Tennessee Court Holds that Wide Area Network Service is a Taxable Telecommunications Service

A Tennessee Trial Court has ruled that wide area network (“WAN”) services provided by IBM are taxable “telecommunication services” under Tennessee’s sales and use tax.  IBM Corporation v. Farr, Civil No. 09-2144-I (Davidson County, Tenn. Chancery Ct. filed July 20, 2012).  The Court’s holding is premised on the conclusion that the “service consisted of the provision of links and hubs that transmitted IBM’s customers’ own information from one point to another.  Further, IBM did not provide any original information to its customers.  What IBM was selling, therefore, was the means of transmitting its customers’ information and not information that IBM itself provided.”  Id., slip op at 6-7 (emphasis added).

During the tax period at issue, IBM provided its WAN service to numerous customers in Tennessee.  The WAN consisted of a group of transmission lines or dedicated circuits from one location to another.  The WAN also included routers, hubs, and other equipment that made up the infrastructure through which customers accessed information.  According to IBM, the WAN services also included design, management, monitoring and troubleshooting the WAN.

IBM’s customers used the WAN service to allow its geographically separated managers, employees, and other authorized users to gain access to information critical to the customer’s day-to-day business operations.  Customers used computers and dedicated phone lines to log onto the WAN and gain access to the available information.  The WAN did not, however, provide IBM’s customers with the ability to send messages form one person to another.

IBM argued that the “true-object” test applied and that the WAN service was similar to the non-taxable online services provided in Prodigy Services Corp., Inc. v. Johnson, 125 S.W.3d 413 (Tenn. Ct. App. 2003) and the truck location service in Qualcomm, Inc. v. Chumley, 2007 WL 2827513 (Tenn. Ct. App. Sept. 26, 2007).  The trial court, however, relied on the fact that IBM did not create or gather the information made available to the users of the WAN service in reaching the conclusion that the WAN service was a telecommunications service more closely resembling the voicemail services that were found to be taxable telecommunications in Bellsouth Telecommunications, Inc. v. Johnson, 2006 WL 3071250 (Tenn. Ct. App. Oct. 27, 2006).

This case presents another in a continuing line of “true-object” cases in Tennessee in which the State has argued that a service is a taxable telecommunications service.  Thus, it is likely that an appeal will follow.

The deadline to file an appeal to the Tennessee Court of Appeals is mid-August.

Tennessee Sales Tax Treatment of Incentive and Recognition Programs

Incentive and recognition programs are becoming a more popular tool for employers to incentivize employees. As part of these programs, employers will hire a company to run the incentive program which allows employees to earn points or credit that can be used to redeem prizes, trips or other rewards. The employer will purchase the points that will then be allocated to employees based on performance. Because many of these programs involve the transfer of tangible personal property to employees, the question is whether there are sales and use tax consequences for these transaction.

In Tennessee, the Department of Revenue recently issued a ruling addressing the sales and use tax treatment of these programs. See Tenn. Letter Rul. 12-01. The ruling concludes that the employers initial purchase of "points" is not subject to Tennessee sales and use tax because there is no sale of tangible personal property or taxable services as part of this initial transaction.

The ruling concludes, however, that when an employee redeems the points for tangible personal property, a taxable sale has occurred, and the manager of the incentive program (and not the employer) must collect Tennessee sales and use tax on the redemption of the "points." In calculating the tax that is due for the transaction, the program manager must collect tax based on the value of the points (i.e. the consideration). The Department concludes that this value is a product of the original purchase price paid by the employer for the "points" and leaves it up to the program manager whether the tax is charged to the employee or whether the program manager represents to the employee that the price of the redeemed prize includes sales and use tax.

While the facts of this particular ruling focused on "points," these programs take a variety of different forms. Providers of these incentive programs should take particular care to determine how sales and use tax may apply to their facts to avoid any sales tax exposure down the road.

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Tennesee Litigation: Is the transfer of a houseboat to a living trust subject to Tennessee sales tax?

There is lawsuit pending in Davidson County Chancery Court in which an individual transferred a houseboat to a living trust, and the Department of Revenue is attempting to tax the transaction under Tennessee's sales tax. Randall Crotts Living Trust v. Trost, Civil No. 10-2004-I. While possession of the houseboat was transferred to the living trust, the mortgage holder refused to allow a transfer of title to the living trust.

This case highlights two important principles in Tennessee sales and use tax law – (1) the occasional sale exemption and (2) what constitutes a sale under Tennessee’s sales tax law.

  

In Tennessee, the occasional and isolated sale exemption, while generally exempting non-dealer transactions, does not apply to transactions involving motor vehicles, boats, and aircraft. Thus, in this case, the Department contends that the transfer to the living trust is not exempt. The taxpayer really doesn’t challenge this point in its complaint.

The Taxpayer challenges the Department’s assertion that the transfer to the living trust is a sale, focusing on the mortgage holder’s refusal to allow the transfer, but the Taxpayer also concedes in the complaint that the living trust has possession of the houseboat. In Tennessee, transfer of title or possession is considered a sale, so the Department may have the better position on this issue.

As a final contention, the Taxpayer also argues that there is no consideration on which a tax can be assessed. It is unclear from the complaint whether any cash was exchanged from the living trust to the trust settler, but that may be a basis on which the taxpayer could prevail. Stay tuned as this case continues to work its way through the Tennessee court system.

A copy of the case can be viewed here:

http://www.babc.com/files/upload/randall_crotts_living_trust.pdf

Twitter: @TNTAXLawyer

Is Tennessee "In the Movies?" - Denial of Film Production Credit Results in Lawsuit

Tennessee is not one of the states that has been agressive in enacting transferrable film credits, but Tennessee did pass a film credit several years ago when the Miley Cyrus/Hannah Montana Movie was being produced that allows for a credit against Tennessee franchise and excise tax. Well ... that credit has now become the subject of a lawsuit in Davidson County Chancery Court involving the production of the movie "Losers Take All" (Losers pictured here). 

The credit applies to production companies that incur "qualified production expenses." The taxpayer, Spies Production, had previously produced a movie, "Nothing But the Truth," and qualified for the credit. The Complaint goes into great detail about the interaction between Spies and the Department of Revenue, but despite the close collaboration, the credit for the second film was denied. It is unclear from the complaint why the credit was denied, but it will be interesting to see how this case is resolved as it will likely include equitable reliance theories in addition to the taxpayer's claim that it simply qualifies for the credit.

The Complaint can be found by clicking here. http://bit.ly/GNsbcn

Multistate Tax Commission Seeking to Revive UDITPA-Revision Debate?

In 2009, the Multistate Tax Commission's effort to  have  NCCUSL (Uniform Law Commission) undertake a rewrite of UDITPA (Uniform Division of Income for Tax Purposes Act) was defeated by industry groups when NCCUSL decided to put the rewrite effort on hold. Not to be deterred, the MTC has continued its efforts to rewrite UDITPA independent of NCCUSL, and on May 10, 2012, the Executive Committee of the MTC will have before it all the pieces of the project to rewrite UDITPA.

On March 7, the MTC Uniformity Committee approved for consideration by the Executive Committee the final pieces of the project which include: a draft revision of the definition of business income, a draft revised section on distortion relief, language narrowing the definition of sales, language revising sales factor sourcing of services and intangibles, and recommendations that the UDITPA apportionment formula be switched to a double-weighted sales factor. Each of these measures will be up for debate by the MTC Executive Committee at its May 10 meeting in Washington D.C.

The National Conference of State Legislators, one of the groups that was oppossed to the UDITPA rewrite in 2009, is again expressing its opposition, and it is likely that COST and other similar groups will again voice their opposition to the MTC's efforts in the coming weeks.

Stay Tuned.

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Tennessee Legislature Takes First Steps to Phase Out Inheritance Tax

The Tennessee Legislature took its first steps on March 21 to phase out the state's inheritance tax (SB3762/HB3760) as the House Finance Subcommittee unanimously approved an amendment that would repeal the inheritance tax by 2016.

The tax which brings in $100 million in annual revenue had been the target of repeal before the session started until Governor Bill Haslam expressed concern that the state does not have the resources to replace the revenue generated by the tax and that a full repeal could jeopardize the state budget if the economic recovery does not continue. Rather than pushing for a full repeal, the Governor in his State of the State address proposed a modest increase in the exemption level from $1 million to $1.25 million.

The Governor’s position appears to have change based on comments from Commissioner of Revenue Richard Roberts following the vote that the Legislature’s move was done with the support of the Haslam administration after reviewing the State budget and citing the recent increase in state revenue. “The thinking was that this is an important step toward (reducing) the tax burden in Tennessee on businesses and farmers,” Roberts stated following the vote.

The fiscal note on the Governor’s original proposal to increase in the exemption was estimated to be an annual $14 million recurring decrease in state revenue. Based on the amendment, the fiscal note will now increase to  an annual $100 million decrease in state revenue starting in 2016. It remains to be seen whether the fiscal impact will serve as an obstacle to efforts to repeal the tax.

Governor Haslam may have been emboldened by the recent repeal of the inheritance tax in Indiana, where the Governor signed a bill into law on March 20, phasing out the Indiana tax. In Tennessee, the Legislature appears poised to follow suit. However,  whether the bill passes will mainly be a product of whether Governor Haslam continues to believe that this is a prudent fiscal move.

The Bill will be considered by the full Finance Committee in the coming weeks.

Do you need a valuation expert in Tennessee?

The question that often comes up for property taxpayers in Tennessee when trying to decide whether to appeal a property tax valuation: How much is it going to cost? A significant factor in determining cost is whether or not the taxpayer will need to hire a professional appraiser.

Many times, taxpayers will go it alone and offer their own personal opinion regarding the valuation of the property, but if there is an appraiser on the other side, that is probably not the best approach. Take, for example, the recent decision in In re Directors Common, LLC. In that case, the property manager testified about the condition of the building and his inability to obtain a tenant to lease the space. Based on his experience (which was not unimpressive), he concluded that the value of the property was $600K. The Assessor presented the testimony of a certified appraiser who prepared a report with comparable sales and an income analysis that the property was worth $1.6 million.

The assessor adjusted the valuation down slightly but favored the appraiser over the testimony over the property manager.

That is not to say that in some instances, no appraisal is needed, but administrative law judges in Tennessee tend to be persuaded by the numbers. Thus, if you want to put forward your best case and cost/benefit analysis makes sense, that oftentimes means engaging the services of a professional appraisal.

http://www.comptroller.tn.gov/repository/SB/judgeminsky/2012.03.09-DirectorsCommonLLC.pdf

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