004 (Aug. 8, 2007). Judge Kuskin held that fictional gain from the deemed sale of assets pursuant to an I.R.C. § 338(h)(10) election was not allocable to New Jersey because the deemed seller of the assets (the target) of income had its primary place of business outside of the State. New Jersey law requires an allocation of operational income but requires that non-operational income be assigned to the taxpayer’s principal place of business. Because a deemed asset sale did not constitute an acquisition, management, or disposition of property that had been an integral part of the taxpayer’s regular trade or business—the standard for determining operational income— the gain was not treated as operational income. Additionally, the gain was not investment income serving an operational function because the taxpayer did not invest the sale proceeds in a business similar to what it conducted in its regular course. Appeal is currently pending.

The Throw Out Rule – Summary Judgment Motions on Facial Constitutionality Pending. New Jersey’s so-called “Throw Out Rule,” which requires a company to exclude from its receipts factor denominator all sales made into states in which the company is not subject to a net income tax when determining its allocation factor, is currently being challenged as unconstitutional under the Commerce and Due Process Clauses by four taxpayers, whose motions for summary judgment were argued together on March 28, 2008. The leading case, Pfizer Inc. v. Division of Taxation, Tax Court Dkt. No. 000055-2006, is followed by General Engines Co. v. Division of Taxation, Tax Court Dkt. No. 008807-2006; Federated Brands, Inc. v. Division of Taxation, Tax Court Dkt. No. 008806-2006; and Whirlpool Properties, Inc. v. Division of Taxation, Tax Court Dkt. No. 00066-2007. A decision expected from Judge Kuskin some time this summer. (For a discussion of the constitutionality of the Throw Out Rule, see Donald Griswold and Leah Samit, “Irrationality, Inconsistency, and Discrimination: Why New Jersey’s Throw-Out Rule Is Unconstitutional,” BNA Tax Management Multistate Tax Report, v. 14, no. 8 (Aug. 24, 2007) available at http://www.mwe.com/info/pubs/multistate_tax_ report082407.pdf.

PERSONAL INCOME TAX

C. Legislative and Regulatory Updates

Preparer of More Than 50 Returns Must File Returns Electronically. Beginning with the 2007 tax year, tax practitioners who filed 50 or more New Jersey resident income tax returns during the previous tax year must file all 2007 New Jersey resident income tax returns electronically. Preparers are liable for a penalty of $50 per return that should have been filed electronically but were not. New Jersey State Tax News vol. 36, No. 4 (Winter 2007).

D. Judicial Updates

Period for Filing Administrative Protest of Additional Transfer Inheritance Tax Runs From Date of Receipt of Assessment Notice – Not Date on Notice or of Mailing. Estate of Pelligra, 23 N.J. Tax 658 (2008). The 90-day period for filing an administrative protest of additional transfer inheritance tax begins when the assessment notice is received by the decedent’s representative or estate – not the date of mailing or the date shown on the notice. The statutory language of N.J.R.S. 54:49-18a provides that the protest must be filed “within 90 days after the giving of the notice of assessment.” The regulations interpreting this statute did not provide any clarification. Because “ambiguities in the tax law are to be construed in favor of the taxpayer” (citing Stryker Corp. v. Director, 168 N.J. 138 (2001)), Judge Pizzuto interpreted the statute as allowing the longer period for filing the protest.

Calculation of Estate Tax Based on Federal Statutes and Rules in Effect on Dec. 31, 2001 Upheld Even Though Decedent Died in 2005. Estate of Stevenson, 23 N.J. Tax 583 (2008). New Jersey’s calculation of estate tax was decoupled from the current federal calculation and tied to the federal statutes and rules as they were in effect on Dec. 31, 2001. Based on the 2001 federal treatment, additional New Jersey estate tax was due on the estate of decedent who died in 2005 – even though the estate was not subject to any federal estate tax in effect at that time. Judge Menyuk determined that New Jersey’s use of 2001 federal statutes did not attempt to calculate the federal tax due but was used to calculate the New Jersey tax and therefore was appropriate.

Retroactive Application of Estate Tax Law Changes to Decedents Manifestly Unjust. Oberhand v. Director, Division of Taxation, N.J. Sup. Ct. Dkt. No. A-106-06 (Feb. 27, 2008). On July 1, 2002, the New Jersey Legislature made changes to the calculation of estate taxes, decoupling from the then-current federal calculation and tying to the federal calculation as of December 31, 2001 (see also Estate of Stevenson, above). The New Jersey law change was effective retroactively to December 31, 2001. Decedents here died after December 31, 2001 (the effective date of the law change) but before July 1, 2002 (when the law change was passed by the legislature). The New Jersey Supreme Court determined that it would be manifestly unjust to apply an estate tax law change retroactively against decedents

who were denied the opportunity to change their estate plans based on the law change (because they were deceased at the time of the law change).

Period for Issuing a Final Determination Runs from the Date of Filing the Original Return, Not From the Date of Filing an Amended Return DiStefano v. Director, Division of Taxation, N.J. Tax Ct. Dkt. No. 000943–2005 (Jan. 30, 2008). The DiStefanos filed their original tax return for the 1999 tax year on October 16, 2000 without any claim for credits paid to New York. Later, New York audited the DiStefanos and determined that New York tax was due for the tax year 1999. The DiStefanos filed an amended New Jersey return for the year 1999 in January 2003 claiming a credit for taxes paid to New York. On October 20, 2003, the Division of Taxation issued a notice of deficiency assessing additional tax reflecting a recomputation of the credit for taxes paid to New York (as shown on the amended return) and credits to three other states (as shown on the original return). The Division argued that the statute of limitations period for assessment ran from the filing of the amended return and therefore the notice of deficiency was timely. Because the issue of whether the filing of an amended return tolled the statute of limitations period was an issue of first impression in New Jersey, Judge Bianco looked to the federal treatment of the statute of limitations period. Under federal case law, and a survey of cases from Missouri, Maryland, Indiana, New York, and Arizona, the period of limitation clearly runs from the filing of the original return and is not tolled by amended returns. Thus, the notice of deficiency was time-barred. (However, the statutory period is extended permanently by an amended return that is filed fraudulently or falsely with the intent to evade tax, N.J.R.S. 54A:9-4(c), and to six years by an amended return that reflects a substantial understatement of 25% or more, N.J.R.S. 54A:9-4(d).)

SALES AND USE TAX

A. Legislative and Regulatory Updates

Refund Procedures Changed for Refund Claims Involving More Than 25 Transactions. The Division of Taxation amended N.J.A.C. 18:2-5.8, effective December 17, 2007. The new provisions affect the documentation requirements for claims involving more than 25 transactions. Documentation must identify the tangible personal property or service that is the subject of the refund claim and the amount requested. Documentation can be invoices, receipts, proofs of payment of tax, and exemption certificates. New rules for PDF imaging require written approval from the Division. The documentation must clearly identify the seller, purchaser, invoice number, invoice date, description of the transaction, amount of the invoice excluding the tax, and the amount of sales tax billed for the transaction. Proof that the tax was remitted is also required.

B. Judicial Updates

Sales Tax Refund Procedures Are the Exclusive Remedy for Overpayments of Sales Tax; Consumer Fraud Act Claim Denied; Conformity with SST Was Intended to Supplement Refund Procedures Already in Place. Kawa v. Wakefern Food Corp., N.J. Tax Ct. Dkt. 008717-2006 (Apr. 3, 2008). Defendant consumer brought a claim on behalf of herself and all similarly situated consumers (i.e., a class action) alleging that defendant supermarkets overcharged sales tax on purchases made while using store-issued discount/membership cards and thereby participated in unconscionable commercial practices, deception and fraud in violation of the Consumer Fraud Act, N.J.R.S. 56:8-2. Under the Consumer Fraud Act a plaintiff may be entitled to attorneys’ fees, treble damages, and interest; under the Sales Tax Act none of these are available. Judge Menyuk held that the Sales Tax Act provided the exclusive remedy for seeking a refund of overpaid sales tax: seek a refund from the vendor or, if the vendor has already paid the amount collected over to the state, then seek a refund by submitting a claim to the Division. Moreover, Judge Menyuk determined that conformity with the Streamlined Sales Tax requirement that written notice of a refund claim against a seller be provided was intended to supplement the remedies already available and was not intended to create a new remedy.

Retailer Not Entitled to Bad Debt Deduction on Sales Tax Return Where Third-Party Finance Company Issued Credit Cards. Home Depot U.S.A., Inc. v Director, N.J. Tax Ct. Dkt. 006005-2005 (Mar. 14, 2008). Retailer sought a refund of sales tax attributable to purchases made with its private label credit card by customers who later failed to pay the amounts they had charged, based on its reading of N.J. Admin. Code 18:24-23.2(a). A third-party finance company issued the credit cards (and bore the risk of the bad debts). The retailer argued that service fees it paid to the financing companies included a projected bad debt loss, this amount was not separately stated and could not be separately identified to the Judge Kuskin’s satisfaction. Judge Kuskin concluded that the state should not bear any of the credit risk for bad debts and that the retailer was “stuck” with the form of a transaction it chose (if the retailer itself had issued the credit card it would have fallen squarely within N.J. Admin. Code 18:24-23.2(a) and would have been allowed the deduction). So long as the retailer receives from the customer an amount sufficient to pay the sales tax due on the purchases, New Jersey is entitled to receive and retain the tax. The Judge rejected the retailer’s arguments that this would result in a tax rate potentially as high as 100%.

Related Party Transactions Disregarded Resulting in Internet Retailer Being Treated as Vendor Required to Collect Sales Tax. Drugstore.com, Inc. v. Director, Division of Taxation, 23 N.J. Tax 624 (2008). Drugstore.com operates a website from Washington State through which New Jersey customers can order products. Under the corporate structure in place, orders placed on the website were for products sold by a wholly-owned subsidiary (DSNP Sales) and were processed and shipped by another wholly-owned subsidiary (DS Distribution). DSNP Sales would purchase products from DS Distribution for resale. When an order was placed by a customer through the website it would be processed by Drugstore.com then sent to DSNP Sales which would transmit the order to DS Distribution for fulfillment. DSNP Sales (the seller) had no physical presence in New Jersey and did not collect on sales to New Jersey customers.

While Judge Menyuk respected the separate entity status of each of the three related corporations, she disregarded the sales transactions between DSNP Sales and DS Distribution. Among her reasons for disregarding the sales were her determinations that the title to goods did not actually shift from DS Distribution to DSNP Sales, only book entries were made in lieu of actual cash payments, and the overall testimony provided on this topic was not credible.

Judge Menyuk determined that Drugstore.com was the real seller of goods and that it maintained a warehouse in the state. Following the United States Supreme Court case of National Geographic Society v. California Board of Equal., 430 U.S. 551, the Court determined that having sales into the state and having a physical presence there – even though those two facts were unrelated – was sufficient to create a sales tax collection obligation.

An appeal is currently pending.

PROVIDER'S BRIEF BIOGRAPHY

Arthur R. Rosen is a partner in the New York City office of the law firm of McDermott Will & Emery LLP, from where he chairs the firm’s nationwide state and local tax practice. His practice focuses on tax planning and litigation relating to state and local tax matters for corporations, partnerships, and individuals. Formerly the Deputy Counsel of the New York State Department of Taxation and Finance as well as Counsel to the Governor’s Temporary Sales Tax Commission and Tax Counsel to the New York State Senate Tax Committee, Mr. Rosen has held executive tax management positions at Xerox Corporation and AT&T. In addition, he has worked with accounting and law firms in New York City.

Mr. Rosen is a Fellow of the American College of Tax Counsel and is listed in the Best Lawyers in America and in the Best Lawyers in New York.

Mr. Rosen is a past chair of the State and Local Tax Committee of the American Bar Association’s Tax Section and a past chair of the National Association of State Bar Tax Sections. He is a member of the Executive Committee of the New York State Bar Association’s Tax Section, and has served as co-chair of its Committees on New York State Tax Matters, New York City Tax Matters, and State and Local Tax Matters. He also served as President and Chairman of the NYU Tax Society and is an active member of the Institute for Professionals in Taxation and the New York Chamber of Commerce and Industry’s Tax Committee. Mr. Rosen was a member of the steering committee of the NTA Communications and Electronic Commerce Tax Project. Mr. Rosen founded and chairs the annual week-long “Introduction to State and Local Taxes” program, as well as the “State and Local Taxation II” program, offered at New York University. He serves as a member of the New York State Commissioner of Taxation and Finance’s advisory council, the New York City Commissioner of Finance’s advisory council, and the New York City Tax Appeals Tribunal’s advisory council.

Mr. Rosen is the editor of the monthly newsletter Inside New York Taxes, co-editor of the semi-monthly newsletters New York Tax Highlights and New York Tax Cases; he was the original editor-in-chief of CCH’s E-Commerce Tax Alert, and was the monthly tax columnist for the E-Commerce Law Journal. He has written numerous articles that have appeared in publications such as the Journal of Taxation, the Journal of State Taxation, the Journal of Bank Taxation, the State and Local Tax Lawyer, Multistate Tax Analyst, Inc. Magazine, the Assessment Digest, the Journal of New York Taxation, and The Tax Executive. In addition, he has spoken extensively throughout the country on state and local tax matters.

Leah Meryl Samit is an attorney at McDermott Will & Emery LLP in the State and Local Tax Practice in New York. With a background in federal transfer pricing litigation, Ms. Samit's practice focuses on controversy work, with transactional and planning projects rounding out her days. She is attorney of record in the leading case challenging the constitutionality of New Jersey's Throw Out Rule. Along with Mr. Rosen, Ms. Samit has provided extensive guidance with respect to FIN 48 accruals.

McDermott Will & Emery LLP has one of the largest state and local tax practices in the United States. With offices located across the country, McDermott is uniquely positioned to advise and represent multi-state businesses on a broad range of state tax matters. You can find full text state and local tax articles at www.mwe.com/articles.

NEW YORK STATE DEVELOPMENTS Arthur R. Rosen William B. Ruehl McDermott Will & Emery LLP McDermott Will & Emery LLP 340 Madison Avenue 340 Madison Avenue New York, New York 10173 New York, New York 10173 (212) 547-5596 (212) 547-5398 arosen@mwe.com wruehl@mwe.com

I. INCOME/FRANCHISE TAX

A. Legislative, Regulatory and Administrative Developments

1. 2008-2009 Budget

Governor David A. Paterson signed the state budget bill into law on April 23, 2008. The bill includes the following tax related provisions:

Corporation franchise tax

Changes affecting banks, general corporations and LLCs

The budget bill lowers the capital tax rate from .178% to .15%, raises the cap that non-manufacturers pay under the capital base from $1 million to $10 million for a three–year period and requires all business taxpayers to add back the amount of the deduction allowed under Internal Revenue Code Sec. 199, Qualifying Production Activities Income, when determining entire net income. The bill also amends provisions enacted last year to ensure that banks with out-of-state REITs are treated the same as banks with New York REITs, extends for four years the temporary MTA business tax surcharges and requires every corporation taxpayer whose tax for the preceding years was in excess of $100,000 to remit 30% (instead of 25%) of its preceding year's corporation tax as its mandatory first installment. In addition, the bill classifies certain credit card companies as taxpayers under Article 32 of the Tax Law, and restructures limited liability company fees and the Article 9–A fixed dollar minimum tax.

A corporation engaged in a credit card business will now be subject to tax under Article 32 of the Tax Law -- essentially an income tax on banks and other financial organizations -- based solely on meeting certain economic nexus thresholds. An out-of-state credit card company with no physical presence in New York is subject to tax if it has any of the following: (1) issued credit cards to 1000 or more customers with a mailing address in New York; (2) merchant customers with 1000 or more total locations receiving payments from the credit card company in New York; (3) receipts of $1 million or more from its credit card customers with a mailing address in New York; (4) receipts of $1 million or more from its merchant customer contracts relating to locations in New York; or (5) the total number of credit card customers and merchant locations under (i) and (ii) equals 1000 or more, OR the total of receipts from credit card customers and merchants under (iii) and (iv) equals $1 million or more. Note: “Receipts” includes merchant discounts from merchants in New York.

Empire State film production credit.

The budget bill triples the percentage of qualified film production costs eligible for the credit from 10% to 30%, extends the program for an additional two years to 2013, refunds 100% of the excess credit up front at the end of the first tax year (previously only 50% of the excess was treated as an overpayment and refunded to the taxpayer) and raises the aggregate amount that can be awarded under the credit during a calendar year from $60 million to $110 million over a six-year period.

Sales and use tax

Collection of tax by "remote sellers"

Under what is being referred to as the “Amazon tax” the new law establishes a rebuttable presumption that remote sellers who enter into contracts with New York residents under which the residents receive compensation for customer referrals are vendors under the Tax Law and, as such, are required to collect sales tax for the state. The presumption applies where receipts from the vendor's sales to New York customers who were referred to the seller by residents receiving compensation for the referrals exceed $10,000 during the preceding four quarterly periods.

Soon after New York State approved the new law requiring online retailers to collect sales tax, Amazon.com filed a complaint with the Supreme Court of the State of New York challenging the constitutionality of the newly enacted statute that requires out-of-state internet retailers, with no physical presence in New York, to collect sales tax. The complaint also argues that the law "intentionally targets Amazon."

Collection of tax by tax-exempt organizations

The bill provides that tax-exempt organizations are required to collect sales tax on on-line sales, mail order sales and rentals or leases of tangible personal property if such activities are not directly related to their non-profit status.

Miscellaneous sales and use tax changes

All vendors will be required to re-register for a sales tax certificate, regardless of their current standing. The re-registration program will be administered by the Commissioner and must be completed by March 31, 2012. Re-registration will include a $50 fee. This provision takes effect November 1, 2008.

Middle Class STAR rebates

The legislation makes some changes to the Middle Class STAR property tax program, most notably delaying the increases in the Middle Class STAR benefit by one year. In addition, the bill increases from 5% to 10% the allowable equalized assessment value for purposes of calculating the STAR benefit and authorizes the Department of Taxation and Finance to capture STAR rebates to offset state debts.

Cigarette tax

The bill increases the tax on cigarettes by $1.25 to $2.75 per pack, effective June 3, 2008. Effective July 1, 2008, little cigars are treated as indistinguishable from cigarettes (in conformity with the federal government) and the tax on smokeless tobacco is converted to a weight-based tax (96¢ per ounce) rather than a tax based on the wholesale price.

Miscellaneous provisions

The bill re-opens the amnesty program enacted in 2005 for a five–month period, beginning November 2008, to allow taxpayers to report participation in tax shelter activities with a reduced penalty, extends tax shelter reporting for two years and establishes a new voluntary disclosure and compliance program. The bill also makes changes to a variety of credits, by specifically eliminating the flat refundable credit for New York City resident personal income taxpayers who have taxable income above $250,000; increasing the aggregate amount of low income housing tax credits that may be allocated by $4 million; extending the sunset date of the investment tax credit for financial services from October 1, 2008 to October 1, 2011; extending by two years the tax credit for equipping taxis and livery service vehicles to make them handicapped accessible; reinstating the credit for bioheat purchased for residential use (available January 1, 2008 through December 31, 2011); and extending the period that a company may certify as a qualified investment project until 2009 and makes technical corrections to the Empire Zone wage tax credit.

2. TSB-M-08(2)C -- Combined Reporting for General Business Corporations (including Real Estate Investment Trusts and Regulated Investment Companies) and Insurance Corporations

On March 3, 2008, the New York Department of Taxation and Finance (“Department”) issued TSB-M-08(2)C which supersedes TSB-M-07(6)C. This memorandum does the following: (1) changes what constitutes a substantial intercorporate asset transfer; (2) changes what items are excluded when determining whether the taxpayer has substantial intercorporate receipts or substantial intercorporate expenditures; and (3) provides new information relating to combined reporting for real estate investment trusts (REITs), regulated investment companies (RICs), and insurance companies subject to Article 33 of the Tax Law. The changes are effective for tax years beginning on or after January 1, 2007. Substantial Intercorporate Asset Transfers Pursuant to the superseded guidance in TSB-M-07(6)C, a transfer of assets to a related corporation would satisfy the “substantial intercorporate transactions” requirement for combined reporting if the assets transferred constituted 10% or more of the transferor’s or transferee’s total assets at the time of transfer. Under current guidance in TSB-M-08(2)C, for asset transfers occurring after January 1, 2007, a transfer of assets to a related corporation will satisfy the substantial intercorporate transactions requirement when 20% or more of the transferee’s gross income results directly from the transferred assets and the corporations are engaged in a unitary business. Only assets transferred to the transferee in exchange for stock or paid-in capital are taken into account for the purposes of the test. If the corporation transfers cash, the transaction is not considered an asset transfer for purposes of the substantial intercorporate asset test. When evaluating intercorporate asset transfers to determine if substantial intercorporate transactions exist, dividends received will be considered in the measuring of gross income for purposes of the 20% of gross income test above. Substantial Intercorporate Receipts or Expenditures TSB-M-08(2)C broadens the items that may be excluded when determining receipts or expenditures for purposes of the substantial intercorporate transaction requirement. Under the previous guidance only extraordinary items were excluded and under the current guidance all nonrecurring items may be excluded. New Combined Reporting Rules for Real Estate Investment Trusts (REITs) and Regulated Investment Companies (RICs) According to new amendments to tax laws of 2007, REITs and RICs may be required or permitted to make a report on a combined basis. A REIT whose capital stock is substantially owned or controlled by one or more corporations that are not REITs but are taxable under Article 9-A (or included in a combined report with a corporation subject to tax under Article 9-A), are required to make a combined report with those corporations. However, a combined report will not be required if all the other corporations are also REITs. Additionally, a REIT is not required to be included in a combined report under Article 9-A if over 50 percent of the capital stock of the REIT is owned by a bank holding company as defined in section 1462(f) of the Tax Law or a banking corporation subject to tax under section 1451 of the Tax Law. A RIC whose capital stock is owned or controlled by one or more corporations that are not RICs but are taxable under Article 9-A (or included in a combined report with a corporation subject to tax under Article 9-A), is required to make a combined report with those corporations. However, a combined report will not be required if all the other corporations are also RICs. Additionally, a RIC is not required to be included in a combined report if over fifty percent of the capital stock of the RIC is owned directly or indirectly by a bank holding company as defined in section 1462(f) of the Tax Law or a banking corporation subject to tax under section 1451 of the Tax Law. A REIT or RIC required to be included in a combined report must add back the federal dividends paid deduction allowed to REITs and RICs in computing New York entire net income. In addition, if a REIT or RIC is required to be included in a combined report, combined business and investment capital includes the business and investment capital of all corporations, including any REIT or RIC included in the combined report. 3. Notice N-07-23 -- SMLLC Filing Fee. In November 2007 the Department of Taxation and Finance issued Notice N-07-23, announcing that for tax years beginning after December 31, 2006, single-member limited liability companies (SMLLCs) that are disregarded entities for federal corporate income tax purposes are no longer required to file Form IT-204- LL, Limited Liability Company/Limited Liability Partnership Filing Fee Payment Form, or pay the $100 filing fee. The Department's notice

also states that the partnership filing fee on an LLC with more than one member that is a disregarded entity for federal income tax purposes has also expired.

B. Judicial Developments 1. Inclusion of subsidiary's receipts in apportionment formula Disney Enterprises, Inc. v. Tax Appeals Tribunal, N.Y., Dkt. No. 37, 03/25/2008, aff'g. N.Y. Sup. Ct., App. Div., 3rd Dept., 830 NYS2d 614 (2007). The highest court in New York, the Court of Appeals, has affirmed a State Tax Appeals Tribunal decision which concluded that the Department of Taxation and Finance properly included a subsidiary's New York destination sales in the numerator of a unitary group's receipts factor even though the subsidiary was not itself subject to New York corporation franchise tax. The taxpayer, a unitary group of related corporations engaged in three segments of the entertainment industry, argued that the business allocation percentage employed by the Department violated federal statute P.L. 86-272. By including the nontaxpayer subsidiary's New York destination sales in the unitary group's receipts factor, New York was, in effect, imposing a tax on the subsidiary. The Court of Appeals agreed with the Appellate Division's rejection of the taxpayer's argument, stating that it was "well settled that, when apportioning a group's in-state taxable income, a state may look beyond its borders and take into account income of companies not subject to its jurisdiction." The Court added that "[i]n doing so, the state is not deemed to have taxed that income but instead to have used it to determine the tax base fairly attributable to the group as a whole." The Court therefore concluded that the Department did not impose a tax on the subsidiary when it included the subsidiary's New York sales receipts in the numerator of the taxpayer's business allocation percentage; rather, it properly included the subsidiary's sales receipts in the numerator of the taxpayer's receipts factor merely to arrive at the best measure of the combined group's taxable in-state activity. The Court dismissed the taxpayer's constitutional claims as without merit, noting that "‘the Constitution imposes no single formula on the States,’ but merely requires a ‘minimal connection or nexus between the interstate activities and the taxing State.’" 2. Loss on Sale of Subsidiary in a Combined Reporting Bausch & Lomb, Inc., and Affiliates, DTA No. 819883, December 20, 2007. The State Tax Appeals Tribunal considered whether a $93 million loss Bausch & Lomb incurred on the sale of its stock in a subsidiary that was included in the parent’s combined group for certain years should be disallowed for Corporation Franchise Tax purposes on the basis that the parent’s ownership of the stock was an investment in ‘‘subsidiary capital.’’ Bausch & Lomb and many of its subsidiaries filed as a combined group for many years during which time the composition of the group varied. The group reported capital gains and losses on a consolidated basis, netting capital gains for one member of the combined group against losses incurred by other members of the combined group. Bausch & Lomb sold all of its stock in one subsidiary that had been included in the combined report for a substantial loss which it carried back to a previous year, resulting in a refund claim for that year. The Division of Taxation denied the claim asserting that the elimination of intercorporate stockholdings from the computation of subsidiary capital does not affect what items are included in entire net income. Bausch & Lomb countered that the language in Tax Law Sec. 211.4(b)(2) essentially modifies the exclusion of income, gains and losses from subsidiary capital under Tax Law Sec. 208.9(a). Tax Law Sec. 211.4(b)(2), which states that ‘‘in computing combined subsidiary capital intercorporate stockholdings shall be eliminated.’’ The question is whether stock in the combined subsidiary should be regarded as ‘‘subsidiary capital’’ in determining whether loss on the sale of that stock is disallowed as being attributable to subsidiary capital. The Division argued that ‘‘distortions’’ that would result from accepting Bausch & Lomb’s argument. The Division maintained that double counting of losses occurred because the losses sustained by the subsidiary reduced its value resulting in reduced tax that Bausch & Lomb had to pay on subsidiary capital. The Tribunal pointed out that this was a function of the different nature of the two taxes and that this result was simply a consequence of the legislature’s decision to apply the Corporation Franchise Tax on more than one base. The Tribunal was also unconvinced by the Division’s alternate theory of distortion -- that built-in losses which economically accrued before a subsidiary joined in a combined report or when members of the combined group were different should not be allowed. The Division could cite no basis in the Tax Law or regulations for imposing such a limitation on the use of losses. Ultimately, the Tribunal concluded that Tax Law Sec. 211.4(b)(2) means that

intercorporate stockholdings are not ‘‘subsidiary capital’’ when a subsidiary is included in a combined report. Accordingly, Bausch & Lomb’s loss was allowed. 3. NOLs Generated by Affiliated Taxpayer Univisa, Inc., DTA No. 820289, September 20, 2007. The Tax Appeals Tribunal held that a taxpayer could not use reattributed net operating losses that were generated by an affiliated taxpayer, its wholly-owned subsidiary, in calculating its New York State entire net income for taxable years ending December 31, 1996 and May 16, 1997. The taxpayer was a corporate group that filed consolidated federal income tax returns, but separate New York corporation franchise tax reports, and the items of income and deduction attributable to each corporation subject to New York tax had to be disaggregated from the consolidated federal return in order to determine the corporation's federal income on a stand-alone basis as the beginning point for the calculation of New York entire net income. The method for making this separate basis computation is a pro forma separate-company federal return prepared as if the corporation did not join in the filing of the federal consolidated return. When corporations file separate rather than combined franchise tax reports, gains and losses attributable to subsidiary capital, such as a loss on the disposition of the stock of a subsidiary, are eliminated in computing the entire net income of the parent corporation. Also, the operating losses of a corporation do not offset the income of an affiliated corporation. 4. New York City Capital Tax - Partnership Interest Valued at Market Value National Bulk Carriers, Inc. and Affiliates, TAT (E) 04-33 (GC), November 30, 2007. With regard to computing the tax on capital under the New York City’s General Corporation Tax the City Tax Appeals Tribunal considered whether the included asset in capital is the corporation’s intangible partnership interest (which would be valued at book value), or its share of the partnership’s real property (which would be valued at fair market value). National Bulk Carriers, a New Jersey corporation, owns various subsidiaries that in turn own interests in partnerships that own real estate, including office buildings in New York City. National Bulk computed its GCT liability based on the capital method, i.e., the amount of its business and investment capital allocated to the City. In determining the value of assets under the capital method, National Bulk included the value of its interests in the partnerships as shown on its books in accordance with GAAP. The Department of Finance disagreed with the position taken by the corporation on its return, asserting that National Bulk should not be treated as owning interests in the partnerships (the ‘‘entity approach’’), but instead should be treated as owning a ratable share of the partnerships’ assets (the ‘‘aggregate or conduit approach’’). Application of the aggregate approach resulted in a substantial assessment for the tax years at issue. The Tribunal concluded that the aggregate or conduit approach should be used, i.e., National Bulk should be treated as owning a ratable share of the partnerships’ property and those assets should be included in business capital at their fair market value. The Tribunal reasoned that since the aggregate approach is required for purposes of computing a corporate partner’s business allocation percentage that the same approach be used in determining the assets to be included in business capital. The Tribunal stated that use of the entity approach ‘‘would permit taxpayers to manipulate the value of their capital under the Capital Method simply by moving assets into and out of entities that can be treated as partnerships or corporations merely by ‘checking a box’.’’

II. SALES AND USE TAX

A. Judicial Developments

1. Audit Methodology

In the Matter of the Petition of Ming Moon Kitchen, LLC, NYS Division of Tax Appeals, Small Claims, Dkt. Nos. 820898; 820987, 09/27/2007.

The Division of Taxation's use of a carefully performed one-day observation test to determine a taxpayer's taxable sales was reasonable, because the taxpayer failed to provide to the Division any records to substantiate its sales. Since the audit method used by the Division's auditor was reasonable, and the taxpayer failed to show by clear and

convincing evidence that the result of the audit was unreasonably inaccurate, the Notice of Determination was sustained. The Division was required, however, to recompute its determination of tax due for one of the periods under audit, because the auditor computed a higher error rate for the earlier of the two periods under audit than was computed for the later period, which was disadvantageous to the taxpayer. Finally, the taxpayer failed to establish that its failure to pay tax was due to reasonable cause and not due to willful neglect.

In the Matter of the Petition of Huntington Hills Wine and Spirits Corp., NYS Division of Tax Appeals, Dkt. Nos. 820995; 821049, 01/03/2008.

An administrative law judge (ALJ) has upheld the Division of Taxation's assessment of additional sales tax against the taxpayers, a retail liquor store and its 100% shareholder/president. The ALJ stated that the record established the Division's “clear and unequivocal written requests for books and records of the corporation's sales, as well as the corporation's failure to produce such books and records for the Division's review.” The ALJ found that when a letter to the corporation's suppliers to verify the corporation's purchase records indicated a discrepancy between the reported purchases and the purchases indicated by the suppliers, the Division properly deemed the business records to be inaccurate and unreliable and justifiably resorted to a markup audit methodology using the amount of purchases as supplied by the suppliers, together with a markup determined on the audit of a similar business located nearby. The taxpayers argued that the Division's audit result was imprecise, but the ALJ concluded that any imprecision in the results of the audit was the result of the taxpayers' failure to keep and maintain records as required under the Tax Law. The ALJ therefore denied the taxpayers' petitions and sustained the Division's notices of determination.

PROVIDERS’ BRIEF BIOGRAPHIES

Arthur R. Rosen is a partner in the New York City office of the law firm of McDermott Will & Emery LLP, from where he chairs the firm’s nationwide state and local tax practice. His practice focuses on tax planning and litigation relating to state and local tax matters for corporations, partnerships, and individuals. Formerly the Deputy Counsel of the New York State Department of Taxation and Finance as well as Counsel to the Governor’s Temporary Sales Tax Commission and Tax Counsel to the New York State Senate Tax Committee, Mr. Rosen has held executive tax management positions at Xerox Corporation and AT&T. In addition, he has worked with accounting and law firms in New York City.

Mr. Rosen is a Fellow of the American College of Tax Counsel and is listed in the Best Lawyers in America and in the Best Lawyers in New York.

Mr. Rosen is a past chair of the State and Local Tax Committee of the American Bar Association’s Tax Section and a past chair of the National Association of State Bar Tax Sections. He is a member of the Executive Committee of the New York State Bar Association’s Tax Section, and has served as co-chair of its Committees on New York State Tax Matters, New York City Tax Matters, and State and Local Tax Matters. He also served as President and Chairman of the NYU Tax Society and is an active member of the Institute for Professionals in Taxation and the New York Chamber of Commerce and Industry’s Tax Committee. Mr. Rosen was a member of the steering committee of the NTA Communications and Electronic Commerce Tax Project. Mr. Rosen founded and chairs the annual week-long “Introduction to State and Local Taxes” program, as well as the “State and Local Taxation II” program, offered at New York University. He serves as a member of the New York State Commissioner of Taxation and Finance’s advisory council, the New York City Commissioner of Finance’s advisory council, and the New York City Tax Appeals Tribunal’s advisory council.

Mr. Rosen is the editor of the monthly newsletter Inside New York Taxes, co-editor of the semi-monthly newsletters New York Tax Highlights and New York Tax Cases; he was the original editor-in-chief of CCH’s E-Commerce Tax Alert, and was the monthly tax columnist for the E-Commerce Law Journal. He has written numerous articles that have appeared in publications such as the Journal of Taxation, the Journal of State Taxation, the Journal of Bank Taxation, the State and Local Tax Lawyer, Multistate Tax Analyst, Inc. Magazine, the Assessment Digest, the Journal of New York Taxation, and The Tax Executive. In addition, he has spoken extensively throughout the country on state and local tax matters.

William B. Ruehl is an associate at McDermott Will & Emery LLP in the State and Local Tax Practice in New York. His practice focuses on multi-state corporate tax controversies, consulting and planning. William provides advice regarding the state and local tax implications of a wide variety of transactions, including mergers and acquisitions, asset dispositions and restructurings. Prior to joining McDermott Will & Emery, William was a manager of state income tax examinations for a $43 billion global company where he was primarily responsible for managing all state income tax audits for numerous diverse business units. In addition, William has significant experience working for Big Four accounting firms in their state and local tax practices. William has an extensive background in state and local tax consulting and transactional analysis. He has worked with taxpayers in diverse industries, including manufacturing, retail/distribution, pharmaceuticals, telecommunications, and financial services.

William is admitted to practice in New York and Connecticut.

________________________

McDermott Will & Emery LLP has one of the largest state and local tax practices in the United States. With offices located across the country, McDermott is uniquely positioned to advise and represent multi-state businesses on a broad range of state tax matters. You can find full text state and local tax articles at www.mwe.com/articles.

NORTH CAROLINA STATE DEVELOPMENTS Charles B. Neely, Jr. (cneely@williamsmullen.com) Nancy S. Rendleman (nrendleman@williamsmullen.com) Steven B. Long (slong@williamsmullen.com) Angie D. Harris (aharris@williamsmullen.com) Robert W. Shaw (rshaw@williamsmullen.com) WILLIA MS MULLEN P.O. Drawer 19764 Raleigh, NC 27619-9764 Telephone 919-981-4000 Telecopier 919-981-4300 Website: www.williamsmullen.com This North Carolina update discusses the legislative and administrative changes to North Carolina tax laws during the period October through May 2008, as well as major appellate court cases.

I. Corporate Income and Franchise Taxes

A. Legislative Developments (None.)

B. Judicial Developments

Superior Court Judge Clarence Horton has issued an important decision in Wal-Mart Stores East, Inc., et al. v. Hinton, Docket Nos. 06-CVS-3928 & 06-CVS-3929 (N.C. Super. Ct. Dec. 31, 2007). Judge Horton granted the Department of Revenue’s motion for summary judgment in its entirety. The case is a refund action by Wal-Mart based on assessments of additional corporate income taxes for the years 1999-2002. The Department based its additional assessments on a forced combination of the tax returns of Wal-Mart, Inc. and two of its wholly owned subsidiaries, Wal-Mart Stores East, Inc. and Sam’s East, Inc. The two subsidiaries established real estate investment trusts (REITs) to which various Wal-Mart properties were conveyed by an unrecorded “Master Deed.” The REITs leased the properties back to Wal-Mart and the subsidiaries, which paid rents to the REITs based on 2.5% of gross sales. The REITs paid dividends to the two subsidiaries on a quarterly basis. The subsidiaries claimed a deduction for rent paid and classified the dividends received as non-business income.

The Department based its combination of tax returns on the sham transaction doctrine and contended that the corporate structure lacked business purpose and economic substance. Wal-Mart challenged the Department’s view of the law regarding authority to force combination.

Inter alia, Wal-Mart contended that the Department could only force combination of tax returns under N.C. Gen. Stat. § 105-130.6 when inter-corporate payments among related parties were in excess of fair compensation. Wal-Mart also challenged the additional assessments based on a variety of state and federal constitutional theories.

The Department contended that it had the authority to issue the additional assessment based on N.C. Gen. Stat. §§ 105-130.4, 105-130.6, 105-130.15, and 105-130.16.

The superior court disagreed with Wal-Mart on virtually every issue. It concluded that N.C. Gen. Stat. §§ 105-130.4, 105-130.6, and 105-130.16 authorize combination, that the Department is not limited to situations in which inter-corporate payments among affiliated companies were in excess of fair compensation, and that the additional assessments were not unconstitutional.

The court expressed particular concern about the circularity of funds, the fact that the restructuring did not affect either daily operations or federal tax positions, and that Wal-Mart Stores controlled all aspects of the funds transfers and real estate asset management. The court also expressed skepticism about the business purpose of the transaction because of the fact that rent was based on a percentage of gross sales, which was not Wal-Mart’s standard practice in structuring rent agreements when leasing real property from third parties.

Wal-Mart has appealed the decision to the North Carolina Court of Appeals.

C. Administrative Developments

1. In the Matter of: Proposed Assessment of Additional Franchise Tax for the Years 2000 through 2002 by the Secretary of Revenue of North Carolina, Docket No. 2007-28 (N.C. Sec’y of Rev. Sep. 14, 2007)

The Assistant Secretary of Revenue has held that a corporation with a partial interest in an LLC doing business in North Carolina must include in its apportionment formula the property, payroll, and sales of its proportional interest in the LLC. In the Matter of: Proposed Assessment of Additional Franchise Tax for the Years 2000 through 2002 by the Secretary of Revenue of North Carolina, Docket No. 2007-28 (N.C. Sec’y of Rev. Sep. 14, 2007). The taxpayer corporation was a holding company that owned a partial interest in the LLC, which leased automobiles and other equipment in North Carolina. It contended that its interest in the LLC did not result in its having done business in North Carolina.

The central holding of the appeal was that the taxpayer was doing business in North Carolina for purposes of the franchise tax. The taxpayer filed tax returns for the years subject to the appeal but reported an apportionment factor of 0.00% for each year, contending that it was not required to include its pro rata share of the LLC’s property, payroll, and sales in the apportionment calculation. The taxpayer justified its tax returns on the basis that its share of the LLC’s income was allocable nonbusiness income. The Assistant Secretary disagreed, because the taxpayer was a holding company the purpose for which was to own interests such as those it held in the LLC. Based on principles enunciated in the Department’s regulations, “[w]here the business of the partnership is directly or integrally related to the business of the corporate partner, the corporate partner’s share of the partnership net income is classified as business or apportionable income.” Id. Conclusion of Law ¶ 12; 17 N.C.AC. § 5C.1702.

The Assistant Secretary concluded that, “[a]s a holding company with no other business activities apart from its ownership interests in its investments, the businesses of Taxpayer and LLC are directly or integrally related.” Id. Conclusion of Law ¶ 14. “Doing business” for franchise tax purposes is defined broadly: “each and every act, power, or privilege exercised or enjoyed in this State, as an incident to, or by virtue of the powers and privileges granted by the laws of this State.” Id. ¶ 17; N.C. Gen. Stat. § 105-114(b)(3). Therefore, the taxpayer was required to apportion its base according to the apportionment formula prescribed in N.C. Gen. Stat. § 105-130.4 for the purpose of computing its franchise tax liability to North Carolina.

The Assistant Secretary waived the penalties pursuant to the Department’s penalty policy. Id. Conclusion of Law ¶ 29. The decision is available online at http://www.dor.state.nc.us/practitioner/hearing/2007-28.pdf.

2. The Department of Revenue promulgates new regulations on alternative apportionment formulas.

Businesses seeking to alter the apportionment formula for purposes of the North Carolina corporate income and franchise taxes must follow a new administrative procedure. The new procedure was enacted as part of the legislation which made substantial changes to North Carolina’s tax appeals process, discussed in the last North Carolina update. The Department of Revenue has issued regulations, effective February 1, 2008, that govern the procedure for applying for a modified apportionment formula.

The new statutory framework dispenses with the Augmented Tax Review Board and places the sole decision-making authority for altering apportionment formulas in the hands of the Secretary of Revenue. The newly promulgated regulations govern the applications procedure before the Secretary. See 17 N.C.A.C. 05D .0107 through .0115.

Taxpayers are limited to applying for a modified apportionment formula for the last tax year and must file their application within 90 days of the regular or extended due date of the tax return. 17 N.C.A.C. 05D .0110. The Secretary must hold a hearing within 90 days, which he or she can extend once for an additional 90 days. 17 N.C.A.C. 05D .0111. The Secretary must issue the final decision within 60 days of the hearing, or 60 days after the date that the taxpayer provides additional information that the Secretary may request.

Legal counsel or a tax practitioner may appear on behalf of the taxpayer before the Secretary of Revenue without the taxpayer’s presence. The rules of evidence will not apply. The Secretary’s decision is not appealable. N.C. Gen. Stat. § 105-130.4(t1).

II. Sales and Use Tax

A. Legislative developments

1. Six counties enact additional .25% sales and use tax. In 2007, the General Assembly authorized counties to levy an additional .25% sales and use tax. 2007 Sess. Laws 323 § 31.17. Referenda on the additional county sales tax were generally defeated at the ballot box in the fall of 2007, though they passed in six counties: Alexander, Catawba, Martin, Pitt, Sampson, and Surry. The additional county sales tax is effective on April 1, 2008. The effective county sales tax rate for these counties is now 2.75%, for a combined state and local sales and use tax rate of 7%.

The Department’s January notice regarding the additional local sales and use tax states that taxpayers who use the cash basis of accounting for sales and use tax purposes are liable for a 2.5% rate of tax for sales that occur prior to April 1, 2008 in those six counties, even if these taxpayers collect the tax on or after April 1.

Additionally, the notice states, “The lease receipts derived by lessors in [the above six counties] who have entered into lease agreements with lessees prior to April 1, 2008, for a definite stipulated period of time to lease property that is subject to the general State rate of sales and use tax continue to be subject to only the 2.5% local sales and use tax for the term of the lease agreement.”

B. Judicial developments (None.) C. Administrative developments

1. The Department of Revenue has published guidelines on bundled transactions.

The last North Carolina report discussed the revised statutes concerning bundled transactions. The Department published a directive summarizing and explaining these statutes, SD-07-1, on October 1, 2007. This directive is available on the Department’s website, http://www.dor.state.nc.us.

2. Assistant Secretary of Revenue confirms that corporate officers are fully liable for deficiencies in sales and use tax.

The Assistant Secretary of Revenue has confirmed, in one of the last appeals to have come before him in the now-obsolete tax appeal procedure within the Department of Revenue, that the “responsible officer” of a corporation is personally liable for state and local sales and use taxes not paid by the corporation. In the Matter of: The Proposed Assessment of Additional Sales Tax for the period December 1, 2004 through January 31, 2005 and May 1, 2005 through June 30, 2005, Docket No. 2007-42 (Dec. 18, 2007). N.C. Gen. Stat. § 105-253(b) (as amended by Session Law 2007-491) defines “responsible officer” to include the president, treasurer, and chief financial officer of a corporation, as well as the manager of a limited liability company with authority over tax matters and “and any other officer of a corporation or member of a limited liability company who has a duty to deduct, account for, or pay taxes.”

Companies with sales and use tax liabilities should be aware of this aspect of the North Carolina sales and use tax. The same rule applies for North Carolina income taxes withheld from employee compensation. N.C. Gen. Stat. § 105-253(b)(4).

As discussed in the last North Carolina update, the tax appeal system in North Carolina has been substantially revised. As of 2008, an appeal of the Department’s position will no longer go before the Assistant Secretary of Revenue for an informal hearing. Rather, the appeal will go to the Office of Administrative Hearings for a formal hearing before an administrative law judge.

A manuscript detailing the new appeal procedures may be found at Williams Mullen’s tax practice group page: http://www.williamsmullen.com/practice_areas/tax_law/Tax+Law.htm. The link to the article is http://www.williamsmullen.com/news/articles_detail/281.htm.

III. Other Tax Developments

A. The Department of Revenue publishes guidelines on the sales tax on room occupancy. The Department of Revenue has published a Notice regarding the sales tax on room occupancy, N.C. Gen. Stat. § 105-164.4(a)(3). The Notice concerns what services are taxable under N.C. Gen. Stat. § 105-164.4(a)(3) (the tax on room occupancy) and what services are taxable under N.C. Gen. Stat. § 105-164.4(a)(2) (which taxes rentals of tangible personal property). The taxability of services and personal property rentals arises when lodging accommodations include in the bill to the customer charges for items other than the room rental. The Department considers charges for items such as credit card fees, damages fees, linen fees, reservation fees, charges for cribs and roll-away beds, and other items that are directly related to rental of the room to be taxed under N.C. Gen. Stat. § 105-164.4(a)(3). However, rentals of items such as video tapes, DVDs, audio/video equipment, beach equipment, and other entertainment equipment are rentals of tangible personal property under N.C. Gen. Stat. § 105-164.4(a)(2). The general dividing line is whether the item is directly related to the rental of the room. However, the line will inevitably be blurred between the two categories, so taxpayers with such issues should consult this Notice and submit a request for written guidance from the Department if the Notice does not address the question.

As of the date of this report, the Department has not added the provisions of this Notice to the Technical Bulletin on the sales tax on room occupancy. The Notice is available on the Department’s website, http://www.dor.state.nc.us.

B. The General Assembly is considering shortening the period between real property revaluations to four years. The N.C. Senate has passed a bill that would shorten the time between general reappraisals for property tax purposes from eight years to four years. S.B. 2007-1309 § 1. Many counties already operate on a four-year revaluation schedule as an option granted to them by the General Assembly. S.B. 2007-1309 would make a four-year revaluation schedule mandatory for all counties. This bill has been passed by the N.C. Senate and is is now pending before the N.C. House of Representatives.

C. The Court of Appeals reaffirms the shifting burdens framework for appeals to the Property Tax Commission.

In a recent ruling reversing a decision in favor of the assessing authority, the North Carolina Court of Appeals has reinforced prior appellate court decisions on the burden of proof. In recent years, observers have noted that the North Carolina Property Tax Commission has been imposing an increasingly stiff burden on taxpayers in hearings before the Commission. The new decision offers some hope of a course correction.

Under North Carolina law, tax assessments are presumed correct. The presumption of correctness is rebuttable, but the burden is on the taxpayer to rebut the presumption.

In In Re Appeal of IBM Credit Corp., ___ N.C. App. ___, 650 SE2d 828 (2007), the Court of Appeals reversed a decision of the Commission in favor of Durham County, holding that the burden on the taxpayer is one of production and not persuasion; to meet its burden, the taxpayer must offer competent, material and substantial evidence that tends to show the assessment is incorrect – it does not have to persuade the Commission at that point. Once its burden is met and the presumption of correctness rebutted, the burden then shifts to the county, which then has the burden of going forward with evidence and of persuasion that its methods would produce true values. Thereafter, it is the duty of the Commission to weigh the evidence and make its decision.

The Court of Appeals remanded the decision to the Commission to reconsider the evidence in light of its decision.

The Supreme Court has affirmed the decision of the Court of Appeals without comment. In re Appeal of IBM Credit Corp., ___ N.C. ___, ___ S.E.2d ___ (Mar. 7, 2008).

D. The General Assembly is considering revisions to the tax appeal legislation passed in 2007. The Revenue Laws Study Committee is considering minor revisions to the legislation passed in 2007 that overhauled

North Carolina’s tax appeal system. See 2007 N.C. Sess. Laws c. 491 (referred to as “SB 242”). Proposed changes include adjusting and clarifying the procedural requirements on the taxpayer for appealing decisions

by the Department of Revenue concerning refund claims. The general rule is that a taxpayer must file an appeal of the

Department’s denial of a refund request within 45 days. N.C. Gen. Stat. § 105-241.11(a). If the Department does not act on the request within six months, however, the request is deemed denied and the 45 day period automatically begins to run. This situation sets up a potential trap for taxpayers that do not realize that the Department’s six month deadline has expired, because the 45 day deadline to appeal would begin running without their having received a denial from the Department. The proposed change would give taxpayers the additional option of filing their appeal within 45 days of the Department’s issuance of the proposed denial of the refund, even if that proposed denial is issued after the six month period.

The Committee is also considering a revision of the statutory filing deadline for the franchise tax return. SB 242

extended by one month the due date for filing the franchise and corporate income tax returns. However, the act was drafted such that the extension for the franchise tax return would occur in 2008, while the extension for the corporate income tax return would tax place in 2009. The proposed bill corrects this inconsistency. If the proposed legislation is enacted, the one-month deadline extension would take effect for both taxes beginning in 2009.

E. The Fourth Circuit denies DirecTV, Inc.’s constitutional challenge to the sales tax on satellite television. The latest chapter in the ongoing battle between cable and satellite television providers over taxation in North Carolina

is the denial of DirecTV’s constitutional challenge to the sales tax on satellite television by the U.S. Court of Appeals for the Fourth Circuit. Beginning in 2002, North Carolina imposed a 5% gross receipts tax on satellite television providers and a corresponding 5% local government franchise tax on cable television providers. These tax rates were increased to 7% in 2005.

DirecTV unsuccessfully challenged this scheme before the N.C. Court of Appeals. See DIRECTV, Inc. v. State, 632

S.E.2d 543 (N.C. Ct. App. 2006). North Carolina changed the tax scheme in 2006, removing the authority of local governments to charge a franchise tax

and vesting the power to issue franchises to cable providers with the N.C. Secretary of State. 2006 N.C. Sess. Laws 2006-151 §§ 1, 10-13. The cable companies no longer had to pay the local franchise tax, and instead were required to pay 7% sales tax. That scheme was at issue in the case before the Fourth Circuit.

The Fourth Circuit affirmed dismissal of the lawsuit on the basis of the Tax Injunction Act, 28 U.S.C. § 1341.

Plaintiffs contended that the Tax Injunction Act did not apply, because the charges made by the local governments were not taxes but fees. The Fourth Circuit disagreed, finding that the charge was sufficiently broad in nature—being paid by all consumers of cable television—and the revenues went into general operating funds of the localities. Therefore, the Fourth Circuit held that the Tax Injunction Act barred consideration of the plaintiff’s claims by a U.S. district court.

F. The N.C. Court of Appeals upholds the state’s economic incentives program in Blinson v. State. North Carolina has an aggressive tax incentives program to stimulate economic development. The Institute for

Constitutional Law, headed by former Associate Justice of the N.C. Supreme Court Robert Orr, challenged the tax incentives program on constitutional grounds in 2005. The subject of the constitutional challenge was a substantial tax incentives package granted to Dell, Inc., for the purpose of building a manufacturing facility in Forsyth County.

The superior court granted the State’s motion to dismiss for lack of standing and for failure to state a claim on May 12,

2006. Plaintiffs appealed this ruling to the Court of Appeals. The Court of Appeals affirmed the decision of the trial court in its entirety. Blinson, et al. v. State of North Carolina,

et al., No. COA06-1258 (N.C. Ct. App. Oct. 16, 2007). Regarding the question of standing, the Court held that plaintiffs had not demonstrated a cognizable injury that was

caused by the tax incentives program. The Court analogized standing doctrine under the federal Dormant Commerce Clause, which requires that the plaintiffs have been “prejudiced by the operation of the challenged statute in order to establish standing.”

The Court also affirmed the trial court with respect to the merits of the case. Plaintiffs challenged the Dell tax

incentives package based on the Public Purpose Clause and the Exclusive Emoluments Clause of the North Carolina Constitution. The Public Purpose Clause requires that the taxing power be exercised “for public purposes only.” The Court held that this case was governed by Maready v. City of Winston-Salem, 342 N.C. 708, 467 S.E.2d 615 (1996). The public purpose requirement was met because of the public benefit that economic development fosters. The Court decided that channeling such public benefits via favoring a particular company was not unconstitutional.

The Exclusive Emoluments Clause bars public spending for the exclusive benefit of one individual or entity. Tax exemptions in favor of a specific class do not violate the Exclusive Emoluments Clause where they (1) are “intended to promote the general welfare,” and (2) there is a reasonable basis for concluding that the tax benefit promotes the public interest. Based on this test, the Court approved the Dell incentives package.

The N.C. Supreme Court denied plaintiffs’ petition for discretionary review on April 10, 2008.

V. Provider’s Biography Williams Mullen’s North Carolina state and local tax practice group is staffed by attorneys Nancy S. Rendleman,

Charles B. Neely, Jr., Steven B. Long, and Robert W. Shaw, and Angie Harris, Director of the Government Relations Practice. The practice group practices extensively in the state and local tax area and handles matters involving all types of state and local taxes, including corporate income and franchise tax, sales and use tax, property tax litigation involving real and personal property and the tax exempt status of real and personal property, excise and license taxes and personal income tax. The practice group also counsels clients on county and state tax incentives, assists them in negotiations to obtain tax incentives, and defends against efforts by the Department of Revenue to attack tax credits.

The practice group’s representation of clients involves litigation and negotiation of contested matters, corporate tax

planning, transactional matters, lobbying and negotiation of tax incentive packages.

NORTH DAKOTA STATE DEVELOPMENTS

OHIO STATE DEVELOPMENTS Maryann B. Gall Laura A. Kulwicki Phyllis J. Shambaugh JONES DAY P.O. Box 165017 Columbus, Ohio 43216-5017 (614) 469-3939 (614) 461-4198 (fax) mbgall@jonesday.com pjshambaugh@jonesday.com lakulwicki@jonesday.com www.jonesday.com I. Corporate Franchise Tax

A. Administrative Developments

1. Family Dollar Stores of Ohio, Inc. v. Wilkins, Case No. 2005-V-469 (Ohio Bd. Tax App. Jan. 4, 2008).

The Ohio Board of Tax Appeals (“Board”) held that an Ohio corporation’s corporate franchise tax refund claim was properly denied under R.C. 5733.024 and R.C. 5733.055 because a related corporation could have filed combined or consolidated returns in Massachusetts and South Carolina. R.C. 5733.024 Requires the “Add Back” of Certain Expenses Paid to Related Corporations R.C. 5733.024 requires corporations to include payments made to a related corporation for intangible expenses such as licensing fees when reporting their Ohio net income. This requirement is referred to as an “add back” provision because such payments are normally deducted as an expense from the corporation’s federal income but must be added back to determine Ohio income. R.C. 5733.055 allows an Ohio corporation, in certain circumstances, to make adjustments to its reported Ohio income no greater than the amount of “add back” reported on its Ohio return. In short, adjustments are permitted when the net interest income and net intangible income are allocated and apportioned to other states that impose a tax on or measured by income. R.C. 5733.055 (A)(2)(a). However, no adjustment is allowed for income from states in which the taxpayer or related member: 1) files or could have filed a combined report or return; 2) files or could have filed a consolidated report or return; or 3) files or could have filed any other report or return resulting in the elimination of the tax effects from transactions directly or indirectly between the taxpayer and another entity. R.C. 5733.055(A)(2). Facts Family Dollar Stores of Ohio (“FDS Ohio”) is an Ohio corporation that operates a chain of discount stores throughout Ohio. FDS Ohio is owned by Family Dollar Stores, Inc., a North Carolina corporation. In addition to FDS Ohio, Family Dollar Stores, Inc. owns a group of corporations that operate stores in forty states. One of the corporations owned by Family Dollar Stores, Inc. is Family Dollar Marketing, Inc. (“FD Marketing”), a North Carolina corporation. FD Marketing owns all the trademarks and service marks used by Family Dollar Stores, Inc.’s subsidiaries. On September 1, 1996, FDS Ohio entered into a trademark and service mark licensing agreement with FD Marketing. For the use of FD Marketing’s trademarks and service marks, FDS Ohio agreed to pay FD Marketing an annual licensing fee of 3% of net sales. FDS Ohio’s corporate franchise returns for 1999, 2000, and 2001 included the annual licensing fees FDS Ohio paid to FD Marketing. On January 18, 2002, FDS Ohio filed refund claims, requesting that the amounts paid to FD Marketing be adjusted pursuant to R.C. 5733.042 and R.C. 5733.055. FDS Ohio argued that the licensing fees paid to FD Marketing were subject to taxation in Massachusetts, South Carolina, and North Carolina. In addition, FDS Ohio asserted that the refund claims were proper because FDS Ohio was not eligible under the laws of Massachusetts, North Carolina, or South Carolina to file consolidated or combined returns with FD Marketing. The Tax Commissioner allowed the refund for licensing fees allocated by FD Marketing to North Carolina. The remaining claims were denied on the ground that FD Marketing could have filed a combined or consolidated return in Massachusetts and South Carolina.

FDS Ohio’s Appeal to the Board of Tax Appeals Before the Board, FDS Ohio argued that because FDS Ohio lacked sufficient nexus with Massachusetts and South Carolina, FDS Ohio could not have filed combined or consolidated returns in those states. FDS Ohio further argued that FD Marketing filed separate tax returns in Massachusetts and South Carolina and paid tax to those states on income it received from FDS Ohio. It also asserted that even if FD Marketing had elected to file combined or consolidated returns with Family Dollar Stores of Massachusetts and Family Dollar Stores of South Carolina in their respective states, the consolidated or combined returns would not have eliminated the tax effects of the licensing fees between related members because both Massachusetts and South Carolina required that each separate company’s taxable income be listed separately. As a result, even when filing consolidated or combined returns in Massachusetts and South Carolina, inter-company transfers were not eliminated. FDS Ohio argued that the Tax Commissioner’s denial of the refund claim resulted in double taxation because licensing fees paid to FD Marketing by FDS Ohio were taxed in Ohio and portions of those same fees were also taxed in Massachusetts and South Carolina. In response, the Tax Commissioner argued that FDS Ohio’s payment of licensing fees to FD Marketing was nothing more than “asset stripping” engineered to reduce FDS Ohio’s tax liability. The Tax Commissioner further contended that the licensing fee revenue received from FDS Ohio and reported in Massachusetts and South Carolina by FD Marketing was not subject to tax because of apportionment. Board Found Statute Is Clear and Mandates Rejection of Adjustments. The Board noted that when construing a statute it must give effect to the words used. When a statute’s language is plain and unambiguous, the Board found it must not interpret the statute but apply it as written. Finding that the statute was plain and unambiguous, the Board held that FDS Ohio was not entitled to a refund because it could have filed a combined or consolidated income tax return with another member. Thus, the Board found that the Tax Commissioner correctly rejected FDS Ohio’s adjustments for fees allocated to FD Marketing in Massachusetts and South Carolina. II. Sales and use Tax

A. Legislative Developments

1. Ohio Has Enacted A Bill Requiring All Vendors to Use Origin Sourcing for All Intrastate Sales. On April 18, 2008, the Ohio Governor signed Amended Substitute House Bill 429, which will align Ohio sales and

use tax law with the Streamlined Sales and Use Tax Agreement’s (SSUTA’s) origin sourcing provisions adopted by the SSUTA Governing Board in December, 2007.

Background of the SSUTA

The SSUTA is designed to provide a uniform set of sourcing rules for members, including associate members. Until recently, SSUTA full members were required to have destination sourcing rules. In other words, full member states were required to adopt the rule that a sale occurred where the goods or services were received by the customer. Destination sourcing rules differed from Ohio’s traditional origin sourcing rule, which provided that a sale occurs where the vendor is located or where the order is received.

In December 2007, the SSUTA was amended to permit member states to use origin sourcing.

Prior Ohio Sourcing Provisions

Under prior R.C. 5739.033, vendors with total annual delivery sales of $500,000 or less were permitted to source sales to the vendor’s location, origin sourcing. Vendors with more than $500,000 total delivery sales were required to source sales to the location where the customer ultimately received the tangible personal property, destination sourcing. Origin vs. destination sourcing affects only intrastate delivery sales. Sourcing the sale for purposes of Ohio sales tax affects the amount of sales tax collected from a customer because Ohio’s sales tax rate varies from county to county. Many vendors resisted Ohio’s switch to destination sourcing because of the bookkeeping difficulties. Under destination sourcing, a vendor was required to know and apply the sales tax rates in all 88 Ohio counties.

R.C. 5739.033 As Revised By Am. Sub. H.B. 429

R.C. 5739.033, as enacted by Am. Sub. H.B. 429, allows vendors currently using origin sourcing to continue to do so with respect to intrastate sales. In addition, it permits vendors that have adopted destination sourcing to switch back to origin sourcing before 2010. Effective January 1, 2010, under origin sourcing a delivery order is received and sourced to the location where the vendor initially receives all information needed to accept the order. R.C. 5739.033(B)(1)(c)(3), as amended by Am. Sub. H.B. 429.

Vendors required to switch from destination sourcing to origin sourcing will receive compensation to assist with the

change. Vendors must apply to the Tax Commissioner for this one-time payment. This temporary compensation is eliminated January 1, 2010.

B. Administrative Developments

1. Handl-It, Inc. v. Wilkins, Case No. 2006-M-492 (Ohio Bd. Tax App. March 7, 2008). A corporation in the business of providing services to manufacturers challenged the Ohio Department of Taxation’s

assessment of use tax on its purchases. The Ohio Board of Tax Appeals (“Board”) affirmed in part, and reversed in part, the determination of the Tax Commissioner. Facts

The appellant, Handl-It Inc. (“Handl-It”), provides various services to manufacturers, including packaging, warehousing, and distributing products to the manufacturers’ customers. The company was founded to bring economies of scale to manufacturers and to allow manufacturers to outsource functions outside their core competency.

The Department audited Handl-It’s purchases and assessed use tax. Handl-It challenged the assessment because it

disagreed with the Tax Commissioner’s assessment of use tax on six categories of property: purchases of repair and maintenance services; packaging products; vendor invoices; data processing and computer services; equipment and vehicle leases; and damaged property. Dissatisfied with the Tax Commissioner’s decision that the entire assessment was valid, Handl-It appealed to the Board.

Before addressing each category, the Board noted that:

The laws of the state of Ohio require that an excise tax be levied upon the “storage, use, or other consumption in this state of tangible personal property or the benefit realized of any service provided.” R.C. 5741.02. While the issue in this appeal is use tax imposed under R.C. 5741.02(A), by virtue of R.C. 5741.02(C), if an item or items would be exempt from the imposition of sales tax, the use of such items is correspondingly exempt from use tax. Thus, our discussion generally centers on the exceptions and exemptions found in R.C. Chapter 5739.

Handl-It’s Purchases of Repair and Maintenance Services

The Department assessed use tax on repair and maintenance services performed on Handl-It’s forklifts, cars, and trucks. These services were performed by VMR Services (“VMR”), a limited partnership comprised of Handl-It as general partner and Phil Midea, a mechanic hired by Handl-It to run the forklift and car service operation. VMR made no profit.

The Tax Commissioner found that the transactions between Handl-It and VMR during the audit period were taxable as

sales between separate entities for consideration. In his final determination the Tax Commissioner stated:

R.C. 5741.02 levies an excise tax on the benefit of any services provided in the state. The petitioner’s contention that the services were part of an inter-company transaction and did not constitute a taxable event is without merit. Companies and their wholly owned subsidiaries can be considered separate entities for taxable transactions. White Motor Co. v. Kosydar (1977), 50 Ohio St.2d 290, 364 N.E.2d 252. Because the transaction in question included a written service agreement between two legally separate entities for consideration, the transaction should be treated as the taxable transfer of services. Ace Doran Hauling & Rigging Co. v. Tracy (Sept. 30, 1994), BTA Case No. 97-R-213, unreported.”

Handl-It argued that VMR was merely a cost center and, therefore, not a separate vendor. The transactions, it argued, should be viewed as non-taxable inter-company transactions. The Board’s decision focused on seven factors for determining whether inter-company payments were taxable. The

Board established these tests in Ace Doran Hauling & Rigging Co. v. Tracy, No. 1992-R-213, (Sept. 30, 1994, unreported). They are:

a. Are the terms and conditions of the lease or rental agreement in writing? If not, are they discernible? b. Are the parties to the transaction separate? c. Did the possession of the property change hands? d. Did the titles to the property change hands? e. Were these transactions recorded in the books and records of the parties? f. Was there testimony or other evidence that these transactions had substance, or were they merely instituted

for accounting purposes? g. Was there consideration, in fact, paid or an obligation incurred for the rental of equipment or vehicles? Applying these factors, the Board agreed with Handl-It that VMR’s charges were not subject to use tax. The Board

found there was no measurable consideration for the transactions between Handl-It and VMR, their separate existence did not extend to control of business functions because all decisions were made by Handl-It’s management, and it was clear that VMR’s charges were merely to measure cost savings.

Assessment Related to Handl-It’s Packaging Services

Handl-It packaged customers’ products. The products arrived in bulk and Handl-It placed them in individual retail packages, either blister packs, cartons, or shrink wraps, and then put the individual retail packages in cartons for delivery to retail outlets. The Tax Commissioner assessed use tax on the purchases of material used to form the packages. The Tax Commissioner found:

One aspect of the petitioner’s business includes providing a repackaging service for other companies. Companies submit items that were opened and returned by their customers to the petitioner and the petitioner repackages the items. The petitioner contends that the purchase of packaging material is tax exempt as inventory purchased for resale. The contention is without merit.

R.C. 5739.01(E)(9) provides an exemption from sales tax by excluding sales that are not retail sales. A sale is not a retail sale if ‘the purpose of the consumer is to resell the thing transferred or benefit of the service provided, by a person engaging in business, in the form in which the same is, or is to be, received by the person.’ The petitioner purchased plastic wrap, cartons and crates from various vendors and did not pay sales tax on the purchases. These items were used by the petitioner to rewrap its customers’ packages, and this service – the repackaging – was sold to the customer, not the plastic wrap, carton and crates. The items were not sold to the customers in the same form as originally purchased, and therefore the original purchases should not have been exempted from tax. Bellemar Parts Indus. v. Tracy, (2000) 88 Ohio St.3d 351, 725 N.E. 2d 1132.)

Handl-It disagreed, stating that the packaging products should be treated as exempt, but the Board affirmed the Tax

Commissioner’s decision. The Board found that if Handl-It purchased the packaging materials and then sold them to another purchaser without changing the packaging materials in any way, Handl-It’s purchases were exempt sales for resale. However, as the Tax Commissioner found, the materials changed form in Handl-It’s possession before they were sold and were not exempt sales-for-resale.

Handl-It Claimed the Tax Commissioner Assessed Use Tax on Purchases on Which Sales Tax Was Paid to the Vendors

Handl-It challenged the assessment of use on tax on vendor invoices on which it claimed it had paid sales tax to the vendor. The Tax Commissioner cancelled part of the assessment on this basis, but refused to remove all use tax because the Tax Commissioner could not verify the payment of sales tax for some of the invoices.

Handl-It claimed that the vendor statements it submitted should be accepted as proof that any tax due was paid to the vendor. In effect, Handl-It claimed that the state’s tax collection efforts should be directed to the vendor and not to the consumer. Indeed, the General Assembly requires certain vendors to collect use tax from their customers. R.C. 5741.02; R.C. 5741.11. However, pursuant to R.C. 5741.02(B), the use tax is ultimately imposed upon the consumer and the liability for tax is not extinguished until the “tax has been paid to this state.” The consumer is only relieved from the payment of use tax if it has paid the tax to the vendor.

Ultimately, the Board agreed with the Tax Commissioner that, for some of the vendor invoices, the vendor statements,

alone, were not sufficient evidence that sales tax had been paid. Because the Board could not verify the payment of sales tax for some of the invoices, the Board found that the use tax was properly assessed.

Damaged Property

Handl-It challenged the assessment resulting from the damage to a customer’s inventory for which Handl-It was responsible to its customer. An accident in the warehouse caused 324 cases of Aquafina water and 6 pallets to be damaged. The cost of goods damaged during storage at Handl-It’s locations was generally reimbursed by Handl-It as a credit against storage charges. However, Pepsi Americas, Handl-It’s customer, requested payment for its loss and invoiced Handl-It for the damaged goods. The Tax Commissioner found that the invoice reflected the purchase of the bottled water and pallets, and as the water and pallets are taxable tangible personal property, concluded that the transfer was subject to tax.

The Tax Commissioner framed his discussion of the taxability of the cases of water by discussing the exemption

granted to purchases of food consumed off premises found in R.C. 5739.02(B)(2). The Tax Commissioner concluded that the charge did not fall within the exemption, because prior to July 1, 2004, the definition of food did not include water. Handl-It did not challenge the Tax Commissioner’s conclusion that the purchase does not fall within the exemption for food consumed off premises. Rather, it claimed that the invoice did not represent the purchase of tangible personal property, as the cases of water were destroyed prior to the “sale.”

R.C. 5741.01 imposes a tax upon the “storage, use, or other consumption” of personal property within the state, and

the question therefore, was whether Handl-It’s payment to Pepsi Americas for damaging the stored products constituted a “storage, use, or other consumption” of tangible personal property.

The Board first noted that Handl-It was effectively a bailee with regards to the property of another. The Board then

stated: In Grabler Mfg. Co. v. Kosydar (1973), 35 Ohio St.2d 23, the Ohio Supreme Court found that sales or use taxes cannot be assessed on monies paid as liquidated damages that are not considered to be part of the “price” as defined by R.C. 5739.01, nor on ‘rental installments’ as defined in R.C. 5739.02. The court therein stated, the monies paid as a deficiency by Grabler were not paid for the use of something; nor were they paid in exchange for anything. Id. at 30.

The personal property of Pepsi Americas was destroyed prior to payment, and the Board determined that Handl-It’s payment of damages for its negligence did not amount to a use of personal property as contemplated by R.C. 5741.01. Therefore, the Tax Commissioner erred in assessing use tax on Handl-It’s payment to Pepsi Americas. C. Judicial Developments

1. DaimlerChrysler Corp. v. Levin, 117 Ohio St. 3d 46 (2008). The Ohio Supreme Court recently held that Daimler Chrysler Corporation (“DCC”) did not owe use tax in connection

with its goodwill repair program. The Court found that DCC was not the consumer of the parts and services provided through the program. Instead, the vehicle owners who enjoyed the benefits of the services and took possession of the parts were the consumers.

Facts

The case involved two use tax assessments for goodwill repairs, which are repairs performed by dealers on DaimlerChrysler vehicles after the warranty has expired. Such repairs are performed at no additional cost to consumers or

dealerships and are reimbursed by DCC. The assessments included parts and labor because both types of transactions are taxable retail sales under Ohio law.

Although DCC funded the goodwill repairs, it did so with its profit goals in mind. When setting sales prices for

vehicles, DCC took into account the anticipated cost of goodwill repairs. So, when customers purchased DCC vehicles from dealerships, the dealers collected sales tax on the total vehicle price, which included a component for goodwill repairs. In short, at the time they purchase their vehicles, consumers not only paid for goodwill repairs but also paid sales tax on the cost of those repairs.

The Court’s Decision

Under Ohio use tax law, a “consumer” is a “person who has purchased tangible personal property or who has been provided a service for storage, use, or other consumption or benefit” in Ohio. R.C. 5741.01(F). Based on that definition, DCC concluded that vehicle owners are the consumers of the goods and services offered through its goodwill repair program. The Tax Commissioner, however, concluded that DCC was the consumer based on a previous case, General Motors v. Wilkins, 102 Ohio St.3d 33 (2004). In that case, the Court found that GM was the consumer of parts and services used in connection with its warranty repair program.

The Court concluded that while General Motors may seem to settle the use tax question, the critical fact in that case

was that the manufacturer was contractually bound to pay for the warranty repairs. That is important because Ohio sales and use tax law considers a warranty to be intangible property purchased separately from a vehicle. As a result, warranty repairs are independently taxed.

In contrast, goodwill repairs are considered part of the vehicle purchase price. When consumers pay for their vehicles,

they pay sales tax on both the vehicles themselves and goodwill repairs. In short, vehicle owners are consumers of both their vehicles and parts and service needed for goodwill repairs. Because vehicle owners are the consumers of goodwill repairs, DCC and other car manufacturers cannot be assessed use tax in connection with such repairs.

III. personal property tax

A. Judicial Developments

1. Columbia Gas Transmission Corp. v. Levin, 117 Ohio St.3d 122 (2008). In Columbia Gas Transmission Corp. v. Levin the Court reversed the Board of Tax Appeal’s finding that Columbia

Transmission should be classified as a natural gas company for public utility property tax purposes. The Court held that because Columbia Transmission’s primary business was the interstate transportation of natural gas Columbia Transmission was properly classified as a pipe-line company.

Ohio Taxes the Public Utility Property of a “Natural Gas Company” at a Lower Percentage of True Value than the

Public Utility Property of a “Pipe-line Company.”

In 2001, the General Assembly amended R.C. 5727.111(c) to reduce the assessment rate on public utility personal property owned by Ohio natural gas companies from 88% to 25%. The 25% rate was effective for the 2001 tax year. See Am. Sub. H.B. No. 287, 148 Ohio Laws, Part V, 11536, 11549-1550. Under R.C. 5727.111(D), however, the assessment rate for pipe-line companies remained at 88%.

Facts

Columbia Transmission operates a natural gas pipeline that runs across several states. In addition, Columbia Transmission owns an underground natural gas storage system. Columbia Transmission provides natural gas transportation services to power companies, industrial plants, farms and local distribution companies.

For tax years 2000 and 2001, the Tax Commissioner assessed Columbia Transmission’s public utility property at the

88% rate for pipe-line companies. Columbia Transmission objected to the 88% rate and asked the Tax Commissioner to assess its public utility property at the 25% rate applied to natural gas companies. The Tax Commissioner found that Columbia Transmission was not a natural gas company “because it does not supply or distribute gas directly to end-use consumers; rather, Columbia Transmission transports natural gas interstate through a network of pipelines.”

Columbia Transmission appealed and the Board reversed the Tax Commissioner finding that Columbia Transmission satisfied the definition of a natural gas company13 because it directly supplied natural gas to end use consumers, including industrial, power and farm tap customers. Moreover, the Board found that R.C. 5727.02(A)14 does not impose a “primary business” test when determining how a business should be classified for public utility property tax purposes.

The Tax Commissioner appealed the Board’s decision to the Court. Columbia Transmission cross-appealed, raising

its constitutional arguments.

The Court Held that R.C. 5727.02 Establishes a Primary Business Test For Classifying Public Utilities.

The Court held that R.C. 5727.02(A) “establishes a primary-business test for determining whether an entity is a public utility for tax purposes and also for distinguishing between types of public utilities.” The Court found that even though Columbia Transmission may satisfy the definition of “natural gas company” in 5727.01(D)(4), it cannot be considered a natural gas company for taxing purposes if it is engaged in some other primary business to which supplying natural gas is merely incidental.

The Court then went on to find that Columbia Transmission’s primary customers are local distribution companies that

distribute natural gas to end users. The Court recognized that Columbia Transmission has direct connect customers, but found they were limited in number, located close to the pipelines, and generated minimal revenue. The Court found that any natural gas that Columbia Transmission supplied to end users was merely incidental to its primary business as a pipe-line company. Thus, the Court held that Columbia Transmission was not a natural gas company. Columbia Transmission is asking the United States Supreme Court to review the decision of the Supreme Court of Ohio.

2. A. Schulman v. Levin, 116 Ohio St.3d 105 (2007).

The Ohio Supreme Court reversed a decision of the Board of Tax Appeals that certain devices used in the production of plastic resins and compounds qualified as “dies,” which are not taxable tangible personal property in Ohio. Dies Held for Use in Business Are Not Subject to Personal Property Tax. Under R.C. 5709.01(B)(1), tangible personal property located and used in business in Ohio is subject to taxation. However, R.C. 5701.03(A) excludes from the definition of tangible personal property any “dies. . . that are held for use and not for sale in the ordinary course of business.” The Ohio Supreme Court has variously described dies as (1) devices that “through applied force, impose their shape” on an object under production, Timken Co. v. Lindley, 17 Ohio St.3d 85, 87, 477 N.E.2d 1121 (1985), (2) “piece[s] of equipment or tooling that [are] capable of forming or creating a part, either by pressure or molding techniques,” Gen. Motors Corp. v. Kosydar, 37 Ohio St.2d 138, 139, 310 N.E.2d 154 (1974), (3) devices that “form the desired metal, rubber or plastic part when pressure is applied by mechanical or hydraulic presses,” id., (4) parts with “specially designed surfaces” in a machine whose “sole purpose and use is to imprint or impress specially designed irregularities. . . upon material placed in the machine,” Am. Book Co. v. Porterfield, 18 Ohio St. 2d 49, 53, 247 N.E.2d 290 (1969), and (5) special devices “which by their nature are capable of only special uses” for impressing, shaping, or forming something, Colonial Foundry Co. v. Peck, 158 Ohio St. 296, 109 N.E.2d 11 (1952). Similarly, the Board of Tax Appeals has defined a die as “a metallic appliance which, by means of pressure used in connection therewith, serves to give a desired shape or form to some softer material.” Cambridge Glass Co. v. Evatt, 19 O.O. 162, 164 (1940). Facts

At issue was a portion of devices, otherwise accepted as “dies.” William Ratliff, who serves as the facility manager for A. Schulman’s Akron manufacturing plant, testified at the Board that the company heats resin and other materials inside “barrel and screw” devices so that the mixture melts and turns into taffy-like molten plastic. As the heat is applied, the screw inside the barrel “convey[s] the material to the die” at the end of the barrel, and then the molten plastic “goes through the die,”

13 R.C. 5727.01(D)(4) provides that any person “[i]s a natural gas company when engaged in the business of generating, transmitting, or distributing electricity within this state for use by others. . . .” Under R.C. 5424.01(D)(5), a person “is a pipe-line company when engaged in the business of transporting natural gas, oil, or coal or its derivatives through pipes or tubing, either wholly or partially within this state.” 14 R.C. 5727.02(A) states that the terms “natural gas company” and “pipe-line company” do not include “any person that is engaged in some other primary business.”

which shapes the plastic into small pellets as the material exits the barrels. Ratliff noted that “you may have different shapes [for the pellets], depending on the type of die that it goes through,” but “[t]he screw and barrel would stay the same” as different dies are swapped in and out to meet the needs of A. Schulman’s customers, who use the pellets as raw materials for a variety of plastic products.

Based on this description, the Tax Commissioner concluded that the barrel-and-screw devices were not “dies,” and

were subject to personal property tax. The Board reversed the Tax Commissioner’s decision and the Tax Commissioner appealed to the Ohio Supreme Court.

The Supreme Court Reversed the Board Finding That Its Decision Was Not Supported by the Record

The Court noted that the definition of “die” is limited to those parts of a machine that have specially designed surfaces for imprinting or impressing special designs upon material placed in such a machine. The barrel-and-screw devices through which the molten plastic passes, the Court pointed out, did not have any such specially designed surfaces. The Court reversed the Board’s decision granting an R.C. 5701.03(A) exemption to A. Schulman’s barrel-and-screw devices. It held that the devices are distinct from the dies that are exempt, and they do not satisfy the definition of “dies” as the Court has long defined that term.

3. Shiloh Automotive v. Levin, 117 Ohio St.3d 4 (2008).

The Supreme Court affirmed the Board of Tax Appeals’ determination that Shiloh Auto incorrectly valued certain tangible personal property it used in business on its 2000 and 2001 property tax returns. The Board found that the price Shiloh Auto paid for the property did not reflect its true value for personal property tax purposes. Facts

Shiloh Auto is a subsidiary of Shiloh Industries, which supplies component parts to the automotive industry. Shiloh Auto was formed and began business in 1999 when Shiloh Industries purchased a division of MTD Products, Inc. (“MT”D), another component parts manufacturer.

MTD had been a shareholder of Shiloh Industries since 1993. At that time, MTD owned 37% of Shiloh Industries’ common stock. In 1998, management from Shiloh Industries and MTD began discussing the benefits of combining operations. MTD prepared an offering memorandum and tendered that memorandum to Shiloh Industries. The memorandum was not given to any other potential buyer. Shortly thereafter, the Shiloh Industries Board of Directors began a due diligence review to evaluate the merits of acquiring MTD. Shortly after the due diligence review was completed, the trusts of two Shiloh Industries officers/directors decided to sell an aggregate one million shares of Shiloh Industries common stock to a wholly owned subsidiary of MTD. As a result of the acquisition, MTD’s ownership interest in Shiloh Industries increased to about 51%. MTD and Shiloh negotiated an asset purchase agreement that the disinterested directors of Shiloh Industries approved. Under the terms of the asset purchase agreement, Shiloh agreed to pay MTD Auto $20 million in cash and $20 million in common stock. After the sale, MTD controlled 56% of the outstanding shares of Shiloh Industries. The newly formed Shiloh Auto filed its 2001 personal property tax return using the purchase price of MTD Auto to establish the value of the equipment and machinery it acquired. The Tax Commissioner rejected the valuation of the assets purchased, finding that the purchase price did not reflect the true value of the taxable assets. Shiloh Auto appealed to the Board of Tax Appeals and the Board affirmed the Commissioner’s determination. Shiloh Auto appealed to the Ohio Supreme Court. The Asset Purchase Was Not an Arm’s-Length Transaction. The Court began by stating that the best evidence of the value of tangible personal property is its sales price in an arm’s-length transaction. Tele-Media Co. of Addil v. Lindley, 436 N.E.2d 1362 (Ohio 1982). An arm’s-length transaction possesses three primary characteristics: 1) it is voluntary; 2) it generally takes place in an open market; and 3) the parties act in their own interests. Shiloh Auto argued that the asset purchase was an arm’s-length transaction, but the Court disagreed. First, the Court noted that the transaction did not occur on the open market because MTD negotiated only with Shiloh Industries and did not solicit any other potential buyers. Second, the Court pointed out that there was a “significant relationship” between Shiloh Industries and MTD. MTD controlled 51% of the shares of Shiloh Industries prior to the sale and the companies’ boards of directors shared

common members. As a result, the transaction was not between independent parties. The Court found that both of those factors required the conclusion that the purchase was not an arm’s-length transaction. Records Showed the Purchase Price Did Not Reflect the Actual Value. In addition, the Court noted that the purchase price did not reflect the true value of the property in light of the fact that six months prior to the sale, MTD recorded the net book value of its assets at almost $780,000,000 with almost $31,000,000 attributed to property and equipment. Nevertheless, Shiloh Auto allocated just short of $4,000,000 of the total purchase price to property and equipment. Due to contingencies in the purchase agreement, Shiloh Auto further reduced that figure to about $1,300,000 by the end of 2002. Shiloh Auto Failed to Cooperate With the Commissioner’s Attempts to Determine the Accuracy of Shiloh’s Valuation. In order to decide whether Shiloh Auto’s valuation and allocation of assets was accurate, the Tax Commissioner requested that Shiloh Auto provide documents including: 1) disposal documentation for the assets acquired; 2) Shiloh Industries’ due diligence report; and 3) a breakdown of accounts receivables that Shiloh Auto acquired from MTD Auto. Shiloh failed to cooperate with the Commissioner’s requests. Conclusion In short, the nature of the transaction, the discrepancies with respect to value, and Shiloh’s failure to cooperate with attempts to determine the purchase price allocation all led the Court to conclude that Shiloh Auto’s valuation did not reflect true value. Instead, the Court found that the Board correctly concluded that the net book value recorded prior to the sale was the best evidence of the true value of the assets.

OKLAHOMA STATE DEVELOPMENTS

OREGON STATE DEVELOPMENTS Robert T. Manicke Eric J. Kodesch Stoel Rives LLP 900 SW Fifth Avenue, Suite 2600 Portland, OR 97204-1268 Ph: (503) 224-3380 Fax: (503) 220-2480 rtmanicke@stoel.com ejkodesch@stoel.com www.stoel.com

I. INCOME/FRANCHISE TAXES

A. Legislative Developments

Special Legislative Session Convened February 2008. Oregon is officially experimenting with a move away from biennial legislative sessions, in favor of annual sessions. This year, the legislature met during most of the month of February and passed serve tax-driven bills. Among them:

• Revisions of the Business Energy Tax Credit (the “BETC”). The Fall 2007 survey described several changes made to the BETC by Oregon Laws 2007, chapter 843 (HB 3201). Oregon Laws 2008, chapter 29 (HB 3619) primarily clarifies theses changes with respect to the amount of BETC available to a manufacturer of renewable resource equipment, including solar panels, but the new law also contains provisions relevant to the BETC generally. One of the 2007 changes increased the maximum BETC from $3.5 million to $10 million for facilities that use or produce renewable energy resources, high-efficiency combined heat and power facilities, and renewable energy resource manufacturing facilities. After the 2007 changes, there was some debate about the definition of a renewable energy resource manufacturing facility and whether components of a single plant were eligible for more than one maximum credit. The 2008 changes apparently resolve the issue by increasing the maximum BETC to $20 million only for a project that qualifies as a renewable energy equipment manufacturing facility, and by authorizing Oregon Department of Energy (“ODOE”) to adopt limits on the costs that are eligible for the credit.

• Revisions to New Withholding Requirement on Sales of Real Estate. The Fall 2007 survey described the enactment of ORS 314.258, which generally created a new income tax withholding requirement with respect to the conveyance of real property located in Oregon by a nonresident individual or by a corporation that does not do business in Oregon. Oregon Laws 2008, chapter 54 (SB 1101) made several clarifying revisions. For example, the revised law limits the applicability of withholding to transfers of fee title in real estate only. Prior to the amendment, withholding applied to other types of transfers, such as leases. In addition, prior to the amendment, the types of property to which withholding applied were determined by reference to an expansive definition of “real property interest” that incorporation federal FIRPTA concepts and thus included certain interests in entities that own real estate and certain types of personal property, in addition to real estate.

Under the revised law, withholding does not apply if: (1) the consideration does not exceed $100,000; (2) the conveyance is pursuant to a foreclosure; (3) the conveyance is in lieu of foreclosure of a security instrument; (4) the transferor is a person acting under judicial review; (5) no gain or loss is recognized because of Section 121 of the Internal Revenue Code of 1986, as amended (sale of a primary residence); (6) the transferor provides a written affirmation that the transferor is unlikely to owe Oregon income tax as a result of the conveyance; or (7) the amount to be withheld is less than $100. If withholding applies, the amount to be withheld is the least of (1) 4% of the consideration for the transaction, (2) the net proceeds to be disbursed to the transferor, or (3) 8% of the gain includable in the transferor’s Oregon taxable income.

The 2008 amendments to the withholding statute apply to transfers on or after January 2008. Certain transactions are grandfathered into the 2007 law, and the Department of Revenue is working on updates to the applicable administrative rule and forms.

• Reconnection to December 31, 2007. Pursuant to Oregon Laws 2008, chapter 45 (SB 1081), those provisions of Oregon tax laws not subject to “rolling reconnection” generally are reconnected to federal law as amended and in effect on December 31, 2007. The prior reconnect date generally was December 31, 2006.

B. Judicial Developments

• The Tax Court Can Uphold a Deficiency for Reasons Not Alleged in the Deficiency. ORS 305.575 generally provides the Tax Court with the authority to determine the correct amount of deficiency, even if it exceeds the amount assessed by the Department of Revenue, and the Tax Court may base its determination on grounds different from those asserted by the Department. In a reminder to taxpayers that the Tax Court has this authority, the Magistrate Division of the Oregon Tax Court upheld a deficiency on the grounds that a federal deduction exceeded certain limitations, even though the Department initially asserted a lack of substantiation as the reason for denying the deduction. Kleps v. Dep’t of Rev, 2007 WL 4145685 (Or Tax Mag Div Nov 20, 2007).

• A Federal Stay Can Make Actions by the Department of Revenue Untimely. Generally, ORS 305.510(5)(a) provides that an appeal of a decision of the Magistrate Division of the Oregon Tax Court must be filed within 60 days of the entry of the judgment. Federal bankruptcy law, however, generally prevents the commencement or continuance of a judicial action once a taxpayer files for bankruptcy, except that federal bankruptcy law generally extends the period for commencing a judicial action to 30 days after notice of the termination or expiration of the stay imposed by federal bankruptcy law. In the case cited below, the taxpayer filed for bankruptcy protection after entry of a judgment by the Magistrate Division in the taxpayer’s favor, but before the Department of Revenue filed an appeal to the Regular Division of the Oregon Tax Court. The Regular Division ruled that the bankruptcy filing made the Department’s appeal invalid. Further, because the Department filed a new complaint more than 30 days after notification of the termination of the federal stay, the regular Division ruled that the Department’s appeal was time-barred. Dep’t of Rev v. Foote, 2008 WL 707298 (Or Tax Reg Div Mar 17, 2008).

C. Administrative Developments

Economic Nexus. The Spring 2007 survey discussed proposed legislation (SB 177) that, if enacted, would have caused Oregon to be one of the first states to adopt the Multistate Tax Commission’s “economic nexus” standard for income tax purposes, taking the explicit position that physical presence is not necessary to confer nexus. Although this bill was not enacted, the Oregon Department of Revenue believes that current Oregon law allows for taxation based on economic nexus without physical presence, and has promulgated an administrative rule declaring and explicating this position. In crafting the rule, the Department has avoided bright-line tests, and instead lists factors to be considered in determining whether a taxpayer has “substantial nexus.” These factors include whether the taxpayer receives “significant gross revenues” attributable to Oregon customers or to the use of intangible property in Oregon.

D. Trends/Outlook for 2008/2009

The absence of a sales tax in Oregon, and the state’s heavy dependence on personal income tax revenues, create a sharply cyclical budgetary environment. In contrast to the record surpluses of the 2005-07 bienniums, Oregon faxes potential deficit for 2007-09. Proposals to curtail income tax incentives, and overall reform proposals, are likely to surface in the legislative session that will commence in January 2009.

II. TRANSACTIONAL TAXES

A. Legislative Developments

Oregon does not currently have a sales tax. Although legislation was proposed in the 2007 biennial session to create a sales tax, no sales tax was created.

B. Trends/Outlook for 2006/2007

Oregon has a long history of opposition to a sales tax. Although the implementation of a sales tax has been discussed for several years, and a tax reform task force is developing and studying proposals, it remains unlikely that a sales tax will be created.

III. PROPERTY TAXES

A. Judicial Developments

• Inventory of a Centrally Assessed Taxpayer Is Exempt from Property Tax. Generally, ORS 307.400 exempts inventory from Oregon property tax. The Spring 2007 survey discussed a pending case, handled by the authors,

involving whether this exemption applies to property assessed under ORS 308.505 to 308.665 (centrally assessed property). The Regular Division of the Oregon Tax Court has since ruled that the ORS 307.400 inventory exemption does apply to centrally assessed property. Northwest Natural Gas Co. v. Dep’t of Rev, 2007 WL 4127669 (Or Tax Reg Div Nov 19, 2007). The case remains under advisement pending a decision on reconsideration.

• A Taxpayer Cannot Delay Acceptance of a Property Tax Refund to Obtain Additional Interest Payments. Generally, ORS 311.806(3) provides that property tax refunds are to be paid with interest accruing at a 12% annualized rate. For the 1999-2000 property tax years a county assessed the real property of a taxpayer using a value that was later determined to be excessive. The taxpayer paid the assessment and timely challenged the valuation. During the years when the matter remained pending in the Magistrate Division of the Oregon Tax Court, the county continued to use the excessive value for property tax purposes and the taxpayer appealed the value for those years. For each of those years, the county issued checks for property tax refunds to the taxpayer, but the taxpayer refused to cash the checks, arguing that the refunds were issued too early. The Oregon Supreme Court ruled that the refunds were not issued too early, so that the taxpayer was not entitled to additional interest. Sharps v. Dep’t of Rev, 343 Or 531, 173 P3d 1223 (2007).

About the Authors

Robert T. Manicke: Mr. Manicke heads the state and local tax practice at Stoel Rives. He regularly represents clients before the Oregon Department of Revenue and the Oregon Tax Court in cases involving unitary taxation; Public Law No. 86-272; apportionment; property tax; and other business tax matters. He also has drafted Oregon tax legislation and advises businesses on Oregon tax incentives. Mr. Manicke graduated summa cum laude from the University of Illinois College of Law in 1992 and is a member of the Oregon, California, and Washington state bars. Eric J. Kodesch: Mr. Kodesch practices in Stoel Rives’ business services group, focusing on state and federal income taxation. Mr. Kodesch graduated from Columbia Law School in 2002 and is a member of the Oregon and New York state bars.

PENNSYLVANIA STATE DEVELOPMENTS RHODE ISLAND STATE DEVELOPMENTS

SOUTH CAROLINA STATE DEVELOPMENTS John C. von Lehe, Jr., Attorney at Law Nelson Mullins Riley & Scarborough, L.L.P. 151 Meeting Street P.O. Box 1806, 29402 Charleston, SC 29401 Phone: 843-534-4311 Fax: 843-534-4348 E-mail: john.vonlehe@nelsonmullins.com I. Income/Franchise Taxes A. Legislative Development -- None, Legislature adjourns in June B. Judicial Developments SCANA v. SCDOR (to be argued on May 28th in S.C. Supreme Court). The case will decide the question of whether the effectiveness of a tax credit carry-forward statute (SCC 12-14-60(D) is limited to carry forward only tax credits which were earned after the effective date of the carry over statute. The S.C. Circuit Court (2006-CP-40-2739, Richland County, Nov. 8, 2006) held that the carry-forward statute was effective to carry forward tax credits which, without the enactment of the statute, would have expired. The SCDOR takes the position that only credits earned on investment made after the effective date of the carry-forward statute can be carried forward. This case presents a question of first impression in S.C. C. Administrative Developments (1) SC Revenue Ruling # 08-1 Nexus (Income Tax) This Ruling discusses the outer limits of the famous (infamous depending on one's perspective) Geoffrey case. Geoffrey, Inc. v. SCTC, 437 S.E. 2d. 13 (S.C.1993) cert. denied 114 S.Ct. 550 (1993). It gives the SCDOR understanding of the Geoffrey decision when it states: "In Geoffrey, the South Carolina Supreme Court...." It then discusses specific examples when Geoffrey does not apply and when nexus does not exist. The discussion includes: Authors, Celebrities, Subsidiary Corporations, owning Bank Accounts, holding Debts, Selling Tangible Personal Property, including Internet Sales, Employee Activities, Printers (which are specifically exempted under S.C. law to protect our printing industry), ownership of Personal Property and conducting Seminars, Meetings and other Similar Visits (such as when the highest performing sales person is given a week vacation in Myrtle Beach ("the Golden Strand"). This ruling is an update of Revenue Ruling #98-3 which was issued shortly after the Geoffrey case was decided. (2) SC Revenue Ruling # 08-2 (Tax Rate Reduction on Active Trade or Business Income from a Pass-Through Business) SCC 12-6-545 provides for a reduced income tax rate (scaled to reach 5% in 2009) for individuals and other non-corporate taxpayers which might ordinarily be taxed at 7%. The reduced rate is limited to active trade or business income and does not include income from personal services. This ruling explains how the reduced rate computed by recipients of pass-through entities and individuals filing composite returns. (3) SC Revenue Procedure # 08-1 (Transfer of Conservation Credits) SCC 12-6-3515 allows income tax credits which are granted as a result of making gifts of land or granting conservation easements on land to be transferred to related or unrelated taxpayers. There is a market in S.C. for the sale of these credits by taxpayers who can not use them. Permission for transfer must be obtained from the SCDOR. This ruling explains the procedure to be followed to successfully transfer these credits. II. Transactional Taxes (Sales/Use) A. Legislative Developments - None

B. Judicial Developments Lexington County Health Services District vs. SCDOR, S.C. Administrative Law Court (06-ALJ-17-0619-CC decided January 7, 2008). The Administrative Law Court ruled that the special sales/use tax exemption (SCC 44-7-2150) which is granted to "health services districts" applied to the purchase of materials for construction and equipping of additions and improvements to the hospital. The SCDOR had argued that the exemption only applied to sales by the hospital of such items. The testimony in the case was that health service districts (e.g., the Lexington Hospital) had never sold construction materials or equipment. The case is on appeal to the S.C. Supreme Court. C. Administrative Developments S.C. Revenue Ruling # 08 (Staff Draft). Withdrawals from Inventory for Use in S.C. or outside S.C. The Ruling addresses the taxability of withdrawals for use when the property is withdrawn for use in S.C. and when withdrawn for use in other states. Of interest is the department's position that a withdrawal is taxable even though the property is immediately shipped to another state for use. III. Property Taxes A. Legislative Developments (1) The S.C. Real Property Valuation Reform Act (2006 Act No 388) became effective in 2007; however, certain of its important provisions take effect in 2008. The Act is now codified beginning at Article 25, Chapter 37, of Title 12, beginning at SCC 12-37-3110. In S.C., property is appraised (reassessed) every five years. SCC 12-37-3140(B) of the new law limits the increase in market value between reassessments to 15%. However, an important exception to that limitation provides that in the case of an "assessable transfer of interest" such as a sale, the property is to be reappraised to market value without limitation. Assessable transfers, i.e., sales made in 2007, will cause reappraisals for 2008. (2) In answer to "public outcry," especially affecting business property purchased during 2007 and slated to be reassessed in 2008, legislation has been proposed in the current legislative session to postpone the reassessment because of an ascertainable transfer until the end of the reassessment period (the end of the 5 year reassessment period) when all property is reassessed. See House Bill 4942. B. Judicial Developments - None C. Administrative Developments - None IV. Other notes of interest Property Taxes: The question has been asked whether or not a reassessment because of the sale (purchase) of a property can be avoided by purchasing the stock or other interest in the entity rather than the assets. It can not. The new property tax law will trigger reassessment upon the purchase of more than 50% ownership. The greater than 50% rule can not be avoided by a series of transfers since it accumulates them over a 25 year period. See SCC 12-37-3150(8). The new law also triggers reassessment based on long term leases. See subsection (7).

SOUTH DAKOTA STATE DEVELOPMENTS Patrick G. Goetzinger & Quentin L. Riggins GUNDERSON, PALMER, GOODSELL, & NELSON, LLP P.O. Box 8045, Rapid City, SD 57709-8045 Tel. 605-342-1078 Fax: 605-342-9503 E-Mail Address: patrick@gpgnlaw.com I. Income/Franchise Taxes

The tax oasis of South Dakota does not have a state income tax and the franchise tax for banks and trust companies were not materially changed.

II. Transactual taxes A. Legislative developments. The South Dakota Legislative Session recently concluded. The enactments affecting

property tax were insubstantial. They do not become effective until July 1, 2007. The fall report will summarize remarkable changes.

B. Judicial Developments

1. Mauch v. South Dakota Dept. of Revenue and Regulation, 738 N.W.2d 537. In this case, Mauch appealed a Department of Revenue and Regulation decision assessing sales tax on engineering services he provided. Mauch also appealed the Department's assessment of use tax for accounting and legal services that were provided to Mauch by out-of-state accountants and attorneys to the Circuit Court. The Circuit Court affirmed the Department’s ruling. The South Dakota Supreme Court held the South Dakota sales tax exemption for engineering services did not require license as professional engineer; and the accounting and legal services were subject to use tax.

2. Metropolitan Life Ins. Co. v. Kinsman, 2008 WL 803651. In this case, a foreign life insurer brought action for

declaratory judgment that South Dakota’s premium and annuity taxes violated equal protection clause by discriminating against foreign insurers. The Circuit Court declared the statutes unconstitutional. State appealed. The South Dakota Supreme Court held state statutes which gave credit to foreign and domestic insurers if they maintained principal or regional home office in state did not discriminate against foreign insurers based on residence and, therefore, did not violate equal protection, and state requirements that insurance companies open a principal place of business in state applied only to domestic companies, not foreign insurers.

3. Sioux Falls Shopping News v. Dept. of Revenue, 2008 WL 1837508. In this case, after an audit of the Shopping

News (a weekly advertiser) the South Dakota Department of Revenue imposed a use tax on the money paid to drivers who drove the papers to distribution points as well as local carriers. The Circuit Court affirmed the imposition of the tax and the South Dakota Supreme Court affirmed.

C. Administrative Developments-Not applicable

D. Trend/Outlook for 2006/2007-Not applicable

III. Property Taxes

A. Legislative Developments. The South Dakota Legislative Session recently concluded. The Legislature enacted

legislation to revise certain provisions of the South Dakota code concerning the tax assessment of agricultural property. The net effect of these changes is to assess agricultural land based on its agricultural income value. More information on the impact of this legislation will follow as the bill created a 12-member advisory committee to work with the Dept of Revenue to develop rules for implementing the system.

B. Judicial Developments-Not applicable C. Administrative Developments-Not applicable

B. D. Trends/Outlook for 2006/2007 – Additional information will follow when the effect of legislation assessing agricultural land based upon its agricultural income value has been implemented.

IV. Other Taxes

The absence of news to report on other taxes is the positive consequence of a positive business environment in South Dakota.

V. Patrick G. Goetzinger leads the Business & Estate Planning Group of Gunderson Palmer Goodsell & Nelson,

LLP. He is a Fellow of the American College of Trust and Estate Counsel, listed among the Best Lawyers in America and Chambers USA America’s Leading Lawyers for Business and Real Property.

TENNESSEE STATE DEVELOPMENTS

TEXAS STATE DEVELOPMENTS Gilbert J. Bernal, Jr. and David J. Sewell Stahl, Bernal & Davies, L.L.P. 7320 N. MoPac, Suite 211 Austin, Texas 78731 Phone: (512) 346-5558 Fax: (512) 346-2712 Gilbert J. Bernal, Jr.’s email address: gbernal@sbaustinlaw.com David J. Sewell’s email address: dsewell@sbaustinlaw.com Firm website: www.sbaustinlaw.com I. TEXAS FRANCHISE TAX The Texas Legislature enacted House Bill 3, a significant revision to the Texas franchise tax, in a special session in the summer of 2006. The revised Texas franchise tax, sometimes called the “Margin Tax,” goes into effect January 1, 2008, but the 2008 tax report will be based on 2007 financial activity. The new tax contains provisions that may render ineffective some tax planning measures implemented during the 2007 calendar year. Business owners should contact their accountant, attorney, or other tax professional as soon as possible to discuss any available planning opportunities under the new tax for their businesses. During the 2007 legislative session, the Texas Legislature passed one significant bill, House Bill 3928, to correct, clarify, and refine the new margin tax. Other bills affecting the tax were also enacted. This section of the Texas tax update provides a complete overview of the margin tax. 2007 legislative changes are italicized for emphasis. IMPORTANT UPDATES SINCE OCTOBER 2007: In the past six months, some important transitional steps have been completed as the Comptroller and taxpayers prepare for the filing of the first margin tax reports in 2008.

1. Fifteen new Comptroller administrative rules were adopted effective December 11, 2007. The new rules are:

3.581 – Margin: Taxable and Nontaxable Entities 3.582 – Margin: Passive Entities 3.583 – Margin: Exemptions 3.584 – Margin: Reports and Payments 3.585 – Margin: Annual Report Extensions 3.586 – Margin: Nexus 3.587 – Margin: Total Revenue 3.588 – Margin: Cost of Goods Sold 3.589 – Margin: Compensation 3.590 – Margin: Combined Reporting 3.591 – Margin: Apportionment 3.592 – Margin: Additional Tax 3.593 – Margin: Franchise Tax Credits 3.594 – Margin: Temporary Credit and Business Loss Carryforwards 3.595 – Margin: Transition

2. 2008 Franchise Tax Report forms became available for download on the Comptroller’s website in March

2008. 3. The Comptroller released a series of answers to Frequently Asked Questions on her website. The “FAQs”

are updated continuously and are represent the Comptroller’s most up-to-date statement of policy positions on various aspects of the margin tax. The FAQs may be accessed at the following website: http://www.cpa.state.tx.us/taxinfo/franchise/faq_questions.html

4. On April 22, 2008, the Comptroller released an announcement that all Texas taxpayers who are unable to

meet the May 15, 2008, due date for their franchise tax reports will have an additional 30 days to submit their returns or file an extension without penalty.

The standard formula for calculating the margin tax is set forth below:

Lesser of:

(A) 70% of Total Revenue from Entire Business or

(B) Total Revenue from Entire Business

- Deduction equal to the greater of:

(i) Compensation and Benefits; or

(ii) Cost of Goods Sold

Unapportioned Taxable Margin

x Texas Apportionment Factor

Apportioned Taxable Margin

- Deductions for Solar Energy/Clean Coal

x Tax Rate (either 1% or 0.5%)

Franchise Tax Due Before Credits

- Applicable Credits

Final Franchise Tax Liability (for non-small business)

x Applicable Small Business Discount (for small businesses)

Final Franchise Tax Liability (for small businesses)

The addition of an optional E-Z Computation for businesses with less than $10 million in total revenue was added

during the 2007 legislative session. The formula for the E-Z Computation is set forth below:

Total Revenue from Entire Business

x Texas Apportionment Factor

Apportioned Total Revenue

x Tax Rate of 0.575%

Final Franchise Tax Liability (for non-small business)

x Applicable Small Business Discount (for small businesses)

Final Franchise Tax Liability (for small businesses)

Some important aspects of the Margin Tax and the various components of the Margin Tax formula are briefly described in this outline.

2007 Legislative Change: House Bill 3928 added the concept of a Small Business Discount. The applicable percentage discount is applied to the franchise tax liability determined after applying the applicable tax rate and subtracting any applicable credits. The following discounts will apply:

A taxable entity with Total Revenue from Entire Business greater than $300,000 but less than $400,000 will receive a discount of 80%.

A taxable entity with Total Revenue from Entire Business equal to or greater than $400,000 but less than $500,000 will receive a discount of 60%.

A taxable entity with Total Revenue from Entire Business equal to or greater than $500,000 but less than $700,000 will receive a discount of 40%.

A taxable entity with Total Revenue from Entire Business equal to or greater than $700,000 but less than $900,000 will receive a discount of 20%.

The amounts listed above will be adjusted based on CPI on January 1 of every even-numbered year beginning in 2010.

TAXABLE ENTITIES

Only corporations and limited liability companies must pay the franchise tax in its pre-2008 form. Under the revised tax, all entities with limited liability under state law (with the exception of “passive entities,” as explained below) will be taxed. This includes partnerships, limited liability partnerships, corporations, banking corporations, savings and loan associations, limited liability companies, business trusts, professional associations, business associations, joint ventures, joint stock companies, holding companies, and other legal entities. Sole proprietorships and general partnerships comprised of only natural persons will not be subject to the revised tax. For the first time under the Texas franchise tax, some entities will be required to file combined tax returns (see discussion below).

2007 Legislative Change: House Bill 3928 added limited liability partnerships to the list of taxable entities. The statute also clarified that the following types of trusts are not taxable entities: (i) grantor trusts taxable under Section 671 and IRC § 7701(a)(30)(E), not taxable as a business entity pursuant to Treasury Regulation Section 301.7701-4(b), and in which all of the grantors and beneficiaries are natural persons or charitable entities as defined in IRC § 501(c)(3); (ii) nonprofit self-insurance trusts for health care liability claims; (iii) trusts that are part of an employer’s stock bonus, pension, or profit-sharing plan; and (iv) trusts that are voluntary employees’ beneficiary associations. 2007 Legislative Change: House Bill 3928 amended the definition of “natural person” to include the estate of a natural person.

The revised tax contains an exemption for certain “passive entities.” An entity qualifies as a passive entity if: (1) the entity is a general or limited partnership or a trust, other than a business trust; (2) during the period on which margin is based, the entity’s federal gross income consists of at least 90% of the following income: dividends, interest, foreign currency exchange gain, periodic and nonperiodic payments with respect to notional principal contracts, option premiums, cash settlement or termination payments with respect to a financial instrument, and income from a limited liability company; distributive shares of partnership income to the extent that those distributive shares of income are greater than zero; capital gains from the sale of real property, commodities traded on a commodities exchange, and securities; and royalties, bonuses, or delay rental income from mineral properties and income from other nonoperating mineral interests; and (3) the entity does not receive more than 10% of its federal gross income from conducting an active trade or business.

2007 Legislative Change: House Bill 3928 modified the inclusion of “gains from the sale of real property” as qualifying passive income so that the provision now reads “capital gains from the sale of real property.” The statute also removed superfluous provisions addressing passive family limited partnerships, investment partnerships, and other specific passive entities.

A taxable entity will not owe any tax if the calculated tax is less than $1,000. A taxable entity will not owe tax if its “revenue from entire business” is less than or equal to $300,000; this $300,000 amount will be indexed based on CPI on January 1 of every even-numbered year beginning in 2010.

The Comptroller recognizes in her FAQs that the margin tax statutes allow taxpayers to combine the E-Z Computation, Small Business Discount, and $1,000 baseline exemption. Based on the combination of these statutory provisions, a taxpayer may have up to $434,782 in Total Revenue on its 2008 Franchise Tax Report and owe no tax.

TOTAL REVENUE FROM ENTIRE BUSINESS Revenue is defined by references to federal income tax forms. The total revenue of a taxable entity treated for federal income tax purposes as a corporation is an amount computed by adding the following: (a) the amount entered on line 1c, Internal Revenue Service Form 1120; (b) the amounts entered on lines 4 through 10, Internal Revenue Service Form 1120; and (c) any total revenue reported by a lower tier entity as includable in the taxable entity’s total revenue. The following are then subtracted from such sum: (a) bad debt that corresponds to the computed revenue; (b) to the extent included in revenue, foreign royalties and foreign dividends, including amounts determined under IRC § 78 or IRC § 951 through IRC § 964; (c) to the extent included in revenue, net distributive income from partnerships and from trusts and limited liability companies treated as partnerships for federal income tax purposes and net distributive income from limited liability companies and corporations treated as S corporations for federal income tax purposes; (d) allowable deductions from Internal Revenue Service Form 1120, Schedule C, to the extent the related dividend income is included in total

revenue; and (e) to the extent included in revenue, items of income attributable to an entity that is a disregarded entity for federal income tax purposes.

The total revenue of a taxable entity treated for federal income tax purposes as a partnership is an amount computed by adding the following: (a) the amount entered on line 1c, Internal Revenue Service Form 1065; (b) the amounts entered on lines 4, 6, and 7, Internal Revenue Service Form 1065; (c) the amounts entered on lines 3a and 5 through 11, Internal Revenue Service Form 1065, Schedule K; (d) the amounts on Form 8825, line 17; and (e) any total revenue reported by a lower tier entity as includable in the taxable entity’s total revenue. The following are then subtracted from such sum: (a) bad debt that corresponds to the computed revenue; (b) to the extent included in revenue, foreign royalties and foreign dividends, including amounts determined under IRC § 78 or IRC § 951 through IRC § 964; (c) to the extent included in revenue, net distributive income from partnerships and from trusts and limited liability companies treated as partnerships for federal income tax purposes and net distributive income from limited liability companies and corporations treated as S corporations for federal income tax purposes; and (d) to the extent included in revenue, items of income attributable to an entity that is a disregarded entity for federal income tax purposes.

2007 Legislative Change: As expected, House Bill 3928 cleaned up some of the confusion surrounding which entries on a partnership’s federal tax forms would be included in revenue. A double-inclusion of guaranteed payments was deleted, and the line for gross rental income on Form 8825 was substituted for the line for net rental income on Form 1065, Schedule K.

The total revenue of a taxable entity other than a taxable entity treated for federal income tax purposes as a corporation or partnership is computed in a substantially equivalent manner.

2007 Legislative Change: House Bill 3928 requires that the amounts entered on federal income tax forms used to calculate total revenue must comply with federal tax law. The definition of total revenue was also modified by stating that the revenue that a lower-tier entity reports as includable by an upper-tier entity is treated as revenue by the upper-tier entity.

DEDUCTIONS

Each taxable entity will be able to take the largest of three deductions—cost of goods sold, compensation and benefits, and what amounts to a 30% deduction (by paying tax based on 70% of total revenue instead of electing to deduct compensation or cost of goods sold).

COST OF GOODS SOLD

Cost of goods sold is defined in the new statute; it does not follow the federal tax concept. A taxable entity’s cost of goods sold is calculated by adding (i) the direct costs associated with acquiring or producing the goods, (ii) certain indirect costs associated with the goods, and (iii) certain administrative or overhead costs allocable to the acquisition or production of goods. Cost of goods sold includes only costs associated with real property or tangible personal property, not intangible property or services. The definition of cost of goods sold does include production, however. So, many construction and manufacturing expenses will qualify as deductible costs of goods sold. In addition, cost of goods sold for a particular good may only be included in the deduction if the taxpayer, or a member of its consolidated group, “owns” the goods based on “all of the facts and circumstances.”

COMPENSATION AND BENEFITS

Deductible compensation includes wages, tips, net distributive income from certain types of entities distributed to natural persons, and stock awards and stock options deducted for federal income tax purposes. A taxable entity electing to deduct compensation may deduct wages and cash compensation and the cost of all deductible benefits. The amount of compensation that may be deducted for any person cannot exceed $300,000. There is no limit on the amount of deductible benefits. Deductible benefits include the cost of all benefits the taxable entity provides to its officers, directors, owners, partners, and employees, including workers’ compensation benefits, health care, employer contributions made to employees’ health savings accounts, and retirement to the extent deductible for federal income tax purposes.

2007 Legislative Change: House Bill 3928 clarified that net distributive income from a disregarded LLC is included in compensation if it is distributed to a natural person.

2007 Legislative Change: House Bill 3928 allows “Small employers,” as that term is defined in Insurance Code § 1501.002, that have not provided health care benefits to any of their employees in the calendar year preceding the beginning date of a report period, but that (i) elect to begin providing health care benefits to all of their employees and (ii) elect to deduct compensation and benefits, to take bonus deductions. For the first 12-month period on which margin is based after which health benefits are provided to all employees, the taxable entity may deduct an additional 50% of the cost of the health care benefits. For the second 12-month period on which margin is based after which health benefits are provided to all employees, the taxable entity may deduct an additional 25% of the cost of the health care benefits. Insurance Code § 1501.002 defines “small employer” to mean a person or entity “who employed an average of at least two employees but not more than 50 eligible employees on business days during the preceding calendar year and who employs at least two employees on the first day of the plan year.”

THIRTY PERCENT DEDUCTION (option to pay on 70% of Revenue)

The 30% deduction ensures that no more than 70% of a taxable entity’s revenue will be taxed in any year. The 30% deduction is not actually described as a deduction in the statute. The technical calculation in the statute provides that taxable margin is equal the lesser of (i) total revenue minus the greater of cost of goods sold or compensation and benefits or (ii) 70% of total revenue.

APPORTIONMENT

For the most part, apportionment rules have not changed for the new tax. A taxable entity’s apportionment factor will be determined by dividing its gross receipts from business done in Texas by its total gross receipts. The comptroller has already adopted lengthy rules that describe when receipts are considered Texas receipts; the rules are expected to remain mostly unchanged for the revised tax.

TAX RATE

For most taxpayers, the tax rate will be 1%. For taxpayers engaged primarily in retail or wholesale trade, the tax rate will be 0.5%. A taxable entity is engaged primarily in retail or wholesale trade only if: (a) the total revenue from its activities in retail or wholesale trade is greater than the total revenue from its activities in trades other than the retail and wholesale trades; (b) less than 50% of the total revenue from activities in retail or wholesale trade comes from the sale of products it produces or products produced by an entity that is part of an affiliated group to which the taxable entity also belongs (this does not apply to total revenue from activities in a retail trade described by Major Group 58 of the Standard Industrial Classification Manual published by the federal Office of Management and Budget); and (C) the taxable entity does not provide retail or wholesale utilities, including telecommunications services and electricity or gas. “Wholesale trade” means the activities described in Division F of the 1987 SIC Manual published by the federal Office of Management and Budget, and “retail trade” means the activities described in Division G of the 1987 SIC Manual.

2007 Legislative Change: House Bill 3928 clarifies that “retail and wholesale utilities” includes “telecommunications services, electricity, or gas.”

CREDITS Most credits available under the current franchise tax are eliminated by the revised tax. Taxpayers are allowed to carryforward economic development credits and business losses accruing under the current tax into the calculation of the revised tax, subject to certain limitations. The provisions of the revised tax related to the carryforward of business losses were clarified in House Bill 3928.

2007 Legislative Change: Under House Bill 3928, the temporary margin tax credit is calculated by (a) determining the entity’s unused business loss carryforwards; (b) multiplying such amount by (i) 2.25% for the first 10 margin tax reports (to January 1, 2018) and (ii) 7.75% for the next 10 margin tax reports (to September 1, 2027); and (c) multiplying that amount by 4.5%. Under the statute, a taxpayer must notify the comptroller in writing of its intent to claim this credit on the first report due under the margin tax.

Note that because the new tax is a tax on an entity’s “margin” and not its net income, the concept of a business loss or net operating loss does not come into play (an entity may owe tax even if it has a net loss in a particular year). In order to qualify for the credit, a taxpayer must file a form claiming the credit with the Comptroller on or before the due date of the taxpayer’s franchise tax return.

COMBINED REPORTING

The requirement to file combined reports may be the most complicated change in the franchise tax. Members of a “combined group” will be required to file combined franchise tax reports. Entities are members of a combined group if they are “affiliated” and if they are engaged in a “unitary business.” Members of a group are “affiliated” if a controlling fifty percent (50%) or greater interest is owned by a common owner or owners or by one or more members of the affiliated group. The definition includes both direct and indirect ownership.

2007 Legislative Change: House Bill 3928 changed the threshold for affiliation from 80% to 50%. Important Note: Newly adopted Comptroller Rule 3.590 defines an “affiliated group” as a group where a Controlling Interest is owned by a common owner (excluding the statutory reference to “or owners”). The Comptroller Rule contains a number of examples showing how entity ownership in various tiered arrangements will be attributed to other entities. The Comptroller Rule does not contain any provisions concerning familial attribution, but the Comptroller FAQs do announce a policy of spousal attribution so that husbands and wives will be deemed a single owner for purposes of the affiliated group test. The Comptroller FAQ does not differentiate between community property and separate property.

Members are conducting a “unitary business” if their business is a single economic enterprise that is made up of separate parts of a single entity or of a commonly controlled group of entities that are sufficiently interdependent, integrated, and interrelated through their activities so as to provide a synergy and mutual benefit that produces a sharing or exchange of value among them and a significant flow of value to the separate parts. In determining whether a unitary business exists, the comptroller will consider three factors, including whether: the activities of the group members are in the same general line, such as manufacturing, wholesaling, retailing of tangible personal property, insurance, transportation, or finance, or are steps in a vertically structured enterprise or process, such as the steps involved in the production of natural resources, including exploration, mining, refining, and marketing; and the members are functionally integrated through the exercise of strong centralized management, such as authority over purchasing, financing, product line, personnel, and marketing.

The mechanics of combined reporting require each entity to calculate its total revenue separately. To determine the combined group’s revenue, each revenue figure is added together, and intragroup revenue is subtracted. Each member of the combined group must elect the same deduction; the deductions are calculated separately and then added together to obtain the total deduction. The combined group’s apportionment factor is determined by dividing the entities’ aggregate Texas receipts by the entities’ aggregate total receipts; intragroup receipts are ignored. Under the current version of the revised tax, the gross receipts of members of a combined group that do not have nexus with Texas will be treated as non-Texas gross receipts (and will be included in the bottom part of the fraction). The combined group’s tax rate will be determined by applying the retail/wholesale classification to the entire group’s receipts. The margin tax includes a second type of combined reporting for tiered partnership arrangements. In a “tiered partnership arrangement,” an “upper tier entity” may report its share of a “lower tier entity’s” taxable margin, in which case, the lower tier entity is not required to pay tax on such portion of its taxable margin. The lower tier entity is required to file a report showing the amount of its taxable margin that each upper tier entity should include in its taxable margin. A “tiered partnership arrangement” means an ownership structure in which any of the interests in one taxable entity treated for federal income taxes as a partnership or as an S corporation (a “lower tier entity”) are owned by one or more other taxable entities (an “upper tier entity”). A tiered partnership arrangement may have two or more tiers.

2007 Legislative Change: House Bill 3928 provides that in the case where an upper tier entity is not subject to the margin tax, the lower tier entity must report the share of its taxable margin that is attributed to the non-taxed upper tier entity. The statute also provides that an upper tier entity may not be exempt for having less than $300,000 in revenue or $1,000 in tax owed if, before the attribution of any total revenue by a lower tier entity to the upper tier entity, the lower tier entity is not exempt for having less than $300,000 in revenue or $1,000 in tax owed.

OTHER 2007 STATUTORY CHANGES TO THE FRANCHISE TAX15: 1. House Bill 3928. The following changes (in addition to the italicized changes noted above) were made to the margin tax by House Bill 3928: Changes related to definitions

• The definition of “lending institution” now includes certain entities regulated by the Department of Savings and Mortgage Lending, certain brokers and dealers, and certain agricultural lenders.

• A three-factor test is adopted for determining whether affiliated companies are participating in a

unitary business.

Changes related to the calculation of the tax

• The indexing of the amounts for the $300,000 taxability threshold, $300,000 compensation cap, and the revenue amounts for small business discount qualification is amended to adjust according to CPI in each even-numbered year beginning in 2010.

• A taxpayer must elect the cost of goods sold or compensation deduction by the due date of its annual

report, and the election cannot be changed on an amended report.

Changes related to the calculation of Total Revenue from Entire Business

• Law firms are permitted to deduct from revenue $500 per pro bono case handled during the report year.

• Pharmacy cooperatives may exclude flow-through funds from rebates from pharmacy wholesalers

that are distributed to the pharmacy cooperative’s shareholders.

Changes related to the calculation of Cost of Goods Sold • The definition of tangible person property was expanded to include television and radio programs

and other media. Film, television, broadcasting, and distribution companies are permitted to treat depreciation, amortization, and other expenses related to the acquisition, production, or use of the media as a deductible cost of goods sold.

• Depreciation, depletion, and amortization are tied to the amounts reported on the taxpayer’s federal

income tax return.

• The taxpayer is permitted to capitalize or expense a cost of goods sold; the taxpayer is not required to follow its federal reporting.

Changes related to the calculation of Compensation and Benefits

• Provisions concerning the $300,000 compensation cap are clarified to provide that the cap applies to

a combined group as a whole, not to each entity in a combined group, so that the combined group may not deduct, in the aggregate, more than $300,000 in compensation paid to one natural person.

Changes related to Combined Reporting

• The “standard deduction” for a combined group is clarified to provide that the taxable margin of a

combined group may not exceed 70% of the group’s total revenue. • A member of combined group is permitted to deduct a cost of goods sold if the related good is

owned by another member of the combined group.

15 All bills and statutory changes referenced in this paper refer to bills passed by the 80th Texas Legislature during the 2007 regular session.

• The period on which the report for the combined group is based must be the same for each member

of the group.

• The statute clarifies that each member of the combined group is jointly and severally liable for the tax owed by the group.

Changes related to Apportionment

• A combined group is required to report to the Comptroller, for information purposes only, certain

information for group members that do not have nexus in Texas. This provision is viewed as a possible precursor to adopting a “Finnigan” method of apportionment.

• If a loan or security is treated as inventory for federal tax purposes, the receipt is treated as a gross

receipt for apportionment purposes.

Miscellaneous changes

• An entity may be required to file information with the Comptroller to prove that it is not subject to the franchise tax.

• A client company of a staff leasing company is permitted to rely on information provided to it by the

staff leasing company for margin tax purposes on a form promulgated by the Comptroller or on an invoice.

• House Bill 3928 provides that if (i) an entity that is not doing business in the state on January 1,

2008, (ii) would have been subject to the margin tax if was doing business on January 1, 2008, (iii) but was not subject to the prior franchise tax, and (iv) was doing business after June 30, 2007—THEN such an entity will file a final report and pay tax if it dissolves between July 1, 2007, and January 1, 2008. The tax due on the final report will be based on the taxable entity’s margin as calculated for the period beginning January 1, 2007, and ending on the date of dissolution. A entity that changed form prior to June 30, 2007, so that it was not subject to the margin tax is not required to file a final franchise tax report.

2. House Bill 3694. This bill added a new tax credit for certain enterprise projects. In order to qualify as an

enterprise project, an entity must be designated as such by the Texas Department of Economic Development between September 1, 2001, and September 1, 2003, or the Texas Economic Development Bank between September 1, 2003, and January 1, 2005. The credit is equal to 7.5% of the qualified capital investment made on or after January 1, 2005. The credit claimed may not exceed 50% of the tax due before other credits. Unused credits may be carried forward for 5 years. A “qualified investment” means tangible personal property first placed into service in an enterprise zone by a qualified business that has been designated as an enterprise project; the term does not include real property.

3. House Bill 387. Under this bill, certain franchise tax exemptions for the Texas National Research Laboratory

Commission are repealed. 4. Senate Bill 377. Requires taxpayers who paid $10,000 or more in one of a list of particular state taxes during

the preceding year to remit payments by electronic transfer for the following year. The list of affected taxes includes the sales tax and the franchise tax. B. Judicial Developments 1. Martin v. State, 2007 Tex. App. LEXIS 6167 (Tex. App.—Austin 2007, no pet. h.). In this case, the Court held that a corporate officer was jointly and severally liable with the corporation for costs incurred by the State of Texas to clean up abandoned oil and gas waste sites. The corporation failed to pay franchise taxes, and its corporate privileges were forfeited. After the forfeiture of corporate privileges, the State used its own funds to clean up the waste sites. When a corporation’s corporate privileges are forfeited, the officers and directors of the corporation are personally liable for all debts of the corporation incurred after the date of forfeiture. The State proved that Martin was an officer of the corporation at the time the State incurred the cleanup costs, so he was held personally liable for the reimbursement of the costs.

2. INOVA Diagnostics, Inc. v. Strayhorn, 166 S.W.3d 394 (Tex. App.—Austin 2005, pet. denied). On May 26, 2005, the Third Court of Appeals affirmed Judge Darlene Byrne’s judgment against INOVA in this case. INOVA sued the Comptroller for a refund of franchise taxes paid under protest. The suit involves report years 1999-2003. INOVA contended that Public Law 86-272 exempts it from the taxable capital component of the franchise tax because INOVA does business in Texas only by soliciting orders for its products, sending the orders outside Texas for fulfillment in California, and then shipping the products to Texas customers by common carrier. Public Law 86-272 exempts taxpayers from a state tax “imposed on, or measured by, net income” when they conduct only solicitation activities. The court did not agree with INOVA’s argument that the taxable capital component is imposed on or measured by net income because INOVA’s net income is included in its retained earnings which form a part of its taxable surplus under the taxable capital component. The court held that the taxable capital component taxes a corporation’s assets or capital and not its net income. The court also held that INOVA had substantial nexus in the state under the U.S. Constitution even though INOVA’s solicitor-employee was present in Texas only a few days out of each month.

INOVA’s Petition for Review was denied by the Texas Supreme Court on December 2, 2005. INOVA subsequently filed a Petition for Writ of Certiorari with the U.S. Supreme Court to decide the question of whether the Texas franchise tax on net taxable capital is a “net income tax” under Public Law 86-272. The U.S. Supreme Court denied INOVA’s Petition for Writ of Certiorari on April 17, 2006.

3. Home Interiors & Gifts, Inc. v. Strayhorn, 175 S.W.3d 856 (Tex. App.—Austin 2005, pet. denied Mar. 9,

2007). In this case, the Third Court of Appeals held that the Texas throwback provision, which is part of the franchise tax’s apportionment formula, is unconstitutional in circumstances where a Texas-based taxpayer is protected from taxation in other states by Public Law 86-272. The court held that, in this situation, the throwback provision of the Texas franchise tax violates the commerce clause of the U.S. Constitution.

The throwback rule is an apportionment provision that plays a role in determining what percentage of a corporation’s

earned surplus or taxable capital will be taxed in Texas. The apportionment fraction is calculated by dividing a corporation’s Texas gross receipts by its total gross receipts; therefore, a corporation pays less tax when its Texas gross receipts are less than its total gross receipts. As a general rule, sales of tangible personal property are apportioned to the state where the delivery of the product is made (the “destination state”). The throwback rule is an exception to this general rule. Under the throwback rule, if the taxpayer does not have sufficient contact with the destination state to require it to pay taxes in the destination state, gross receipts that would otherwise be apportioned to the destination state are “thrownback” to Texas.

In Home Interiors, Home Interiors was located in Texas and did not have sufficient contact to pay net income taxes in

any other state because its solicitation activities in the other states were protected under Public Law 86-272. The Comptroller applied the throwback rule to these sales, thus causing an increase in Home Interior’s apportionment fraction and total franchise tax due. Home Interiors argued that applying the throwback rule to it violated the commerce clause of the U.S. Constitution.

The Third Court of Appeals reversed the trial court’s granting of the Comptroller’s motion for summary judgment in

this case and rendered judgment for Home Interiors. The court held that the application of the throwback rule to Home Interiors violated the commerce clause’s internal consistency test. When analyzing a tax statute under the internal consistency test, the court must (1) suppose a hypothetical world in which all fifty states have a tax system identical to Texas’ and (2) judge whether or not interstate commerce would be discriminated against in favor of intrastate commerce in this hypothetical world. If interstate commerce is discriminated against, then the state tax system violates the commerce clause.

When applying the internal consistency test, the court determined that, because of Public Law 86-272, Home Interiors,

as an interstate seller, would be subject to higher cumulative state taxes than would a fictional taxpayer that made sales to only Texas customers (an “intrastate seller”). The intrastate seller in the hypothetical would owe Texas franchise tax on 100% of its earned surplus, but would not owe taxes to any other state.

The interstate seller, on the other hand, would owe Texas franchise tax on 100% of its earned surplus but would also

owe franchise tax based on its taxable capital in any state where it had sufficient connection to create an obligation to pay the taxable capital component of the franchise tax but was exempt from the earned surplus component of the franchise tax by Public Law 86-272. The court cited the holding in INOVA Diagnostics, Inc. v. Strayhorn for the proposition that Public Law 86-272 does not protect a taxpayer from taxation based on taxable capital. The court’s ultimate conclusion was that the interstate seller would owe a greater aggregate tax than the intrastate seller. This result causes the throwback rule to fail the commerce clause’s internal consistency test, thus rendering the throwback provision, as applied in the facts of this case, unconstitutional.

The Comptroller filed a Petition for Review with the Texas Supreme Court on January 1, 2006. The Texas Supreme Court denied the Petition for Review on March 9, 2007. As a result of the holding in this case, many Texas taxpayers with operations similar to Home Interiors may be entitled to a refund of franchise taxes. These taxpayers should take appropriate action under Texas law to prevent their refunds from being time-barred under the four-year statute of limitations that applies to tax refunds. The Comptroller recently issued a letter ruling describing the process for taxpayers seeking refunds based on the decision in Home Interiors:

If you decide to file amended franchise tax reports for [the corporation] based upon the recent Home Interiors decision concerning the unconstitutionality of throwback in that situation, all supporting documentation should be attached to your request. The refund request will be denied. [The corporation] will then need to properly request a refund hearing. [The corporation]’s request will be held in hearings, along with similar requests from other entities, until the final appeal on the Home Interiors case is completed. (Comptroller Letter of September 28, 2005, STAR Document No. 200509289L).

Taxpayers should note that this case will not have significant effect on the Margin Tax (which becomes effective January 1, 2008) because the throwback rule was repealed and will not apply to the Margin Tax. 4. Anderson-Clayton Bros. Funeral Home, Inc. v. Strayhorn, 149 S.W.3d 166 (Tex. App.—Austin 2004, pet. denied January 27, 2006). This case arises from Anderson-Clayton’s franchise tax treatment of investment earnings on its prepaid funeral benefits trusts during the 1993-96 tax years. Throughout this period, Anderson-Clayton deposited proceeds from its sales of prepaid funeral benefits contracts into Texas trusts, in accordance with Texas Finance Code section 154.253(a)(3). These trusts, in turn, invested those funds in accordance with Texas Finance Code section 154.258 and accumulated investment earnings. It is undisputed that, at all relevant times, the investment earnings on Anderson-Clayton’s prepaid funeral benefits were paid by out-of-state corporations. The issue in this case is whether, under the Comptroller’s “location of payor” rule, the distributions of earnings on the taxpayer’s trust accounts, which were maintained in Texas trusts, but which consisted of payments from non-Texas companies, were Texas gross receipts. The general franchise tax rule apportions investment earnings to the state where the payor of the earnings is located. Anderson-Clayton argued that the earnings were not a Texas gross receipts because the income was earned from investments in out-of-state corporations. Anderson-Clayton essentially wanted the Comptroller to look through the trusts and source the receipts based on the actual investments by the trusts in the out-of-state corporations. The Comptroller argued that the location of payor rule should be applied to the trusts, and if the trusts are Texas trusts, then Anderson-Clayton’s receipts from those trusts would be Texas gross receipts. The trial court granted the State’s motion for summary judgment, and the Third Court of Appeals upheld the trial court’s judgment and agreed with the Comptroller’s argument that the subject receipts were gross receipts from business done in Texas. The court reasoned that under longstanding Texas law, trusts are considered separate entities, even when they may not be subject to federal income tax or the franchise tax. And because it is ultimately the trusts that pay income to the funeral homes, the Comptroller’s determination that the trusts are the payors is reasonable. The taxpayer’s Petition for Review in this case was denied by the Texas Supreme Court on January 27, 2006. C. Administrative Developments 1. Comptroller Letter Ruling 200696694L (June 1, 2006). In this letter, the Comptroller advises a Canadian corporation that the corporation does not need to obtain the Comptroller’s approval to change its accounting year, the filing of a short period return is not required, and the change in accounting year should be reflected on the next annual report. 2. Comptroller Letter Ruling 200606695L (June 1, 2006). This letter ruling clarifies the Comptroller’s policy concerning nexus in certain LLC ownership structures. In the letter ruling, the Comptroller considers an ownership structure where a single-member LLC (which is disregarded for federal tax purposes) is owned by a multi-member LLC. The single-member LLC does business in Texas, but the multi-member LLC does not. Under Texas law, the single-member LLC must report Texas franchise tax based on its own financial condition. The multi-member LLC will not be required to pay Texas franchise tax because the mere ownership of an interest in a LLC doing business in Texas does not create nexus for the owner. 3. Comptroller Ruling 200607697L (July 19, 2006). The Comptroller advised a nonprofit library that it was required to prove its exempt status before it could claim an exemption from Texas franchise tax. Once the exemption is granted by the Comptroller, the unrelated business income of the nonprofit corporation will not be subject to franchise tax.

4. Comptroller Letter Ruling 200606693L (June 1, 2006). In this letter, the Comptroller responds to an LLC’s request that it be refunded a pro rata portion of its franchise taxes paid during its year of dissolution. The Comptroller advised that the LLC was not entitled to a refund because a dissolving entity is required to pay tax through the end of the privilege period containing the effective date of the dissolution. 5. Comptroller Hearing 44,982 (January 5, 2006). The taxpayer challenged the auditor’s determination that certain accounts were not excludable from surplus as reserves for uncollectible accounts or as deductible debts. The taxpayer’s customers had the option of financing equipment purchases through third-party lenders. The taxpayer and the lenders had an arrangement where the taxpayer would purchase uncollectible accounts from the lenders. The difference between the loan payoff amount and the fair market value of the collateral was recorded as a reserve in the taxpayer’s books and records. The Comptroller argued that (1) these accounts were not excludable as bad debt reserves because the taxpayer did not have corresponding accounts receivable for the items and (2) they were not excludable as debts because they were contingent in nature. The administrative law judge ruled for the Comptroller. 6. Comptroller Hearing 45,598 (March 2006). In this hearing, the administrative law judge ruled that an S corporation whose only shareholder was a federal-tax-exempt employee stock ownership plan (ESOP) was required to pay franchise tax based on its earned surplus despite the tax-exempt status of the shareholder. Texas law provides that an S corporation’s reportable income (which is the starting point for the franchise tax’s earned surplus calculation) is the amount of income reportable to the IRS as being taxable to its shareholders. The taxpayer argued that the fact that its sole shareholder was a tax exempt ESOP prevented it from having income that is taxable to its shareholders. But, Texas law and Comptroller policy state that limitations or restrictions related to the S corporation’s shareholders are ignored for franchise tax purposes. The administrative law judge ruled that an S corporation must use the amount of reportable federal taxable income shown on its federal tax form 1120 to calculate its earned surplus, regardless of whether its shareholders will pay any tax. 7. Comptroller Hearing 43,881 (July 12, 2006). In this hearing, the taxpayer argued that the unitary business principle required the exclusion of the receipts from three of taxpayer’s divisions from the taxpayer’s earned surplus component and taxable capital component calculations because the three divisions had no functional integration with taxpayer’s core business. The Tax Division agreed that the divisions’ receipts should be excluded from earned surplus but argued that the unitary business principle did not apply to the taxable capital component. The administrative law judge disagreed with the Tax Division and held that the unitary business principle applies to both the earned surplus component and the taxable capital component of the franchise tax. 8. Comptroller Hearing 46,585 (September 21, 2006). The taxpayer in this hearing provides taxable security services to customers throughout the nation. The taxpayer’s main alarm monitoring facility is located in Texas. The taxpayer argued that its receipts from the sale of its services should be apportioned based on where the monitored property is located while the Comptroller argued that all of its receipts should be apportioned to Texas because its monitoring facility is located in Texas. The issue in the case was where the taxpayer’s services are performed—at the monitored property or at the Texas monitoring facility. The administrative law judge ruled that the services are performed at the monitoring facility, thus all of the taxpayer’s gross receipts were apportioned to Texas. 9. Comptroller Hearing 46,702 (October 3, 2006). The taxpayer in this hearing was an airline company. The company argued that two of its general ledger accounts—an accident receivables account and a related accident liabilities account for insurance claims related to the September 11, 2001, terrorist attacks—should be excluded from surplus in the calculation of net taxable capital. The administrative law judge held that the two accounts should be included in surplus. The receivables account was included in surplus because it was a GAAP asset. The liabilities account was included in surplus because it contained only estimated and contingent obligations. 10. Comptroller Letter Rulings 200605665L (May 18, 2006) and 200606622L (June 26, 2006). These letter rulings clarify the Comptroller’s policy concerning certain membership fees, enrollment fees, and discount fees collected by independent marketing representatives and credit card issuers. Under Comptroller franchise tax policy, membership fees and enrollment fees are deemed receipts from the sale of intangible rights and are apportioned to the location of the payor. Discount fees, which consist of a discount retained by the credit card company when the card is used to purchase goods from retailers, are considered fees from the performance of a service and are apportioned based on where the service is performed. D. Outlook for 2007-08 The most pressing issue for Texas in the franchise tax area is the adoption of administrative rules for the new margin tax. Proposed rules have been circulated by the Comptroller, but final rules are not expected until closer to the end of the year. The first franchise tax reports based on taxable margin will be filed in May 2008.

II. TEXAS SALES AND USE TAX A. Legislative Developments

1. House Bill 3319. This bill makes a number of significant changes to the sales tax. The most significant changes are described below:

• Makes services performed by a landman necessary to negotiate or secure land rights or mineral

rights not taxable as a real property service. • Provides that a wireless voice communication device transferred as an integral part of a taxable

service, whether or not there is a separate charge for the device, and whether or not the purchaser is a provider of the service, exempt as a sale for resale if payment for the service is a condition for receiving the device.

• Requires a ready-mix concrete contractor to separately and individually invoice its customer for

each yard of concrete produced and consumed for an improvement to real property and to collect and remit applicable taxes on the concrete.

• Provides that pharmaceutical biotechnology cleanrooms and installed equipment that are part of a

new cleanroom facility, regardless of value, are exempt so long as construction began after July 1, 2003.

• Moves the three-day sales tax holiday from the first weekend in August to the third weekend in

August and establishes that backpacks that cost less than $100 are tax-free during the tax holiday. This provision is also contained in House Bill 3314.

• For state and local tax purposes, provides that local sales taxes for taxable services will be based on

the local of the service provider (i.e., “origin” sourcing as opposed to “destination” sourcing). Local sales taxes for the repair, remodel, or restoration of nonresidential real property will be based on the location of the job site (i.e., “destination sourcing”).

• Repeals the requirement that retailers must collect local sales taxes for a local taxing entity even if

the retailer does not have a nexus with the local taxing entity.

2. Senate Bill 377. Requires taxpayers who paid $10,000 or more in one of a list of particular state taxes during the preceding year to remit payments by electronic transfer for the following year. The list of affected taxes includes the sales tax and the franchise tax.

3. House Bill 1459. Makes coin-paid telephone calls not subject to sales tax by removing them from the

definition of telecommunications service. 4. House Bill 373. Exempts the sale of property by an individual as an occasional sale if the individual or his

family originally bought the property for personal use, the individual does not hold a sales tax permit, and the individual’s total sales of personal use items do not exceed $3000 during the year. The individual is not permitted to employ an agent to sell the property but may sale the property in an online auction.

5. House Bill 3693. This bill creates a new sales tax holiday for energy efficient products. The holiday will

occur on Memorial Day weekend. Tax-free items include certain appliances and other products that have an Energy Star designation and that do not exceed a maximum sales price (which varies based on the type of item).

6. House Bill 387. The bill repeals sales tax exemptions related to the Texas National Research Laboratory

Commission. 7. House Bill 3694. Establishes a sales tax refund for all sales taxes paid on taxable items purchased for use at a

qualified business site related to an enterprise project. The amount of the refund is subject to certain limitations. 8. House Bill 4. Exempts tangible personal property used to process, reuse, or recycle wastewater from

fracturing work at an oil and natural gas well.

9. House Bill 142. Repeals the exemption from sales and use tax assessed by special purpose taxing authority,

such as a mass transit authority, of a taxable item shipped outside of the authority’s boundaries.

B. Judicial Developments 1. Houston Wire & Cable Co. v. Combs, No. 03-07-00006-CV, Tex. App.—Austin (March 12, 2008). The Court of Appeals held that a cable supplier’s purchases of reels to spool cable sold to customers were taxable. The supplier’s purchases of cable were exempt as purchases for resale, but the spools were deemed to be packaging materials, which are not exempt under the resale exemption. If the taxpayer had been a manufacturer of cable, the spools could have been exempt under the manufacturing exemption, but the taxpayer was merely a reseller of the cable. 2. Combs v. Chevron USA, Inc., No. 03-07-00127-CV, Tex. App.—Austin (pending). In this case the taxpayer purchased scaffolding services as part of a construction project. The taxpayer argues that it purchased nontaxable scaffolding services and/or that the separately stated labor charged for installing, dismantling, etc. the scaffolding are not taxable. The Comptroller argues that the taxpayer rented tangible personal property (the scaffolding) and that sales tax is due on the full rental price. The Comptroller prevailed in the administrative hearing in this case, but the taxpayer prevailed in the trial in district court. The case is currently pending in the Court of Appeals. 3. Reynolds Metals Company v. Combs, No. 03-07-00709-CV, Tex. App.—Austin (pending). The taxpayer in this case argues that its purchases of repair and replacement parts for ship unloaders are nontaxable because the unloaders were exempt rolling stock. The unloaders are operated on and are supported by rails. The Comptroller argues that the rails are not standard gauge, the taxpayer is not a common carrier, and that the unloaders are merely used for intraplant transportation. The Comptroller argues that these factors exclude the unloaders from the definition of exempt rolling stock. The Comptroller prevailed in the administrative hearing and in the trial in district court in this case. The case is currently pending in the Court of Appeals.

4. Levy v. OfficeMax, Inc., 228 S.W.3d 846 (Tex. App.—Austin 2007, no pet. h.). In this case, the Austin Court of Appeals held that purchasers may pursue a class action against a retailer to force the retailer to assign claims for refund of sales taxes to the class. By state statute, a purchaser may not pursue a tax refund claim directly against the State unless it first obtains an assignment of the claim from the retailer who remitted the tax. The Tax Code does not provide a procedure for a purchaser to force the retailer to assign the claim for refund. The district court in this case dismissed the purchasers’ action to force the retailer to assign a claim for refund for want of jurisdiction. The Court of Appeals reversed and remanded the case.

5. E. de la Garza, Inc. v. Strayhorn, 2005 W.L. 3004138 (Tex. App.—Austin 2005, no pet.) (unpublished

opinion). The Austin Court of Appeals held that paper bags and plastic sacks sold by a manufacturer of the items to grocery stores, convenience stores, bakeries, and restaurants do not qualify for the sale for resale exemption. Such items are taxable because they are used by the stores and not resold to customers. The court also rejected the taxpayer’s argument that it relied on resale certificates in good faith because the certificates, which claimed the resale exemption on behalf of such stores, were facially invalid. C. Administrative Developments 1. Comptroller Hearing No. 47,797 (February 15, 2008). The administrative law judge held that the taxpayer, which constructed utility improvements for an exempt electric cooperative, was not the authorized agent of the cooperative such that the taxpayer’s purchases of materials were sales-tax-free. The taxpayer did not have a written agency agreement with the electric cooperative, but the electric cooperative designed the utility improvements, directed the activities of the taxpayer, required the taxpayer to use certain materials, and inspected and approved the improvements before accepting them. The judge ruled that these factors did not indicate an agency relationship.

2. Comptroller Letter Ruling 200704926L (April 25, 2007). The Comptroller issued this letter ruling to clarify the sales tax effect of sales transactions involving PTAs. When a PTA is a seller or reseller of taxable items, it may hold two one-day sales-tax-free fundraising events. If a PTA acts as the agent of a seller, the sales-tax-free fundraising exemptions do not apply, the PTA must collect applicable sales tax from its customer, forward the tax to the seller for which it is acting as agent, and the seller must report and remit the tax (this situation in common when the PTA sells items like gift wrap, cookie dough, school pictures, etc.). Candy sales by a PTA or school organization are not taxable so long as all of the proceeds go to the group of its exclusive use. 3. Comptroller Hearing No. 45,566 (December 21, 2006). Successor liability was upheld against the purchaser of a business because it neither withheld a sufficient amount from the purchase price (as required by Comptroller Rule) nor

obtained a no tax due certificate from the Comptroller. A provision in the purchase agreement providing that the buyer did not assume any tax liabilities of the seller was not binding on the Comptroller and did not prevent the Comptroller from imposing successor liability. 4. Comptroller Hearing No. 47,222 (December 4, 2006). A taxpayer restaurant that did not maintain adequate sales tax records was audited and assessed additional sales tax on the difference between its total bank deposits and its reported taxable sales. Because the taxpayer failed to maintain adequate records, the Comptroller was permitted to treat all of the business’s deposits as taxable sales. 5. Comptroller Hearing No. 46,406 (December 13, 2006). An operator of a social club was assessed sales taxes on cover charges collected from its patrons. The fact that the operator recorded the cover charges on its daily sales reports and federal income tax reports demonstrated that the operator was the provider of the taxable amusement services. The operator’s arguments that third party promoters were the actual service providers was rejected even though the operator had issued 1099s to some promoters. 6. Comptroller Hearing No. 45,677 (December 13, 2006). In this case, the taxpayer did not submit sufficient documentation to claim an export exemption. The taxpayer submitted (i) invoices showing the items were delivered to freight carriers and that the purchasers were located in Mexico and (ii) letters from the purchasers. The Comptroller Rules require one of the specifically forms of proof of export identified in the Comptroller Rules. 7. Comptroller Letter Ruling 200611755L (November 15, 2006). In this letter, the Comptroller announced a new policy of ignoring entities that are used solely for tax planning purposes. This policy seems to be a departure from the sales tax’s separate entity basis of taxation. The genesis of this new policy was to undo what the Comptroller considered to be abusive transactions involving the purchase of airplanes, but the application of the policy is not limited to the purchase of airplanes. The letter states:

[S]uch a transaction should be analyzed by looking at all of the facts and circumstances from its inception to its ending. If the method of transfer of … tangible personal property does not have a business purpose other than tax avoidance, then the transitory entity should be ignored and use [or sales] tax should be assessed accordingly. This analysis will be applied to all transactions that occur on or after December 1, 2006 . . . .

8. Comptroller Hearing No. 45,878 (December 20, 2006). In this hearing, the taxpayer provided electronic bill presentment and payment services to clients. As part of its services, the taxpayer received fees from licensing specifications and codes that allowed a client to customize its own software so that the client’s software could utilize the taxpayer’s bill presentment services and send data through a secured communication. The taxpayer argued that the licensing fees related to a nontaxable license of a software product. The Tax Division argued that the fees related to a taxable license to access the taxpayer’s services. The administrative law judge disagreed with both parties and held that the licensing fees were not taxable because under Comptroller policy licensing source codes and specifications is not taxable unless a computer software program was also sold by the taxpayer; in this case, the taxpayer did not sell a computer program to the customer. The hearing addressed other issues as well. The taxpayer was not entitled to write-off certain sales as bad debts because the taxpayer could not demonstrate that the sales were written off in the reporting period when the sales were made. Further, the taxpayer was not entitled to a resale exemption for software that it acquired because when the taxpayer ultimately abandoned the project that was intended to utilize the software, the taxpayer impaired the asset, wrote off the account, and transferred the rights to the software to a third party. By writing off the asset, the taxpayer demonstrated that it was not purchased for resale. In addition, by storing the software in Texas, the taxpayer was required to pay use tax. 9. Amendment to Comptroller Rule 3.313 (eff. August 12, 2007). The Comptroller Rule concerning cable television services was amended to incorporate the holding in the Clearview Cable Television case decided in 1998.16 Under the amended rule, a cable television service provider can provide a resale certificate for tangible personal property such as remote controls and converters if it transfers care, custody, and control of the property to its customers as part of the cable service. In addition, a taxable service such as the repair of a converter may be purchased tax free if the service is transferred as a integral part of the cable service. The amended rule also addresses satellite cable television services. The rule provides that satellite service broadcasted directly to a customer’s premises without the use of ground receiving or distribution equipment, except for the equipment at the

16 Clearview Cable Television, 960 S.W.2d 424 (Tex. App. – Austin 1998).

subscriber’s premises, is not subject to local sales tax under § 602 of the Telecommunications Act of 1996. But, equipment used to provide the service is subject to local sales and use tax unless another exemption applies. 10. Comptroller Hearing 40,286 (February 9, 2006). The taxpayer was not allowed to claim the manufacturing exemption for food warmers, heat cabinets, coolers, and related items used in restaurants because the items were not used in the actual manufacturing process. 11. Comptroller Letter Ruling 200604534L (April 6, 2006). The Comptroller clarified the following three issues related to sales of digitized music to juke box operators: (1) sales of digitized music are taxable because they constitute sales of taxable items in electronic form; (2) if a digitized music provider is paid through a revenue sharing arrangement whereby it receives a percentage of a juke box operator’s revenue, the payments to the provider are not taxable; and (3) the music provider’s payment of a copyright fee to a musician is not taxable because a copyright is an intangible. 12. Comptroller Letter Ruling 200604532L (April 13, 2006). The Comptroller clarified its policy that arborist services provided as part of a new home construction contract are nontaxable, but the services are taxable when provided as part of the preparation and development of residential lots for eventual construction. 13. Comptroller Hearing 43,519 (January 20, 2006). The Comptroller’s administrative law judge ruled that packaging supplies were not exempt when used to repackage finished materials that the taxpayer purchased for resale. Packaging supplies purchased to package items manufactured by the taxpayer were exempt. 14. Comptroller Letter Ruling 200602552L (February 16, 2006). The Comptroller issued a letter ruling clarifying that pest control services provided as part of a new home contract are taxable. When a lump sum contract is used, the home builder must pay sales tax to the pest control provider. When a separated contract is used, the home builder may issue a resale certificate and collect tax from the homeowner. Pest control services provided under a license issued by the Texas Department of Agriculture are not taxable. 15. Comptroller Hearing 43,965 (April 6, 2006). The Comptroller prevailed in her argument that a vendor’s separately stated charges for installing software purchased from it were taxable as part of the sales price of the software. The Comptroller also successfully argued that (1) purchases of certain bid management services were taxable because more that 5% of the charge related to taxable data processing and (2) the rental of certain water purification equipment was taxable as the rental of tangible personal property under the essence of the transaction test even though a portion of the charge was related to nontaxable water purification services. The taxpayer prevailed in its argument that the benefits administration services that it purchased were not taxable because they did not include taxable data processing. 16. Comptroller Letter Ruling 200601438L (January 27, 2006). The Comptroller clarified its position on certain advertising services. According to the letter ruling, charges for services provided by the advertising company’s proofers, Q/A specialists, technical architecture specialists, production artists, rich media specialists, developers, and production managers are taxable if related to finished art or other taxable services sold to clients. III. PROPERTY TAX In 2005 the Texas Supreme Court ruled in Neeley v. West Orange-Cove I.S.D. (Nov. 22, 2005) that the Texas school finance system was unconstitutional. The Texas Constitution prohibits a statewide property tax, and state law caps school property taxes for operations at $1.50 per $100 of valuation. Because the legislature has failed to fund schools in an amount necessary to meet state standards, school districts have been forced to raise local property taxes to the maximum allowable rate. The court ruled that because nearly all school districts were taxing themselves at the maximum allowable rate, the school’s finance system violated the ban on a statewide property tax. The court further mandated that the legislature pass remedial legislation by June 2006. On May 31, 2006, Governor Rick Perry signed into law a bill designed to reduce property taxes by one-third over the next two years. House Bill 1 was part of a package of five bills passed in a special session earlier this year that was devoted to the school finance reform that had been mandated by the Texas Supreme Court. House Bill 1 provides for property tax relief through state aid to school districts. In 2007 aid will be provided to school districts in amounts that will effectively reduce their nominal maintenance and operations tax rate to 88.67% of the M&O rate adopted for the 2005 year. In 2008 aid will be provided to reduce the rate to 66.67% of the district’s 2005 adopted M&O rate.

Therefore, the legislation requires school districts to lower their property tax rate for operations by 11% (from $1.50 to $1.33 per $100 valuation) in 2006, and by 33% (to a rate of $1.00 per $100) in 2007. The projected property tax savings on a $200,000 home will be approximately $1,000 in the second year. 2007 Property Tax Legislation includes: 1. House Hill 2. This bill makes a supplemental appropriation of $14.2 billion for the 2008-09 biennium to the Texas Education Agency. This appropriation was necessary to fund the decrease in funds received by the agency due to the one-third property tax reduction enacted in 2006. 2. House Bill 3496. Under this bill, school district tax bills are required to show the difference between the 2005 tax imposed and the 2007 tax imposed either on the bill itself or in a separate statement. The bill or statement will indicate the reduction attributable to the 2006 property tax legislation. 3. Senate Bill 812. Nonprofit corporations that provide chilled water and steam to certain health-related facilities are exempt from property taxes under this bill. 4. House Bill 1928. This bill exempts certain trailers used primarily as temporary living quarters for recreational use as tangible personal property not producing income. 5. House Bill 1742, Senate Bill 1908. Designates entities that acquire, hold, and transfer unimproved real property under an urban land bank program as exempt charitable organizations. 6. House Bill 3191. Organizations constructing or rehabilitating housing projects for the purposes of selling single family homes to low-income buyers will receive a 100% exemption for the property. The property must be located in a county with a population of at least 1.4 million. 7. House Bill 1022. This bill exempts an individual from property taxes for one personally owned car or truck used for both business and personal activities. This exemption must be approved by the voters in a referendum. 8. House Bill 621. This bill adopts a property tax exemption for goods in transit. The exemption applies to property that (1) is acquired in or imported into Texas, (2) detained at a location in Texas not owned by the owner of the property, (3) is used for assembling, storing, manufacturing, processing, or fabricating purposes, and (4) is transported to another location (in Texas or out of Texas) not later than 175 days after it was acquired or brought into Texas. This exemption does not apply to: oil, natural gas, petroleum products, aircraft, motor vehicle inventory, vessel and outboard motor inventory, heavy equipment inventory, or manufactured housing inventory. 9. House Bill 438. This bill limits the amount by which an appraisal district can increase the appraised value of a residential homestead to 10% of the appraised value of the property for the preceding tax year, plus the market value of any improvements. Current law allows an increase of 10% of the property value from the last year in which the property was appraised multiplied by the number of years since the last appraisal, plus the market value of any improvements. This statute must be approved by the voters in a referendum. 10. House Bill 41. Allows federal and state judges to request that their home address information contained in appraisal tax records be kept confidential. Judicial Developments: In Irannezhad v. Aldine Independent School District, No. 01-07-00794-CV, Tex. App.—Houston [1st Dist.] (March 20, 2008), the appellate court held that a taxing district could recover delinquent property taxes from a resale purchaser. In the first tax sale after the delinquency judgment, the property was struck off to the taxing district at a bid that was not enough to satisfy the tax delinquency. While the taxing district owned the property, the property was exempt from tax. When the property was sold by the taxing district to the resale purchaser, the taxing jurisdiction sued the purchaser for the tax that had accrued from the date of the original delinquency judgment until the date of the first tax sale. The Court of Appeals agreed that this was permitted under Texas law.

IV. OTHER TAXES 1. House Bill 1571. This bill imposes a $5 per customer fee on certain sexually-oriented business. The Comptroller is directed to deposit the first $25 million received from the fee each biennium into the sexual assault program fund. Excess fees must be deposited into the Texas health opportunity pool. 2. House Bill 735. The Telecommunications Infrastructure Fund assessment is repealed effective September 1, 2008. V. TAX ADMINISTRATION 1. House Bill 3314. This bill does the following: (1) establishes Travis County as the exclusive venue for suits to challenge state tax liens; (2) requires that a suit challenging the validity of a state tax lien be brought within 10 years from the date the lien was filed; (3) establishes a rebuttable presumption that if a person files a tax return showing an amount of tax due, then the person is presumed to have collected the tax; (4) establishes personal liability for an officer, manager, or director of a taxpayer that engages in certain fraudulent tax evasion schemes; and (5) establishes a rebuttable presumption that a taxpayer received a notice of tax due if it was delivered to the taxpayer’s last address of record. 2. Senate Bill 377. Requires taxpayers who paid $10,000 or more in one of a list of particular state taxes during the preceding year to remit payments by electronic transfer for the following year. The list of affected taxes includes the sales tax and the franchise tax. 3. Senate Bill 242. This bill transfers the Comptroller’s administrative law judges to a new taxation division of the State Office of Administrative Hearings. 4. House Bill 11. Permits the Comptroller to require distributors of beer, wine, liquor, cigarettes, cigars, or tobacco products to file electronic report of monthly sales with the Comptroller’s office. 5. House Bill 2010. This bill allows Texas taxpayers to seek declaratory judgments in Texas district courts that another state’s attempts to collect taxes or impose tax obligations on the Texas taxpayer constitutes an undue burden on interstate commerce under applicable federal law. VI. BIOGRAPHIES

Gilbert J. Bernal, Jr. is a partner in the law firm of Stahl, Bernal & Davies, LLP. Before joining a predecessor of the firm in January 1995, Gilbert J. Bernal, Jr., was an Assistant Attorney General for the State of Texas from 1975 to 1983 where he represented the Comptroller of Public Accounts, the Texas Alcoholic Beverage Commission, and the Texas Workforce Commission in tax litigation. He was the chief of the Attorney General’s Taxation Division from 1981 to 1983. In private practice since, 1983, Gilbert limits his practice to Texas tax controversies and litigation where he represents clients from all parts of the country in audits, administrative appeals, and in state courts, both trial and appellate, as well as in state tax planning. He has had numerous trials in the state’s district courts and has argued tax cases in the Courts of Appeals, the Texas Supreme Court, and the United States Fifth Circuit Court of Appeals. Gilbert serves on the Practitioner’s Liaison Committee of the Comptroller of Public Accounts.

Gilbert has also taught Texas State Taxation and Tax Controversies and Litigation at The University of Texas School of Law. For several years, he has spoken at various continuing legal education seminars on topics such as state taxation, tax litigation in the district courts and administrative courts, and oral argument in the Court of Appeals. Gilbert received both his B.A., with honors, and his J.D. from the University of Texas at Austin. He is a former member of the Board of Directors of Volunteer Legal Services of Central Texas, Austin Literacy, and former member of the Board of Advisers of the University of Texas’ Hispanic Law Journal, and is also a former member of the Austin chapter of the Inns of Court. He is currently serving as a participating counsel on the Austin Diocesan Legal Aid Clinic providing pro bono counsel to indigent clients. Gilbert is fluent in Spanish.

David J. Sewell joined Stahl, Bernal & Davies in 1999 and became a partner in 2008. He practices in the firm’s Texas tax litigation, commercial real estate, wind energy development, and corporate law areas. David advises the firm’s corporate and real estate clients on Texas tax issues associated with various transactions and entity combinations and represents the firm’s tax clients in administrative proceedings before the Texas Comptroller’s office and in Texas state courts. David’s corporate and real estate practice areas include acquisition and sales transactions, mergers, lending transactions, business entity choice and formation, investment transactions, and leasing transactions. He also represents clients in wind energy project development.

David is Board Certified in Commercial Real Estate Law by the Texas Board of Legal Specialization and is a member of the Real Estate Council of Austin. David received his B.A. degree, with highest honors and special honors, from the University of Texas at Austin. He received his J.D. degree, with honors, from the University of Texas School of Law, where he was a member of the Texas Law Review and the Board of Advocates and was a Teaching Quizmaster. David is also a member of Phi Beta Kappa and the Order of the Coif.

UTAH STATE DEVELOPMENTS

VIRGINIA STATE DEVELOPMENTS William L. S. Rowe William K. Taggart Hunton & Williams LLP 951 East Byrd Street Richmond, Virginia 23219 (804) 788-8410 (804-788-7301 (804) 788-8218 (fax) Email: wrowe@hunton.com

I. CORPORATE INCOME TAX

A. Legislation

The 2008 Session of Virginia’s General Assembly considered over 3,300 pieces of legislation, including bills and resolutions, during its regular 60 day term. Of this number, 49.7% (1,654) gains passage.

1. Biodiesel Fuel Credit. HB 139 provides up to $5,000 annual tax credit for production of biodiesel

and green diesel fuels.

2. Space Flight Exemptions. HB 238 and SB 286 exempt income from provision of certain launch related services and gains from certain resupply service contracts with space flight entities.

3. Land Preservation Tax Credits. HB 849 establishes procedures related to audits of transferred land preservation tax credits.

4. Reporting designated campaign contributions. HB 359 requires PACs, out-of-state PACs, and federal PACs to provide a candidate's campaign committee with information regarding the contributor of any designated contribution so that the candidate can identify the donor of the designated contribution on his or her campaign finance report.

5. Single sales factor apportionment study. House Joint Resolution 177 establishes a joint subcommittee to study the benefits of adopting a single sales factor to apportion the income of multistate corporations for purposes of the corporation income tax.

6. Conformity. SB 582 and HB 912 move Virginia’s income tax conformity date to December 31, 2007.

II. Rulings of the State Tax Commissioner

1. Telecommunications Company. P.D. 07-147 (September 12, 2007). During corporate income tax audit, telecommunications company discovered that its gross receipts as reported to the SCC had been overstated. Because statute of limitations for correcting errors by the SCC had expired, corporate income tax must be assessed on gross receipts as certified by the SCC, without adjustment.

2. Lottery/Nexus & Withholding. P.D. 07-119 (July 19, 2007). Corporation with no employees or property in Virginia purchased lottery annuities. Commissioner confirms that corporation has no nexus with Virginia and no liability for Virginia income tax on this Virginia source income. Nevertheless, the Lottery Commission is required to withhold from payments unless corporation files an appropriate exemption certificate annually.

3. Nexus. P.D. 07-163 (October 17, 2007). Company selling petroleum chemicals to Virginia manufacturers held not to have nexus. Deliveries were made by common carrier, and an independent agent witnessed delivery of the goods, with its fee being shared by the buyer and seller.

4. Nexus and Consolidated Factors/Financial Services. P.D. 08-6 (January 11, 2008). Affiliated group of Virginia corporations included a contractor which referred business to related mortgage lenders and title insurers. Department acknowledges rule that Virginia corporation can be required to file a return, but is not included in the consolidated return if it otherwise does not have nexus with Virginia. Mortgage lender with no property or payroll in Virginia had no “costs of performance” in Virginia and was not included in the consolidated return. Another entity, however, that had an office and employees in Virginia had “costs of performance” and therefore was included in the consolidated return. PL 86-272 (applied by Virginia to both sales of property and sales of services) did not apply because presence of an office exceeded mere solicitation. As to financial corporation to be included in the consolidated return, it must convert its single apportionment factor to a three apportionment factor. It does this by multiplying its property, payroll and sales included in the denominator by the percentage derived from its single financial apportionment factor.

5. Nexus/Telecommunications Reseller. P.D. 08-2 (January 7, 2008). Company resold landline telecommunications services to offshore company. Commissioner ruled that company had no property, payroll or sales in Virginia and therefore no corporation income tax nexus. Similarly, no sales and use tax nexus because it did not sell tangible personal property. Finally, no communications services sales tax was owed because services were resold.

6. Corporate Group/Guarantees. P.D. 07-116 (July 19, 2007). Corporate affiliates provided lease guarantees for related retail stores located in Virginia. Commissioner holds that these lease guarantee activities are de minimis under PL 86-272 also applied by Virginia to sales of services. No nexus of the out of state entities with Virginia. To the extent that guarantees are provided by entities with Virginia nexus, all services related to the guarantees provided outside Virginia so the services are included in the denominator of the sales factor but not the numerator. Commissioner notes Department’s ability to reallocate income if there is a determination that fee arrangements are not based on fair market value, etc.

7. Intangible Holding Company. P.D. 08-34 (April 4, 2008). This is another in a long line of rulings by the Department that a Delaware holding company holding intangibles licensed to related parties and making loans to related parties distorts Virginia taxable income. In this case, the Department notes that in the 15 year existence of this intangibles holding company, the Virginia parent never paid corporate income tax but would have paid such taxes absent that arrangement.

8. Intangible Holding Company. P.D. 07-174 (November 14, 2007). Intangible holding company engaged in business with unrelated parties for over five years before it began to make loans to affiliates. Even so, the Department holds that it must be combined with the Virginia affiliated group for income tax purposes. The Commissioner argues that “the taxpayer completely controls the activities of IHC. The investment and loan decisions are made by personnel, officers and directors of the taxpayer. The activities of IHC are conducted by employees of the taxpayer.” Query: Would the Department apply this same test to allow a loss corporation in the Virginia affiliated group?

9. Add back/Subject to Tax. P.D. 07-153 (October 2, 2007). This is the first ruling of the Department concerning the “add back” legislation enacted in 2004. One statutory exception to the add back requirement provides:

This addition shall not be required for any portion of the intangible expenses and costs if … the corresponding item of income received by the related member is subject to a tax based on or measured by net income or capital imposed by Virginia, another state …

Tax practitioners who lobbied this legislation thought that it provided a simple exception to add back whenever the royalty payment would be subject to tax in another state. The Department, however, reads the exception as if the statute provided “no add back shall be required to the extent that the payment is actually taxed in another state.” Thus, the ruling holds that a taxpayer is allowed a deduction (no mention of deduction in the statute) equal to the royalty payments multiplied by the total of the apportionment factors in the states where the recipient is subject to an income tax. For example, if the recipient pays income tax in two states, and has a 2% and 3% apportionment factors in those states, it can deduct 5% of the royalty payment on its Virginia return. Comment: How

does the Department conclude that statutory language stating that there shall not be any add back for “any portion” of an expense really means that there is a deduction only for the portion of the expense that is taxed by another state? Can Virginia make its tax depend on actions by another state?

10. Intangibles Addback. P.D. 07-217 (December 20, 2007). Department continues its questionable policy of adding back royalties paid to related entities except to the extent those royalties are actually taxed by another state. As this taxpayer argued unsuccessfully, the statute appears to be clear in not requiring any addback if the royalties in question are subject to tax by any other state.

11. Property Factor/CWIP. P.D. 07-189 (November 14, 2007). Auditor correctly adjusted the denominator of the property factor to match amounts reported for federal income tax purposes. He neatly used nonfederal tax numbers, however, to determine the numerator, including construction work in progress therein. The Commissioner adjusts both numerator and denominator to match federal tax information and excludes CWIP until it is actually used.

12. Sales Factor/Costs of Performance. P.D. 07-57 (May 10, 2007). Taxpayers effectively have an election in Virginia to calculate costs of performance for sales factor purposes either including costs attributable to independent contractor activities or excluding those costs. Compare General Motors v. Commonwealth, 268 Va. 289 (2004) (cost of performance must include indirect costs) with 23 VAC 10-120-230 (cost of performance may not include indirect expenses).

13. Sales Factor/Satellites. P.D. 07-80 (May 19, 2007). Sale of satellites by joint venture resulted in an increase in the denominator of the Virginia sales factor, but not the numerator. The satellites were not located in Virginia.

14. Franchisor/Sales Factors. P.D. 07-121 (July 31, 2007). Income earned by out-of-state entity from Virginia franchisee was included by the auditor in the numerator of the sales factor on the theory that this income was from selling tangible personal property (e.g., training manuals and marketing catalogs). Wrong. Income was from services, not tangible personal property. Because services were performed primarily out-of-state, they are excluded from the Virginia numerator.

15. Allied Signal/Services Contracts. P.D. 07-197 (November 30, 2007). Affiliated group was involved in various real estate activities, including design and construction. Affiliates pooled excess cash in an investment partnership. Commissioner holds that investment income in this partnership meets the standard of Allied Signal. Such income is allocated to the corporate domiciles of two affiliates headquartered outside Virginia; but Virginia affiliate must include its distributable share in apportionable income. Because a majority of service activities were performed outside Virginia, these sales were properly excluded from the numerator of the sales factor.

16. Alternative Apportionment/Pass Through. P.D. 07-75 (May 18, 2007). Taxpayer owned a partnership interest which held interests in various other pass through entities, one of which recognized gain on the sale of real estate in Virginia. Even though doing so would increase its Virginia income tax liability, taxpayer sought alternative apportionment method to separately account for the Virginia real estate gain. Permission denied because (i) Department’s method not unconstitutional and (ii) Department will not change apportionment method if the alternative method increases taxpayer’s liability in Virginia.

17. Alternative Apportionment. P.D. 07-117 (July 19, 2007). Procedure for applying for an alternative

apportionment method requires the taxpayer to file its return using the statutory method and then file an amended return proposing the alternative method. Taxpayer must show that the statutory method produces an unconstitutional result or, because of Virginia law, produces a double tax.

18. Alternative Apportionment/Real Estate. P.D. 07-118 (July 19, 2007). Hotel owned by a pass through entity in Virginia was managed by an unrelated company. Taxpayer asserts that hotel entity should pay Virginia tax on a separate accounting basis, i.e., that the income, losses and factors should not flow through to the LLC owners. Relying on conformity with federal law, Commissioner holds that LLC is treated as partnership and results flow through. Comment: This and other rulings suggest that taxpayers are lining up to challenge Virginia’s ability to tax entity income on a flow

through basis to “shareholders.” Why should LLCs be treated differently than C corporations? Will tax withholding change these dynamics?

19. Consolidated Return/Change of Policy. P.D. 07-155 (October 4, 2007). The traditional policy of the Department was that a new Virginia affiliated group created by a merger or acquisition must take the filing status of the acquiring corporation. Changes from separate return to consolidated return were rarely (never?) granted after the initial election year. This rigid rule has now been changed so that in a “merger of equals” the new Virginia affiliated group will be permitted to elect the filing status of either the acquiring group or the target group. To qualify (1) neither group must have owned any substantial interest in the other prior to the merger and (2) the target group’s assets or net value immediately prior the merger or acquisition transaction must be greater than 45% of the combined value of the acquiring group and target group. SRLY rules will apply to any NOLDs carried forward by the target group.

20. NOL Carryovers. P.D. 07-120 (July 31, 2007). Consolidated group plans to eliminate through liquidation or reorganization affiliates having NOLs. Some of these affiliates are not members of the Virginia consolidated group. Nevertheless, Department holds that these NOLs, to the extent they become part of the federal consolidated return, can be used in the Virginia consolidated return even though they were “earned” by entities having no nexus with Virginia.

21. Neighborhood Assistance Act. P.D. 07-160. (October 17, 2007). Doctor donated time at a County clinic but the clinic was not timely certified by the Department of Social Services for that year. Credit denied.

22. Long-Term Care Insurance. P.D. 07-211 (December 5, 2007). Discusses the interplay of the Long-Term Care Insurance Tax Credit, the Virginia deduction for long-term health care premiums and the Federal Deduction for Medical Expenses. Hint: The ruling uses phrases such as “how complicated it is;” “determining which tax preference to use … is difficult;” “further restrictions;” and “I no longer believe that interpretation is correct.” And the summarizing phrase: “This can become complicated.”

23. Underpayment Penalty. P.D. 07-54 (May 4, 2007). Underpayment penalty waived. An extension was filed after the weekend due date, but that filing deadline is automatically extended by statute to the next business day.

24. Officer Liability/Withholding. P.D. 08-7 (January 11, 2008). Department has authority to assess any corporate officer with unpaid taxes if the officer had knowledge of the lack of payment and the authority to correct the problem. Here, the President directed that corporate debt, which he had personally guaranteed, be paid before taxes. Nevertheless, the CFO was held personally responsible for the unpaid withholding taxes.

25. Officer Liability/Withholding. P.D. 07-216 (December 20, 2007). Former officer was let off the hook for unpaid taxes upon showing that he was not an officer for the periods in question and that tax payments were handled by the corporation’s President.

26. Officer Liability/Statute of Limitations. P.D. 07-90 (May 25, 2007). Tax Department “converted” corporate income tax assessments against corporate officer who then appealed those converted assessments over two years later. Commissioner holds that taxpayer missed his 90 day filing deadline for an administrative appeal. Comment: Note that this taxpayer still had, as of the date of this adverse ruling, time to file in court. Does it make any practical sense for the Commissioner to refuse to resolve these cases administratively?

27. Appeal/Statute of Limitations. P.D. 07-93 (June 1 2007). Taxpayer missed by one day the deadline for filing its 90 day administrative appeal. Comment: Keep in mind that taxpayers have a variety of other remedies available to them, though these may involve payment of the tax.

28. 90-day Appeals. P.D. 08-25 (March 20, 2008). Although taxpayer filed its Notice of Intent to Appeal in a timely fashion, it failed to file the appeal within 90 days. This administrative remedy is therefore barred. (Note, however, that other administrative remedies are still available).

29. Withholding Ship Crews. P.D. 07-115 (July 19, 2007). Commissioner reviews federal statutes governing state income tax withholding on wages paid to crewmen of boats operating in navigable waters. Under these statutes, Commissioner concludes that the taxpayer should look to employees’ state of residence for withholding requirements. Commissioner goes on, however, to decline to rule concerning Virginia withholding requirements with respect to the taxpayers’ non-resident employees, saying that there is a conflict in the federal statutes when a non-resident earns more than 50% of his pay in Virginia. Comment: Why did the Commissioner leave this taxpayer in a quandary? Who better to rule about Virginia income tax withholding than the Virginia State Tax Commissioner?

30. Interest. P.D. 07-195 (November 27, 2007). Virginia law does not conform to federal law for purposes of calculating interest. When taxpayer allocated overpayment to a subsequent year’s liability, the taxpayer could not thereafter change its mind and apply the overpayment to a deficit reflected in an amendment for the prior year. Although federal law would not have charged interest in that situation, Virginia law does.

II. TAX CREDITS

A. Rulings of the State Tax Commissioner

1. Historic Tax Credits/Purchase. P.D. 07-82 (May 25, 2007). GCAM 2007-002 addressed the treatment for federal tax purposes of partnership which allocated credits to partners who promptly sold their partnership interests. IRS held that taxpayers would be deemed to have acquired their credits from the partnership by purchase. State Tax Commissioner rules that federal tax consequences will flow through to the Virginia return, but taxpayer would be allowed to claim any Virginia income tax credits “purchased” by them.

2. Riparian Buffer Credit/Trust. P.D. 07-200 (November 30, 2007). Trusts are not included within the statutory provisions allowing the Riparian Buffer Credit. Thus, land held in a revocable trust could not qualify for this credit. Comment: Although firmly grounded in the statutory language, this ruling ignores the fact that grantor trusts are basically ignored for federal income tax purposes. Is there any significant policy reason for requiring the individual grantor/trustee/beneficiary to terminate the trust in order to claim the credit?

3. Land Preservation Tax Credit/Park Service. P.D. 07-132 (August 24, 2007). Notwithstanding vagaries in the statute, Commissioner accepts a bargain sale to the National Park Service as a conveyance that will qualify for the Land Preservation Tax Credit.

4. Land Preservation Credits/Queue Priority. P.D. 07-95 (May 25, 2007). The amount of land preservation tax credits that can be claimed is limited by statute. The Department of Taxation will apply a first come first served analysis to allocating these credits, but will not place an application in the queue until the DCR has verified the donation. Comment: The early bird gets the worm.

5. Land Preservation/Timing. P.D. 07-201. (November 30, 2007). Effective for donations made in 2007, a taxpayer must apply to receive his credit. Thus, until the credit has been issued, the taxpayer has nothing which can be transferred. This means that credits cannot be used to offset taxes in a taxable year before they are approved and issued. Note. Because credits are not earned in the year of the donation, rather in the year they are awarded, do not wait until the end of a taxable year to apply.

6. Land Preservation/DCR Review. P.D. 07-172 (November 14, 2007). As long as the taxpayer does not request a credit of $1 million or more, he does not have to follow the dual application process with the Department of Conservation and Recreation and the Department of Taxation. (Taxpayer did not want to comply with DCR’s restrictions relating to fencing livestock and pre-approval for stream crossings).

7. Land Preservation Tax Credits/Limitation. P.D. 07-131 (August 17, 2007). The $100,000 limitation on land preservation tax credits is a per taxpayer limitation, not a per return limitation. Thus, each

member of an affiliated group filing a single consolidated return was entitled to claim a credit of up to $100,000. Note carefully that each member of the group had its own credit.

8. Qualified Equity and Subordinated Debt. P.D. 08-11 (January 11, 2008). Subordinated debt that will be convertible into equity does not qualify for the credit.

III. RETAIL SALES & USE TAXES

A. Legislation

Sales Tax Holidays. HB 1229 adds yet another sales tax holiday - - this one for water-efficient products. Exemption for Certain Computer Equipment. HB 1388 creates an exemption for computer equipment used in

data centers that (i) are located in a Virginia locality having an unemployment rate above 4.9 percent for the calendar quarter ending November 2007 and (ii) meet certain investment and job creation criteria. The investment in the computer equipment would be made in accordance with a memorandum of understanding entered into or amended between January 1, 2008, and December 31, 2008.

B. Court Decisions

1. Marshall v. Northern Virginia Transportation Authority, 275 Va. 419, 657 S.E.2d 71 (2008). The Supreme Court of Virginia ruled that a special 5% sales tax on automobile repair services authorized by Transportation Reform legislation, 2007 Va. Acts 896, violated the Virginia Constitution. The legislation created the Northern Virginia Transportation Authority and the Hampton Roads Transportation Authority and authorized each Authority to impose a special 5% tax on (i) charges for separately stated labor or services in the repair of motor vehicles and (ii) charges for the repair of a motor vehicle in cases in which the true object of the repair is a service provided within a city or county embraced by the respective Authority. The Court ruled that the General Assembly impermissibly delegated taxing power to the Authorities because the Virginia Constitution requires that taxes may be imposed only by a majority of elected representatives within a legislative body. The Authorities are unelected political subdivisions. The Court also found that municipal bonds to be paid for by the taxes therefore could not be validated and that the invalid portions of the enactment were severed from the rest of it. See also Virginia Department of Taxation Tax Bulletin 08-3, P.D. 08-20 (Feb. 29, 2008) (explaining that the motor vehicle repair labor and services sales use tax in the Northern Virginia Transportation Authority area is now invalid); Tax Bulletin 08-5, P.D. 08-24 (March 13, 2008) (explaining that the motor vehicle repair labor and services sales tax in the Hampton Roads Transportation Authority area is now invalid); Tax Bulletin 08-6, P.D. 08-27 (March 25, 2008) (instructing providers of repair services to remit to the Department of Taxation all repair tax collected through the end of February, 2008)

2. Bloomingdale’s Inc. v. Department of Taxation, Cir. Ct. City of Richmond, Case No. CL-05T00891-00-1/07-3860 (August 7, 2007). This case reverses the Department of Taxation’s policy, unique in the United States, that sales are taxable in Virginia if they are delivered outside Virginia to anyone but the purchaser. In recent years, the Department has applied this position whenever an order is accepted and payment is processed at a location in Virginia even if the goods are never in Virginia. The policy affects primarily gift transactions shipped to donees out-of-state. The Circuit Court held that the transactions were not taxable in Virginia because title and risk of loss remained with the retail merchant until the goods were delivered out-of-state. The Circuit Court also held that the transactions qualified for the interstate sale exemption which contains no requirement that the goods be delivered “to the purchaser.”

3. Gibson v. Commonwealth, 649 S.E.2d 214 (Ct. Apps., August 28, 2007). Corporate officer filed truthful and appropriate returns reporting sales tax collections from customers and employee withholding taxes. He failed to remit those “trust fund” taxes. Court of Appeals upholds his conviction of three Class One misdemeanors. The statute makes it a crime for a corporate officer to fail to “account for and pay over” certain trust fund taxes. Failing either to account for the taxes accurately or pay them over is a crime. One cannot avoid conviction simply by filing an accurate return but not paying the taxes.

4. GFT, Inc. v. Commonwealth, Cir. Ct. City of Richmond, Case No. CL06-7245-00 (April 16, 2007). Taxpayer was assessed successor liability with respect to unpaid sales and use taxes of a business, the assets of which it bought at a foreclosure sale. Virginia Code § 58.1-629 requires the purchaser of a business’ assets to withhold from the purchase price sufficient funds to pay any unpaid taxes or to obtain a certificate of no taxes due from the Department. It is not the Department of Taxation’s burden to prove that such taxes were not withheld. It assessed the successor in interest for the unpaid taxes, and it is that person’s burden to prove that the assessment is incorrect.

C. Rulings of the State Tax Commissioner

Taxable Transactions & Measure

1. Demonstration Equipment. P.D. 07-158 (October 17, 2007). Equipment used in customer demonstrations was held to be taxable. The equipment was never sold to customer and was treated as depreciable fixed assets in company records. The equipment was taxable when withdrawn from inventory. Comment: Under the withdrawal from inventory provisions, the equipment should be taxed based on cost, not fair market value.

2. Barter Transactions. P.D. 07-94 (June 1, 2007). Barter transactions are taxable. Tax is the ultimate responsibility of the buyer, not the seller.

3. Frequent Stayer Points. P.D. 07-12 (March 23, 2007). Chain hotel awards “guest loyalty points” to frequent stayers. Each hotel contributes to a segregated bank account a percentage of its gross receipts. When royalty points are redeemed, the hotel receives cash from the fund. The redemption of royalty points for a complimentary room is not subject to sales and use taxation. Moreover, the payments from the fund to the hotels are not subject to tax as the payments are not made in exchange for the use of a hotel room by the user and, more importantly, these funds were taxed on the original room rental transactions.

4. True Object/Operate System. P.D. 07-98 (June 27, 2007). When true object of the contract is for services, contractor is the user and consumer of all tangible personal property provided. Note rule change as of July 1, 2006. Second contract in audit was unrelated to the first contract and should be analyzed individually. Services provided under that contract to operate equipment were “of incidental scope and duration,” Commissioner holds that subcontract was for the sale of tangible personal property. Comment: This could be an important ruling under the new regime in effect on and after July 1, 2006. Traditionally, the Department has considered sellers taxable when equipment sold was operated by them (e.g., computer centers). This ruling appears to establish a “incidental” test that will surely be applied in the future.

5. Services/Dentists. P.D. 07-183 (November 21, 2007). Dentist was taxable on 100% of invoice from vendor which claimed to provide “teeth whitening services.” Invoices indicate that dentist purchased only tangible personal property, all of which are taxable to the dentist.

6. Services/Home Infusion Pharmacies. P.D. 07-14 (March 26, 2007). Home infusion companies held to be engaged in selling medicines, not providing services. Thus, exemptions not lost.

7. Airline Food Service. P.D. 07-143 (September 12, 2007). Reviews a long list of services provided by a catering company. Because majority of services were with respect to airline owned property and equipment (e.g., cleaning and servicing), were unrelated to the sale of food, and were separately stated on invoices, held not taxable.

8. Photo/Advertising Agency. P.D. 07-185 (November 21, 2007). Advertising agency was taxable as the user and consumer of (i) photographs and (ii) printing purchased for a customer. With respect to the photographs, total charge of independent contractor for obtaining and creating the photographs was held to be part of taxable “sales price.”

9. Equipment Rental with Operator. P.D. 07-128 (August 17, 2007). Upon reconsideration, the Commissioner agrees that the rental of a mechanical bull and rock climbing wall, both with

operators, are nontaxable services. The operators have sophisticated skills and computer knowledge and are not mere attendants as previously ruled.

10. Federal Purchasing Agent/New Law. P.D. 07-139 (September 5, 2007). The new rules in effect July 1, 2006 with respect to the application of the “true object” test to government contractors do not change the way that duly authorized purchasing agents are taxed.

11. Government Contract/True Object. P.D. 07-165 (October 17, 2007). Procurement services in aid of the government’s obtaining a computer system and a maintenance contract for hardware and software both were related to the acquisition of tangible personal property and are exempt.

12. Real Estate Contractor/Direct Pay Permit. P.D. 07-124 (August 17, 2007). Even though manufacturing customer gave real estate contractor a direct pay permit number, real estate contractor was required to accrue and pay tax on all of its purchases. If manufacturer did pay the tax, it is entitled to a refund; the contractor is not.

13. Contractors/Credits. P.D. 07-135 (September 4, 2007). Taxpayer erroneously treated sale of cabling installed in buildings as a retail sales, charging tax to its customers. Commissioner refuses to allow a credit against the contractors use tax for the taxes erroneously collected. Previous ruling allowing such a credit reversed.

14. Real Estate Fixture. P.D. 07-81 (May 18, 2007). Racking system used in industrial warehouse was held not to be part of the real estate. Even though the system was anchored to the building with concrete and epoxy anchors which would have to be cut to remove the racks (and the holes filled in with concrete), the Commissioner holds that “racks are trade fixtures that come and go as the building’s use changes and its ownership changes.” Thus, the racking system was held not to be a permanent improvement to the real estate.

15. Contractor/Retail Sales. P.D. 07-111 (July 19, 2007). In a change of tactics, auditor tried to assess real estate contractor with sales tax with respect to (i) partitions installed in a government building and (ii) signage. Commissioner holds that both items are integral parts of the real estate and not sales of tangible personal property that should have been taxed.

16. Landscaper/Change of Policy. P.D. 07-171 (November 7, 2007). Under past policy, the Department treated contractors and others that furnished sod, trees, etc. as making taxable resale sales, not as using and consuming contractors. Under changed policy, construction contractor, landscape contractors and other who perform real property services will not be treated as retailers with respect to furnishing and installing trees, shrubbery, nursery stock, plants, sod, silt fence and similar items. They will be taxable under the real estate contractor rules. The previous policy will continue to be applied, however, to florists, nurserymen, garden centers, green house operators, and similar retail businesses that sell and install plant materials. Important: Read carefully the Department’s statement of who the changed policy will and will not apply to.

17. Contractor/Nurseryman. P.D. 07-67 (May 10, 2007). Contractor renovating golf course was deemed to be in two businesses: (i) retailer with respect to the sod, shrubbery, etc. that it sold as part of renovation and (ii) contractor/service provider with respect to other services. Sales tax should have been charged on cost of plant material. Comment: On what basis does the Department apply this rather unusual dual status to this form or real estate contractor? Why should other contractors be treated differently?

18. Cabinet Fabricator/Real Estate. P.D. 07-161 (October 17, 2007). Company that fabricated cabinets for contractors was not itself a real estate contractor because it had no contractual obligation to perform installation work. It did not “sell and install cabinets.” It was taxable as a retailer of those cabinets.

19. Retailer versus Contractor. P.D. 07-108 (July 6, 2007). Company that fabricates granite and marble countertops and installs those countertops will be classified as either a retailer or contractor based on a 50% of gross receipts test. The test is applied annually. Only if the taxpayer is principally a retailer can it obtain a direct pay permit to permit all material purchases to be made initially exempt.

Commissioner declines to treat this company under the exception to the contractor’s sales tax for persons “selling and installing cabinets, kitchen equipment and other like items.” Comment: Why? This would seem to be exactly the sort of situation the General Assembly thought should be treated under the retailer rules to produce a fair result.

20. Real Estate Contractor. P.D. 07-84 (May 25, 2007). Taxpayer sold and installed bank equipment, some of which became part of the real estate after installation. Taxpayer was taxable consumer of the equipment that it installed as part of the real estate or furnished in connection with the provision of monitored services. It was also assessed consumer use tax with respect to items permanently installed for exempt banking customers such as federal credit unions. As a real estate contractor, taxpayer could not purchase items for resale exempt to a federal entity.

21. Software/Separate Contracts. P.D. 07-92 (June 1, 2007). Taxpayer executed separate contracts for the sale of computer software and services related to the installation, testing and training with respect to that software. Commissioner’s ruling appears to feel free to ignore the separate contract and tax labor components from the “services contract” that taxpayer cannot prove were unrelated to the sale of the compute software. For example, labor charges for “testing” could be attributable to either taxable or exempt software; therefore, they are taxable.

Subcontract. Even though signed on same day, contract between purchaser, prime contractor and subcontractor was recognized as separate and distinct billing arrangements. Accordingly, services provided to software purchaser held not taxable. Vendor of software was apparently subcontractor to services provider.

LOI. Taxpayer provided “gap analysis” under a Letter of Intent that eventually led to the sale of

software. Because the LOI was clearly separate from any future license agreement, it stands on its own for sales and use tax purposes. Service is not taxable.

Foreign Sales. License fees charged to foreign affiliates not subject to Virginia tax. Both original

licenses and second tier licenses were used on hardware outside the United States.

22. Software/Acquiescence. P.D. 07-74 (May 18, 2007). Department appears to acquiesce to the holding in Intersections, Inc. v. Department (Cir. Ct. Fairfax Co., November 8, 2006). Holds that true object of taxpayer in this ruling was to obtain a tax exempt service, not purchase software.

23. Custom Software. P.D. 07-202 (December 5, 2007). Software developed after numerous hours of programming and other work was too customized to sell to other customers. Held: Exempt as customized software. Notwithstanding that vendor took exemption certificate from manufacturer, Commissioner holds that because software used to analyze production data to detect waste in the manufacturing process is an administrative tool and not exempt under well established policy. Commissioner will consider detailed records segregating charges for services used to modify prewritten software, exempt under § 58.1-609.5(6).

24. Computer Software/Electronic Delivery. P.D. 08-17 (February 29, 2008). Even though sales agreement did not specify method of delivery, taxpayer was able to provide specific documentation showing that computer software and all related documentation was delivered electronically. Exemption allowed.

25. Interstate Sales/Bloomingsdale’s. P.D. 07-134 (August 9, 2007). This document is a copy of the Final Order in Bloomingdale’s v. Department of Taxation. Note the specificity with which the Final Order details, as to each of five transactions, that risk of loss and title did not pass in Virginia.

26. Gifts. P.D. 07-156 (October 17, 2007). Department reiterates its position with respect to interstate gifts. In this case, the taxpayer is an internet company that makes retail sales of flowers. Because orders are processed at a Virginia location, Commissioner holds that all transactions are taxable even if delivered out of state. Commissioner notes pending appeal in Bloomingdales case.

27. New Business/Computer Services. P.D. 07-126 (August 17, 2007). Commissioner rules that corporation not previously doing business in Virginia can bring computer equipment into Virginia,

free of any use tax, provided it can prove that the equipment was purchased more than six months before coming to Virginia. The service to be offered in Virginia allows customers, via the Internet, to access computing resources. The Commissioner holds that charges for this service are not subject to sales and use tax. The equipment used to provide the service, however, is taxable unless exempt under the six month rule noted above.

28. Separately Stated Tax. P.D. 07-4 and P.D. 07-5. (January 15, 2007). Business making sales in “outdoor setting” permitted to use a tax inclusive pricing method. Tax determined by dividing total receipts by 1.05.

29. Transportation Charges. P.D. 07-55 (May 10, 2007). Manufacturer of small loads of concrete held taxable on all charges for delivering concrete, without regard to a separate statement for such charges.

30. Transportation. P.D. 07-73 (May 18, 2007). Freight from the manufacturer to the retailer is included in the sale price and taxable. Separately stated transportation charges from the retailer to the customer are exempt.

31. Sales Prices/Travel Insurance. P.D. 08-37 (April 10, 2008). Travel insurance sold by real estate agent for vacation homes held not part of the taxable “sales price.” This was so even though regulations “deemed” all additional charges to be part of the room charge. In this case, customers could elect to buy or not buy the insurance, were separately billed for the insurance, and the insurance was provided by a third party.

32. Separately Stated Installation Charges. P.D. 07-107 (July 2, 2007). Taxpayer separately stated charges on its invoices for “commissioning services” which involved testing equipment after installation. Commissioner rejects that such services are “installation charges” which can avoid tax if separately charged. These are services rendered in connection with the sale of tangible personal property and taxable.

33. Separately Stated Hotel and Park Fees. P.D. 08-4 (January 7, 2008). Commissioner agrees with taxpayer that auditor incorrectly assessed tax on cost of park admission fees in package vacations. The package deal included hotel rooms, sold for unrelated parties, and park admission tickets. Fact of separate vendors for items apparently supported exemption for admission tickets.

34. Sales Price/Finance. P.D. 07-184 (November 21, 2007). Taxpayer was not relieved of obligation to pay use tax by the fact that the fabrication business from which it purchased failed to collect the sales tax. Damage waiver fees are simply part of the “sales price.” The Commissioner rules, however, that a piece of equipment purchased outside the audit period is not taxable based on the fact that payments to the bank related to the financing of the purchase occurred during the audit period.

35. Leases/Delivery Charges. P.D. 07-127 (August 17, 2007). Taxpayer leased cones, barricades and other traffic control property to construction companies. It separately stated charges for delivering the leased equipment, picking it up, setting up the equipment and remaining with it under certain circumstances. The separately stated charges for delivery and pick up are not taxable. The other charges are part of the taxable leased proceeds.

36. Royalties. P.D. 07-213 (December 20, 2007). Commissioner holds that royalty fees paid upon the sale of tangible personal property are part of the sales price and are taxable. No exemption was provided by the fact that the charge for the royalty fee and the tangible property were not invoiced together.

37. Sale Leaseback/Resale. P.D. 07-152 (September 27, 2007). Ruling confirms that a resale exemption is available for a sale for exempt leaseback notwithstanding statements to the contrary on the face of ST-10 (resale exemption certificate). Manufacturing company intended to sell its exempt production equipment to a company which would lease it back to the manufacturer. As production equipment used directly in manufacturing, the leaseback would be exempt. Held that the resale exemption is available even if the leaseback is exempt and not taxable.

38. Resale/Occasional Sale. P.D. 08-35 (April 10, 2008). Company providing gas compressing services proposed to transfer compressors to two disregarded entities, one to lease the compressors to related entities and the other to lease to unrelated parties. Commissioner holds that transfers qualify for resale exemption purposes because taxpayer is ultimately leasing the compressors and not selling a service under the true object test. Even though the taxpayer did not ask, Commissioner also acknowledges that transaction qualifies as a reorganization and is an exempt occasional sale.

Exemptions: Industrial

39. Direct Use Manufacturing. P.D. 07-112 (July 19, 2007). Filter cartridges filtered soluble oil used in machinery which formed beverage cans. Filtered oil is reused on the production line. Commissioner holds that filters were an indispensable part of actual production. Comment: Note that the oil actually touched the product and that the filter was necessary to quality control (but no mention was made of quality control).

40. Manufacturing/Forklifts. P.D. 08-39 (DATE). Forklift held exempt because it was used more than 50% of the time in production related activities. 40% of activity was unloading raw materials and 20% was moving unfinished products from one production area to another. The remaining 40% was in loading goods for shipment which was not an exempt activity. Nevertheless, Virginia does not prorate exemption, so preponderance of use establishes the exemption. Commissioner makes impractical (for the taxpayer) comment that records should be kept detailing usage of each piece of equipment.

41. Paper Manufacturing/Direct Use. P.D. 07-168 (November 7, 2007). Immunol was used to clean stack rollers, but not when paper was actually being pressed. Held to be general maintenance items and not used directly. No analysis of quality control.

42. Direct Use Manufacturing. P.D. 07-113 (July 19, 2007). Biocide chemical used to prevent biological growth on the product was exempt. It was an indispensable part of quality control and it also protected the integrity of the product and became part of the product. The biocide was exempt. An electric wench used to remove jammed materials from a pulping machine was taxable. (Note: tool used to repair or maintain a machine is indirectly used).

43. Manufacturing/Direct Use/Software. P.D. 07-173 (November 14, 2007). Manufacturer of coffee products used two software systems, one of which was a software tracking system that fed data into a second system which actually controlled and directed production machinery. Because the first software system did not actually direct or control machinery, it was taxable.

44. Lumber mill/Direct Use. P.D. 07-203 (December 5, 2007). Following items held to be taxable: (i) catwalks used to make equipment accessible to operators; (ii) steel rebar and other structural support for machines (not an integral part of the machinery itself); (iii) computers used to record log data (administrative function that does not directly control machinery); (iv) bobcat used for mill cleanup and (v) ATV used for dust control.

45. Manufacturer. P.D. 07-61 (May 10, 2007). (1) Chart paper not certified by DEQ is not exempt pollution control facility; (2) casters installed onto machine to enable it to be rolled between locations is an integral part of the machine and exempt; (3) taxpayer paid for a maintenance contract that provided for both parts and services. Even though it no longer received subscription updates (i.e., tangible property) its continuing payments to enable it to receive product support are taxable. Exempt status is determined at time of sale, not at time of subsequent delivery of service/property.

46. Manufacturing/Gas Transmission. P.D. 07-63 (May 10, 2007). Natural gas pipeline argued that equipment used to compress, scrub, filter and cool gas in an interstate transmission pipeline should be exempt as used in industrial processing. Commissioner holds that transmission activity is part of the distribution function, occurring after the natural gas is a complete product ready for sale. Also holds that activity is not “industrial in nature” because it does not fall in the appropriate SIC codes.

47. Fabrication/Repair. P.D. 07-193 (November 27, 2007). Distributor of automotive equipment which crimped battery cables, hoses and other equipment sold to repair businesses held to be taxable on a fabrication service. Separately stated labor charges were not exempt as “repair services.”

48. Drilling/Trucks. P.D. 07-71 (May 18, 2007). Equipment used in gas drilling activities was mounted on trucks. Commissioner holds that the actual drilling equipment must be analyzed separately from the motor vehicles on which they are mounted. Repair parts for the equipment used in gas drilling was exempt, but not the motor vehicle itself.

Exemptions: General

49. Charitable. P.D. 07-198 (November 30, 2007). Nonprofit high school orchestra holding a fundraising event had applied for and received appropriate exemption certificates from Department of Taxation under new procedures of Virginia Code § 58.1-609.11. Therefore, orchestra could purchase and sell products exempt of sales and use tax as part of its fundraising activities.

50. Media Advertising. P.D. 07-86 (May 25, 2007). Calendars designed by an advertising agency were not part of a media campaign. Therefore, the sale of those calendars was not exempt “advertising.”

51. Direct Mail Advertising. P.D. 07-110 (July 19, 2007). Out-of-state printer sold printing to Virginia franchisees who delivered those materials to households for their customers. Virginia franchisees are media advertisers. Their sales to customers are exempt, but they are taxable on all their purchases. Therefore, sales from out-of-state printer to Virginia franchisees are taxable.

52. Advertising. P.D. 07-135 (August 17, 2007). Manufacturer claimed an advertising exemption for video catalogue stands and room planner guide. The Commissioner agreed that the video was intended for the general public who came to view furniture at retail stores. This was accepted as “media advertising.” The catalogue stands and room planner guides were simply administrative tools and were taxable.

53. Country Club Newsletter. P.D. 07-182 (November 21, 2007). Commissioner holds that newsletter published by a country club is exempt “publication.” Newsletter had subjects of interest both to club members and the general community; was distributed to club members; and was available at its public sales office for the general public.

54. Agriculture/Tree Farm. P.D. 07-58 (May 10, 2007). Commissioner holds that weed eaters used to control grass between rows of Christmas trees are not exempt because their only purpose is to allow access for customers cutting their own trees. Distinguishes weed eaters used to control grass between rows of grapes in a vineyard where grass serves an erosion control purpose. Comment: Doesn’t grass between rows of trees also serve an erosion control purpose?

55. Free Employee Meals. P.D. 08-36 (April 10, 2008). Retail merchant with a restaurant in its store must charge sales tax on meals provided free of charge to nonrestaurant employees. Nevertheless, because taxpayer could prove that it had been given contrary advice in a previous audit, tax was waived on past years.

56. Restaurants/Disposables. P.D. 07-62 (May 10, 2007). Restaurant items that are disposed of after use by one customer are considered part of the meal and can be purchased under a resale exemption. This includes: foil wrap for baked potatoes; shish-kabob skewers; paper napkin rings; carryout containers.

57. Implants/Dentists. P.D. 07-169 (November 7, 2007). Dental implants, when purchased for specific patients, qualify as exempt prosthetic devices. Dentists, however, did not maintain documentation to establish that implants were purchased for particular patients so exemption was not available.

58. Energy Star/Tax Holiday. P.D. 07-151 (September 20, 2007). Sets forth extensive rules implementing the energy star sales tax holiday during the second week of October annually until 2012.

59. Food for Home Consumption. P.D. 07-137 (September 5, 2007). Even though sold to nursing homes, hotels and other commercial entities, food that is packaged in a closed container and not for immediate consumption is eligible for the “food for home consumption” reduced tax rate.

60. Food for Home Consumption. P.D. 07-122 (July 31, 2007). Auditor incorrectly determined that 5% tax rate should apply to all sales of food by this taxpayer. Because 80% of its sales were not for immediate consumption, its sales of food sold in closed containers and not for immediate consumption are eligible to the reduced rate applicable for “food for home consumption.”

61. Biofuel. P.D. 07-159 (October 17, 2007). Corn, wheat, barley and other grains are not among the different types of fuel exempted from the sales and use tax. They are not specifically listed in the statute.

62. DME. P.D. 08-28 (April 2, 2008). Ruling provides an extensive listing of medical products used by cardiologists and radiologists that do and do not qualify for the exemption provided durable medical equipment.

63. Packaging for Export. P.D. 08-26 (March 20, 2008). Company that packaged grain for export was taxable on packaging materials used in rendering that service. There was no resale to customers. There was no exemption for foreign commerce because there was no sale.

Audits & Procedure

64. Nexus. P.D. 07-138 (September 5, 2007). Out-of-state manufacturer with a Virginia based sales rep held to have nexus for sales and use tax purposes but, because of PL 86-272, no nexus for corporate income tax purposes.

65. Services/Nexus. P.D. 07-181 (November 21, 2007). Company provided service that assisted customers in selling unused electricity into the energy grid. Although company had a salesman in Virginia, Commissioner holds that company is not a “dealer” because it is not selling tangible personal property, it is providing a service.

66. Burden of Proof. P.D. 07-88 (May 25, 2007). Taxpayer has the burden of proof. If supporting information is not provided during audit appeal, taxpayer loses.

67. Documentation. P.D. 08-29 (April 2, 2008). Taxpayer learns the hard way, with tax, compliance penalty, amnesty penalty, and interest, that every deduction must be established by documentation. Lacking documentation, the taxpayer was even taxed on a meal purchased by its resident manager while traveling outside the United States!

68. Exemption Certificate. P.D. 07-87 (May 25, 2007). Exemption certificates provided after the fact merely evidence facts that may support an exemption. Such certificates do not create a presumption in the taxpayer’s favor as they would if obtained before the sale is made.

69. Incomplete Exemption Certificates. P.D. 07-91 (June 1, 2007). Exemption certificates provided during audit are not entitled to presumption of correctness. Moreover, exemption certificates that are incomplete or contain incorrect information (e.g., registration numbers) are not acceptable.

70. Exemption Certificates. P.D. 07-180 (November 21, 2007). Wholesaler and retailer of welding and safety supplies accepted a completed exemption certificate in good faith from a customer that was a real estate contractor. Commissioner protects taxpayer’s good faith reliance on that exemption certificate but directs, on a prospective basis, that tax should be collected from this customer. Similar protection was not accorded to an exemption certificate obtained during the audit. Moreover, the after-the-fact exemption certificate was incomplete because the “trading as” and “kind of business” lines were not completed. Comment: The first part of this ruling suggests that the Department is taking a more reasonable position as to exemption certificates.

71. Exemption Certificate/Advertising Agency. P.D. 07-76 (May 18, 2007). Commissioner does not permit advertising agency to use its form of “blanket resale exemption certificate.” Form ST-10A

must be used when purchasing for resale materials in media advertising. Form ST-10 should be used when purchasing items for resale and other than media advertising.

72. Electronic Exemption Certificates. P.D. 08-18 (February 29, 2008). Commissioner holds open door for national retailer to use electronic exemption certificates developed from information provided by the customer at the POS. Retailer’s specific program, however, was rejected because its current system does not present all the information required for the Virginia exemptions.

73. Sample/Distortion. P.D. 07-60 (May 10, 2007). Sample period spanned two fiscal years of the taxpayer and picked up similar annual expense for each fiscal year. Commissioner holds that this produced a distortion.

74. Sample. P.D. 07-83 (May 25, 2007). Taxpayer requested that a new sample period be utilized for the second half of the audit to affect its change in accounting personnel during that time. Commissioner rejects this request, noting that taxpayer had not proved (in fact showed to the contrary) that addition of new personnel improved compliance.

75. Sample. P.D. 07-85 (May 25, 2007). Department will not remove transactions from a sample unless (i) the transaction is isolated and (ii) not a normal part of the taxpayer’s operations. In this case, it is reasonable to expect the taxpayer to purchase software licenses on a regular basis.

76. Sample/Customer Payments. P.D. 07-68 (May 10, 2007). Department continues its position that when retailer shows customers paid use tax, retailer is allowed only a credit for that specific sale. The sale is not removed from the sample period, nor will the Department allow a credit for all sales to that same customer without specific proof that each sale was self-assessed by the customer. Comment: If the theory of sampling is that an error can be presumed to repeat throughout the audit period, then why should not the same theory apply to corrections of errors? Stated another way, if it is shown that a customer has self-assessed the use tax, then why should not that correction be spread across the entire audit in order to determine the correct amount of tax that has not been paid, one way or the other, to the Commonwealth?

77. Sample/Burden of Proof. P.D. 07-56 (May 10, 2007). Because taxpayer failed to file returns, sampling methodology was utilized. Taxpayer failed to prove that this method was inaccurate. Lack of records (because federal government had seized them) was no excuse, though the Commissioner held that those records would be considered if they could be presented within the three year court filing limitation.

78. Sample. P.D. 08-16 (February 29, 2008). An unusually large sale will not be removed from the audit sample because there is no indication that this sale was not consistent with the taxpayer’s normal business sales.

79. Sampling Authority. P.D. 08-9 (January 11, 2008). Taxpayer enraged by results of a sample audit, demands detailed audit. Commissioner rejects, citing Virginia Code § 58.1-202(1) as authority for samples. Statute allows Commissioner “to ascertain best methods of reaching such property, of effecting equitable assessments and of avoiding conflicts and duplication of taxation of the same property.” Query: Does this statutory authority deal with anything other than property taxes? Even if it does, how does the Commissioner reconcile sampling procedures to specific provisions of the Retail Sales and Use Tax Act imposing the tax on each transaction, requiring the tax to be passed on to the customer, and making the tax the debt of the customer? How is the merchant to recover tax from customers unless tax is assessed on specific transactions?

80. Sale of Business. P.D. 07-64 (May 10, 2007). Purchaser of a business is liable for unpaid sales and use taxes of that business. Statutory procedure allows purchaser to obtain certification from Department that all sales and use taxes have been paid.

81. Advice/Prospective Application. P.D. 07-79 (May 18, 2007). Landscaper failed to separately state installation charges, but had relied on advice of Local District Office that such separate statements were not necessary if labor charges were supported by internal documentation. In what appears to be a refreshing change from some of the hard line rulings in past years, the Commissioner allows the

taxpayer to rely on this erroneous advice and requires compliance with separate statement rules prospectively.

82. Absorption Tax. PD 07-32 (April 9, 2007). Virginia Tax Bulletin 07-5: specifically overturns all prior rulings and advice given by the Department on this subject. Virginia Code § 58.1-626 prohibits any person from advertising indirectly an intention to absorb all or any part of the sales or use tax. Any promotion that offers to reduce the sales price of an item and mentions the sales tax in connection with that reduction will be deemed an indirect attempt to circumvent Virginia Code § 58.1-626. Accordingly, such an advertisement will be deemed to violate the provisions against dealer absorption. Provides examples and explains the tax holiday exception.

83. Sales Tax Absorption. P.D. 07-123 (August 3, 2007). Tax Bulletin 07-5 concluded that any advertisement that mentions the sales tax in connection with the price reduction will be deemed an attempt to circumvent Virginia Code § 58.1-626 prohibiting absorption of the tax. Commissioner agrees that the language in the Bulletin is overly broad. Thus, advertisement of a 5% discount on the sale of goods but stating that the sale is still subject to sales tax will not be treated as an illegal absorption.

84. Audit Appeals/Statute of Limitations. P.D. 07-97 (June 27, 2007). Taxpayer’s request to reopen its audit not filed within 90 day appeal (and well after even the court filing limitation had passed).

85. 90-Day Appeals. P.D. 08-22 (February 29, 2008). Appeals not filed within 90 days of the date of assessment are barred.

86. Complete Appeals. P.D. 08-19 (February 29, 2008). Taxpayer filed the Administrative Appeal Form but apparently did not state any reasons why the assessment was erroneous notwithstanding phone calls from staff requesting details. Appeal was time barred. Comment: It is noteworthy, and commendable, that the Commissioner appears to have tried to work with this taxpayer even after the 90 day period had expired.

87. Statute of Limitations. P.D. 07-157 (October 17, 2007). Because taxpayer did not file administrative appeal within ninety days of date of assessment, the assessment was not corrected. Comment: If the taxpayer had valid exemption certificates, as its appeal claimed, is the Commissioner simply suggesting that the taxpayer file a lawsuit? Wouldn’t the Department be better served to resolve meritorious cases with a settlement?

88. QSSS. P.D. 07-72 (May 18, 2007). A Qualified Subchapter S Subsidiary is a separate legal entity for sales and use tax purposes. Each QSSS should be separately registered for sales and use tax purposes. Transactions made by one subsidiary corporation cannot be assessed to the owner.

IV. BUSINESS LICENSE TAX

A. Court Decisions

1. W.C. English, Inc. v. City of Lynchburg, Law No. CL05025331-00 (Lynchburg Cir. Ct. 2008). Circuit Court for the City of Lynchburg ruled that Lynchburg cannot tax gross receipts of a contractor attributed to a definite place of business of the contractor in another jurisdiction, even if that other jurisdiction does not tax such receipts. Virginia’s BPOL tax statute provides that, for business license tax purposes, the gross receipts of a contractor generally are attributed “to the definite place of business where his services are performed.” Some localities in Virginia do not impose a BPOL tax. Lynchburg argued for a broad reading of Virginia Code § 58.1-3715 to claim it had authority to tax gross receipts earned by a contractor in such localities. Based on the plain wording of Virginia state law, the Circuit Court ruled that because English had established a definite place of business in the other jurisdictions, Lynchburg can tax only those gross receipts attributable to English’s definite place of business in Lynchburg. Lynchburg has indicated its intent to appeal the ruling to the Supreme Court of Virginia.

B. Rulings of the State Tax Commissioner

Classification

1. Maritime Cranes/Contractor. P.D. 07-179 (November 14, 2007). Taxpayer was engaged in the business of modifying, repairing and transporting large maritime cranes. Because none of its services related to real property, the taxpayer was properly classified as a “business service” even though it held a contractors license. Query. Did the taxpayer remember to take a deduction for its interstate receipts under Virginia Code § 58.1-3732B(2)?

Exclusions, Exemptions and Reductions

2. Cellular Telephone Company. P.D. 07-162 (October 17, 2007). City of Richmond attempts to tax cellular telephone company at its 3% “grandfathered rate.” Commissioner holds that city must use its ½% rate because it significantly broadened the definition of “telephone company” from that in effect in 1972 when the grandfathering provisions of Virginia Code § 58-578 (now Virginia Code § 58.1-3731) were enacted.

Telephone Company. Commissioner holds that a cellular provided is a “telephone company” because it is “authorized to provide commercial mobile service” under the Communications Act of 1934. Problem is that the statute defines a “telephone company” as the person who holds the certificate and, in this case, the cellular provider’s affiliate held the certificate.

Public Service Company. In order to allow the locality to tax at the ½% rate, Commissioner had to conclude not only had the cellular provider was a telephone company (see above) but also that the special classification is not limited to “public service corporations.” Even though the statutory heading refers to “public service corporation” and uncodified grandfathering provisions specifically refer to “public service corporations,” the Commissioner argues that the text of the codified statute does not.

Grandfather Rate. Although the Commissioner holds that the grandfather rate does not apply, because the ordinance expanded the definition of “telephone company” after 1972, query whether the correct answer (at least in a court) is that the city’s 3% rate is no longer applicable to any entity. The simple fact is that the ordinance as originally grandfathered no longer exists in that form.

Statute of Limitations. Ruling contains a confusing analysis of how the statute of limitations applies to BPOL taxes. The statute of limitations should apply to “tax years” which are measured by gross receipts earned during “taxable years.” Thus, a taxpayer has until 3 years after the close of the “tax year” in which to file its amended return (not 3 years from the close of the taxable year).

3. Wireless Telephone Company. P.D. 08-21 (February 29, 2008). LLC that was operating entity providing the services for which its affiliated held the license held to be a telephone company and taxable under § 55,1-3731. City’s grandfathered rate inapplicable.

4. Affiliated Group. P.D. 07-176 (November 14, 2007). The definition of “affiliated group” for purposes of the BPOL exclusion is very mechanical. Corporations A and B, which were 23% owned by an individual, could not provide tax free services to that individual’s wholly owned corporation. Even if the individual were a “entity,” 23% is not 80%.

5. Agent/Media Buyer. P.D. 07-140 (September 5, 2007). Company that purchased advertising media for its clients, keeping a percentage of the media as its fee, was fully taxable on that fee. These do not meet the definition of “agency receipt.” Moreover, the taxpayer did not provide information during the audit to support its agency theory.

6. Petroleum Terminal/Definite Place of Business. P.D. 07-177 & P.D. 07-178 (November 14, 2007). Taxpayers received petroleum products at a terminal facility located in the City of Richmond. Commissioner holds that the “through-put” agreement with the terminal owner and operator is not a “lease.” Because taxpayer did not (i) have any employees at the terminal; (ii) had no office or telephone at the terminal; (iii) did not receive mail at the terminal; (iv) did not maintain records at the terminal; and (v) did not hold itself out as engaging in business at the terminal, it did not have

a definite place of business at the terminal which is a prerequisite to local taxation. Note: One of the chief “reforms” of the 1996 BPOL legislation was to make clear the nexus rules and that the BPOL tax is not an income tax. Query. Would the mere warehousing of goods in a locality in an owned or leased facility be a “definite place of business”?

7. Terminal Facility/Peddler. P.D. 07-196 (November 27, 2007). Another taxpayer at the same fuel terminal argued that it was exempt from BPOL taxation as a “peddler at wholesale” under Virginia Code § 58.1-3719. The Commissioner rejected this argument because many of the company’s sales were to end users and not licensed dealers as required by the statute. It appears that the taxpayer got lucky, however, because the Commissioner noted its two previous rulings with respect to the same terminal facility and held for the taxpayer on that basis. (It was unclear if the taxpayer had ever made the “definite place of business” argument).

8. Interstate Deduction/Professionals. P.D. 07-66 (May 10, 2007). Reversing an earlier ruling (P.D. 05-58), the Commissioner acknowledges that a professional partnerships’ deduction for interstate receipts under Va. Code § 58.1-3732(B)(2) is not limited to hours worked by partners. The deduction is not one that is given to each partner. Rather, it is a deduction for the firm as a whole so that hours worked by all billing personnel should be included in the deduction calculation.

9. Interstate Receipts/Pass-Through Entity. P.D. 07-142 (September 5, 2007). Revenues earned by a single member LLC, which was a disregarded entity, flowed through to other affiliated entities and were included in a consolidated return. Even though the single member LLC itself did not file tax returns in other state, revenues earned by it from business in other states are excludable under § 58.1-3732B(2) to the extent it can be demonstrated that such revenues are included in some type of income tax return (combined, separate, consolidated or otherwise) filed in another state.

10. Manufacturing/Data Conversion/Apportionment. P.D. 07-208 (December 5, 2007). Commissioner holds that the conversion of data into a form that is ultimately used for catalogues is not manufacturing. Commissioner also holds that payroll apportionment may not be appropriate for an interstate business if the taxpayer can separately account for the gross receipts of its local business activities.

11. Title Insurance Agent. P.D. 07-146 (September 12, 2007). Title insurance agent is subject to local BPOL taxation based on revenues from real estate settlement services. The Commissioner deems this to be a separate licensable business which is not covered by the exclusion provided by Virginia Code § 58.1-2508B for insurance companies. Comment: Note that the Commissioner treats this exclusion as an exemption to be strictly construed against the taxpayer. Is a restriction on a locality’s power to tax an exemption in a Dillon Rule state?

12. Real Estate Rentals/Private Home. P.D. 07-141 (September 5, 2007). Gross receipts from renting

second home during portions of the year are not subject to local business license taxation. Private residences are exempt from this local taxing authority.

13. Church Daycare Centers. P.D. 08-12 (January 11, 2008). Daycare center held to enjoy church’s exemption because center was operated on church premises, using church accounts and church’s identification number. Same result likely, but not certainly, applies to daycare center operated on church’s premises but under a separate taxpayer identification number with its own bank accounts. This second daycare center described itself in IRS filings as a “church controlled organization.”

Procedure

14. Jeopardy Assessments. P.D. 07-192 (November 21, 2007). Taxpayer sold meals to elderly residents on Monday evenings, primarily as a hobby, and also engaged in some catering activities. When taxpayer did not provide records during the audit, the City assessed tax assuming a volume of sales equal to the largest catering business in the community. Because taxpayer did not have adequate records to establish otherwise, Commissioner upholds the assessment. Quotable Quotes: (1) With respect to “estimated assessments:” one method of inducement is to make estimated assessments. Such assessments are made in such a way as to protect the locality from the possibility of under assessing and persuade a taxpayer to provide the records necessary to make an accurate assessment.”

(2) With respect to the taxpayer’s burden: “it is, however, the obligation of the Taxpayer to show that the assessments made by the City are incorrect by providing sufficient evidence to compute the correct amount of tax due.”

15. Two Licenses Two Locations. P.D. 07-209 (December 5, 2007). Taxpayer split its original office and opened a second place of business. Commissioner confirms that business licenses were required for both locations. Note that the effect of the “beginners convention” will cause a doubling up of tax in the first year because the original office must pay tax on the prior year’s receipts when it had a full complement of staff, and the new office where the staff went must pay tax on an estimate of receipts for that year.

V. PROPERTY TAXES

A. Court Decisions

1. Botetourt County v. Virginia Baptist Homes, Inc., Case No. CL06000061-00, Cir. Ct. Botetourt County (June 6, 2007). Notwithstanding that Virginia Baptist Homes has been designated as exempt by the General Assembly as a religious and benevolent organization, the Circuit Court held that its retirement facility in Botetourt County was subject to property taxation. Even though this retirement home is operated on a not for profit basis, the trial court held that the dominant purpose of the facility was neither religious nor benevolent. The trial court’s opinion equates “religious purposes” to “religious services” and further equates “benevolence” to “charity”. Because this start up entity charged residents, at cost, for services (in order to pay the bond financing), the Court held that it had not established a sufficient record of “charitable care.” The record was nevertheless clear that the facility is operated on a not for profit basis (indeed at a loss for the first two years) and will provide increasing levels of subsidized care for financially needed residents as the facility matures. VBH has noted its appeal.

2. Chesterfield County v. Palace Laundry, Inc. d/b/a/ Linens of the Week. CL06-1982 (Cir. Ct., June 14, 2007)(Chesterfield County). The Circuit Court applied a presumption of validity to a decision of the County Tax Commissioner after the State Tax Commissioner had already determined that the County Tax Commissioner’s decision to be in error. Chesterfield County assessed Linens of the Week (“LOW”) with unpaid business tangible personal property tax. LOW argued that it was either a laundry business and exempt from the business tangible personal property tax or, in the alternative, an exempt processing business. Upon administrative appeal, the State Tax Commissioner determined that LOW was an exempt processing business. Chesterfield County filed a successful lawsuit challenging the State Tax Commissioner’s decision. The Circuit Court chose to apply the applicable presumption of validity in favor of the County Tax Commissioner’s local determination and not to the State Tax Commissioner’s decision on the administrative appeal. LOW believes the Circuit Court should have applied its presumption of validity in favor of the decision of the appellate authority, the State Tax Commissioner, and not the County Tax Commissioner. LOW filed a petition for appeal with the Virginia Supreme Court. If the Virginia Supreme Court grants the petition the Court will be given the opportunity to address this issue for the first time since administrative appeals of certain business property taxes were authorized by the General Assembly in 1999.

3. Keswick Club v. Albemarle County, 273 Va. 128, 639 S.E.2d 243 (January 12, 2007). County Assessor paid lip service to having considered all three approaches to value, but advised the taxpayer that he had chosen the cost approach as the most appropriate method of valuing “special use property.” Reviewing the evidence at trial, the Supreme Court concluded that the Assessor had not tried to obtain sufficient information about comparable sales nor even requested data that would have allowed application of the income approach. Under these circumstances, the Court held that the proper standard of review was a showing by the taxpayer that the assessment was erroneous, not that the Assessor had committed “manifest error.”

B. Opinions of State Tax Commissioner

1. Machinery and Tools Guidelines. P.D. 08-1 (January 1, 2008). Implements 2007 legislation providing for state-wide rules concerning the classification and taxation of idle machinery and tools.

Most of the regulation focuses on the two-part definition of M&T as (1) idle on tax day, idle for the entire previous year and expected to be idle for the current year; and (2) identified to the local taxing authorities as of April 1 of the previous year that the equipment will not be in service as of January 1 of the following year.

2. Capital/Holding Company, P. D. 07-191 (November 21, 2007).

Manufacturer. Commissioner holds that the holding company parent of an affiliated group of manufacturers is not itself a manufacturer. Thus, its office furniture, fixtures, computers, etc. were not eligible for the capital tax exclusion. Query. What if this property were held by one of the subsidiaries?

Statute of Limitations. Taxpayer had filed a two-part refund request with the locality, one under § 58.1-3983.1 (one year statute of limitations) and another under § 58.1-3980 (three year statute of limitations). Commissioner holds that denial of the refund under § 58.1-3980 is not a new assessment permitting those years to be appealed to her under the provisions of § 58.1-3983.1. Comment: Note that the result should be different for BPOL taxes since the definition of an “appealable event” under § 58.1-3703.1 includes the denial of a claim for refund which necessarily must be filed under § 58.1-3980.

3. Valuation. P.D. 07-2 (January 10, 2007). Stock in a manufacturing corporation was sold, and both new owner and locality agreed that valuation made at the time of sale reflected fair market value. The question was how to fit this valuation into the locality’s depreciation guidelines that reduced taxable value by 10% per year to a minimum value of 50%. The locality wanted to start the depreciation process over using the appraised value as “100% good.” The company wanted to plug the appraised value into the appropriate age-life bracket (50% given the average age of the plant and equipment was more than six years). The Commissioner disagreed with both. She essentially backed into a new “original cost” by dividing the appraised value of each asset by the age-depreciation factor for that asset. For example, assume a four year old asset with an appraised value of $6,000 and a local depreciation factor of 70%. The original cost of $10,000 would be adjusted to $8,571 ($8,571 x 0.70 = $6,000).

Comment: This ruling will be especially important now that recent legislation requires local assessing officers to consider fair market valuation appraisals. Assuming the locality and the taxpayer can agree on a new appraised value, this ruling indicates how the Department would recommend that the locality adjust reported original cost to reflect that valuation.

4. Capital/Capitalized Costs. P.D. 08-30 (April 2, 2008). This ruling addresses several important issues, both procedural and substantive, and some of the conclusions are questionable.

Procedure. Taxpayer filed a 3-year refund request under Virginia Code § 58.1-3980. When locality granted partial relief (and therefore an amended assessment), taxpayer then filed an appeal to the State Tax Commissioner under § 58.13983.1D(1). Even though the earliest years in the refund request were beyond the one year period of limitation normally applicable to the review of local business taxes, State Tax Commissioner accepted the appeal, apparently on the theory that the revised assessment was a “new assessment.” Comment: This ruling provides taxpayers with a new and potentially expanded right to obtain review of business taxes beyond the current one year statutory period. While any such expansion is welcomed, will this make localities reluctant to do anything other than deny all refunds requested under the three year amended return procedures? Note that a different rule clearly applies under the BPOL appeal procedures which treat the denial of a claim for refund as an “appealable event.”

Capital/Packaging. Commissioner distinguishes between packaging activities necessary to produce

a finished product and those that place products in quantities for shipping and sales. Packaging that is necessary for sanitation and other reasons is an integral part of producing a product for sale. It is taxable as machinery and tools. Packaging used to place finished product into cases for shipping is not directly part of manufacturing.

Engineering Costs. Commissioner holds that design and engineering stages of a manufacturing job are part of manufacturing and therefore the equipment used in those stages is machinery and tools. Comment: The ruling does not provide sufficient facts to understand the holding. Nevertheless, it is based on a clearly wrong reading of Brown Boveri. The ruling fails to distinguish between manufacturing, as part of a manufacturing business, and engineering as a direct part of the manufacturing process. To the extent it holds that true engineering and design computers are taxable as machinery and tools, it is almost certainly wrong.

Installation Costs. Vendors support cost necessary to the installation process are properly

capitalized as part of the machinery’s “original cost.” Expenses related to training, however, are not so capitalized and are intangible.

Modification Costs. Facts are not sufficient to understand holding. Dispute appears to relate to

costs used to rebuild certain equipment. Commissioner returns to locality to reconsider whether including those costs, or method for doing so, accurately reflects fair market value.

5. FMV/Appraisal Standards. P.D. 07-103 and 07-104 (June 27, 2007). Acknowledging the

constitutional mandate that assessments be made at fair market value, both the taxpayer and local assessor retained professional appraisal firms. Those firms differed on the treatment of costs to be capitalized (e.g., sales taxes, installation costs and freight) and functional obsolescence. Concluding that the local assessor has exercised his “due diligence” by hiring an outside appraisal firm, the State Tax Commissioner holds, based on the presumption of correctness of local assessments, that there is no basis for overturning the local assessor’s opinion of value as based on its outside appraiser’s work. Comment: It is remarkable that the Commissioner recites not once, but twice, that “fair market value is a subjective judgment.”

6. Church Property/Musical Instruments. P.D. 07-65 (May 10, 2007). Instruments used by the music director of a church for both church purposes and other business purposes not exempt because not used exclusively for charitable purposes. Instruments were depreciated on music director’s individual returns.

VI. MISCELLANEOUS TAX

A. Rulings of the State Tax Commissioner

1. Resident Trusts. P.D. 07-164 (October 10, 2007). Wishing to change their status as Virginia trusts, out-of-state corporate fiduciary was appointed and situs of administration was moved out-of-state. Trustees thereafter consisted of one Virginia resident, two nonresident individuals and the corporate fiduciary. Because the Committee of Trustees does not operate in Virginia and is not controlled in Virginia, the trusts are not required to file as Virginia trusts.

2. Estate Tax/Real Estate/LLC. P.D. 07-214 (December 20, 2007). Confirming what is believed to be a long-held Department view, nonresident’s interest in an LLC was held to be intangible property, not subject to Virginia estate taxation, even though LLC owned Virginia real estate.

3. Tobacco Tax. P.D. 07-170 (November 7, 2007). Audit of retail store found 117 packs of unstamped cigarettes. Penalty for first violations is $250 per pack in excess of 100 packs of unstamped cigarettes.

4. Forest Products Tax. P.D. 07-167 (November 7, 2007). Operator of a chip mill is defined by the statute as a “manufacturer” even though it does not take title to the logs being chipped.

VII. TRENDS & OUTLOOK

The major tax trends for Virginia businesses continue to be driven by the same old same old - - desperate need for highway funding and refusal by the House of Delegates to increase taxes. The transportation package enacted by the 2007 Session was based on sleight of hand maneuvers including “abusive driver fees”

and taxes that could be enacted by special transportation districts in Northern Virginia and Hampton Roads. When the abusive drivers fees became law, taxpayer outrage at their unfairness (both in amount and the fact that they applied only to Virginia drivers) dominated headlines for weeks. Frightened legislators stampeded to introduce corrective legislation. A more serious blow was struck when the Supreme Court of Virginia invalidated the special taxing measures authorized for Northern Virginia and Hampton Roads. Bottom line, after many years of dominating the legislative agenda, Virginia still has not resolved the transportation funding problem. It is likely that businesses will continue to see measures designed to nibble at the problem. Both in audit policy and legislative policy, it is likely that Virginia will continue to “raise revenue without raising taxes.” Many believe the business community will eventually demand the obvious solution - - an increase in the gas tax. The 2008 Session took a serious run at adopting single factor sales apportionment for manufacturers. As proposed in the 2008 Session, single factor sales apportionment was to be optional for manufacturers, based on the current Missouri example. The Department of Taxation was concerned with the revenue implications of such an election and appeared to favor an all or nothing approach, at least for manufacturers. The measure was narrowly defeated in the Senate Finance Committee. Although the revenue impact was delayed in the draft bill until the next budget biennium, a vote along party lines in the now Democratic controlled Senate Finance Committee apparently heeded demands from the Governor’s Office to kill this legislation. The matter will now be studied during 2008 and undoubtedly reconsidered during the 2009 Session.

VERMONT STATE DEVELOPMENTS

WASHINGTON STATE DEVELOPMENTS Bob Mahon Mike Young Perkins Coie LLP Perkins Coie LLP 1201 Third Avenue, Suite 4800 1201 Third Avenue, Suite 4800 Seattle, WA 98101 Seattle, WA 98101 Tel. (206) 359-6360 Tel. (206) 359-6359 Fax (206) 359-7360 Fax (206) 359-7359 Email: RMahon@perkinscoie.com Email: MikeYoung@perkinscoie.com www.perkinscoie.com www.perkinscoie.com I. INCOME/FRANCHISE TAXES

Washington does not impose an income tax. II. TRANSACTIONAL TAXES (SALES/USE AND BUSINESS AND OCCUPATION TAXES)

A. Legislative Developments

Aerospace industry incentives. Washington adopted legislation that reduced the state business and occupation (B&O) tax rate and expanded B&O tax credits for a variety of aerospace-related activities. The legislature also adopted a sales and use tax exemption for computer hardware and software used in providing aerospace services. The legislation also specified that sales of parts to commercial aircraft manufacturers are deemed to take place at the site of the final testing or inspection as required by a federally approved production inspection system or quality control program. 2008 Wash. Laws, Ch. 81. Local B&O tax allocation and apportionment. Effective January 1, 2008, Washington cities that impose local B&O taxes are required to allocate gross receipts from the sale of goods to the location where delivery to the buyer occurs. Washington cities are also required to apportion gross receipts from service activities using a two-factor apportionment formula based on a payroll factor and a service income factor. RCW 35.102.130. The City of Seattle has adopted a square footage business tax with a B&O tax credit mechanism in order to offset revenue losses that it anticipates as the result of the B&O tax apportionment requirements. Seattle Municipal Code, Ch. 5.46. Sales and use tax sourcing. Washington will move to destination-based sourcing for local sales and use taxes effective July 1, 2008. 2007 Wash. Laws, Ch. 6.

B. Judicial Developments

Cities barred from taxing access to interstate telecommunication service. The Washington Supreme Court held that state law preempts cities from taxing charges for interstate telecommunications service and access to interstate service. The court further held that charges imposed pursuant to Federal Communications Commission tariff are charges for interstate service or access to interstate service as a matter of law. Qwest Corp. v. City of Bellevue, 166 P.3d 667 (Wash. 2007). Sales tax on extended warranties valid. The Washington Supreme Court held that the legislature did not violate state law by enacting several tax increases, including a sales and use tax on extended warranties, without voter approval. Washington State Farm Bureau Federation v. Gregoire, 162 Wn.2d 284, 174 P.3d 1142 (2007). "Direct seller's representative" exemption narrowly construed. The Washington Court of Appeals held that an out-of-state seller did not qualify for the direct seller's representative exemption from B&O tax because a small portion of its Washington sales consisted of non-consumer products. The court concluded that the exemption was limited to taxpayers that exclusively sell consumer products. Although it did not change the outcome of the case, the court rejected the Department of Revenue's position that the seller's representative must be a natural person. The court concluded that a corporation could be a direct seller's representative. Dot Foods, Inc. v. Department of Revenue, 141 Wn.App. 874, 173 P.3d 309 (2007).

C. Administrative Developments

High technology incentives require timely filing of taxpayer survey. In two administrative decisions, the Department of Revenue confirmed that a taxpayer that fails to timely file an annual taxpayer survey loses the benefit of the high technology B&O tax credit and high technology sales and use tax deferral. Wash. Dept. of Rev. Det. No. 07-0115, 26 W.T.D. 241 (2007) and Det. No. 07-0221, 27 W.T.D. 6 (2007). Refunds – revised rule. The Department of Revenue has revised WAC 458-20-229, relating to tax refunds. The rule contains several new requirements for timely making and substantiating refund claims, including a requirement that taxpayers specifically identify all bases for the refund claim on the refund application.

III. PROPERTY TAXES Simple majority for school property tax levies. Washington voters amended the state constitution to reduce the vote required to authorize school property tax levies from 60% to a simple majority of voters. The amendment also eliminated voter turnout thresholds for validating school levy elections. Engrossed House Joint Resolution 4204 (approved November 6, 2007).

IV. AUTHORS' BIOGRAPHIES Mike Young is a partner in Perkins Coie, a 600-lawyer firm with fourteen offices in the United States and Asia. He helps clients reduce their cost of doing business through state and local tax planning and litigation, particularly in Washington, Oregon and Alaska. Mr. Young is Editor-in-Chief of THE JOURNAL OF MULTISTATE TAXATION; Editor-in-Chief of the ABA SALES AND USE TAX DESK BOOK; Adjunct Professor (Tax), University of Washington School of Law; Past Chair of the ABA Committee on State and Local Taxes, and of its Subcommittees on Sales & Use Taxes, Interstate Transactions, and Important Developments; Past Chair of the Tax Section, Washington State Bar Association. Mr. Young has taught or spoken at New York University, Georgetown University, University of Washington, Council on State Taxation, Tax Executives Institute, Institute of Professionals in Taxation, American Bar Association and others. Mr. Young received his B.S. from the United States Naval Academy (1966); his J.D. from the University of Washington (1975); and was Managing Editor of the Washington Law Review. Bob Mahon is a partner in the Seattle, Washington office of Perkins Coie, where his practice focuses on state and local tax planning, controversies, and litigation. Mr. Mahon is an Adjunct Professor (Tax) at the University of Washington School of Law. He currently serves as the President of the Tax Section of the Washington State Bar Association and has served for six years as chair of its State and Local Tax Committee. Mr. Mahon writes and speaks frequently on state and local tax topics, including authoring a monthly "U.S. Supreme Court Update" column in the JOURNAL OF MULTISTATE TAXATION AND INCENTIVES. He is also actively involved in numerous civic activities, including serving as the Vice Chair of the Seattle Ethics and Elections Commission and a member of the City of Seattle's Campaign Public Financing Advisory Committee. Mr. Mahon received his B.A. with honors from Grinnell College (1992); his J.D. with high distinction from the University of Iowa (1995); and his LL.M. in Taxation from the University of Washington (1996).

WISCONSIN STATE DEVELOPMENTS Maureen A. McGinnity Foley & Lardner LLP 777 East Wisconsin Avenue Milwaukee, WI 53202-5367 Tele: 414-297-5510 Fax: 414-297-4900 E-Mail: mmcginnity@foley.com Website: www.foley.com

I. Income/Franchise Taxes

A. Legislative Developments

New Disclosure Requirements. Wisconsin taxpayers must now disclose any federal "reportable transactions" (as designated by the Internal Revenue Service) with the Wisconsin Department of Revenue on a separate form. The disclosure requirements are retroactive to transactions that affect tax liability in years beginning after January 1, 2001. This means that transactions that occurred before this date are reportable if the transaction led to a decreased tax liability in a tax year beginning after January 1, 2001. The taxpayer must file with the Department within 60 days of the required filing of the federal form. However, if the transaction was required to be reported to the IRS before October 28, 2007, but has not yet been disclosed to the Department, the taxpayer must file by May 31, 2008. Penalties range up to $30,000 per undisclosed reportable transaction. Penalties also attach when an undisclosed transaction created a tax underpayment. Certain advisors to reportable transactions under federal law also must file the disclosure with the Department. Failure to do so can lead to a $15,000 penalty for a reportable but not listed transaction to $100,000 for a listed transaction. Such advisors must also maintain a list of taxpayers who have been advised regarding a reportable transaction. Advisors have earlier deadlines for reporting than participants. 2007 Wis. Act 20 § 2138, creating Wis. Stat. § 71.81 Tax Avoidance Transaction Voluntary Compliance Program (Tax Amnesty). In conjunction with the new reporting requirements, Wisconsin is also allowing a limited amnesty from tax penalties. New legislation allows taxpayers who have engaged in "tax avoidance transactions" (generally any transaction entered into for the principal purpose of avoiding federal or Wisconsin income or franchise tax) to pay tax and interest while avoiding penalties that may be later imposed on the transaction. Taxpayers must file under the program on or before May 31, 2008. When the taxpayer pays the amount of Wisconsin income or franchise tax due to the tax avoidance transaction and the amount of interest due, the Department will waive all penalties applicable to the underreporting or underpayment of tax. The application must be filed on or before May 31, 2008. The taxpayer must file a complete amended Wisconsin tax return without including the tax avoidance transaction. A taxpayer who takes advantage of this program may not appeal or claim a credit for the tax avoidance transaction, except where omitting the transaction led to an adjustment to the taxpayer's federal income tax liability. 2007 Wis. Act 20 § 2137 creating Wis. Stat. § 71.805. In all, the new provisions are fairly limited. Wisconsin taxpayers will now send copies of federal disclosure forms to the Wisconsin Department of Revenue, which may make it slightly more likely that the state will investigate any transactions. Some taxpayers have engaged in transactions that specifically lower their Wisconsin income or franchise, but not federal, tax liability, and will not need to be reported under the new rules. To the extent taxpayers believe the Department of Revenue will investigate these transactions, litigate, and win (or force taxpayers into expensive settlements), taxpayers will need to weigh the risks and rewards of the voluntary compliance program. Dairy Manufacturing Facility Investment Credit. 2007 Wis. Act 20 § 1966 created Wis. Stat. § 71.07(3p), the Dairy Manufacturing Facility Investment Credit. The credit is available to businesses modernizing or expanding a dairy manufacturing operation, effective for taxable years on or after January 1, 2007. S corporations, partnerships, limited liability companies, estates, and trusts may compute and pass through the credit to their respective shareholders, partners, members, and beneficiaries. The maximum credit available for fiscal year 2007-2008 is $600,000, but increases to $700,000 for fiscal year 2008-2009 and subsequent years.

Filing Extensions. 2007 Wis. Act 20 §§ 2018 and 2087 amended Wis. Stat. §§ 71.24(7) and 71.44(3) to allow corporations a seven-month automatic extension of time to file a return. Further, any extension of time granted by law or the IRS also extends the time to file a Wisconsin return by such extension of time plus thirty days. Additional Exemption to Withholding for Nonresident Members of Pass-Through Entities. 2007 Wis. Act 20 §§ 2131, 2133, 2134, 2135 and 2132 amended Wis. Stat. §§ 71.775(3)(a)2., (4)(b)2., and (4)(d) and (f), and created Wis. Stat. § 71.775(3)(a)3 (together, the “Withholding Act”). Under the current law, a pass-through entity for federal income tax purposes is required to pay a withholding tax on a nonresident member’s share of income attributable to Wisconsin with two exceptions: (1) the member is exempt from Wisconsin income tax, or (2) the member’s share of income from the pass-through entity is less than $1,000. Effective for taxable years beginning on or after January 1, 2006, in addition to the two exemptions described above, the Withholding Act provides that a pass-through entity does not need to withhold Wisconsin income tax on a member’s share of income attributable to Wisconsin if the member files an appropriate affidavit with the Department in which the member agrees to file a Wisconsin income or franchise tax return and be subject to the personal jurisdiction of the Department, the Tax Appeals Commission, and the courts of Wisconsin for the purpose of determining and collecting Wisconsin income and franchise tax and related interest and penalties. Development Zones Credit. Effective April 10, 2008, for those seeking the development zone capital investment credit, applications shall receive higher priority for airport development projects located or proposed to be located in a distressed area. In addition, the Department of Commerce must designate an airport development zone within northern Wisconsin. The legislation also alters funding allocation among several development credit programs. 2007 Wis. Act 183, amending Wis. Stat. §§ 560.798(2)(b), 560.7995(3)(b), 560.7995(4)(b) and 560.96(2)(b), and creating Wis. Stat. 560.7995(2)(d) and 560.7995(4)(am).

B. Judicial Developments

Capital Contributions. In Minocqua Country Club, Inc. v. Department of Revenue, [2 Wis.] St. Tax Rep. (CCH) ¶ 401-055 (Tax App. Comm’n Nov. 7, 2007), the Commission ruled that deposits paid by the members of a private golf club to finance expansion of the course and other facilities constituted taxable income to the club rather than non-taxable contributions to capital. The Commission found such deposits did not qualify as capital contributions because they (i) were not pro rata, (ii) did not have an investment motive, and (iii) allowed members to continue receiving services from the club. Advertising Services. In Ameritech Publishing, Inv. v. Department of Revenue, [2 Wis.] St. Tax Rep. (CCH) ¶ 401-075 (Tax App. Comm’n Jan. 22, 2008), the Commission ruled that an out of state corporation’s performance of directory advertising services for advertisements placed in Wisconsin telephone directories constituted the performance of income-producing activities in Wisconsin. For corporations that engaged in business both inside and outside the state of Wisconsin during the years at issue, 1994-1997, Wis. Stat. § 71.25(6) contained a three-factor apportionment formula relating to the taxpayer’s sales (50%), payroll (25%), and property (25%). Ameritech concerned the amount of the taxpayer’s directories advertising revenue that was includable in the numerator of the 50% sales factor fraction. Notwithstanding the fact that most of the taxpayer’s employees and independent contractors solicited, created, developed, designed, assembled, and produced the advertisements at issue outside Wisconsin, the Department prevailed in arguing that the taxpayer’s income-producing activities were performed entirely within Wisconsin. The Commission relied on one of its previous decisions, The Hearst Corporation v. Department of Revenue, [1990-1993 Transfer Binder Wis.] St. Tax Rep. (CCH) ¶ 203-149 (Tax App. Comm’n May 15, 1990), that had very similar facts and held that national advertising income was a result of income-producing activity of broadcasting in Wisconsin, and was therefore fully includable in the sales factor fraction. The taxpayer failed to distinguish Hearst, and the Commission ruled because of precedent, and the fact that virtually all who received the directories were located in Wisconsin, the income-producing activities were performed in Wisconsin. Gain on Sale of Partnership Interest. In Louis Dreyfus Petroleum Products Corp. v. Dep’t of Revenue, [2 Wis.] St. Tax Rep. (CCH) ¶ 401-072 (Tax App. Comm’n Jan. 2, 2008), a Wisconsin out-of-state corporation that sold its interest in a partnership had capital gain income from the sale that was apportionable to Wisconsin. However, interest income that the corporation derived from a loan to its parent company was not apportionable to Wisconsin, despite the fact that the loan was made using a portion of the proceeds from the sale of the partnership interest. When the corporation sold its partnership interest, it sold its rights to the specific partnership property of the partnership. The partnership’s assets included ownership or leasehold interests in certain travel centers, one of which was located in Wisconsin. The corporation was co-owner of the partnership’s property in Wisconsin, and income from the sale of that property, which was used in the production of business income, was apportionable income.

Although the capital gain appeared to be apportionable under Wisconsin law, such apportionment still had to pass constitutional muster under the unitary business and operational function tests. There were essentially no facts in the record showing a history or pattern of arm’s-length transactions between the corporation and the partnership. Because its ownership interest in the partnership was the corporation’s only business activity, and the partnership was a general partnership, there was little support for drawing a distinction between the two entities for tax purposes; overall, the record showed that they were functionally integrated. In addition, the corporation’s 50% ownership of and concomitant right to control the partnership via representation on the partnership executive committee reflected an active, rather than passive, investment. Therefore, the facts indicated that the partnership and the corporation had centralized management. Further, because the partnership was the corporation’s only business activity, the two entities were in the same line of business. The corporation provided half of the capital investment to start up the partnership and had joint control over the management of the partnership’s capital requirements. These facts showed that there were economies of scale between the corporation and the partnership, and in sum the applicable factors all indicated that the corporation and the partnership were a unitary business. The record also showed that, from inception to disposition, the corporation’s investment in the partnership served an operational purpose tied to the parent company’s ongoing operations. The parent company was in the business of selling petroleum products to the corporation’s general partner. To bolster this relationship and to profitably use its hedging transaction expertise, the parent formed the corporation and entered into the partnership. When the partnership terminated, the proceeds from the sale were returned to the parent to use as working capital in its ongoing business. Accordingly, the corporation’s investment in the partnership served an operational rather than investment function. With respect to the corporation’s interest income, however, the Department’s assessment of additional tax was incorrect. After selling its interest in the partnership, the corporation no longer had a unitary or operational connection with the partnership, and the corporation ceased to have any contacts with Wisconsin. Therefore, when the corporation made the loan to the parent company, the interest income from that loan was not apportionable to Wisconsin. II. TRANSACTIONAL TAXES (SALES AND USE)

A. Legislative Developments

Sales Tax Definitions. The definitions of “gross receipts,” “purchase,” “retail sale,” “retailer” “sale,” “sale, lease or rental,” and “sale at retail” and “seller” have all been expanded to repeal the decision in Dep’t of Revenue v. River City Refuse Removal, Inc., 299 Wis. 2d 561, 729 N.W.2d 396 (2007). In River City, the Wisconsin Supreme Court held that transfers of trucks, tractors and tractor trailers between related subsidiary corporations of a common parent were not taxable transactions. The sole consideration received for each transfer consisted of a book entry to an inter-company account payable or receivable. The court held that the subsidiary corporations lacked the requisite mercantile intent in transferring the assets and therefore were not “retailers” under Wis. Stat. § 77.51(13)(a), and that recording inter-company payables and receivables did not amount to “consideration” pursuant to § 77.51(12)(a). The definitions referenced above now include transactions with the consideration of a sale on credit, for which there is an obligation to pay money in the future or the creation of a receivable to be received in the future. Additionally, sales tax applies to transactions regardless of whether or not the transaction is mercantile in nature, the seller sells smaller quantities from inventory, the seller makes or intends to make a profit, the seller or buyer obtains a benefit the seller or buyer bargained for, the percentage of the seller’s total sales the transaction represents, and any activities other than those described in pars. (a) to (o) of Wis. Stat. § 77.51(13). See 2007 Wis. Act 20 §§ 2200m, 2224ac, 2237d, 2253d, 2253e, and 2269d, amending Wis. Stat. §§ 77.51(4)(c)1, 77.51(12)(a), and creating Wis. Stat. §§ 77.51(13)(p), 77.51(14)(m), 77.51(14)(n) and 77.51(17)(a) to (f). Motion Picture Exemption. Wis. Stat. 77.54(23m) has been amended to expand the exemption of the gross receipts from the sale, lease, or rental of or the storage, use or other consumption of motion picture film or tape to now include “motion pictures or radio or televisions for listening, viewing or broadcast.” 2007 Wis. Act 20 § 2381. “Green” Power Exemption. Newly created Wis. Stat. § 77.54(56) establishes an exemption for the gross receipts related to a product whose power source is wind energy, direct radiant energy received from the sun, or gas generated from anaerobic digestion of animal manure and other agricultural waste so long as the product produces at least 200 watts of alternating current or 600 British thermal units per day. The exemption does not apply to an uninterruptible power source that is designed primarily for computers. 2007 Wis. Act 20 § 2419c. Rock County Sales Tax. Rock County adopted a county sales tax effective April 1, 2007. Wis. Dep’t of Rev. Sales and Use Tax Rep. March 2007.

B. Judicial Developments

Taxability of Real Property Improvements. In Visu-Sewer Clean & Seal, Inc. v. Dep’t of Revenue, 2007 WI App 251, 742 N.W.2d 74 (Ct. App. Oct. 4, 2007), aff’g [2 Wis.] St. Tax Rep. (CCH) ¶400-920 (Cir. Ct. Dane County June 12, 2006), aff’g 2005 WL 2569323, [2 Wis.] St. Tax Rep. (CCH) ¶400-850 (Tax App. Comm’n Oct. 6, 2005), the Wisconsin Court of Appeals affirmed the Dane County Circuit Court’s determination that the installation of sewer liners in previously existing sewer lines is subject to Wisconsin sales and use tax as real property construction activity. Section 77.51(2) of the Wisconsin Statutes provides that contractors are consumers of tangible personal property used in real property construction activities. The taxpayer installed liners into host sewer pipes to plug leaks in the pipes and extend their useful lives. The court applied the three factors outlined in Department of Revenue v. A.O. Smith Harvestore Products, Inc., 72 Wis. 2d 60, 67-68, 240 N.W.2d 357, 360 (1976) and determined that the sewer liners, once installed, became part of the real estate. The court found that (1) the sewer liners were physically annexed to the real estate, (2) the liners are adapted to the purpose to which the sewers are devoted, and (3) such installation formed a permanent accession to the property. The court rejected the taxpayer’s argument that such activities constitute exempt manufacturing activities because Wis. Admin. Code Tax § 11.39(4) (2006) makes real property construction activity mutually exclusive from exempt manufacturing activities. Netting of Assessment and Refund Claims. In Badger State Ethanol, L.L.C. v. Dep’t of Revenue, 2007 WL 2875486, [2 Wis.] St. Tax Rep. (CCH) ¶ 401-036 (Tax App. Comm’n Sept. 26, 2007), the Commission held that the taxpayer could not unilaterally net a sales tax assessment from one year against a sales tax refund from a different year. The taxpayer filed a voluntary compliance agreement for unpaid sales tax related to calendar years 2002-2004 and agreed to pay an assessment of $516,000, plus interest at 18%. Prior to paying the assessment, the taxpayer filed a refund claim for calendar year 2005 for $246,000, plus interest at 9%. The taxpayer then offset the amount due on the assessment by the amount of the refund claim including any resulting interest. The Department subsequently denied the refund claim. The commission reasoned that the offsetting of interest lies with the discretion of the Department pursuant to Wis. Stat. 77.59(5) and is therefore outside the commission’s jurisdiction. Additionally, the commission reasoned the unrelated factual basis between the assessment and refund prevented the application of the doctrine of equitable recoupment. Under that doctrine, a party may assert an otherwise barred claim as a set-off against a claim brought by the opposing party, provided the claim arises from the same transaction or occurrence as the opponent’s claim, seeks relief of the same kind or nature, and does not seek an amount in excess of the opponent’s claim.

C. Administrative Developments

Interstate Sports Club Apportionment. The Department of Revenue has amended Wis. Admin. Code Tax § 2.505, to reflect that interstate professional sports clubs are subject to the same form of single sales factor apportionment as corporations in general. Prior to the amendment, the rule provided for apportionment according to the previously used three-factor formula with sales weighted 50%, and property and payroll each weighted 25%. Wis. Admin. Reg. No. 627, April 1, 2008.

D. Trends/Outlook for 2008

Combined Reporting Legislation. The Wisconsin Senate recently passed legislation that would require all corporations and their subsidiaries to file combined reports and tax returns for state income and franchise tax purposes. If enacted, the legislation will apply to taxable years beginning on January 1, 2008. 2007 SB 510. A number of organizations have voiced strong opposition to such legislation. III. PROPERTY TAXES

A. Legislative Developments

Abandoned Property. 2007 Wis. Act 157 amends Wis. Stats. §§ 177.06(3)(b) and 177.17(4)(a)1, which address abandoned property, to define “fiscal year” as the period beginning on July 1 and ending on June 30. A holder of abandoned property must file a report with the Wisconsin State Treasurer by November 1 for the preceding fiscal year. Exemption for High Density Sequencing System. 2007 Wis. Act 20 § 1935d created Wis. Stat. § 70.111(26), which establishes a personal property tax exemption for high density sequencing systems that by mechanical or electronic operation move printed materials from one place to another within the production process, organize the materials for optimal staging, or store and retrieve the materials to facilitate the production or assembly of such materials. The new exemption is effective October 26, 2007.

Property Tax Assessment Objection Procedure. On March 13, 2008, Governor James Doyle signed into law 2007 Wisconsin Act 86 (Act 86), which significantly curtails non-manufacturing property owners' options for challenging property tax assessments in municipalities that adopt ordinances allowing taxpayers to obtain a 60-day postponement of board review hearings. Act 86 applies retroactively to property tax assessments as of January 1, 2008. Prior to the enactment of Act 86, all Wisconsin taxpayers other than manufacturers (who are assessed by the State Department of Revenue) had the choice of two principal avenues to obtain court review of local property tax assessments: (1) the certiorari review procedure under Wis. Stat § 70.47, or (2) a claim for recovery of an excessive assessment and de novo refund action under Wis. Stat § 74.37. Both avenues required the taxpayer first to file an objection to the assessment and participate in a hearing before the local board of review. Court review of the board's determination under the Wis. Stat § 70.47 certiorari procedure was limited to a review of the record evidence presented before the board, with the court giving the decision of the board substantial deference. Review under Wis. Stat § 74.37, on the other hand, permitted a taxpayer to seek relief from the taxation district and, if unsuccessful, to challenge the assessment anew on any grounds in a de novo refund action filed in circuit court. In the de novo circuit court action, the parties could present evidence not submitted to the board previously, and the court was not required to give any deference to the board of review's prior decision. Act 86 eliminates the uniformity of these review options, empowering municipalities to deprive property owners of the Wis. Stat § 74.37 claim for excessive assessment and de novo court review option so long as the municipality adopts an ordinance that gives property owners the right to request a 60-day postponement of the board of review hearing (extension ordinance). To take advantage of the extension, the taxpayer must pay a $100 fee. The 60-day period may be further extended by the taxpayer upon a showing of good cause. In contrast, absent an extension ordinance boards of review may schedule hearings on 48 hours' notice. Under Act 86, other board of review procedures and court review options also vary according to whether or not the municipality has adopted an extension ordinance.

• In municipalities that adopt an extension ordinance, and regardless of whether or not the taxpayer invokes the extension, both the taxpayer and the assessor are required to present “all evidence” (to be specified in the Wisconsin Property Assessors Manual) at the board of review hearing.

• If the municipality has enacted an extension ordinance, and if the taxpayer requests an extension, then the taxpayer and assessor must simultaneously exchange reports and other exhibits they intend to submit at the hearing at least 10 days prior to the hearing.

• If the municipality has enacted an extension ordinance, and regardless of whether or not the taxpayer requests an extension, the board of review may, upon a showing of good cause, compel the attendance of witnesses for deposition prior to the hearing.

• If a taxpayer is seeking review of a board of review determination in a municipality that has enacted an extension ordinance, then the traditional certiorari review standards under § 70.47 are modified. So long as the taxpayer rebuts the presumption of correctness (by coming forward with evidence that supports the taxpayer's position), then the court on review determines the assessment without deference to the board of review. Moreover, the court on review may consider evidence outside the board of review record if the evidence was not available as of the time of the board of review hearing, or if the board of review refused to consider the evidence, or if the court otherwise determines the evidence should be considered to determine the correct assessment.

Act 86 also makes a number of modifications to board of review and court review procedures that do not depend on whether the municipality has enacted an extension ordinance, and which should be beneficial to all taxpayers. Specifically, Act 86:

• Requires boards of review to allow “a sufficient amount of time for a hearing” on an objection to an assessment to permit both the taxpayer and the assessor to present their evidence

• Requires boards of review to compel the attendance of witnesses at the hearing at the request of either the taxpayer or the assessor, whereas prior law only mandated attendance on behalf of the assessor and gave the board the discretion to determine whether to compel witnesses at the taxpayer's request

• Permits the parties to agree that, where a subsequent year's assessment has not been resolved as of the time a § 70.47 action is filed in court to challenge a prior year's assessment, the court may review the subsequent year's assessment in the same action without an additional hearing by the board of review

Finally, Act 86 reduces the interest rate payable on refund claims. Whereas interest on refunds previously was allowed at the rate of 0.8 percent per month, or 9.6 percent per year, the interest rate now is tied to the annual discount rate determined by the last auction of six-month U.S. treasury bills. The City of Milwaukee has enacted an extension ordinance, so the new provisions will apply to Milwaukee assessments as of January 1, 2008.

B. Judicial Developments

Waste Treatment Facilities; Presumption of Correctness. Wis. Stat. § 70.11(21) exempts property “purchased or constructed as a waste treatment facility used for the treatment of industrial wastes, . . . for the purpose of abating or eliminating pollution.” In City of Green Bay v. Dep’t of Revenue, [2 Wis.] St. Tax Rep. (CCH) ¶ 401-070, at 34,971 (Tax App. Comm’n Dec. 21, 2007), the commission upheld the board of assessors’ determination that the exemption applied to a paper recycling and manufacturing plant under the authority of The Newark Group, Inc. v. Dep’t of Revenue, [2 Wis.] St. Tax Rep. (CCH) ¶ 400-740 (Tax App. Comm’n Mar. 22, 2004), aff’d, [2001-2005 Transfer Binder Wis.] ¶ 400-809 (Wis. Cir. Ct. Dane County Jan. 31, 2005). The department did not appeal the circuit court decision in Newark and was deemed to acquiesce in the court’s statutory construction pursuant to § 73.015(2) (department obligated to follow circuit court’s statutory construction from which it fails to appeal). The commission held in Green Bay that as the party challenging the assessment, the city had the burden of overcoming the presumption of correctness of the board of assessors determination. It rejected the city’s argument that the taxpayer, who had intervened in the action, had the burden of proof. [2 Wis.] St. Tax Rep. (CCH) ¶ 401-070, at 34,972-34,973. The city urged the commission to conclude that Newark was wrongly decided, based in part on the legislature’s post-Newark amendment of § 70.11(21). 2007 Wis. Act 19, secs. 1-2. The commission noted that although the amendment tightened the requirements for the exemption, it was first effective for assessments made as of January 1, 2007 and therefore did not apply to this case, which involved a 2005 assessment. Id. at 34,974. The commission discussed, but did not expressly decide, whether it had the authority to reverse its Newark decision, were it inclined to do so. The city argued the commission is not bound by its prior decisions and that circuit court decisions have no precedential value. The commission observed, however, that the court of appeals has stated the purpose of § 73.015(2) is served if both the department and the commission are bound by unappealed circuit court decisions. Id. at 34,975. The commission reasoned that even if it could choose not to follow Newark, the city had failed to prove Newark was incorrectly decided. First, contrary to the city’s contention, the Newark determination that pollution abatement includes pollution prevention was reasonable in light of the legislative history that referenced prevention; was necessary to avoid the absurd result that a facility that produced pollution and routed it to a waste treatment facility would benefit from the exemption, whereas a facility that prevented the creation of pollution in the first place would not; and the fact the legislature did not restrict the definition of pollution abatement in its 2007 amendment suggested the Newark construction was correct. Id. at 34,974-34,976. Second, the fact the property at issue was manufacturing property did not affect the applicability of the waste treatment facility exemption because the exemption only required that pollution abatement be one of the purposes for which the property was used, not the primary purpose. Id. at 34,976. Although it “reaffirmed” Newark in the Green Bay case, the commission limited the scope of the exemption, accepting the city’s “partial exemption” argument, i.e. that only the specific areas of the plant where waste treatment occurred qualified for the exemption. Whereas the commission held in Newark that the entirety of the paper mill was exempt, including the office and parking lots, it held in Green Bay that the main office, maintenance shop, parking lots, and shipping building were not exempt. Id. at 34,976-34,977.

Computer Exemptions. Wis. Stat. § 70.39 exempts from property tax “mainframe computers, minicomputers, personal computers, networked personal computers, servers, terminals, monitors, . . . electronic peripheral equipment, [and] printers,” but the exemption does not apply to “fax machines, copiers, [or] equipment with embedded computerized components.” The issue in the Xerox Corp. case is whether the exemption applies to multifunction document processing equipment that combines a computer server, scanner, printer, and fax capabilities (“MFDs”).

The Commission held that the MFDs are taxable as copiers and fax machines. Xerox Corp. v. Dep’t of Revenue, [2001-2005 Transfer Binder Wis.] St. Tax Rep. (CCH) ¶ 400-814 (Tax App. Comm’n Feb. 17, 2005). This ruling followed an evidentiary hearing, including an equipment demonstration and the taxpayer’s presentation of expert witness testimony. The commissioner who conducted the hearing retired before issuing a decision, and the two commissioners who issued the decision did not consult with him. Xerox petitioned for circuit court review, arguing that the undisputed facts mandated a decision in its favor or, in the alternative, that if there were disputed factual issues, due process required that the commissioner who conducted the hearing participate in the decision. The circuit court held that the commission violated Wis. Stat. § 73.01(4) by failing to confer with the commissioner who heard the case, and it therefore remanded the matter for further proceedings. Xerox Corp. v. Dep’t of Revenue, [2 Wis.] St. Tax Rep. (CCH) ¶ 400-919 (Wis. Cir. Ct. Dane County July 18, 2006).

On remand, the commissioner who conducted the hearing provided a report and proposed findings of fact that supported Xerox’s position. Xerox Corp. v. Dep’t of Revenue, [2 Wis.] St. Tax Rep. (CCH) ¶ 400-999, at 34,489-34,493 (Tax App. Comm’n Mar. 23, 2007). The commission acknowledged that if it followed the hearing commissioner’s findings, it would be required to reverse its decision. Id. at 34,486-34,487. The commission held that it was not obligated to adopt the hearing commissioner’s proposed findings, however, and it reaffirmed its original decision without modification. Id. at 34,484-34,488.

Xerox filed a renewed petition for review which ultimately was assigned to a different judge than the judge who ordered the remand. The substitute judge upheld the commission’s decision on the merits, holding that the determination whether Xerox’s equipment fell within the exempt or taxable categories enumerated in Wis. Stat. § 70.11(39) was a question of law and that the commission’s decision was supported by common use dictionary definitions of the statutory terms. Xerox Corp. v. Dep’t of Revenue, [2 Wis.] St. Tax Rep. (CCH) ¶ 401-042 (Wis. Cir. Ct. Dane County Sept. 21, 2007). Xerox has appealed to the court of appeals. Xerox Corp. v. Dep’t of Revenue, Appeal No. 2007AP002884.

C. Trends/Outlook for 2008

Transfer Tax Returns. Proposed legislation recently passed by the Wisconsin Senate would provide more public information regarding real estate transfer tax returns, although it would continue to restrict the disclosure of personal information such as social security numbers Currently, such returns are subject to significant disclosure restrictions. The proposed legislation would also require electronic filing of all transfer tax returns. 2007 SB 549. IV. Taxation of Insurers

A. Judicial Developments

2007 Wis. Act 170 § 3 amends Wis. Stat. §76.68(2), effective April 9, 2008. The amendment makes suits against the state in Dane County Circuit Court the exclusive venue for insurers to recover any taxes, fees or administrative assessments. Such suits must be brought within six months from the time of payment. V. Other Notes of Interest

New Tax Appeals Commissioner. On February 29, 2008, Governor James Doyle announced the appointment of former circuit court judge Roger LeGrand as the newest member of the Tax Appeals Commission. The Tax Appeals Commission is an independent agency that hears and decides disputes between persons or entities and the Department of Revenue involving all major state-imposed taxes. Judge LeGrand begins his service on April 14, 2008 and serves until March 1, 2009. At the current time, there is only one other Tax Appeals Commissioner, David C. Swanson. The third seat on the Commission remains vacant. Gov. Doyle Press Release, Feb. 29, 2008. Electronic Filing. Electronic filing for several manufacturing property forms is now available. The Department of Revenue now accepts electronically filed returns (and extension requests) for M-P Forms (Manufacturing Personal Property), M-R Forms (Manufacturing Real Estate) and M-L Forms (Leased, Rented, or Loaned Personal Property). More information can be found at http://www.revenue.wi.gov/forms/manuf/m-forms.html. Publication of Delinquent Taxpayers. 2007 Wis. Act 20 § 2153p amends Wis. Stat. § 73.03(62), which concerns the internet posting of persons who owe delinquent taxes (including interest, penalties, fees, and costs to the Department of Revenue). The posting threshold is now only $5,000, whereas the previous posting threshold was $25,000. VI. Provider/s Brief Biography/Resume

Ms. McGinnity specializes in tax litigation, including federal and state income, franchise, sales and use tax litigation and state and local ad valorem and property tax litigation.

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