Daily Tax Report: State provides authoritative coverage of state and local tax developments across the 50 U.S. states and the District of Columbia, tracking legislative and regulatory updates,...
By Che Odom
States could run afoul of the Constitution by following a federal border-adjustments plan advocated by House Speaker Paul Ryan (R-Wisc.) to tax imports and exempt exports.
The commerce clause, and even the equal protection clause, could factor in how states respond to whatever bill is finally presented by Ryan and other congressional members.
Border adjustments, part of Ryan’s broader tax blueprint, haven’t yet been introduced in the House. President Trump has said he thinks they are “complicated,” but hasn’t said he opposes the idea.
Many details are unclear, such as how border adjustments would apply to direct sales from foreign businesses to U.S. individuals.
Some state tax experts, however, say not all states will be impacted the same way if the adjustments become law. And constitutional pitfalls loom large depending on whether and how they conform to federal law.
States such as California, New York and Texas that require “combined” or “unitary” reporting of business income, which counts income from all business units inside and outside the state, could find border adjustments a particularly complicated matter.
The problem is the foreign commerce clause and the U.S. Supreme Court’s 1992 ruling in Kraft General Foods Inc. v. Iowa Department of Revenue and Finance, Steve Wlodychak, a principal at Ernst & Young LLP who focuses on state, local and federal tax issues, told Bloomberg BNA.
“As I read that ruling, states can’t discriminate in the tax treatment of foreign companies, and that goes even if the state merely follows the federal treatment of a transaction,” Wlodychak said.
In Kraft, Iowa required the taxpayer to report taxable income based on an Internal Revenue Code that excluded foreign dividends from a deduction. Iowa’s conformity to the code meant that it also taxed foreign dividends, but not those received from domestic companies.
“The same principle should theoretically apply to border adjustments,” Wlodychak said. “Inputs from foreign companies would not be deductible while inputs from U.S. domestic companies would.”
And he said it’s unclear whether that would be constitutional.
But if the federal legislation limits federal income tax deductions, such as the cost of goods sold for goods imported into the country, a state income tax that simply uses the federal tax base may not violate the commerce clause, according to Kirk Lyda, a Dallas-based partner in Jones Day’s tax practice.
In Kraft, Iowa didn’t tax dividends from domestic subsidiaries doing business outside Iowa, “notwithstanding the fact that Iowa largely piggy-backed off the federal tax base,” he said.
However, “if a state imposes its income tax on a unitary combined basis, the analysis would become more complex, as cases since Kraft have noted,” Lyda said.
Indeed, an unanswered question surrounding the border-adjusted tax is whether companies would apply the adjustment to the entity level or the business as a whole, according to Peter Michalowski, national practice leader of PwC LLP’s state and local tax practice.
Other constitutional provisions prohibiting discrimination against foreign commerce, such as the equal protection clause, might also come into play for states, depending on what Congress enacts, Lyda said.
Another interesting question relates to calculating the sales factor for purposes of calculating income, Wlodychak said.
States typically allow the use of generally accepted accounting principals for determining gross revenue or that reported on Internal Revenue Service Form 1120, he said.
“If export revenues aren’t even reported or otherwise excluded from the determination of gross receipts, would that mean that the sales factor denominator would be diluted by the exclusion of exports in the factor?”
States would have to modify their determination of gross receipts for factor-apportionment purposes or maybe not because of the border adjustability feature in determining the gross receipts in the first place, he said.
“I am not sure of the answer,” he said.
To contact the reporter on this story: Che Odom at COdom@bna.com
To contact the editor responsible for this story: Ryan C. Tuck at firstname.lastname@example.org
Copyright © 2017 Tax Management Inc. All Rights Reserved.
All Bloomberg BNA treatises are available on standing order, which ensures you will always receive the most current edition of the book or supplement of the title you have ordered from Bloomberg BNA’s book division. As soon as a new supplement or edition is published (usually annually) for a title you’ve previously purchased and requested to be placed on standing order, we’ll ship it to you to review for 30 days without any obligation. During this period, you can either (a) honor the invoice and receive a 5% discount (in addition to any other discounts you may qualify for) off the then-current price of the update, plus shipping and handling or (b) return the book(s), in which case, your invoice will be cancelled upon receipt of the book(s). Call us for a prepaid UPS label for your return. It’s as simple and easy as that. Most importantly, standing orders mean you will never have to worry about the timeliness of the information you’re relying on. And, you may discontinue standing orders at any time by contacting us at 1.800.960.1220 or by sending an email to email@example.com.
Put me on standing order at a 5% discount off list price of all future updates, in addition to any other discounts I may quality for. (Returnable within 30 days.)
Notify me when updates are available (No standing order will be created).
This Bloomberg BNA report is available on standing order, which ensures you will all receive the latest edition. This report is updated annually and we will send you the latest edition once it has been published. By signing up for standing order you will never have to worry about the timeliness of the information you need. And, you may discontinue standing orders at any time by contacting us at 1.800.372.1033, option 5, or by sending us an email to firstname.lastname@example.org.
Put me on standing order
Notify me when new releases are available (no standing order will be created)