24 Annual Health Sciences Tax Conference - EY · PDF file12/8/2014 · 24th Annual...

24th Annual Health Sciences Tax ConferenceWhat’s shaking? State and local tax hot topics for the life sciences industry

December 8, 2014

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What’s shaking? State and local tax hot topics for the life sciences industry

Presenters

► Mollie MillerDirector, State Tax Fresenius Medical CareWaltham, MA

► Keith EisensteinErnst & Young LLPNew York, [email protected]+1 212 773 9052

► Dan LiptonErnst & Young LLPBoston, [email protected]+1 617 585 1873


Agenda

► New York tax reform

► Virtual partnerships through collaboration agreements

► Massachusetts sourcing changes

► Other significant state tax developments


New York tax reform


Manufacturing companies

► 0% income tax rate► Maximum capital tax = $350,000► Taxpayer must be “principally engaged”

in the production of goods► More than 50% of gross receipts are

from the sale of goods produced by manufacturing, processing, etc.

► Must have New York (NY) Investment Tax Credit (ITC) eligible property with >$1m adjusted basis or 100% of its property is in NY

► If “principally engaged” test is not met, the taxpayer or combined group may still qualify if it has at least 2,500 NY manufacturing employees and NY manufacturing property with an adjusted basis of $100m

► 3.25%–6.5% income tax rate► Maximum capital tax = $350,000► Taxpayer must be “principally engaged”

in the production of goods► More than 50% of gross receipts are

from the sale of goods produced by manufacturing, processing, etc.

► Must have NY ITC-eligible manufacturing property with > $1m adjusted basis or 100% of its property in NY

► Focused on small, upstate manufacturers:► Have a metropolitan commuter

transportation district (MCTD) allocation percentage of < 15%

► Average of 100 or fewer full-time employees in NY during the tax year

New law (effective January 1, 2014) Old law


Manufacturing companies

► Considerations► Tests are applied on a separate or combined group basis; consider

interplay with combined reporting with respect to: ► Principally engaged test► Manufacturing v. distribution activity► Alien companies

► The $1m NY property requirement is based on ITC-eligible assets; consider the following:► Depreciation of assets► Placed in service requirement► Type of property

► Contract manufacturing – consider level of involvement and asset test

► Nature of receipts – tangible v. intangible


Net operating losses (NOLs)Pre-2015 NOLs: subtraction conversion pool

► Provisions► All pre-2015 tax year pre-apportionment NOL carryovers unused on a

taxpayer’s 2014 return must be recomputed into a post-apportionment “subtraction conversion pool” deduction.► Existing losses are “grossed up” using a .071/.065 ratio and then multiplied by

a taxpayer’s 2014 business allocation percentage.► Such a “pool” can be deducted over a 20-year period commencing with

the 2015 tax year. ► The 20-year carryover period applies regardless of the year the NOL

originated. ► No more than 10% of the pool may be deducted in any year, but if the 10% is

not used in a year, it may be aggregated in a subsequent year. ► Accordingly, it will take at least 10 years to utilize the conversion pool.

► Taxpayers can elect to deduct 50% of the conversion pool in 2015 and 50% of the conversion pool in 2016. However, any unused conversion pool is forfeited.


Net operating lossesPre-2015 NOLs: subtraction conversion pool

► Considerations► Position to recalculate pre-2015 NOL carryforwards to remove IRC

Section (Sec.) 382 limitations► Maximizing the NOL “pool” – evaluate changes to sourcing rules

and filing methodology► Modeling of anticipated 2015 and 2016 New York apportioned

business income to evaluate the 2-year election v. the 20-year carryforward ► Timing regarding cash tax v. financial statement► Revocable v. irrevocable election


Net operating lossesPost-2014 net operating losses

► Provisions► Post-2014 NOLs are no longer limited to federal NOL deduction

(NOLD).► Post-2014 NOLs are subject to a 3-year carryback (but not to

years preceding 2015) and a 20-year carryforward. ► The New York NOLD is computed as if the combined group is a

single corporation, although federal limitations on the deductibility of such losses to consolidated groups (e.g., separate return limitation year (SRLY) limitations) apply to New York. ► Note that the SRLY limitation applies even if federal non-consolidated

returns are filed as long as combined New York filings are made.


Filing methodologiesCombined reports

► Pre-2015 (Article 9-A) ► 80% direct or indirect ownership of voting stock► Other criteria – substantial intercorporate transactions or distortion► Alien corporations – excluded from combined report► Excluded entities – Article 32 (banks); Article 9 (utilities); Article 33

(insurance); entities with different tax year or apportionment

► 2015–forward ► Ownership criteria reduced to more than 50%► Other criteria – unitary business► Alien corporations (i.e., not treated as domestic corporations under the

Internal Revenue Code (IRC)) – included to the extent of US effectively connected income (without regard to a tax treaty)

► Excluded entities – Article 9 (utilities); Article 33 (insurance)► Controlled group election – seven-year election


Filing methodologiesCombined reports

► Considerations► The term “unitary business” is not defined by New York statute

► Evaluate the traditional indicia of a unitary business (centralized management, etc.) to exclude/include entities

► Review for consistency with other “traditional” unitary states► Modeling of the benefit/detriment of the controlled group election

► Consider forecasts due to seven-year binding term► Provides certainty and mitigates controversy risk

► May be advisable if there are holding companies within the group

► Review the impact of the inclusion of alien companies to the extent of US effectively connected income (regardless of a tax treaty)► Consider interplay with “qualified NY manufacturer” provisions


Alien corporations

► Provision► Pre-2015

► Taxed on a worldwide basis► Excluded from combined returns

► 2015–forward► Taxed to the extent of US effectively connected income (regardless of

a tax treaty) unless treated as a domestic corporation under the IRC► Includable in combined returns

► Considerations► Modeling of tax posture of alien corporations subject to tax on a

separate company basis or through inclusion in a combined return► Interplay with economic nexus, combined reporting and

manufacturing provisions


Tax rates and bases

► Provisions► 2015–forward

► Metropolitan Transit Authority surcharge increased from 17% to 25.6% of pre-credit New York state (NYS) liability

► Investment income and capital – now exempt, but limited (i.e., no debt instruments)

► Other exempt income – tax-free distributions (dividends from non-combined domestic and foreign affiliates; Subpart F income; Sec. 78)

► Expense attribution – only interest with 40% safe harbor election► Subsidiary income and capital – all aspects of this regime repealed► Only tax on business capital; set to phase out in 2021; cap = $5 million

► 2016–forward► Income tax rate reduced from 7.1% to 6.5%


Tax rates and bases

► Considerations► Application to significant treasury functions and investment

companies► Timing of sale of subsidiaries► Modeling of tax impact and elections► Documentation requirements for interest expense attribution


Receipts sourcing

► Provision► Applicable to services and “other business receipts” ► Pre-2015 – generally cost of performance rules► 2015–forward – hierarchy of market-based rules (e.g., the location

where the customer takes benefit, customer location)► Considerations

► Receipt of benefit – implies ability to allocate to more than one location; consider services where benefit is overseas

► Customer location – presumably its commercial domicile► Other backup rules exist► Availability of information (data sources, systems, etc.)

► Taxpayers are required to use the hierarchy unless information is not available for each tier of the rule, but must substantiate that information is not available


Economic nexus

► Provision► $1,000,000 or more of receipts

Or► If a taxpayer has at least $10,000 in New York receipts but is a member of

a combined group that, in aggregate, meets the $1,000,000 or more threshold

► Considerations► Interaction with Public Law (PL) 86-272 and the federal constitution► Consider interplay with the new market-based sourcing provisions► Impact of new combined reporting rules and the Finnigan Rule for single

sales factor purposes► Application to alien corporations and partnerships► Modeling of potential Accounting Standards Codification (ASC) 740

reserves


Collaboration agreements


Background

► What is a collaboration agreement?► An arrangement among parties as to the research, development,

manufacture and ultimate sale/exploitation of a product

► Examples► Licensing agreements (in-license or out-license)► Contract research or contract manufacturing► Risk sharing arrangements (co-development or co-promotion)► Joint venture or partnership► Option-based collaboration with option to ultimately acquire

smaller entity► Any combination of above


Background

► Typically, the collaboration agreement will provide for:► Joint governance, usually in the form of a board comprising

persons from both collaborators, but, on many issues, requiring unanimous consent

► Sharing of some elements that comprise net bottom-line profit► A providing and acknowledgement of the creation of joint property,

such as intangible property

► In some situations in which there is not a sharing of net bottom-line profits, there is a sharing of some above-the-line gross income and cost of goods sold items, as well as some sharing of development costs.


Background

► Increase in collaboration agreements► Selective licensing by life sciences companies looking to fill in drug

development pipelines, identify additional sources of revenue, expand into emerging technologies and remain competitive

► Source of funding for biotechnology development due to lack of initial public offering market and venture capital funding opportunities

► Dollar amount of up-front license fees and milestone payments significantly increasing

► Deals occurring earlier in biotech life cycle


Issues to consider: benefits and burdens

► When a virtual partnership is created, both parties share the benefit and burden from the characterizations of the other party. ► Example of sale and manufacturer collaborators

► Federal impact► Guidance regarding ability for sales partner to share in manufacturing

partner’s § 199 deduction► State issues to consider

► Nexus (86-272, economic nexus, partner flow-through)► Effectively connected income for alien corporations► Sourcing rules – partner flow-through, etc.► Manufacturing classification► § 199 addbacks► Tax credits (research and development, ITC)


Significant apportionment and sourcing changes


Massachusetts (MA) sourcing changes

► Services now sourced using a “market approach”► License or lease of intangible property

► Similar to prior law, receipts from intangibles are sourced to MA if the intangible is used in MA

► Throwout rule applies for tax years beginning on or after January 1, 2014, if:► The taxpayer is not taxable in the destination state.► The destination state cannot be determined.

► For combined filers, application of the Finnigan Rule may reduce application of the throwout rule

► Unlike throwback as applied to tangible personal property, foreign sales can be subject to throwout


MA sourcing: rules of reasonable approximation

► Taxpayer must consider all available information ► Method of reasonable approximation must be determined and

applied in good faith and must be used consistently year over year

► Methodology cannot change without permission and is subject to Commissioner’s right to change

► Taxpayer must maintain contemporaneous records► Unassigned sales (sales where taxpayer cannot reasonably

approximate the market) will be assigned in the same proportion as assigned sales so long as the taxpayer reasonably believes that the geographic distribution of the unassigned sales follows the assigned sales


Continued trend to market-based sourcing

► Pennsylvania (PA) – effective for tax years after December 31, 2013► A sale of a service is in PA if the service is delivered to a location in

PA based upon the percentage of total value of the service delivered to a location in Pennsylvania.

► Nebraska (NE) – effective January 1, 2014► A sale of a service is in NE if the sale is derived from a buyer

within NE.► Sales of intangible property are in NE if the buyer uses the

intangible property at a location in the state (if property is used within and without the state, the sales are apportioned between this state in proportion to the use of the intangible property in NE and the other state).


Alternative apportionment consideration

► Ultimate destination► Kentucky (KY)

► Sales of goods destined for delivery outside of KY shall not be assigned to KY, irrespective of method of shipment or delivery.

► If title passes to another distributor in the state, the sale of tangible personal property may be sourced to KY.

► There may be specific facts and circumstances.► Currently, other alternative apportionment methods are being pursued.

► Ohio► If property is delivered by common carrier or other transportation, the

place at which such property is ultimately received after all transportation has been completed shall be considered as the place at which such property is received by the purchaser.


Alternative apportionment considerations

► Other considerations for life sciences companies► Illinois

► Receipts from licenses, royalties or other similar intangibles are excluded from the numerator and denominator only if such receipts comprise more than 50% of the taxpayer’s total gross receipts.

► Mississippi► Effective January 1, 2014, a “major medical or pharmaceutical supplier

of a Mississippi distribution facility” must use an apportionment formula consisting of double-weighted payroll and property factors and a single-weighted sales factor. ► A “major supplier” is defined as a company or group of affiliated companies

that ship (at least $100 million annually) medical or pharmaceutical products to a “Mississippi distribution facility”.

► A “Mississippi distribution facility” is defined as “a distribution facility that received funding from the Mississippi Industry Incentive Financing Revolving Fund to open a facility in Mississippi and construction on the facility began between July 1, 2010 and December 31, 2010.


Other state and local tax (SALT)/life sciences hot topics


Other SALT hot topics

► Rhode Island tax reform (effective January 1, 2015)► Life sciences tax rate = 4% (v. reduction from 9% to 7%)► Mandatory unitary combined reporting

► 80/20 rule and tax haven provision► Five-year federal consolidated group election► Pre-2015 NOLs and credits cannot be shared

► Single sales factor with throwback and market-based sourcing► Repealed related-party expense addback


Other SALT hot topics

► Virginia Ruling No. 14-145 (August 2014)► Detailing services protected under PL 86-272► Clinical trial conducted by an independent third-party research

organization does not create nexus if an independent contractor► Employees presence in Virginia to recruit clinical trial participants

and relating to medical education, lobbying and outreach to state associations and licensing boards is not likely to be de minimis


Questions?


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