In the past month, Massachusetts enacted significant income tax legislation and courts in other states released decisions on a variety of interesting topics. The Massachusetts legislation widely adopts single sales factor apportionment and includes some noteworthy individual income tax provisions. Iowa announced that a planned reduction in the corporate income tax rate will be accelerated because the state has exceeded specified tax revenue thresholds. In judicial decisions, a Florida court held that software that was sold and electronically delivered by a procurement company to affiliated entities was not subject to sales tax. The Mississippi Supreme Court determined that online travel companies are not considered hotels for sales tax purposes. Finally, the Pennsylvania Commonwealth Court held that a school district’s selection of property tax assessments to appeal violated the Uniformity Clause of the Pennsylvania Constitution. These developments are covered in our summary of SALT news for October 2023.
Florida court holds electronically delivered software not subject to sales tax
On Sept. 27, 2023, in T-Mobile Resources LLC v. Florida Department of Revenue, the circuit court for Leon County, Florida granted sales tax refund claims for tax paid on prewritten software that a procurement company sold and delivered electronically to an affiliated entity. None of the software was purchased at the same time as hardware and all the software was uploaded onto pre-existing equipment. The court rejected the Florida Department of Revenue’s (Department) argument that the software was taxable because it was a service sold with tangible personal property.
The taxpayer, T-Mobile Resources LLC (TMR), was an affiliate of a major wireless carrier, T-Mobile. TMR acted as a procurement company for affiliated entities by centralizing purchases for equipment, software, and services. T-Mobile had master supply contracts with third-party vendors providing general terms and conditions for making purchases. Software purchased by TMR was electronically delivered to and stored on TMR’s servers located at its virtual warehouses. TMR subsequently sold the software to one of four of T-Mobile’s regional operating entities, including TM South. Upon its sale to an operating entity, all software was electronically transferred to a support server owned by the purchasing entity and then electronically transferred to individual cell sites owned by the purchasing entity. During the Feb. 1, 2011, through Dec. 31, 2015, tax periods at issue, TMR collected and remitted sales tax on the sales price of the software sold to TM South and remitted the tax to the Department.
All purchases and sales between TMR and TM South were recorded within T-Mobile’s third-party accounting software. TMR also used third-party software to document sales and calculate the associated sales or use tax. The software received accounting software data regarding sales transactions and calculated the tax due on the transaction. The accounting software generated an invoice at the time of the sale to record the details of the transaction.
TMR submitted a refund claim with the Department and included a complete sales reconciliation report generated by its third-party software programs that detailed all the sales transactions, including sales of software and hardware, and indicated if sales tax had been collected and paid. The Department’s auditor used a statistical sample of these transactions and recommended the approval of TMR’s refund claim. TMR subsequently refunded the sales tax to TM South as a prerequisite to receiving the refund from the Department. Following this necessary action, TMR received an email stating that the auditor was no longer with the Department and requesting TMR to provide copies of contracts relating to sales of the software from TMR to TM South. No contracts existed between TMR and TM South, but TMR supplied the Department with purchase orders, the master supply contract, and the full sales reconciliation report. Each of the invoices in the Department’s sample contained only items of electronically delivered software and did not include any hardware. The Department ultimately denied TMR’s refund request and petitions to reconsider the refund denial. TMR filed a timely complaint appealing the refund denial with the circuit court.
The circuit court explained that Florida imposes sales tax on the “sales price” of tangible personal property and certain services sold at retail in the state. Under Florida sales tax law, “sales price” is defined as “the total amount of tangible personal property, including any services that are a part of the sale.” The sale of electronically delivered software is not a sale of tangible personal property or a taxable service that is subject to sales tax.
The Department argued that while electronically delivered software is not subject to sales tax, the software was taxable in this instance because it constituted a service that was sold with tangible personal property. In rejecting the Department’s argument, the court determined that as a matter of law, electronically delivered software is an intangible and not a service. Florida courts and the Florida Office of Administrative Hearings have held that electronically delivered computer software is an intangible for sales tax purposes. Software also is defined as intangible property in other Florida statutes. The Department cited an administrative rule providing that customized software is a service for purposes of applying sales tax. However, the court noted that this case did not involve the sale of custom software, which is treated differently than prewritten software for sales tax purposes.
The court also concluded that the software was not subject to sales tax because it was not sold with tangible personal property. TMR presented credible testimony that each line item on the software invoices requested by the Department was electronically delivered software and that no tangible property was listed on the invoices. Also, all the software was electronically delivered for use on existing hardware and the software was not part of the original purchase with the hardware.
In determining that TMR proved its refund claim should be granted, the court rejected the Department’s argument that TMR failed to produce sufficient documentation. The Department contended that the invoices detailing the transactions were not “source documents” and did not indicate whether the items were hardware or software. The court determined that TMR submitted sufficient documentation and noted that the Department’s auditor found the information to be adequate and determined the amount of the recommended sales tax refund. The Department claimed that a statute governs the provision of books, records, and other documents that must be submitted to determine whether transactions are subject to Florida sales tax. The court determined that the statute lists the types of documents that may be considered, but this is not an exclusive list. Also, TMR satisfied other statutory and regulatory requirements by maintaining and submitting invoices and adequate records to support its refund claims. The court granted TMR’s request for the sales tax refund. Based on this decision, a sales tax refund opportunity may be available to certain wireless carriers with similar facts and circumstances surrounding their procurement company transactions with affiliates.
Iowa corporate income rate further reduced for 2024 tax year
On Sept. 22, 2023, Iowa Gov. Kim Reynolds announced that the state’s top corporate income tax rate will drop from 8.4% to 7.1% for tax years beginning on or after Jan. 1, 2024. The announcement notes that this rate reduction was not projected to happen until after the 2027 tax year. Pursuant to legislation enacted in 2022 (H.F. 2317), the top corporate income tax rates are being significantly reduced because Iowa’s net corporate income tax receipts exceeded $838 million for the 2023 fiscal year, well over the $700 million threshold needed to be met for a reduction to be authorized.
As clarified by the Iowa Department of Revenue in Order 2023-02, also issued on Sept. 22, 2023, the 7.1% tax rate applies to the top two income tax brackets, which encompass income of more than $100,000. A rate of 5.5% continues to apply to income of $100,000 or less. For the 2023 tax year, pursuant to H.F. 2317, the corporate income tax rates for income between $100,001 and $250,000 (previously, 9%) and income greater than $250,000 (previously 9.8%) were both reduced to 8.4%. Thus, 2024 will be the second consecutive year with a significant Iowa corporate income tax rate reduction.
Massachusetts adopts single sales factor apportionment, amends individual income tax
On Oct. 4, 2023, Massachusetts enacted legislation, H.B. 4104, which includes significant corporate excise tax and individual income tax changes that are expected to reduce taxes by approximately $1 billion. Gov. Maura Healey issued a statement announcing that the legislation provides Massachusetts’ first tax cuts in more than 20 years.
Effective Jan. 1, 2025, Massachusetts is broadly adopting single sales factor apportionment. Under existing law, Massachusetts generally uses a three-factor apportionment formula with a double-weighted sales factor, but corporations in certain industries such as manufacturing, defense, and mutual fund services currently use single sales factor apportionment. Massachusetts is following the state trend of adapting a single sales factor methodology for practically all types of businesses.
H.B. 4104 also amends the apportionment provisions for financial institutions to adopt a single sales factor method effective Jan. 1, 2025. In addition, the legislation changes the special sourcing provisions for financial institutions that apply to the interest, dividends, net gains, and other income from investment assets and activities and from trading assets and activities.
The legislation amends some individual income tax statutes. For tax years beginning on or after Jan. 1, 2023, any gain from the sale or exchange of capital assets held for one year or less is taxed at a rate of 8.5%. Previously, all capital gains were taxed at a rate of 12%. At the November 2022 general election, Massachusetts voters approved a constitutional amendment to impose an additional 4% tax on income over $1 million, effective for tax years beginning in 2023 and thereafter. As a result, the lower short-term capital gains rate may provide some relief for high-income individuals.
For tax years beginning on or after Jan. 1, 2024, a married couple must file a joint return for any year in which they file a joint federal income tax return. This provision may prevent some high-income taxpayers from filing separately to avoid the 4% surtax. In cases where one spouse or both spouses are nonresidents of Massachusetts and have exemptions or deductions unrelated to their Massachusetts income, the Massachusetts Department of Revenue is directed to promulgate regulations for appropriate adjustments or for exemption from the requirement to file a joint return.
Mississippi Supreme Court holds online travel companies not taxed as hotels
On Sept. 28, 2023, the Mississippi Supreme Court, in a 5-3 decision, held in Priceline.com, LLC v. Fitch that online travel companies (OTCs) are not taxed as “hotels” for state and local sales tax purposes. As a result, OTCs are not subject to state sales tax or the 75 local sales taxes imposed on hotels.
The taxpayers in this case were major OTCs that operate websites that enable travelers to research destinations, comparison shop, plan trips, and request reservations from hotels. The OTCs provide their services primarily through either the merchant model or the agency model. Under the merchant model at issue in this case, the OTC acts as the merchant of record and facilitates the booking of hotel rooms from travel suppliers. The OTCs facilitate reservations for consumers at lower rates (“net rates”) than hotels advertise to the public. When a consumer books a hotel room through an OTC, the OTC charges the consumer’s credit card at the time the hotel issues a reservation. The charge includes a “tax recovery charge” to cover the estimated taxes the hotel will owe on its net rate. The contractual agreements between the hotels and the OTCs provide the OTCs will collect the amounts for applicable taxes from the consumers. In a small number of transactions, known as “breakage transactions,” the total amount the OTC expected to forward to the hotel does not match the total amount collected by the hotel. Therefore, the OTC occasionally retains a portion of the net rate or tax recovery charge.
In late 2011, Mississippi filed a complaint alleging the OTCs failed to remit the full and proper amount of taxes imposed under the state’s sales tax law. The state claimed that the OTCs were subject to the state’s 7% sales tax on “hotels,” which are defined by state law as an entity or individual: (i) engaged in the business of furnishing or providing one or more rooms intended or designed for lodging or sleeping purposes; and (ii) known to the trade as a hotel. The state alleged the OTCs were required to collect and remit 7% sales tax for each retail rental of a hotel room to consumers based on the gross amount paid by the consumer, rather than the net rate. Also, the state alleged that the OTCs had been unlawfully keeping taxes collected under the authority of local law.
After a lengthy series of motions, orders, rulings, and stipulations that occurred through 2020, the trial court held that the sales tax on hotels was a broad transaction tax that encompassed the OTCs. The trial court granted partial summary judgment in favor of the state, resulting in OTC liability of more than $10 million in past due taxes. Also, the trial court found that the OTCs had acted willfully and in intentional disregard, and assessed penalties and interest for a total judgment of more than $50 million. The OTCs subsequently filed a notice of appeal with the Mississippi Supreme Court that appealed many of the trial court’s rulings and raised many issues. The first issue was whether the trial court mistakenly ruled that the OTCs were subject to state and local hotel sales taxes.
In reversing the trial court, the Mississippi Supreme Court only considered the issue of whether the OTCs were subject to the sales tax imposed on hotels because this was dispositive of the other issues raised. After reviewing the legislative history of hotel taxes, the court determined that the OTCs were not subject to the tax, as the OTCs met neither of the requirements of a “hotel” as provided above. First, the OTCs do not furnish or provide rooms for their customers. While a customer may reserve a room through an OTC, it is the physical hotel that furnishes a room for the customers when they arrive. The OTCs merely provide the services that allow customers to compare hotels and reserve rooms for future use. Furthermore, the OTCs are not known to the trade as hotels. The court reversed the trial court’s order granting partial summary judgment on the issue of liability for state sales tax as a hotel and rendered judgment for the OTCs.
As part of its argument that the sales tax on hotels did not apply, the OTCs contended that they are instead considered marketplace facilitators under a relatively new provision that was not at issue in the tax periods covered in the litigation. In 2020, Mississippi enacted marketplace facilitator provisions that impose a tax collection obligation on persons who facilitate a retail sale by: (i) listing or advertising for sale by the retailer of tangible personal property, services or digital goods that are subject to sales tax; and (ii) arranging with third parties to collect payment from the customer and transmit that payment to the retailer. The law requires marketplace facilitators to collect and remit tax on sales into Mississippi if the sales are greater than $250,000 in any consecutive 12-month period. The OTCs cited to a formal notice posted by the Mississippi Department of Revenue clarifying that the term includes the online sale of hotel stays.
The Mississippi Supreme Court also determined that the OTCs were not liable for taxes under 75 different local hotel tax laws. In its order granting partial summary judgment, the trial court agreed with the state and found that the OTCs failed to remit taxes of online sales of Mississippi hotel rooms owed under local sales tax laws. At the Mississippi Supreme Court, however, the OTCs successfully argued that the language of the local tax laws defining “hotels” fails to impose liability on the OTCs. One of four different definitions of “hotels” is used by each of the local hotel tax laws. Similar to the state definition of “hotels,” the local taxes define “hotels” as an establishment or place of lodging that furnishes or provides rooms to transient guests. As discussed above, the court concluded that OTCs neither provide nor furnish rooms, they are not physical establishments or places of lodging, and they are not known to the trade as hotels. The court reversed the trial court’s order granting partial summary judgment on the issue of liability under local hotel tax laws and rendered judgment for the OTCs. The court also held the state failed to prove its common law theories of liability, and accordingly the trial court erred by granting damages, penalties, and interest to the state.
Two justices wrote dissenting opinions arguing that the OTCs should have been classified as “hotels” because they furnish or provide rooms at the request of guests of large numbers of hotels. The second dissent would have affirmed the trial court’s order granting partial summary judgment for the state sales tax liability but would have reversed the trial court’s holding that the OTCs are liable under 75 local hotel tax laws and would remand to determine whether the OTCs are liable under each local hotel law.
There is significant variance in the state sales tax treatment of OTCs. Some states are consistent with this opinion and hold that OTCs are not liable as hotels, but other states have taken the opposite approach and hold that OTCs qualify as hotels subject to tax. The fact that the justices were split in this opinion further demonstrates the differing views regarding the imposition of sales tax on OTCs as hotels. The decision also reflects the fact that the advent of broad marketplace facilitator provisions in many states require OTCs to collect and remit sales tax as marketplace facilitators. Taxpayers operating as an OTC should carefully consider the statutes, regulations, and case law for each state when making sales tax liability determinations.
Pennsylvania court holds property tax appeals violate Uniformity Clause
On Oct. 6, 2023, the Pennsylvania Commonwealth Court, in a 2-1 decision, held that a school district’s appeal of property tax assessments based on a monetary threshold violated the Uniformity Clause of the Pennsylvania Constitution because assessments of only commercial property were appealed. In School District of Philadelphia v. Board of Revision of Taxes, the court affirmed a trial court’s decision to quash the school district’s appeal of 138 commercial property tax assessments.
On Aug. 9, 2016, the School District of Philadelphia requested proposals seeking professional assistance to pursue property tax assessment appeals likely to produce at least $7,500 of additional annual revenue. Based on trial testimony, the property would need to be underassessed by nearly $1 million to meet this threshold. The school district chose Keystone Realty Advisors (Keystone) to identify tax assessment appeals that could produce this amount of revenue. On Oct. 3, 2016, the school district appealed the assessments on 138 commercial properties to the Philadelphia Board of Revision of Taxes. After the board upheld the assessments, the school district appealed to a trial court.
In 2017, in Valley Forge Towers Apartments N, LP v. Upper Merion Area School District, the Pennsylvania Supreme Court interpreted the Uniformity Clause to mean a “taxing authority is not permitted to implement a program of only appealing the assessments of one sub-classification of property, where that sub-classification is drawn according to property type – that is, its use as commercial, apartment complex, single-family residential, industrial, or the like.” Based on this holding, the taxpayers that owned the commercial properties appealed by the school district filed a motion to quash with the trial court. After the trial court granted the motion to quash, the school district appealed to the Pennsylvania Commonwealth Court and argued that the trial court improperly used judicial notice and statements by counsel to support its findings. The Commonwealth Court vacated the trial court’s judgment and remanded the case so that the trial court could consider an evidentiary record before ruling on the motion to quash.
At trial, testimony indicated the school district wanted to appeal underassessed properties that would generate an additional $7,500 per year and targeted commercial and industrial properties because they had not been recently reassessed. On Sept. 8, 2016, the school district awarded the contract to Keystone, which left a “fairly compressed timeframe” to identify properties for appeal by the Oct. 3, 2016, deadline. The school district did not evaluate the fair market value of underassessed properties and followed Keystone’s recommendations.
A principal for Keystone testified that he “only had three weeks” to identify the underassessed properties for appeal. He acknowledged that no single-family residences were contained in his recommended list of 138 properties for tax assessment appeals. The Keystone principal began his review by listing 580,000 properties and randomly eliminated 520,000 properties. After creating this reduced list, he looked at some properties, skipped other properties, and consulted real property sales data sources oriented to commercial property. He testified that he reviewed a report prepared by the taxpayers’ appraisal expert which identified 33 single-family residential properties that met the school district’s criteria for appeal, but he did not have time to consider these properties.
In granting the taxpayers’ motion to quash, the trial court noted that all the properties that Keystone recommended for tax assessment appeals were commercial property. The trial court acknowledged that Valley Forge left open the possibility of using monetary thresholds to choose assessment appeals but held that the school district violated the Uniformity Clause by ignoring all properties for 2017 assessment appeals except for a small number of commercial properties. The school district appealed this decision to the Commonwealth Court.
On appeal, the Commonwealth Court affirmed the trial court and held that the school district’s appeal of only commercial property assessments violated the Uniformity Clause. The court began its analysis by explaining that the Uniformity Clause provides that “[a]ll taxes shall be uniform, upon the same class of subjects, within the territorial limits of the authority levying the tax, and shall be levied and collected under general laws.” Because all real property in a taxing jurisdiction is a single class, taxing authorities cannot treat different property sub-classifications in a disparate manner. Citing the Pennsylvania Supreme Court’s Valley Forge decision, the court explained that if a taxing authority appeals the assessments of only one type of property, it violates the Uniformity Clause. In Valley Forge, the court explained that “systematic disparate enforcement of the tax laws based on property sub-classification, even absent wrongful conduct, is constitutionally precluded.” However, the Pennsylvania Supreme Court explained that a neutral selection criteria, such as a monetary threshold, is permissible provided it was “implemented without regard to the type of property in question or the residency status of its owner.”
The school district argued that the trial court incorrectly assumed that because the 2017 assessments appeals were all commercial properties, those appeals violated the Uniformity Clause. The Commonwealth Court disagreed with the school district’s assumption that its monetary threshold for selecting assessments satisfied the Uniformity Clause. Although the school district’s stated tax assessment appeal policy may be facially neutral, the “haphazard implementation” of this policy was not neutral. The Commonwealth Court agreed with the taxpayers and the trial court that implementation of the school district’s policy violated the Uniformity Clause by arbitrarily selecting only commercial property and deliberately exempting from review other types of property that could have satisfied the monetary threshold. As a result, the Commonwealth Court concluded that the school district’s implementation of its property tax appeals policy created a systematic and disparate treatment of taxpayers in violation of the Uniformity Clause. The school district may decide to appeal this decision.
A dissenting opinion argued that the school district’s policy did not violate the Uniformity Clause because it was based on a monetary threshold and implemented without regard to the property’s sub-classification or ownership. According to the dissent, the Keystone principal implemented his analysis without consideration of property type and focused on meeting the $7,500 threshold.
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