Current corporate income tax developments: This two-part article discusses a myriad of recent state tax activity in the corporate income tax area. Part I addresses nexus, IRC sec. 338(h) (10) transactions, allocable/apportionable income and tax base.

• Author: Boucher, Karen J.
• Position: Part 1

EXECUTIVE SUMMARY

* Numerous cases and rulings addressed the state tax base and nexus issues in New York and in many other states.

* During 2005, a number of states decoupled from the IRC Sec. 199 deduction, requiring an addback to the state tax base.

* Several cases and rulings addressed the effects of IRC Sec. 338(h)(10) and allocable and apportionable income issues.

**********

During 2005, numerous state statutes were added, deleted or modified; court cases were decided; regulations were proposed, issued and modified; and bulletins and rulings were issued, released and withdrawn. This two-part article focuses on some of the more interesting items in the following corporate income tax areas: nexus; Internal Revenue Code (IRC) Sec. 338(h)(10) transactions; allocable/apportionable income; tax base; apportionment formulas; filing methods/unitary groups and administration. It also includes several other significant state tax developments. The first four areas are covered in Part I, below; the remaining areas will be covered in Part II of this article, in the April 2006 issue.

Nexus

* Alabama

The Chief Administrative Law Judge (ALJ) ruled (1) that an out-of-state railcar leasing company was not doing business or deriving income from sources in Alabama based merely on a lessee's use of railcars in the state. The leases were executed, the fixed lease payments were generally made, and the railcars were retrieved and returned, in either Illinois or Texas.

* Connecticut

SB 1232, Laws 2005 excludes from the definition of "doing business" wade show activity limited to displaying goods or promoting services when no sales are made, any orders received are sent outside the state for acceptance/rejection and fulfillment, and the activity is limited to 14 days per year.

* Georgia

Among other provisions, HB 488, Laws 2005, expands nexus to include corporations "deriving income from sources within" the state to the extent permitted by the U.S. Constitution.

* Idaho

The State Tax Commission ruled that an out-of-state household products company that sold nonexclusive franchise rights to in-state contractors had nexus, because the in-state contractors conducted numerous solicitation and business marketing activities on the company's behalf. (2)

* Indiana

The Department of Revenue (DOR) ruled that a trademark holding company had acquired economic nexus for adjusted gross income tax purposes through its exclusive license of trade and service marks to affiliated in-state retail stores. (3) The DOR also held that an out-of-state credit-card servicing company had nexus, based on services provided to resident credit-card holders on behalf of affiliate issuing banks. (4)

* Kentucky

Among other provisions, HB 272, Laws 2005, adopted a "doing business" nexus standard that includes (1) owning or leasing property, employing one or more individuals, maintaining an interest in a general partnership doing business; (2) deriving income from, or attributable to Kentucky, directly or indirectly from a trust doing business in the state; or (3) directing activities at Kentucky customers for the purpose of selling them goods or services.

* Louisiana

Reversing and remanding a lower court decision, the state Supreme Court held (5) that the state has personal jurisdiction over a nonresident corporate shareholder to tax the investment (dividend) income received from a corporate real estate investment trust (REIT) that received rent from land located in the state.

* Massachusetts

The Appellate Tax Board (ATB) held (6) that a nonresident corporate limited partner in a utility partnership was deemed to be doing business from attribution through the partnership and, thus, was subject to the state utility corporation excise tax on its share of partnership income earned in Massachusetts.

* Michigan

The Court of Appeals held (7) that an out-of-state business whose sole presence was sales solicitation was not subject to the state's single business tax (SBT) for tax years prior to the release of Gillette (8) (which held that the SBT is not subject to RL. 86-272 limitations), because the business had relied on a then-existing favorable departmental ruling that exempted it from the SBT under RL. 86-272.

* New Jersey

In a case involving a trademark subsidiary, the Appellate Division of the New Jersey Superior Court held (9) that the U.S. Supreme Court's physical presence ruling in Quill Corp. (10) applies only to sales and use taxes; physical presence is not required for income tax purposes.

* New Mexico

The state Supreme Court let stand without hearing, and allowed to be filed, the Court of Appeals decision that income from licensing trademarks to an in-state affiliate is subject to corporate income tax. (11)

* New York

The Department of Taxation and Finance (Department) advised (12) that an Ohio-based professional employer organization (PEO) did not have nexus from merely processing payroll checks for two New York residents who work outside the state as truck drivers for an Ohio-based trucking company. Even though New York income tax was withheld, the PEO was not deemed to be doing business, employing capital, owning or leasing property or maintaining an office in the state. Similarly, the Department advised (13) that an out-of-state corporation will not have nexus merely from acting as the administrative payer of wages to New York employees working for a subsidiary, even if the parent is treated as the "employer" for Federal income tax withholding purposes. In other rulings, the Department advised that:

* Delivery of ready-mix cement via cement mixers is a P.L. 86-272 protected activity, when the concrete is first mixed at a business's out-of-state location. However, RL. 86-272 protections will be exceeded if the concrete ingredients are mixed by the business's trucks while in transit to a New York delivery location. (14)

* The in-state presence of a sales representative's company-owned laptop computer and the use of his New York home as an office qualified as P.L. 86-272 protected activities. (15)

* An out-of-state independent brokerage company did not acquire nexus when it obtained the rights to receive future New York lottery prize annuity payments from the original winners. (16)

* An out-of-state company performing emergency response/alarm system monitoring services for New York customers from its out-of-state location via telephone lines and radio signals does not have nexus, as long as its relationship with the third-party independent contractors that buy and install monitoring equipment in New York homes does not evolve into an agency relationship. (17)

* An out-of-state company was not subject to franchise tax because in being a defendant in an in-state product liability...