Do Intangible Holding Companies Need to Refile Add-Back Applications in Tennessee?

Tennessee passed legislation in 2012 to require preapproval for companies seeking to deduct intangible expenses paid to affiliates. This resulted in an laborious application process in Tennessee that many taxpayers undertook in 2013 to seek the Commissioner's "approval" to deduct these intangible expenses. The application process required a significant amount of documentation and detail from taxpayers and had to be filed 60 days before the filing of the applicable Tennessee franchise and excise tax return. The Commissioner was ostensibally required to either approve or deny the applications before the due date of the return, but in the event that the Commissioner was unable to complete this task, taxpayer's were absolved of penalties in the event that the applications were ultimately denied. Over 1 year later, the applications that were filed have not been acted on, and taxpayers are now in a position of asking ... "What now?" Under the statutory application process, taxpayers whose applications were approved in 2013 would be filing a renewal of the form with no obligation to provide further support for the deduction in 2014. Because there have been no approvals (or denials for that matter), it is unclear whether a renewal can be filed as there is no provision that deems the applications approved. For some taxpayers who have extended the filing of their franchise and excise tax returns, the 60-day due date for the application for the 2013 tax year is approaching, and they should consider whether they should resubmit the application out of an abundance of caution to make sure that the taxpayer qualifies for penalty abatement in the event that the application is ultimately denied. While the other alternative would be to file for a renewal, there does not seem to be a statutory basis for doing so. That said, the Department will not likely be stringent on this requirement considering that it was their delay in acting on the 2013 applications that has resulted in this dilemma. Taxpayers in this situation should, however, consider what their filing position will be and execute on that to avoid an unintended bad result.

Tennessee Tax Weekly: Business Tax, Collections and Moves in the News

The Tennessee Department of Revenue presented at the TSCPA Liaison meeting on December 18, 2013, focusing its attention on the business tax, improvements to the informal taxpayer conference process and the Department's "Retail Accountability Program." The big news with the business tax was that the Department is going to begin a transition of the staggered filing deadlines under current law to filing deadlines that are tied to taxpayer's fiscal year. In the past, the filing deadline was based on the types of taxable sales a taxpayer made and required taxpayers to prepare proforma financial statements to prepare the business tax returns. Details of the transition can be found on the Department's website. Practitioners should focus on these changes as the Department has begun sending out letters to taxpayers to advise them of the change and how the transition will be administered. In addition to business tax, the Department indicated that it will continue to monitor efforts by the NFIB on an Independent Tax Tribunal. The Department has proposed legislation that would modify the informal conference process, so this will be an item to watch in the upcoming legislative session. The Department provided numbers on its "Retail Accountability Program" which focuses on tobacco and beer wholesalers. The Director of Audit indicated that, under this program, over 2,000 assessments have been made this year totaling $14 million for tobacco and beer retailers who were determined to be underreporting sales of beer and tobacco. This program follows on the heals of legislation that was passed in 2013 to allow the Department to access information from tobacco and beer wholesalers. Taxpayers in these businesses should be aware of the Department's effort and review current sales tax filing positions to make sure that they are in compliance. Details about the Program can be found on the Department's website. Other items in the tax news include tax collections, Larry Hyatt's CPA firm merging with Decosimo, and the hotel/motel tax in Maury County.

Tennessee Tax Weekly: What's Going on In Tennessee Tax?

Amazon scheduled to start collecting sales tax on January 1, 2014, so enjoy your last Christmas shipments without the sales tax being collected by Amazon. Tennnesse Jock Tax continues to be focus of NHL. Putnam County Property Tax Cases set for hearings in January.

Dateline ABC-Nashville: Metro Council Approves New Tax on Sales in Central Business District

This is not the behind-the-scenes work of Lamar Wyatt of the ABC hit Nashville despite the fact that it does have the appearance of a deal that he would love.

That aside, last night at the actual Nashville Metro Council meeting the city council enacted Legislation to tax sales of services and tangible personal property sold at retail within the central business district. Revenue from the new tax (labeled a "fee") will be used to promote the new Music City Center.

The new tax will be .25% of the sales price of the taxable items and will be collected by the Tennessee Department of Revenue in the same manner as state sales tax is collected. Sales of professional services, lodging, concerts, sporting events, newspapers, long-term parking, and liquor are not subject to the new tax.

The boundaries of the district are roughly the Cumberland River to the east,  Lafayette Street to the south, 8th Avenue to the West and Charlotte avenue to the North.

Further background on the the tax/fee can be found in this link to the Tennessean Article.

For tax professionals, the legislation is light on details regarding when a sale is considered to be in the district and the exemptions are similarly vague. What about computer software... Don't get me started.

Because the tax is so low it is hard to imagine much push back when enforcement begins in January 2014, especially when considering it only adds 1cent to a $4 beer according to sponsors. We will see. 

Tennessee Court of Appeals Holds that Dial-up and Broadband Internet Access Services Are Not Taxable Telecommunications Services

The Tennessee Court of Appeals held on September 20, 2013 that dial-up and broadband Internet access services sold to Internet Service Providers that in turn provide these services to end-users were nontaxable “enhanced” services rather than “basic” services and that the true object of the services was not telecommunications.  Level 3 Communications, LLC v. Roberts, No. M2012-01085-COA-R3-CV (Tenn. Ct. App. Sept. 20, 2013).

Level 3 provides two internet services known as (3)Connect Modem and (3)Crossroads, which provide dial-up and broadband access to the internet, respectively. Level 3’s customers – retail or consumer Internet Service Providers such as Earthlink Communications and America Online – purchase the Level 3 services to enable their end-users to access the Internet. Level 3 would also sell these products to large corporations that used the service for remote access to corporate networks.  As part of the dial-up service, Level 3 provided local numbers so customers could access the local dial network, but Level 3 did not provide a local dial network infrastructure, which was instead provided directly by the local exchange carrier.

In January 2004, Tennessee published Sales and Use Tax Notice #04-03, which indicated that “Internet access is no longer considered a taxable ‘telecommunications service’ under Tennessee law.”  This Notice was issued following the Tennessee Court of Appeals ruling in Prodigy Serv. Corp., Inc. v. Johnson, 125 S.W.3d 415 (Tenn. Ct. App. 2003) and established a refund procedure for taxpayers to seek refunds of Tennessee sales and use tax collected and remitted on Internet access.  Level 3 filed a claim for refund, seeking a refund of Tennessee sales and use tax on its Internet access services.  The State denied the refund, maintaining that the Level 3 services were telecommunications services.

The Trial Court held that, under Prodigy’s analysis, Level 3’s wholesale internet access business was not taxable.  [Cite to Tennessee Court Says Wholesale Internet Access is Not Subject to Sales Tax, April 27, 2012.]

On appeal, the Tennessee Court of Appeals affirmed the Trial Court, concluding that “[r]egardless of whether an end-user used a dial-up modem ((3)Connect Modem) or broadband ((3)Crossroads) to connect with the internet, Level 3 converted the end-user’s information into IP packets and, using its routers and other hardware, enabled the end-user to access the Internet.”  In so holding, the Court of Appeals recognized that the Prodigy decision had identified “Internet access” as an example of an enhanced service that did not qualify as telecommunications. Prodigy, 125 S.W.3d at 419.

The Court of Appeals also concluded that the “true object” or “primary purpose” of the Level 3 services was to provide access to the Internet and not to provide telecommunications.

The State will have 60 days to decide whether to seek discretionary review by the Tennessee Supreme Court.

Tennessee Trial Court Holds that Third-Party Logistics Provider Is Not Exempt from Tennessee Business Tax

A Tennessee trial court has rejected a third-party logistics provider’s challenge to a Tennessee business tax assessment.  In the decision, the court concluded that some of the taxpayer’s logistics services were not covered by the “public utility exemption,” which exemption, by definition, extends to “common carriers.”  Exel, Inc. v. Roberts, Case No. 06‑2869-IV (Davidson County Chancery Court June 28, 2013).

            The taxpayer is a third-party logistics and transportation management company, providing large manufacturers and retail companies with design, logistics, and transportation management services.  These services include transporting raw materials or other products on a fully integrated basis through the customer’s manufacturing process and transporting, distributing and delivering the manufactured products to their ultimate destinations.  The taxpayer also provides warehouse management services.

            With operations throughout the world, the taxpayer had seven customers in Tennessee during the audit period.  The Department determined during audit that some of the transportation-related services provided to customers in Tennessee qualified for the public utility/common carrier exemption from the business tax.  The Department further determined, however, that many of the taxpayer’s other services were not exempt and assessed business tax on those services involving supply chain analysis and design, supply chain management, in-plant services, warehousing and order fulfillment, assembly and packaging, transportation management, service parts logistics and reverse logistics, among others.

            The parties filed cross-motions for summary judgment.  The taxpayer argued principally that because its services generally fell within the category of exempt public utility/common carrier services, it was fully exempt from the Tennessee business tax.  The trial court rejected that argument, concluding instead that “[t]o find an entire class of business exempt from business tax, regardless of the actual services conducted by that business, would operate to extend the enumerated services exemption provision beyond its plain meaning.”  Id., slip op. at 25-26.  The trial court further stated that the “determination of a business’ ‘dominant business activity’ is significant only to the determination of which classification the business would fall under, and even if the dominant business activity is not subject to business tax, those remaining revenues from activities that are subject to business tax are not exempt but rather accrue business tax.”  Id., slip op. at 26 (citing National Gas Distributors, Inc. v. State, 804 S.W.2d 66, 67 (Tenn. 1991)).

            The Court also rejected the taxpayer’s arguments that the sales should be treated as wholesale transactions and that the pass-through costs to provide the logistics services should not be included in the tax base.  Finally, the Court held that the business tax, as applied to this taxpayer, did not violate the Commerce Clause of the U.S. Constitution.

            The taxpayer has until July 28, 2013 to appeal to the Tennessee Court of Appeals.

Tennessee Department of Revenue Issues Last Call for Intangible Holding Company Voluntary Disclosure

The Tennessee Department of Revenue issued Notice 13-06 in June notifying taxpayers that its acceptance of voluntary disclosure of intangible expense deductions at a preferred settlement rate will be ending later this year. The Department states in the notice that, beginning September 30, 2013, it will no longer recommend settlements of cases involving intangible expenses paid to affiliates - the infamous "intangible holding company" structure.

The Department's settlment initiative began back in late 2011, and since that time, the law has changed, now requiring taxpayers for the 2012 tax period and after to file an application to claim deductions for intangible expenses paid to affiliates. The settlement generally only requires a taxpayer to pay only 25% of the proposed assessment from the disallowance of such deductions.

The timing of this is not surprising as the Department is starting to see the first of the applications under the new law being filed, with many that will be filed in August, as the pending extended deadline for filing for the 2012 tax period is in October (the application must be filed 60 days before the due date of the return).

Taxpayers still on the fence on this issue should seriously consider the voluntary disclosure, especially if they plan to continue to claim the deduction for future periods. The application process will put a taxpayer on the radar with the Deparment, and to the extent that the state denies the application, they would have a right to pursue the open years through an audit/assessment if no VDA has been submitted.

We knew this day would come, so consider this the last call ...