Insight: Reed Smith’s Relationships: Ronald Penny, Secretary of Revenue, North Carolina Department of Revenue

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Reed Smith attorney Jeremy Abrams meets regularly with heads of state revenue departments to bring Bloomberg Tax readers candid and timely observations from the country’s top state tax decision-makers. In this column, North Carolina Secretary of Revenue Ronald Penny discusses his career and background, recent and proposed changes to North Carolina tax laws, and his greatest challenges in leading the Department of Revenue.

Ronald G. Penny Jeremy S. Abrams

Interview by Jeremy Abrams

Ronald Penny is Secretary of the North Carolina Department of Revenue. Jeremy Abrams is an attorney with Reed Smith LLP and can be reached at jabrams@reedsmith.com. Megan Miller contributed to this article and can be reached at megan.miller@reedsmith.com.

Editor’s Note: This interview between Ronald Penny and Reed Smith’s Jeremy Abrams originally took place in October 2017. Some updates appear in brackets. At the conclusion of the interview are recent North Carolina developments that have occurred since this interview took place.

Voting Rights Advocate

Abrams: Great to see you again, Ron. It’s been almost five months since you were confirmed as Secretary in June. [Ed. Note: Governor Roy Cooper named Ronald Penny Acting Secretary on January 3, 2017, and he was unanimously confirmed by the North Carolina Senate as the Secretary of Revenue on June 15, 2017.] You’ve had a fascinating career up to this point. In particular, you were an accomplished voting rights advocate for the NAACP at one point. How does that experience compare to being Revenue Secretary?

Penny: It isn’t all that different in the sense that, one, voting rights are premised a lot on the Constitution of the United States and most real substantive tax cases these days are not really swirling around the code, they’re swirling around the U.S. Constitution, or the various state constitutions. So it’s similar in the analysis and in using that foundational document. And the other thing that’s similar is that because in North Carolina we deal with both state and local taxes, an understanding of how government works is important in how you administer those taxes and how you talk to and advise the various local government tax administrators out there. So my work in that area – since I created many of the systems – I became uniquely familiar with local government. You can grab parts of your career and apply them in other parts of your career. But I will say this – back in the day when I was arguing voting rights cases, it was pretty easy to win. People were unfamiliar with the law and so those decisions – well, I never lost one.

Abrams: Can you be the same force for change in the tax space that you were in the voting rights space?

Penny: It’s a different world. And it’s a different role. My job is to collect and administer. But strangely enough, even though Governor Cooper and I are of a different party than the majority of our legislature, the finance committees and leadership of the General Assembly have been very open and non-partisan as it may be, as we talk about the needs of our department and as we talk about how to tax the citizens of North Carolina. We have a constitutional requirement that we be fair. And that is something that I think – it doesn’t matter whether you are a Democrat or a Republican in that you want to approach these issues in a fair and consistent manner. So we’ve had good relationships with our General Assembly. Obviously they confirmed me.

The Market-Based Sourcing Trend Continues

Abrams: I’ve heard you and many other commissioners say you don’t make policy, you just administer policy.

Penny: That’s our line. But I also recognize that there is some broad discretion given to the Secretary. But with that broad discretion comes broad responsibility to be a good fiduciary for the people of North Carolina, and to try to reach a fair decision.

Abrams: But I’m curious – because the Department has proposed market-based sourcing regulations pending the enactment of legislation – so I’m curious whether that’s something you’d like to see happen, and whether you can provide any update. [Ed. Note: Click here for a link to the proposed regulations which were approved by the North Carolina Rules Review Commission in February 2017 and will be entered into the North Carolina Administrative Code upon enactment of market-based sourcing legislation.]

Penny: I’m hopeful that the General Assembly will pass market-based sourcing but I can’t give you any specific information on the timing. One of our chambers – I won’t identify which one – is supportive of the concept. The other chamber, I don’t know if they’re against it, they just need to be educated about it. The proposed change to market-based sourcing along with the phasing in of single sales factor apportionment has created many issues, implications for certain companies that were never intended or anticipated by the General Assembly. So we need to give the General Assembly some of those examples to help them start making decisions. The Department is involved in the education process and we will continue to have discussions with the General Assembly. I don’t want to say I’m optimistic but I am not pessimistic.

Abrams: Many states have eliminated or capped their corporate franchise/net worth taxes. Might North Carolina be next?

Penny: I don’t believe they’re going to eliminate it. While I could foresee a movement towards a cap, that could have been done last year when they were lowering the rates on both the corporate tax and the franchise tax but it wasn’t done. I think this General Assembly is going to see how their corporate tax reductions have impacted our collection and our budget before they start tinkering with the franchise tax again.

This General Assembly has been very generous to our corporate taxpayers. They brought the corporate income tax rate down from three percent to two and a half percent last year. They believe they have put North Carolina in a position to compete for and retain industry here. So I will tell you that they’re going to look very cautiously as we talk about lowering or eliminating taxes. That being said, we are in regular communications about the concerns that industry has raised, particularly in the event that it is making us less competitive. To that extent, again the General Assembly would be at least open to the discussion.

Abrams: Can taxpayers or practitioners like me raise legislative concerns directly with the Department?

Penny: We have regular meetings with various industry groups and I am hoping to bring on another person whose main goal is to deal with industry groups and non-profits so that we can continue those discussions so that yes, we can be a conduit for ideas. Some of those ideas we may not agree with. Some of those ideas we may agree with and we would say to the General Assembly these are some of the concepts that you are going to be faced with, this is the impact of this, here’s where we are, you make the decision. We’ve been pretty cautious about advocating one way or the other. Our General Assembly has a great staff. They work with us tremendously. So we’ve managed to be as neutral as we can about that. When it all boils down it doesn’t make much difference what my opinion is.

A Whole New World (of Sales Tax)

Abrams: North Carolina recently expanded its sales tax base. Tell us about that.

Penny: That happened before I got there. That’s my story and I’m sticking to it. That was probably the story of the year last year. That was a decision again of the General Assembly that led to a lot of confusion but we have done a good job in clarifying things.

Abrams: What areas needed the most clarification?

Penny: Certainly repair and renovation was difficult for people to understand. Strangely enough, as a lawyer who did real property it was easy for me to understand but most people aren’t that demented.

Abrams: We’re all a little demented.

Penny: It is a very nuanced tax. And you have to remember, as I reminded my staff, every time you expand the base you create another group of tax collectors for the state of North Carolina. And these tax collectors sometimes are not very anxious to do that. But they want to do it right and so they have a lot of questions. It will take a couple of years for us to clearly get that on the smoothest sailing of seas. But they’ve done an excellent job in trying to educate the public.

Abrams: Speaking of creating another group of tax collectors, SB 81 would have enacted economic nexus and done just that.

Penny: Although it didn’t pass, that bill was one that our General Assembly felt passionate about, or at least some of the members did, because they want to position us to be ready to collect taxes once Quill is overturned.

Abrams: You’re betting on it, huh?

Penny: We’re betting on it. The Supreme Court needs to take a look and see how the world has changed since that day. The founding fathers never envisioned me ordering anything from Amazon or any of the other places that we now order things from daily. So getting back to the bill, we were trying to get ourselves ready for Quill.

[Update: The Supreme Court will hear oral arguments in South Dakota v. Wayfair, Inc., et al., No. 17-494, on April 17, 2018. North Carolina joined an amicus curiae brief filed in support of South Dakota on March 5, 2018.]

Abrams: North Carolina participated in the MTC’s online marketplace voluntary disclosure program last year. Was that successful in terms of creating new filers and generating revenue?

Penny: Remember, we already prior to that had a program that brought in a number of online merchants with nexus to North Carolina that voluntarily reported, so that was already happening. The MTC program was sort of the next tier. I do not have any revenue figures yet.

But on that issue, certainly on several occasions I have vowed to abide by the constitution of the United States and North Carolina. But as lawyers we have an obligation to try to advance the development of constitutional theory. Remember, we live in a digital world where merchants outside of North Carolina are at an advantage over merchants inside North Carolina because they are not collecting the sales tax. I’m caught with these merchants here that I need to be fair to. And I understand there’s this constitutional nexus argument but I also understand that the constitution when it was written never envisioned the virtual world. Not even when Quill was decided were we thinking of the virtual world. And on my phone I have apps from various merchants that all pay tax in North Carolina. These are people who have significant enough connections to our state that they feel the need to participate. Some of these merchants will have goods warehoused by a third party in our state. Some will have apps sitting on phones in our state so the citizens of the state of North Carolina can readily purchase from them. So they have a physical presence in the state of North Carolina and a virtual presence in the state of North Carolina. Actually that virtual presence is a physical presence because those digits are locations in North Carolina.

Leadership in the Tar Heel State

Abrams: When I interviewed Secretary Gray back in 2014 he told me his biggest challenge was cancellation of the multimillion dollar Tax Information Management System or TIMS project. What is your greatest challenge as Secretary?

Penny: Let me first say I am following Lyons Gray and Jeff Epstein. Within a week of walking in on January 1 I had calls from those gentlemen offering whatever assistance they could offer. Lyons has come over and Jeff and I have had a series of calls. I’m following some class acts. Let me also say, having led a state agency, and I know the public haranguing that you get when you pull back on a multimillion dollar project, Lyons Gray deserves the name “Lion.” It took a lot of guts to do what he did.

The biggest challenges to us center around two things - our employees and our data. I’ll talk about the data first but that’s not necessarily the order of importance. With many of the private sector breaches of data, many of the things that we would otherwise use to verify and protect against identity theft, some of those tools have disappeared and we have to find new ways of figuring out how to do that. We’re going to do that in rapid manner for this tax season. Every state is going to have that same challenge. I’m not letting fictitious taxpayers walk away with refunds that they don’t deserve and delaying the refunds of honest taxpayers out there. And we’re doing some things right now and preparing to do a number of new things in the future.

The next thing is our people. With the Kansas event it’s not unusual particularly during tax season for us to get threats – I was a civil rights lawyer and I didn’t get threatened as much doing that. And sometimes those threats get moved into the white noise of the business but we want to make sure. With the Kansas incident it’s heightened our awareness of our offices all across the state. We have 13 across the state of North Carolina. We’re putting in new alarm systems all across the state, new ways of communicating with our employees across the state, and other measures, as well as getting other departments both federal and state to look at our operations to make sure that our people our secure.

Another challenge I have is that 30 percent of our leadership team has the time in to retire. These are people who the legislature depends on to build our trust. Which means that I have to make sure we develop the compensation systems necessary to attract people and retain them or else we’re going to have a brain drain. But we are fortunate to have folks like Lennie Collins (Director, Corporate Tax Division) and John Seibert (Assistant Director, Corporate Tax Division) and others on our team. Those individuals, to name just a couple, are consummate professionals.

Abrams: Any final thoughts for North Carolina taxpayers?

Penny: Just know that we are very serious – we meet with trade groups and others on a regular basis. That is not to say I am going to agree with them every time but I will promise that I am going to listen. And we will seek to understand and strangely enough there are going to be some times when I agree with the trade industry and have to talk to some of my people and ask the hard question of why. And then there will be other times where I am going to toe the company line. We’re certainly interested in making sure that North Carolina is business friendly. I recognize that the only way I can collect taxes is if I have industry employing people. People need jobs, we need good jobs, we’re trying to grow the economy of North Carolina. And this Governor is doing a great job in doing that. There is a reason why the Secretary is on a number of economic development issues and committees because we recognize that how we administer and advise on tax laws will impact the future of North Carolina.

Abrams: Thank you, Ron. It sounds like the Department is in great hands.

Penny: I hope so. Nice talking to you, Jeremy.

New Developments Since this Interview Took Place

Cloud Computing Services Not Subject to Sales and Use Tax

The North Carolina Department of Revenue issued its first guidance on the taxability of cloud computing services in Private Letter Ruling No. SUPLR 2018-0005 (January 24, 2018). Specifically, the Secretary ruled that a taxpayer’s license revenue from its master subscription agreements for access to cloud based software are not subject to sales or use tax because North Carolina does not “currently” impose sales and use tax on revenue from access to cloud based software accessed electronically via an internet connection.

The Impact of Federal Tax Reform

On February 16, 2018, the North Carolina Department of Revenue published a document entitled “IMPACT OF THE TAX CUTS AND JOBS ACT AND THE BIPARTISAN BUDGET ACT OF 2018 ON NORTH CAROLINA’S CORPORATE AND INDIVIDUAL INCOME TAX RETURNS.” For both corporate and individual income tax purposes, North Carolina currently references the Internal Revenue Code (IRC) in effect as of January 1, 2017, as the starting point for computing taxable income. The North Carolina General Assembly is scheduled to convene May 16, 2018, to determine whether the law will be updated to reflect the IRC in effect as of 2018 or decouple from specific IRC provisions. Taxpayers that will wait to file their 2017 income tax returns in order to incorporate the General Assembly’s determination must file Form CD-410 (individuals) or Form CD-419 (corporations) to receive an automatic six-month extension. Taxpayers who do not request an extension and file their 2017 North Carolina income tax returns prior to any action by the General Assembly may be required to file an amended North Carolina income tax return to the extent impacted by the General Assembly’s determinations.

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