WorldTrade Executive, Inc. PRACTICAL US DOMESTICboost tax revenues. The absence of signiﬁ cant...

October 2010Volume 10, Number 10

Planning PerspectiveTexas Margin Tax Update: Potential OpportunitiesBy Allen B. Craig III and John A. Eliason (Gardere Wynne Sewell LLP) ...................................................................................... p. 2

Federal TaxHouse Passes RIC Modernization Act of 2010By William P. Zimmerman and Jarrod A. Huffman (Morgan Lewis & Bockius LLP) ..................................................................... p. 3

Capital Gain Exclusion Rate Increased to 100 Percent for Qualifying Investments By Christopher M. Flanagan and Paul W. Decker (Sullivan & Worcester LLP) ..................................................................... p. 4

State and Local TaxesCalifornia--Tax Provisions of the 2010-2011 California Budget By Michael J. Cataldo (Pillsbury Winthrop Shaw Pittman LLP) . p. 7

MarylandMaryland--May State Claim Nexus Over Intangible Maryland--May State Claim Nexus Over Intangible MarylandHolding Company that Lacks Economic Substance?By Alexandra P.E. Sampson and Stephen J. Balzick (Reed Smith LLP) ...................................................................................... p. 8

New JerseyNew Jersey--New Jersey Tax Court Decides in New Jersey--New Jersey Tax Court Decides in New JerseyFavor of Taxpayer in First Interest Addback CaseBy Jeffrey M. Vesely and Annie H. Huang (Pillsbury Winthrop Shaw Pittman LLP) ......................................................................... p. 10

New York--Related Parties Found Not to be New York--Related Parties Found Not to be New YorkShamsBy Hollis L. Hyans (Morrison & Foerster LLP) ...................... p. 11

PennsylvaniaPennsylvania--Pennsylvania Cracks Down on Independent Contractor Misclassifi cation in the Construction IndustryBy Bruce W. Ficken, Richard J. Reibstein and Lisa B. Petkun (Pepper Hamilton LLP) ......................................................... p. 13

HOW US BUSINESS MANAGES ITS TAX LIABILITY

Advisory Board page 6

www.wtexec.com/dts.htmlwww.wtexec.com/dts.htmlwww.wtexec.com/dts.html

Planning Opportunities for Texas Margin TaxFour years ago Texas replaced its franchise tax with a margin tax designed to close loopholes and boost tax revenues. The absence of signifi cant administrative guidance to clarify the new tax law has created planning opportunities. Page 2

Pennsylvania Targets Construction Companies that Misclassify EmployeesPennsylvania is the latest in a growing number of states to enact legislation that seeks to stop misclassification of employees as independent contrac tors . Construction-industry businesses could face substantial liability for misclassifi cation. 3

Opportunity for Investors in Qualifi ed Small Business StockA provision in the recently enacted Small Business Jobs Act eliminates the tax on investments in QSBS. However, taxpayers must act before the end of the year to take advantage of this planning opportunity. Page 4

Maryland Seeks to Broaden Authority over Out-of-State Intangible Holding CompaniesMaryland tax authorities are suing an out-of-state holding company, and arguing that income shifting transactions between the holding and an independent operating company are suffi cient for Maryland to assert nexus. Several intangible holding company appeals are pending in Maryland. Page 8

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IN THIS ISSUE Articles

2 Practical US/Domestic Tax Strategies® October 2010

TEXAS

Planning Opportunities, continued on page 15

Planning Perspective

Four years ago, the Texas Legislature replaced the franchise tax with a new business tax commonly known as the “margin tax.” The Texas comptroller has published very little administrative guidance interpreting the new tax laws. This lack of guidance provides planning opportunities for taxpayers.

Margin Tax—OverviewThe margin tax revised and expanded the franchise

tax by changing the tax base, lowering the rate and extending coverage to all active businesses receiving state law liability protection. Under the margin tax, limited partnerships became subject to business tax for the fi rst time. The margin tax levies a tax of up to 1 percent on a taxable entity’s “taxable margin,” which is an amount equal to either (a) the taxable entity’s total revenue minus cost of goods sold (COGS), or (b) the taxable entity’s total revenue minus aggregate wages and compensation. Taxable margin is capped at 70 percent of total revenue. The margin tax includes several exemptions and limitations. For example, taxable entities with total revenue of less than $1 million are exempt from tax through fi scal year 2011. Thereafter, taxable entities with total revenue of less than $300,000 will remain exempt and those taxable entities with total revenue of $300,000-$1 million will benefi t from a graduated system of deductions. The margin tax introduced “combined reporting” to Texas. Entities that share more than 50 percent common ownership and are engaged in a “unitary business” must

Allen Craig ([email protected]) is a Partner in the Houston office of Gardere Wynne Sewell LLP. His practice is focused on tax and business planning, including mergers and acquisitions, corporate reorganizations, and international transactions. John Eliason ([email protected]) is a Partner in the Dallas offi ce of Gardere Wynne Sewell LLP. His practice is concentrated in federal, state and international taxation, and particularly on structuring domestic and offshore acquisitions, sale and development projects.

Texas Margin Tax Update: Potential OpportunitiesBy Allen B. Craig III and John A. Eliason (Gardere Wynne Sewell LLP)

calculate their margin tax liability on a combined basis as if they were a single taxpayer.

Potential Opportunities The lack of administrative guidance provides the opportunity for taxpayers to take aggressive, but not unreasonable, positions because they will not be constrained by unfavorable interpretive precedent. Potential opportunities include the following:

Claiming the 0.5 percent tax rate. The margin tax provides a 0.5 percent tax rate to taxpayers primarily engaged in “retail or wholesale trade” and a 1.0 percent tax rate to all others. To be considered primarily engaged

The lack of administrative guidance provides the opportunity for

taxpayers to take aggressive, but not unreasonable, positions.

in a retail or wholesale trade, more than 50 percent of the taxpayer’s total revenue must be derived from activities described in Division G or F of the 1987 Standard Industrial Classifi cation Manual published by the federal Offi ce of Management and Budget. If the types of activities your business conducts are arguably described in these divisions of the SIC Manual—and more than 50 percent of your total revenue is derived through these activities—then consider claiming the lower tax rate. (See also discussion regarding combined group reporting, below.) Maximize the benefi t from using the COGS method.As defi ned for margin tax purposes, COGS includes all “direct costs” of acquiring or producing goods, as well as certain additional “indirect costs” and other adjustments. Neither the margin tax statutes nor the limited administrative guidance available provide a standard of differentiating between direct and indirect costs. While the comptroller’s published administrative rules identify specifi c items that must be included in

October 2010 Practical US/Domestic Tax Strategies® 3

FEDERAL TAX

RIC Act, continued on page 5

On September 28, the U.S. House of Representatives passed the Regulated Investment Company (RIC) Modernization Act of 2010 (Act), which will go a long way toward updating and streamlining a number of mutual fund tax rules. It may be premature, however, to start celebrating. No companion bill is currently pending in the Senate, so the Act’s prospects remain uncertain. On the upside, the Act is viewed as noncontroversial and, as a result of a slight tweak to the excise tax rules to increase the required distribution for capital gain net income of a RIC from 98 percent to 98.2 percent, it is now a revenue raiser. Following is an overview of some of the more signifi cant changes that would arise if the Act is passed by the Senate in its current form and signed into law.

Income from Transactions in Commodities Would Be Qualifying Income

Currently, income from certain transactions in commodities is not treated as “qualifying income” for purposes of the RIC qualifi cation requirement that 90 percent of a RIC’s gross income constitute “qualifying income.” The Act would provide that income from commodities and commodities-linked derivatives would be counted as qualifying income. This change, however, doesn’t mean that the workarounds of commodities-linked notes and controlled foreign corporations (CFCs) that currently offer RICs exposure to commodities should be put aside. RICs will still need to meet the asset diversifi cation requirements with respect to their investments in “securities,” and commodities are not considered “securities” for these purposes. Open questions remain as to whether derivatives based on commodities are “securities” under the Internal Revenue Code’s (IRC) cross-reference to

William Zimmerman ([email protected]) is a Partner in the Philadelphia offi ce, and Jarrod Huffman ([email protected]) is an Associate in the San Francisco offi ce, of Morgan Lewis & Bockius LLP. Mr. Zimmerman’s practice is concentrated in tax, and particularly on the creation and operation of private and pooled investment vehicles, including mutual funds, hedge funds and other investment-related vehicles. Mr. Huffman’s practice is focused on a wide range of federal income tax-related matters, including domestic and cross-border mergers and acquisitions, restructurings, and representation of clients in audits and appeals.

House Passes RIC Modernization Act of 2010By William P. Zimmerman and Jarrod A. Huffman (Morgan Lewis & Bockius LLP)

the Investment Company Act of 1940 (1940 Act) for purposes of defi ning what constitutes a “security” for these purposes.

Form 1099 to Replace 60-Day Designation Rules Currently, a RIC must designate the character of certain of its dividends not later 60 days after the close of its taxable year. These requirements predate the requirement that a RIC send a Form 1099 to shareholders. The Act would replace the 60-day designation requirements with a requirement that these designations be made by means of a written statement to shareholders that would include Form 1099.

Clarifi cation of Foreign Currency Gains Currently, the U.S. Department of the Treasury (Treasury) has the authority to promulgate regulations to exclude from qualifying income certain foreign

Income from commodities and commodities-linked derivatives would be

counted as qualifying income.

currency gains that are not directly related to a RIC’s principal business of investing in stock and securities. To date, however, no such regulations have been issued. The Act would remove the Treasury’s authority to issue these regulations, thereby clarifying a RIC’s ability to invest in foreign currencies.

Repeal of Preferential Dividend Rules for Publicly-Offered RICs

Currently, RICs are subject to the preferential dividend rules. Under these rules, the dividends paid deduction is not available to a RIC unless, generally, the dividends it pays are paid pro rata with no preference to any shares of stock, except to the extent a class of stock is entitled to a preference. The Act would repeal the application of the antiquated preferential dividend rules as they apply to RICs and, as a result, would remove an area of considerable uncertainty and traps for the unwary.

Capital Loss Carryforwards Currently, capital loss carryforwards are limited


Capital Gain Exclusion, continued on page 5

FEDERAL TAX

One under-publicized tax planning opportunity contained in the Small Business Jobs Act of 2010 (2010 Act), signed into law on September 27, is a provision permitting non-corporate taxpayers to lock in during 2010 a zero percent federal income tax rate on gain (subject to certain limitations) realized on a later sale of certain “qualified small business stock” (QSBS). Individuals looking to invest in QSBS, and qualifi ed small business corporations looking to raise capital, may want to take advantage of this planning opportunity. Taxpayers looking to benefit from this provision, however, need to act by year end.

Background The Internal Revenue Code generally permits an exclusion from income for 50 percent of a non-corporate taxpayer’s gain realized on the qualifying sale or exchange of QSBS. The determination of whether a particular investment qualifi es for this exclusion is initially made at the time of such investment. The exclusion, to the extent available, then applies to gain realized upon a later sale of the underlying stock, which could occur several years later (in fact, the law requires that the stock be held for more than fi ve years in order for the exclusion to apply). Under pre-2010 Act law, however, any gain remaining after allowance for this exclusion is taxed at a maximum capital gains rate of 28 percent (in lieu of the general 15 percent currently applicable rate). In addition, a portion of the excluded gain is required to be treated as a preference item for purposes of the alternative minimum tax (AMT), potentially subjecting the taxpayer to this alternative tax regime. The combination of these two collateral effects generally, and sometimes signifi cantly, reduces the potential benefi t of

Christopher Flanagan (cfl [email protected]) is a Partner, and Paul Decker ([email protected]) is an Associate, with the Boston offi ce of Sullivan & Worcester LLP. Mr. Flanagan’s practice is focused on tax planning and analysis of the tax implications of transactions. He has particular experience working with public and private companies in taxable and tax-free acquisitions and reorganizations. Mr. Decker’s practice is concentrated in tax aspects of real estate investment trusts, tenant-in-common sponsors, investment partnerships and midsize and large corporations.

Capital Gain Exclusion Rate Increased to 100 Percent for Qualifying Investments By Christopher M. Flanagan and Paul W. Decker (Sullivan & Worcester LLP)

the exclusion, inconsistent with the statutory intent of encouraging investment in QSBS. Legislation enacted in 2009 increased the amount of the gain exclusion to 75 percent for certain purchases of QSBS, but left in place the 28 percent maximum tax rate on the remaining gain and the AMT preference treatment, thus continuing to dampen the enthusiasm for qualifying investments, even at this increased rate of exclusion.

The Three-Month Opportunity The 2010 Act (i) increases the exclusion rate to 100 percent for qualifying investments in QSBS made after September 27, 2010 and before the end of the year, and (ii) eliminates the AMT preference treatment for the

Taxpayers looking to benefi t from this provision need to act by year end.

excluded gain on such investments. Accordingly, both of the factors that previously reduced the benefi ts of investment in QSBS have been eliminated by the 2010 Act for investments covered by its provisions. There is no remaining gain to be taxed at the elevated 28 percent capital gains tax rate, and taking advantage of the exclusion will not increase a taxpayer’s exposure to the AMT. Dispositions of QSBS qualifying under the 2010 Act’s provisions, and meeting the other requirements for gain exclusion, including the minimum fi ve-year holding period discussed above and an overall cap on gain that can be excluded discussed below, may thus truly be subject to a zero percent effective federal income tax rate. The 2010 Act’s provisions, however, do not apply to QSBS acquired on or prior to September 27, 2010, or to QSBS acquired after the end of the year, when the regular 50 percent exclusion and the AMT preference treatment will return. Thus, only acquisitions of QSBS within this three-month window in 2010 create interests eligible for the 100 percent exclusion and the special AMT treatment on a later sale.

Qualifi ed Small Business Stock Requirements In order for stock to qualify as QSBS and be entitled


FEDERAL TAX

Capital Gain Exclusion (from page 4)

to the benefi ts of the exclusion, the stock must meet the following requirements:

• It must be acquired at original issue in exchange for money or other property (generally excluding stock) or as compensation for services (other than underwriting services), and held for more than fi ve years prior to sale. For stock acquired through the exercise of certain qualifying options, warrants, or convertible bonds, the holding period would begin with the date of exercise (thus, exercise would have to occur by year end in order for 2010 Act’s provisions to apply).

• The issuing corporation must be a qualifi ed small business corporation and must agree to certain reporting requirements.

• The amount of gain that can be excluded by a taxpayer with respect to any single issuing corporation is generally limited to the greater of ten times the adjusted basis of the QSBS disposed of or $10 million.

For this purpose, a qualified small business corporation is a domestic C corporation with aggregate gross assets not exceeding $50 million at any time before or immediately after the issuance of the subject stock. A qualifi ed small business corporation must also satisfy an active business requirement, which generally means that at least 80 percent of its assets must be used in the active conduct of one or more qualifi ed trades or businesses during substantially all of the holding period for the stock. Under certain circumstances, start-up and research and development activities may be treated as

active trade or business activities for this purpose. Care must be exercised, because some trades or businesses are excluded from being qualifi ed trades or businesses for this purpose, including (i) many professional service businesses, (ii) fi nancial service businesses, (iii) farming businesses, (iv) mining and extraction businesses, and (v) hospitality businesses (hotels, restaurants, or similar businesses). In addition, certain corporations subject to special tax treatment (for example, RICs, REITs, and cooperative corporations) cannot be qualifi ed small business corporations, and certain purchases or redemptions of stock by a qualifi ed small business corporation in close proximity to a stock issuance can cause the loss of QSBS status for the issued stock. Special rules also apply for QSBS held by partnerships, including investment funds treated as partnerships for tax purposes.

Summary The 2010 Act eliminates the erosion of potential

tax benefi ts formerly associated with investments in QSBS. In addition, with capital gains tax rates scheduled to rise over the coming years, the possibility of receiving tax-free capital gains becomes more appealing. Individuals looking to invest in QSBS, and qualifi ed small business corporations looking to raise capital, should consider the limited opportunity to do so before year end to take advantage of the 2010 Act’s provisions. While some members of Congress have proposed extending the 2010 Act’s provisions beyond the end of this year, the prospects for such proposals are uncertain at best.

© 2010 Sullivan & Worcester LLP

RIC Act (from page 3)

to eight years. Under the Act, losses would be carried forward indefi nitely and retain their character as either short-term or long-term losses.

More Forgiving Penalties for RIC Qualifi cation Missteps

Currently, some minor RIC qualifi cation missteps might result in complete qualifi cation failure for a RIC. The Act would provide for certain cures for failures due to reasonable cause and certain de minimis failures. These failures would generally be able to be cured with monetary penalties (with a minimum penalty of $50,000, similar to what is currently available for REIT qualifi cation failures).

Pass-Through of Exempt Interest Dividends and Foreign Tax Credits for Certain RIC Fund of Funds

Fund of funds structures have become more common, but there exist some defi nitional restraints in the IRC regarding the pass-through of exempt interest dividends and foreign tax credits. The Act would permit the pass-through of these items through fund of funds. In addition, certain loss deferral provisions of the IRC would not apply to redemptions of lower-tier RICs in these structures.

Redemptions of Open-End RIC Shares Currently, there is some uncertainty concerning the treatment of the redemption of open-end RIC shares regarding whether certain redemptions are to be treated as dividends or are to be treated as sale or exchange transactions, depending on the circumstances. The Act

RIC Act continued on page 6


FEDERAL TAX

RIC Act (from page 5)

Richard E. AndersenArnold & Porter LLP (New York)

Joan C. ArnoldPepper Hamilton LLP (Boston)

William C. BenjaminWilmer Cutler Pickering Hale and Dorr LLP

(Boston)

Eric J. Coffi llMorrison & Foerster (Sacramento)

Joseph B. Darby IIIGreenberg Traurig LLP (Boston)

Rémi DhonneurKramer Levin Naftalis & Frankel LLP

(Paris)

David FlanaganDJF Consulting (Boston)

Jeff FriedmanSutherland Asbill & Brennan LLP

(Washington)

Jorge GrossPricewaterhouseCoopers LLP

(Miami)

Jamal Hejazi, Ph.D.Gowlings, Ottawa

Lawrence M. HillDewey & LeBoeuf LLP (New York)

Advisory Board

Marc LewisSony USA (New York)

Lisa C. LimErnst & Young (New York)

Keith MartinChadbourne & Parke LLP

(Washington)

Yongjun (Peter) NiErnst & Young (New York)

Kevin RoweReed Smith (New York)

Eric D. RyanDLA Piper (Palo Alto)

John A. SalernoPricewaterhouseCoopers LLP

(New York)

Michael J. SemesBlank Rome LLP (Philadelphia)

Michael F. SwanickPricewaterhouseCoopers LLP

(Philadelphia)

Edward TanenbaumAlston & Bird LLP (New York)

David R. TillinghastBaker & McKenzie LLP (New York)

would provide that the redemption of stock of certain publicly-offered RICs be treated as a sale or exchange transaction if the redemption is on the demand of the shareholder.

Spillback Dividends Currently, some antiquated rules govern the timing of the declaration and distribution of spillback dividends. The Act would permit fl exibility regarding their declaration and distribution.

Increase in Excise Tax Distributions As a pay-for, the Act would provide an increase in the required distribution for capital gain net income of a RIC from 98 percent to 98.2 percent. For a number of reasons, such as late Form K-1s or other tardy information, a number of RICs end up paying excise taxes (usually in a de minimis amount). Interestingly, the change was made only with respect to capital gain net

income; the required distribution amount with respect to a RIC’s ordinary income remains at 98 percent.

Other Proposed Changes in the Act• Modifi cation of rules for allocating certain RIC

capital gain dividend distributions• Inclusion of certain nondeductible items of RIC

income in earnings and profi ts calculations for tax-exempt funds

• Permission of the deferral of certain end-of-year losses of RICs

• Modifi cation of certain return of capital distributions of RICs

• Deferral of certain gains and losses of RICs for excise tax purposes

• Determination of distributed amount for excise tax purposes on the basis of taxes paid by the RIC

• Repeal of certain defi ciency dividend penalties for RICs

• Modifi cation of sales load basis deferral rules for RICs

© 2010 Morgan, Lewis & Bockius LLP


CALIFORNIA

Budget Tax Provisions, continued on page 8

[Editor’s Note: The income and franchise tax provisions of California’s budget for the 2010-2011 fi scal year were signed into law by Governor Schwarzenegger on October 14, 2010. The new provisions extend the suspension of net operating loss deductions, relax the 20 percent corporate understatement penalty, and remove recently enacted market-based sourcing rules for taxpayers that do not elect the single sales factor method of apportionment.]

Extension of Net Operating Loss Deduction Suspension

For both corporate and individual taxpayers, the suspension of net operating loss (NOL) carryover deductions is extended for two additional years, through the 2010 and 2011 tax years.1 The carryover period for any suspended NOL deduction is extended for the number of years the deduction is suspended.2

The NOL carryback deduction allowed for the 2011 tax year has been delayed for two years, and will now be allowed beginning in the 2013 tax year.3 The deduction may be carried back two years, and will be phased in gradually, allowing carryback of 50 percent of the NOL sustained in 2013, 75 percent of the NOL sustained in 2014, and all of the NOL sustained on or after January 1, 2015.4 SB 858 also specifi es that the fi ve-year NOL carryback provisions for losses attributable to federally declared disasters do not apply for tax years beginning on or after January 1, 2011.5

Individual taxpayers with modifi ed federal adjusted gross income of less than $300,000, and corporate taxpayers with less than $300,000 of pre-apportioned income for the tax year are exempt from the 2010-2011 suspension of the NOL carryover deduction.6

“Pre-apportioned income” is defi ned as net income after state adjustments and before apportionment and allocation, and includes the aggregate amount of such income for all members included in a combined report.7

A corporate taxpayer that ceased doing business prior to August 28, 2008, and who recognized a gain on the sale of substantially all of its assets pursuant to a plan of reorganization under federal bankruptcy laws may offset such gain with existing NOLs despite any

Michael J. Cataldo ([email protected]) is a Senior Associate at the San Francisco offi ce of Pillsbury Winthrop Shaw Pittman LLP. His practice is concentrated in state and local tax issues. He is a member of the fi rm’s Tax and Tax Controversy Groups.

Tax Provisions of the 2010-2011 California Budget By Michael J. Cataldo (Pillsbury Winthrop Shaw Pittman LLP)

suspension of NOL deductions.8

Relief from the 20-Percent Strict Liability Corporate Understatement Penalty

For tax years beginning in 2010, the 20-percent corporate understatement penalty may not be imposed unless the understatement of tax exceeds both $1 million and 20 percent of the tax shown on the original return.9

However, for tax years beginning in 2003 and before 2010, the penalty continues to apply to understatements of tax in excess of $1 million without regard to the percentage of tax understated.10

The Return of Cost of Performance Sourcing Rule For multistate corporate taxpayers that do not elect to use a single sales factor apportionment formula, the assignment of sales other than sales of tangible

Beginning in 2011, a corporation has California nexus if its California sales exceed the lesser of $500,000 or 25

percent of the corporation’s total sales.

personal property for purposes of the sales factor is determined by where the greatest portion of income-producing activity is performed, based on the costs of performance (the “cost of performance” rule).11 This provision reverses prior legislation that repealed the cost of performance rule, and replaced it with a market-based sourcing rule effective for tax years beginning in 2011.12

However, taxpayers that elect to use a single sales factor apportionment formula must still assign such sales to the market state for tax years beginning in 2011.13

Effect on Economic Nexus Provisions Beginning in 2011, a corporation has California nexus if its California sales exceed the lesser of $500,000 or 25 percent of the corporation’s total sales.14 For purposes of applying this nexus provision, California sales of other than tangible personal property are determined by market-based sourcing rules.15 SB 858 specifi es that market-based sourcing rules must be used to determine the amount of sales sourced to California for purposes of applying this nexus provision, irrespective of whether


CALIFORNIA

Nexus, continued on page 9

Budget Tax Provisions (from page 7)

a corporation makes a single sales factor election, or if the election is ultimately repealed.16

____________1California Revenue and Taxation Code (CRTC) sections 17276.21(a) and 24416.21(a). 2CRTC sections 17276.21(b) and 24416.21(b). 3CRTC sections 17276.20(c)(1), 17276.21(c), 24416.21(c), and 24416.22. 4CRTC sections 17276.20(c)(2) and 24416.20(d)(2). 5CRTC sections 17276.05 and 24416.05. 6CRTC sections 17276.21(d)(2) and 24416.21(e). 7CRTC section 24416.21(e)(2) and (3).

8CRTC section 24416.21(f). 9CRTC section 19138(a)(1)(A) and (B). 10CRTC section 19138(h)(2). 11CRTC section 25136(a). 12See Assembly Bill X3 15 (2009) and former CRTC section 25136(b). 13CRTC section 25136(b)(5)(A). If Proposition 24 passes in the California general election on November 2, 2010, the single sales factor election would be repealed, and all taxpayers would be required to use the cost of performance rule. 14CRTC section 23101(b)(2). 15Id. 16CRTC section 25136(b)(5)(C).

© 2010 Pillsbury Winthrop Shaw Pittman LLP

MARYLAND

In October, the Maryland Tax Court heard arguments in ConAgra Brands, Inc. v. Comptroller of the Treasury, No. 09-IN-OO-0150. ConAgra Brands is the most recent case in which the Comptroller has asserted nexus over an intangible holding company, and is the fi rst case to be heard by the Tax Court on an intangible holding company issue since the court’s October 2008 decision in Nordstrom, Inc., et al. v. Comptroller of the Treasury.1

However, it does not appear to be the last. Several other intangible holding company appeals are pending in Maryland. It remains to be seen whether ConAgra Brands or any of the taxpayers in the other pending cases will break the Comptroller’s winning streak stretching back to Comptroller of the Treasury v. SYL, Inc.

Background ConAgra Brands, Inc. (CBI) was a Nebraska corporation and subsidiary of ConAgra Foods, Inc., a leading packaged food company.2 CBI was created in 1996 and licensed intellectual property to certain independent

Alexandra Sampson ([email protected]) is an Associate in the Washington, D.C. offi ce of Reed Smith LLP. She is a member of the State Tax Group. Stephen Balzick ([email protected]) is an Associate in the Philadelphia offi ce of Reed Smith. His practice is focused on complex multistate tax appeals, litigation, and minimizing state tax burdens. He is a member of the fi rm’s State Tax Group.

May State Claim Nexus Over Intangible Holding Company that Lacks Economic Substance?By Alexandra P.E. Sampson and Stephen J. Balzick (Reed Smith LLP)

operating companies (IOCs) of the ConAgra family for use in the manufacture and distribution of food and related food products at locations outside of Maryland. In return, the IOCs paid CBI a royalty for their use of the intellectual property. CBI did not fi le Maryland tax

Several other intangible holding company appeals are pending

in Maryland.

returns and had no property, payroll or sales in the state. In addition, CBI performed quality control testing, licensed intellectual property to third parties, and defended and protected the intellectual property. CBI was also responsible for ConAgra’s national advertising and marketing programs—spending millions of dollars on advertising and marketing campaigns each year. In 2005, the Comptroller audited the Maryland returns fi led by the IOCs. After the audit, and despite the aforementioned facts, the Comptroller determined that CBI was operated, at least in part, as a conduit to shift income outside of the state. However, instead of disallowing the deductions taken by the IOCs for the royalties paid to CBI, the Comptroller instead issued an assessment against CBI covering all years going back to 1996. For purposes of this assessment, the Comptroller


MARYLAND

Nexus (from page 8)

attributed income to CBI equal to the royalties deducted by the IOCs. Further, in apportioning CBI’s “income,” the Comptroller used the combined apportionment factors of all of the IOCs that fi led in Maryland. The total amount of tax, interest and penalties assessed against CBI exceeded $2.8 million for the tax years 1996 through 2003. Upon the Comptroller’s Notice of Final Determination, which upheld the audit assessment, CBI appealed the matter to the Maryland Tax Court.

Maryland Tax Court Hearing Maryland Tax Court Chief Judge Walter C. Martz II heard arguments from both parties in October.

During the hearing, counsel for CBI focused heavily on the activities of CBI and its relationship with ConAgra Foods and the IOCs, and compared those activities and relationships with those described in Comptroller of the Treasury v. SYL, Inc. In SYL, the Tax Court found that an intangible holding company had nexus with Maryland based on the presence of the holding company’s parent within Maryland, and the fact that the subsidiary had no economic substance separate from its parent. Counsel for CBI argued that, unlike the holding company in SYL, CBI had economic substance and was formed for a valid business purpose. Counsel for CBI also argued that, even if CBI was subject to tax in Maryland, the Comptroller’s assessment was distortive because it used the receipts of the IOCs to apportion CBI’s income to Maryland. In contrast, the Comptroller argued that SYL did not require a licensing arrangement to be deemed a sham or to lack economic substance in order for Maryland to assert nexus with the intangible holding company. In fact, during the hearing, the Comptroller’s Audit Manager claimed that CBI had nexus with Maryland, because it was involved in “income shifting” transactions with the IOCs, not because the transactions between CBI and the IOCs lacked economic substance. (Of course, it is not clear how the Comptroller was able to come to the conclusion that the transactions between CBI and the IOCs involved “income shifting” without examining the economic substance of those transactions.)

Both parties will submit post-trial briefs after a transcript of the proceedings has been prepared. The Tax Court is expected to issue a decision sometime next year.

More Cases to Follow A number of other cases involving intangible holding company-type issues are lined up behind ConAgra Brands at the Maryland Tax Court. The next cases scheduled to be heard by the Tax Court are Staples,

Inc. v. Comptroller, No. 09-IN-OO-0148 (Staples) and Staples the Offi ce Superstore, Inc. v. Comptroller, No. 09-IN-OO-0149 (Staples Superstore).

Staples involves the Comptroller ’s attempt to tax the interest receipts of Staples received from two affiliates that operated retail stores in Maryland. Staples, a corporation with payroll in excess of $100 million, provided loans to the two affi liates and, in return, received interest payments from the affi liates. The Comptroller, looking at the signifi cant Maryland activities of the affi liates, and their reduction in federal, and therefore, Maryland taxable income, determined that Staples was conducting financing activities in Maryland based on the activities of those affi liates. Staples had no Maryland property, payroll, or sales of its own, and did not fi le tax returns with Maryland.

In Staples Superstore, the Comptroller is using the same theory posited in the Staples case to attempt to tax the royalty receipts of Staples Superstore. In this case, Staples Superstore licensed certain trademarks to two affi liates that operated retail stores in Maryland, and in turn, those affi liates paid royalties to Staples Superstore for use of the trademarks. While Staples Superstore operated retail stores and distribution centers in various states, none were located in Maryland. Despite this, the Comptroller asserts that Staples Superstore is subject to tax in Maryland based on the signifi cant Maryland activities of its affi liates from which it receives royalty payments.

Observations Taxpayers should keep an eye on the intangible holding cases in Maryland. Although previous decisions suggest that relief at the Maryland Tax Court may be diffi cult to obtain, the possibility remains that the Tax Court will determine that not all intangible holding-company cases are alike.

The ConAgra Brands, Staples, and Staples Superstorecases are of particular importance because if the court rules in favor of the Comptroller, the decisions could be used by the state as support for the proposition that mere assertion of “income shifting” by the Comptroller—regardless of the existence, or lack thereof, of economic substance—is enough to assert nexus over out-of-state affi liates. Such holdings would make it almost impossible for taxpayers to successfully challenge intercompany transactions. However, if any of the cases results in a taxpayer victory, it may serve as support for companies that truly have economic substance to avoid nexus.__________________1Nordstrom was later remanded back to the Tax Court to address other issues in that case, and a decision was issued by the court on those supplemental issues in February 2010.2In 2007, ConAgra Brands, Inc. was merged into ConAgra Foods, Inc., and ceased to exist.

© 2010 Reed Smith


NEW JERSEY

Interest Addback, continued on page 11

On August 31, 2010, the New Jersey Tax Court issued a memorandum decision in Benefi cial New Jersey, Inc. v. Director, Division of Taxation,1 concluding that the taxpayer satisfi ed one of the enumerated exceptions to the interest addback statute under N.J.S.A. 54:10A-4(k)(2)(I), and was thus entitled to its interest expense deductions. The case involved the interest addback provisions of N.J.S.A. 54:10A-4(k)(2)(I), which were enacted as part of the Business Tax Reform Act of 2002. The statute provides that the determination of a taxpayer’s “entire net income” shall be made without the exclusion, deduction or credit of “interest paid, accrued or incurred … to a related member.” However, the Legislature also provided several exceptions whereby such interest expense deductions would be permitted. During the tax years at issue, Benefi cial New Jersey (BNJ) offered consumer fi nance products to customers at its retail branch lending operations located in New Jersey. The fundamental business practice of BNJ was to make loans to its customers. In order to fi nance those loans, BNJ needed to borrow money, which it did from its parent, HSBC Finance Corporation (HSBC). HSBC borrowed funds from unrelated third parties at a more favorable rate than any of its subsidiaries, including BNJ, could do on their own. HSBC then loaned those funds to the subsidiaries at the maximum Applicable Federal Rate. For the tax years at issue, BNJ deducted the interest payments paid on its loans from HSBC in arriving at its taxable income. Upon audit, the Director of the New Jersey Division of Taxation disallowed the interest expense deductions pursuant to the interest addback

Jeffrey Vesely ([email protected]) and Annie Huang ([email protected]) are Partners in the San Francisco offi ce of Pillsbury Winthrop Shaw Pittman LLP. Mr. Vesely’s practice is focused on state and local tax matters, including income, franchise, sale and use, property and employment, and other taxes. He is head of the fi rm’s State & Local Tax Practice. Ms. Huang’s practice is concentrated in state and local tax matters, including income, property, and sales and use taxes. She regularly practices before the California Franchise Tax Board and the California State Board of Equalization. She frequently works with multinational businesses in tax disputes with other jurisdictions.

New Jersey Tax Court Decides in Favor of Taxpayer in First Interest Addback CaseBy Jeffrey M. Vesely and Annie H. Huang (Pillsbury Winthrop Shaw Pittman LLP)

statute and refused to apply any of the enumerated exceptions in N.J.S.A. 54:10A-4(k)(2)(I). In its Tax Court complaint, BNJ alleged that it was entitled to the interest expense deductions because it satisfi ed three of the exceptions in N.J.S.A. 54:10A-4(k)(2)(I). Specifi cally, BNJ alleged that it satisfi ed the “three percent” exception, the “guarantee/conduit” exception, and the “unreasonable” exception.2

“Unreasonable” Exception Applies In its memorandum decision, the Tax Court concluded that BNJ did not satisfy the “three percent” and “guarantee/conduit” exceptions. However, the

The court found that the reason for the practice whereby HSBC borrowed funds to lend to its subsidiaries was credible

because HSBC could receive more favorable rates than its subsidiaries

could on their own.

court held that “the totality of these circumstances present the kind of situation contemplated by the drafters of the ‘unreasonable’ exception.” The court found that BNJ’s loans from HSBC had economic substance, and that the reason for the practice whereby HSBC borrowed funds to lend to its subsidiaries was credible because HSBC could receive more favorable rates than its subsidiaries could on their own. The court also noted that HSBC paid taxes in other jurisdictions on the interest income it earned from BNJ. Although the Director argued that BNJ was not entitled to the “unreasonable” exception because the statute was not enacted solely to address tax avoidance, the court disagreed. The court noted that the Director offered only two scenarios where the “unreasonable” exception would apply, and while those situations are perhaps unreasonable, “they are not the ‘alpha and omega’ of unreasonable situations.” Moreover, despite the Director’s concession that the “unreasonable” exception applies to more than the two specifi cally


NEW JERSEY

Corporate Existence Respected, continued on page 12

Interest Addback (from page 10)

named situations, the Director could not suffi ciently explain its approach to the “unreasonable” exception. The court concluded that

[I]f the Director’s overly strict interpretation of the statute were to prevail, he would not be exercising any discretion himself but only that confi ned to specifi c pre-determined situations. Had the Legislature intended for such strict circumstances, it would not have drafted the statute as it did … . The Director’s overly narrow interpretation of the statute, in this matter, at least, goes beyond reasonable limits, calling into question the reasonableness of the methodology.

The court then held that the “unreasonable” exception operates to permit BNJ’s interest expense

deductions.

Discretion Permitted What is the signifi cance of the Tax Court decision in Benefi cial New Jersey, Inc. v. Director, Division of Taxation? It confi rms that even without the “three percent” or the “guarantee/conduit” exception, the addback of interest expense is not automatic or purely mechanical, and that the “unreasonable” exception is a viable one for taxpayers despite the Director’s attempts to limit its applicability to “pre-determined situations.” As the court held, the applicability of the “unreasonable” exception shall be determined on a case-by-case basis dependent on the totality of the taxpayer’s facts and circumstances.________________1N.J. Tax Court, Docket No. 009886-2007 (Aug. 31, 2010).2N.J.S.A. 54:10A-4(k)(2)(I) gives the Director discretion in determining when the disallowance of a deduction is unreasonable.

NEW YORK

An Administrative Law Judge (ALJ) has held that a company that owned two aircraft and leased them to offi cers and family members of a related company was not a sham and should not be disregarded for sales and use tax purposes. Matter of WRBC Transportation, Inc., DTA No. 822722 (N.Y.S. Div. of Tax App., Sept. 16, 2010). The ALJ rejected the arguments of the Division of Taxation that the Petitioner was so dominated and controlled by its parent corporation that the use of the Petitioner’s aircraft by its parent and the parent’s offi cers and employees amounted to “self use” rather than commercial use. WRBC Transportation (Transportation) was a wholly-owned subsidiary of a privately-held fi nancial services company, W.R. Berkley Corporation, Inc.

Hollis L. Hyans ([email protected]) is a Partner in the New York offi ce of Morrison & Foerster LLP. Her practice focuses on state and local tax planning and litigation. The views expressed in this article are those of the author only and are not attributable to Morrison & Foerster LLP or any of its clients. The information provided herein may not be applicable in all situations and should not be acted upon without specifi c legal advice based on particular situations.

Related Parties Found Not to be ShamsExemption from Sales and Use Tax Permitted

By Hollis L. Hyans (Morrison & Foerster LLP)

(WRBC). Transportation owned all the shares of Interlaken Capital Aviation Holdings, Inc., which in turned owned all the shares of Interlaken Capital Aviation Services, Inc. (Interlaken). The companies had interlocking boards of directors and offi cers. During the audit period, Transportation owned a helicopter and a jet, which were registered in its name and stored in a hangar in New York State, owned by Interlaken. Transportation charged WRBC for all flights. The charges were considered revenue to Transportation and expenses to WRBC on their respective books and records, although no funds were transferred. The charges were computed by multiplying the number of fl ight hours by a fi xed rate, which was based upon certain of the costs of operating the aircraft for the previous year. Revenue and expenses were reported via journal entries, which were eliminated when the entities’ federal returns were consolidated. Transportation had no bank accounts of its own. Interlaken paid all of the bills related to the operation expenses of the aircraft, and treated the management fees owed to it by Transportation as an item of revenue, while Transportation treated the fees as an expense, but again no funds moved between the two entities.


NEW YORK

Corporate Existence Respected, continued on page 13

Corporate Existence Respected (from page 11)

Senior Editor: Scott P. Studebaker, Esq.

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Special Interviews: Scott P. Studebaker

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Interlaken provided all of the services needed to maintain, manage and operate the aircraft, including all accessory equipment, and had approximately 26 employees to perform those services. Interlaken was responsible for hiring all of the pilots and other personnel, approving all flights, administering

no evidence it was set up as a sham or for the purpose of tax avoidance. The ALJ stated that, while courts will disregard the corporate form when necessary to “prevent fraud or to achieve equity,” no such situation was present. The facts that the aircraft were used exclusively by offi cers, directors, employees and family members of WRBC, that the compensation paid covered only the operating costs and that WRBC had funded the purchase of the aircraft did not require that the corporate form be disregarded. While the ALJ noted that the Division “seems to allege” that Transportation was formed for the purpose of tax avoidance, there was no evidence in the record to support such a contention, and the history of the company indicated otherwise: Transportation had been in existence since 1983; it owned various aircraft since 1996; and it had a service contract with Interlaken, which had also entered into similar service agreements with third parties. The ALJ also did not appear to be

Even though the companies had interlocking offi cers and directors

and the subsidiary had no bank accounts of its own, the tribunal

found that the tax exemption for the subsidiary was appropriate.

scheduling and documentation and providing dispatch services. The only uses of the aircraft were for the offi cers, directors, employees and family members of WRBC. No sales or use tax was paid by Transportation on the aircraft.

Sales and Use Tax Exemption New York’s law provides an exemption from the sales and use tax for commercial aircraft primarily used in intrastate or interstate commerce, and an exemption from the tax otherwise due on the service of maintaining or repairing tangible personal property for services rendered with respect to commercial aircraft. Tax Law §§ 1115(a)(21), 1105(c)(3)(v). During the years in issue, “commercial aircraft” was defined as aircraft used primarily to transport persons or property for hire, as well as to transport passengers’ tangible personal property. Tax Law § 1101(b)(17) (in effect during the years in issue).

Exemption for Subsidiary Appropriate The ALJ held that Transportation’s aircraft met the defi nition of commercial aircraft, and that adequate compensation was paid by WRBC for its use, so that Transportation was entitled to the sales and use tax exemption. He then considered—and rejected—the Division’s argument that the corporate form of the entities should be disregarded, whether that argument was framed as “piercing the corporate veil” or “substance over form” or “alter ego.” He found that the company had a legitimate business purpose, and that its desire to limit liability made business sense. Transportation carried on its business, and there was


Misclassifying Employees, continued on page 14

NEW YORK

Corporate Existence Respected (from page 12)

troubled by Transportation’s lack of a bank account, noting that its contractual arrangement with Interlaken obviates the need for one.

Additional Insights Since the years at issue in this case, the defi nition of exempt “commercial aircraft” has been amended, and it now excludes aircraft used primarily to transport employees, offi cers, members and others associated with affi liated persons. However, the principles articulated in this case are still of great interest. In many areas of the

tax law, including Article 9-A, the Division’s auditors have argued that related corporations should be disregarded, and often the facts cited are very similar to the facts in this case: interlocking offi cers and directors; intercompany payments made via journal entry, without actual transfer of cash; and all transactions of the taxpayer conducted with related parties. Here, the ALJ reviewed all of those facts and realized that they are normal indicia of business relationships; without other, real evidence that a company is a sham or was formed for tax avoidance rather than business purposes, its existence should be respected.

© 2010 Morrison & Foerster LLP

PENNSYLVANIA

On October 13, 2010, Gov. Edward G. Rendell signed the Construction Workplace Misclassification Act, making Pennsylvania the latest in a growing number of states to target an industry where misclassifi cation of employees as independent contractors is believed to be most prevalent.

Strict Standards for Independent Contractors in the Construction Industry

The law, which takes effect 120 days following enactment, creates a strict defi nition of “independent contractor.” No individual can be classified as an independent contractor unless he/she:

A. has a written contract to perform services

Bruce Ficken (fi [email protected]), a recognized authority in managing risk in construction projects, chairs Pepper’s Construction Law Practice Group and has conducted more than 60 trials as lead counsel. Richard Reibstein ([email protected]) co-chairs Pepper’s Independent Contractor Compliance Practice and has lectured and written extensively on diagnosing and minimizing exposure to independent contractor misclassification liability. Lisa Petkun ([email protected]) is a Senior Partner in Pepper’s Tax Department and also co-chairs its Independent Contractor Compliance Practice.

Pennsylvania Cracks Down on Independent Contractor Misclassifi cation in the Construction IndustryGovernor Signs Law that Imposes Strict Standards, Substantial Fines and Criminal Penalties

By Bruce W. Ficken, Richard J. Reibstein and Lisa B. Petkun (Pepper Hamilton LLP)

with the construction industry business;B. is free from control or direction over the performance of such services under the contract and in fact; and

C. is customarily engaged in an independently established trade, occupation, profession or business.

This type of three-part standard is commonly called an “ABC” test—but the Pennsylvania standard is less

Construction industry businesses that retain a signifi cant number of independent contractors will face

substantial liability for misclassifi cation.

onerous than the “ABC” laws governing independent contractors in the construction industry in New Jersey and New York. The new law contains a six-criteria requirement to satisfy the third prong of the “ABC” test. Under this “ABC-6” standard, an individual is only “customarily engaged in an independently established trade, occupation, profession or business” with respect to


Misclassifying Employees (from page 13)

PENNSYLVANIA

Misclassifying Employees, continued on page 15

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services performed in the construction industry if all six of the following criteria are met:

• the individual must possess the essential tools to perform the services independent of the business for which the services are performed

• under the individual’s arrangement with the business, the contractor must realize a profi t or suffer a loss

• the worker must have a proprietary interest in his/her business

• he/she must have a business location separate from the company for whom the services are being performed

• the individual must have previously performed the same services for another person, or “holds himself out to other persons as available and able, and in fact is available and able, to perform the same or similar services” and

• the contractor must maintain liability insurance during the term of the contract of at least $50,000

Violations and Penalties Section 4 of the new law provides that a company or its “offi cer or agent” is in violation of the Act if the business “fails to properly classify” an individual as an employee under the Pennsylvania Workers Compensation Act or Unemployment Compensation Act or fails to provide coverage or make contributions on behalf of an individual who should be classifi ed as an “employee” under those laws. Each individual misclassifi ed by an employer is a

separate violation of the law. Therefore, construction industry businesses that retain a signifi cant number of independent contractors will face substantial liability for misclassifi cation in Pennsylvania. Violations are enforced in a variety of ways. The Pennsylvania Secretary of Labor may seek a stop-work order from a court, assess penalties of up to $1,000 for the fi rst violation and up to $2,500 for each subsequent violation, and/or refer intentional or negligent violations of the Act to the Attorney General for criminal prosecution. An intentional violation of the law is a criminal misdemeanor; a negligent misclassifi cation is a criminal summary offense.

Other Provisions of the New Law The law includes what appear to be two groundbreaking provisions. First, in an effort to avoid the imposition of penalties for mistaken misclassifi cations, the new law provides that it “shall be a defense to an alleged violation of this Section [4] if the person for whom the services are performed in good faith believed that the individual who performed the services qualifi ed as an independent contractor at the time the services were performed.” Second, the law provides that a party that does not meet the defi nition of employer but “intentionally contracts with an employer knowing the employer intends to misclassify employees” is subject to the same penalties and remedies as an employer found to be in violation of the new law. This provision may cover employment agencies and other providers of labor for the construction industry.


PENNSYLVANIA

Planning Opportunities, continued on page 16

Misclassifying Employees (from page 14)

Another unusual provision of the law is a section that makes it a violation of the Act for a business to require or demand that an individual enter into an agreement or sign a document that results in the improper classifi cation of that individual as an independent contractor. It is unclear if the “good faith” defense applies to this provision of the law. If not, merely directing a worker to sign a Form W-9 (Request

many individuals are retained as independent contractors

• reviewing business agreements, records, and actual practices relating to the “ABC-6” factors

• restructuring the parties’ agreements and relationships in a bona fide manner including actual practices in the fi eld to ensure that current, legitimate independent contractor relationships, which may be capable of withstanding even greater scrutiny under the restrictive tests in the new law, can be maintained and will not be stricken down and penalized

• reclassify workers and groups of workers previously classifi ed as independent contractors, including those who would otherwise qualify as such under the common law test, if they cannot survive the “ABC-6” test, even after a bona fi de restructuring

• ensure that any reclassified workers as well as existing employees are reported to Unemployment Compensation and covered by the company’s Workers’ Compensation policy, and that income taxes are withheld and payroll taxes are reported and paid to federal, state and any applicable local government tax agency

ConclusionPennsylvania has joined 16 other states that have

enacted legislation in the past three years seeking to curtail misclassifi cation of employees as independent contractors in a particular industry or in all industries. The laws in those states (as well as Massachusetts, which has had an independent contractor law since 1992), can be found at <http://independentcontractorcompli-ance.com/legal-resources/state-ic-laws-and-selected-bills/>http://independentcontractorcompliance.com/legal-resources/state-ic-laws-and-selected-bills/. There also are two pending federal bills addressing independent contractor misclassifi cation (the Employee Misclassifi cation Prevention Act and the Fair Playing Field Act of 2010), which can be found at <http://independent-contractorcompliance.com/legal-resources/federal-ic-laws-and-bills/>http://independentcontractorcompli-ance.com/legal-resources/federal-ic-laws-and-bills/.

Businesses that engage independent contractors should take action to ensure

compliance with the law.

for Taxpayer Identifi cation Number and Certifi cation), which the IRS requires businesses to obtain from independent contractors, could be a violation of the law, even if the business mistakenly believes the individual is an independent contractor. Hopefully, the new law will not be enforced in that manner. The law includes a non-retaliation provision. Retaliation is prohibited against any person who exercises rights under the law, including the right to fi le a complaint or inform another about an employer’s noncompliance with the Act. Finally, the law provides that the Pennsylvania Labor Department shall create a poster for job sites and make the poster available on its Web site. The Act seems to have overlooked the typical statutory language that employers in the construction industry must post a copy of the Labor Department’s notice.

Steps to Ensure Compliance In advance of the effective date, construction industry businesses that engage independent contractors should take action to ensure compliance with the law. Steps to be taken may include the following:

• conducting an internal audit to determine how

TEXAS

Planning Opportunities (from page 2)

each of these categories, the lack of comprehensive guidance in this area provides taxpayers with some fl exibility to make their own interpretations of which other items should be included in the taxpayer’s COGS calculation. Note, however, that the margin tax statutes do make clear that a taxpayer must have COGS to use

the COGS method. If you are primarily providing professional services, it is unlikely that you will be able utilize the COGS method because your COGS, if any, will probably be less than your aggregate wages and compensation. (See also discussion regarding combined group reporting, below.) Calculating tax liability for a combined group. The


FEDERAL TAX

Planning Opps. (from page 15)

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A survey of more than 300 corporate tax and fi nance professionals in New York found that 60 percent of respondents indicated that the effects of additional U.S. legislation or regulations was their single greatest tax risk. The survey was conducted by Ernst and Young of attendees to their Annual International Tax Conference in New York on October 7 and 8, 2010. The survey also found:

U.S. Tax Legislation and Policy• The three proposed corporate tax changes that cause

most concern are U.S. check-the-box rules, effective deferral of U.S. deductions and an increase in the corporate tax rate.

• In the context of the global economic environment, respondents ranked potential aspects of U.S. international tax reform that would make their companies more competitive:

— 60 percent chose a reduction of the U.S. corporate income tax rate to 28 percent;

— 37 percent selected moving to a dividend exemption regime similar to most other countries;

— only 3 percent reported establishing a U.S. Value Added Tax (VAT) as the strongest solution.

• Among the U.S. international tax revenue raisers passed in August 2010, respondents expect to focus the most attention on two key changes:

— 43 percent anticipate that foreign tax splitter provisions will require the most attention;

Main Concerns of International Tax Professionals: New Tax Laws and Regulations

margin tax requires affiliated entities engaged in a “unitary business” to fi le their margin tax as a combined group. While the tax statutes make clear that “affi liated” entities share more than 50 percent common ownership, there is little guidance regarding whether two or more such entities should be considered engaged in a unitary business. Because members of the same combined group must calculate their combined tax liability using the same method (i.e., using either the COGS method or the aggregate wages plus compensation method) and the same tax rate, taxpayers with both service and manufacturing and/or retailing lines of business conducted through separate entities may want to consider whether those business lines are suffi ciently distinct to avoid including them in a combined group, if calculating margin tax liability on a separate basis provides a lower overall tax burden.

© 2010 Gardere Wynne Sewell LLP

— 26 percent percent expect to focus primarily on limitations to affi rmative use of Section 956 (controlled foreign corporations);

— other changes were also considered demanding: 12 percent focused on covered asset acquisition rules; 10 percent on the change in the 80/20 rules; and 10 percent on redemptions by foreign subsidiaries under Section 304.

International Tax Authority Cooperation• One-quarter (25 percent) of respondents say they are

experiencing the effects of tax authority cooperation. Among those:

— 39 percent faced such cooperation in the form of competent authority procedures;

— 36 percent saw treaty information exchange;— 31 percent noted the activities of international tax

authority groups such as the Joint International Tax Shelter Information Center (JITSIC);

— 21 percent experienced joint or bilateral audits.

Transfer Pricing• Most respondents (60 percent) say they prepare transfer

pricing documentation for more than 10 different countries.

• Fifty-eight percent said they are facing transfer pricing audits in just one to three countries. Another 13 percent are experiencing transfer pricing audits in more than 10 countries.

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