Expert Insight: COST's Hot State Tax Topics in 2013

In this Expert Insight, we speak with Ferdinand Hogroian and Fred Nicely from the Council on State Taxation (COST) about the issues they expect to be “hot topics” in 2013.  COST is a nonprofit trade association with nearly 600 members, making it the premier state tax organization representing taxpayers.  COST's objective is to preserve and promote equitable and nondiscriminatory state and local taxation of multijurisdictional business entities.

Independent Tax Tribunals

BBNA : More than half the states have adopted independent state tax tribunals (either in the judicial or executive branch). In the 2012 legislative session, Georgia and Illinois enacted bills to establish independent state tax tribunals. The issue was also considered in Alabama, Louisiana, Oklahoma, and Pennsylvania.

What are the prospects for the Alabama tax tribunal created by the “Alabama Taxpayers’ Bill of Rights II” which was passed by the legislature last year but pocket vetoed by the governor? Are there any other states that are likely consider similar legislation this year?

Hogroian : Fairness can only be achieved through a truly independent tax tribunal. The tribunal must not be located within or report, directly or indirectly, to the department of revenue or to any subordinate executive agency. Without independence, the appearance of objectivity is simply not present. That perception, regardless of its accuracy, necessarily detracts from even exemplary personnel and work product of the adjudicative body. 

As noted, last year saw adoption of independent tax tribunals in Georgia and Illinois, and this year has seen legislation to this effect introduced in multiple states. In addition to those listed, Colorado also saw independent appeals tribunal legislation introduced this year. While it is premature to opine on the prospects for proposals in the various states, it is fair to say that the proposed Alabama Tax Appeals Tribunal (ATAC) is very near the finish line. As noted in COST’s letter to Governor Bentley, this year’s reintroduction of legislation (H.B. 264 and S.B. 223) addresses the technical issues that caused the “pocket veto” of similar legislation last year, in particular concerning how the ATAC judges are chosen. We are very hopeful for enactment in Alabama this year and potentially of similar reforms in other states such as Oklahoma, Pennsylvania, and Louisiana.

Qui Tam Lawsuits

BBNA : The Federal False Claims Act, which allows private citizens to bring lawsuits on behalf of the government, does not authorize such actions to be initiated on tax-related grounds. But many states have adopted their own version of the False Claims Act that does not include such a ban. In fact, 29 states and several major municipalities have False Claims Act or qui tam statutes that allow private citizens to bring so-called “whistleblower” lawsuits against companies on tax related grounds. 

Does COST have a position with respect to qui tam tax lawsuits? What types of issues does this type of lawsuit raise for your members?

Nicely : COST is concerned with state laws that allow qui tam actions (under state false claims acts) and/or class action suits in tax disputes. State tax challenges using either a qui tam action or a class action suit are made outside of the purview of the state agency responsible for the administration of the tax, including any resulting appeals of a tax determination. These suits do not occur in specialized tax tribunals and, compounding matters, these courts are faced with interpreting grey areas in a state’s tax law, often with limited input from the state’s tax agency. 

Qui tam suits are often used in cases of the asserted under-collection of tax, often involving issues such nexus or failure to collect the tax on a component of a transaction (e.g., delivery charges). A defendant subject to a qui tam suit not only has to defend itself on grounds of whether it owes the tax, but it will likely also face treble damages and attorney’s fees in the action.  

Class action suits are often focused on an asserted over-collection of the tax, e.g., resulting from nontaxable items or a tax rate difference. In a class action suit, a taxpayer is faced with potential attorney’s fees and refunding taxes that have already been remitted to the state. Sellers are mandatory tax collectors for the state. It is unfair to place the burden of class action lawsuits on these sellers, already inadequately compensated for the administrative burden of collecting and remitting a state’s tax. Such refund requests should be handled by the entity that gives guidance to the tax collectors on what is taxable – the states’ tax agencies. A state’s tax agency is in the best position to determine if an error was made and, if an error was made, to process the refunds.   

COST supports changes to a state’s tax law to ensure neither qui tam nor class action suits apply in state and local tax disputes. The ABA has developed a model act, the Transactional Tax Overpayment Model Act, which can be used for guidance.

Contingent Fee Audits

BBNA : In 2012, North Carolina enacted H.B. 462, which expressly prohibits the state’s Secretary of Revenue from hiring contingent fee auditors. What do you believe were some of the major factors that led to the legislation’s enactment? Are there other states that are likely to consider similar legislation in 2013?

Hogroian: Contingent-fee arrangements encourage auditors to be overly aggressive; to interpret State laws to their own advantage rather than in society’s best interest; to “cherry pick” audit targets; and to ignore taxpayer errors that would result in lower assessments. The risk of abuse creates a perception of unfairness that colors taxpayers’ relationships with administrators, and creates an atmosphere of mistrust that hinders compliance. All of these factors led to the enactment of H.B. 462 in North Carolina. While taxpayers had specific concerns regarding the conduct of local property tax audits in North Carolina, the bill as proposed and subsequently enacted addressed unclaimed property audits and DOR audits as well. It is good policy to apply a contingent fee audit ban to all taxes and unclaimed property, and we encourage the North Carolina General Assembly to repeal the sunset on the local property tax contingent fee audit ban, and to extend the unclaimed property contingent fee audit ban to all property types.  

I believe that we will see other states likely consider and enact similar legislation in 2013. Michigan considered legislation to apply a contingent fee audit ban on all taxes and unclaimed property in 2012, and momentum appears to be building based on North Carolina’s actions last year. The principal hurdle is convincing states and localities that budgeted audit activities, in spite of the outlay of funds, result in higher returns of revenue to the government, and thus to the public, as opposed to filling the pockets of private interests at the public’s expense. Public opinion could play a significant role here – especially where unclaimed property is involved. It is unconscionable that unclaimed property laws designed to protect the rights of property owners should be administered in a way that hands the property to “bounty hunters” whose sole motive is private gain.

Tax Reform and Restructuring

BBNA : Some of the states poised for tax reform after the 2012 elections include Louisiana and Nebraska, where the governors have proposed replacing the corporate and personal income taxes with a higher sales tax. Virginia Gov. Bob McDonnell began the year by proposing to replace the state’s gas tax regime with a higher sales tax.

Does COST have any stance on how tax reform should be achieved?

Hogroian : The concept of “tax reform” certainly varies according to the goals of the proponents: witness the differences between discussions in Ohio, Louisiana, and Nebraska on one hand, and Massachusetts and Minnesota on the other. However, unfortunately for business taxpayers, there appears to be one constant among the most recent crop of major tax restructuring proposals: applying sales taxes to business inputs. Estimates of the increased burden borne by businesses under some state proposals are as high as $2 billion in new taxes. COST will soon be releasing an updated study on the impact of sales taxes on business inputs, which will drive home the point that such taxes are bad tax policy by any measure, and must be avoided.

A sales tax on business inputs violates several tax policy principles—economic growth, equity, simplicity and efficiency—and causes a number of economic distortions. Notably, these distortions result from pyramiding, where a tax is imposed at multiple levels, such that the effective tax rate exceeds the retail sales tax rate. Companies are forced to either pass these increased costs on to consumers or reduce their economic activity in the State in order to remain competitive with other producers who do not bear the burden of such taxes. As a result of the choices businesses are forced to make, the economic burden of taxes on business inputs inevitably shifts to labor in the State (through lower wages and employment) or consumers (through higher prices).

Earlier this month (March 8), Governor Dayton announced that he was abandoning his proposal to expand the sales tax to business-to-business transactions. Further, opposition to service tax proposals in Ohio and other states is growing, in significant part because they largely rely on revenue from business purchases.

Sales Tax on Remote Access to Software

BBNA : The state tax treatment of remote access to software or “cloud computing” varies considerably among the states. State treatments ranges from a sale or license of software, an information or data processing service, or a digital product or enumerated digital service. The SSUTA member states have yet to adopt a uniform policy addressing the tax treatment of remote access to software and cloud computing models.

What do you see as the most effective way to achieve greater uniformity on this issue?

Nicely : It is troubling to see that several state tax agencies are attempting to tax the remote access to software as tangible personal property. While it is the prerogative of a state’s legislature to tax such access to software as a service (if it so desires), a state tax agency should not contort what constitutes taxable tangible personal property in attempt to tax a product (assuming access to software is not an enumerated service in the state). More problematic is that some state tax administrators are asserting that merely accessing information, such as using a tax research product, constitutes a purchase of “prewritten computer software.” The true object of the purchaser is not the indirect use of any software--it is obtaining the information service.

A purchaser paying to access software lacks the requisite possession and control of the software to constitute tangible personal property. Further, even if such a purchase is construed as tangible personal property, the tangible property is likely not located in the purchaser’s taxing jurisdiction (state and/or local taxing jurisdiction). This creates sourcing issues if the product is treated as tangible personal property; thus, this is another reason why access to software needs to be treated as a service. A purchaser’s location of use of a service controls for determining the taxable location of a service, while possession controls for sales of tangible personal property.

We hope that federal legislation, such as the Digital Goods and Services Tax Fairness Act, will be enacted to uniformly address this issue. 

Market-Based Sourcing for Sales Factor

BBNA : The latest round of proposed amendments (Dec. 6, 2012) to Article IV of the Multistate Compact would make a number of significant changes affecting businesses with income in more than one state. Among them would be amending the provisions governing “sales other than tangible personal property” by replacing “cost of performance” sourcing  with market-based sourcing. What are some issues that are likely to arise for multistate taxpayers that attempt to comply with this rule?

Hogroian : In 2009, COST wrote the Uniform Law Commission in opposition to an effort to revise UDITPA, citing a survey of our membership showing that those companies most affected by a rewrite “have no desire for endorsing such a lengthy and complex project with such poor prospects for success.” The Multistate Tax Commission will surely encounter the same concerns as they go forward with proposed revisions to Article IV of the Multistate Tax Compact. It is unlikely – perhaps beyond the realm of realistic possibility – that the MTC’s effort will result in uniform application of the changes being proposed.  

Market-based sourcing of services and intangibles is one such area: the MTC has gone through multiple proposed approaches, and has gutted previous proposals of the detail necessary for implementing the sourcing change. State adoptions in the interim have shown that there is little appetite in the states for “uniform” apportionment approaches. In fact, state actions have shown quite the opposite. Ultimately, decisions on changes to the apportionment formula will be driven by individual states’ economic development policies, which make uniformity efforts ill-suited for this area of tax law. The complexity of determining the “market” further guarantees that the ultimate work-product of the MTC – or any other organization delving into this area – is unlikely to be uniformly adopted. Multistate taxpayers therefore will continue to encounter and need to resolve these issues on a state-by-state basis (barring federal action to the contrary).

Property Tax—Split Roll and Split Rates    

BBNA : Can you explain the difference between “split roll” and “split rate” property taxes? What are the advantages for each? What are some of the justifications for imposing higher property taxes on commercial properties?  

Nicely : Unlike California, which caps property taxes for residential and businesses properties in a similar manner, some states are providing favorable property valuation increase limitations (caps) to residential property. Business properties in those states either have a higher cap or no cap limitation at all. This effectively creates a split roll tax system and, over time, inappropriately burdens the business sector with a greater share of the property tax. It is understood that some tax policymakers (e.g., legislators) want to appease voters (homeowners) by protecting them from property tax increases; however, those same homeowners also want jobs. In the long run, a split roll property tax structure will become an impediment to attracting (and retaining) businesses in a state. Property tax increases need to be controlled; however, the best mechanism to do that is to continue valuing all property at fair market value. Circuit breakers, which automatically reduce the property tax rates in a given tax jurisdiction as the jurisdiction’s property tax valuation base increases, are a much better approach to controlling rising property tax values in a state.  

Ferdinand Hogroian serves as COST’s Legislative Counsel. Ferdinand’s responsibilities at COST include state and federal legislative analysis, monitoring, and advocacy, as well as engagement on a variety of administrative and judicial issues impacting COST’s member companies. Ferdinand has written on SALT topics for numerous publications, including the BNA Multistate Tax Report, and is a frequent speaker at local and national conferences.

Fred Nicely is COST’s Senior Tax Counsel.  Fred’s role extends to all aspects of the COST mission statement: “to preserve and promote equitable and nondiscriminatory state and local taxation of multijurisdictional business entities.” He is a frequent speaker and author on Ohio’s tax system and on multistate tax issues generally.

By Steven Roll and Melissa Fernley

Follow us on Twitter at: @BBNATax
Join BNA's State Tax Group on LinkedIn here.