An Assessment of Last Year s Most Significant Litigation and its Impact on Your Balance Sheet

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1 Maria Biava Associate General Counsel, State and Local Tax, Verizon Eric Tresh Partner, Sutherland Asbill & Brennan LLP TeleStrategies Orlando, FL May 15, 2014 An Assessment of Last Year s Most Significant Litigation and its Impact on Your Balance Sheet

2 Overview Nexus Issues Transaction Tax Cases Bill Presentment/Absorption Income Taxes Property Taxes Class Actions 2

3 NEXUS ISSUES 3

4 Click-Through Nexus Amazon.com, LLC v. New York Dep t of Taxation and Finance; Overstock.com, Inc. v. New York Dep t of Taxation and Finance, N.Y. Lexis 542 (N.Y. Ct. App. Mar. 28, 2013) New York Court of Appeals upheld the constitutionality of New York s click-through nexus law. U.S. Supreme Court denied cert. in December Performance Marketing Assn., Inc. v. Hamer., Dkt. No (Ill. Oct. 18, 2013) The Illinois Supreme Court upheld an Illinois circuit court decision and determined that the Illinois click-through nexus statute was preempted by federal law. 4 4

5 Use Tax Reporting Direct Marketing Assoc. v. Colorado Dep t of Rev., Case No. 13CV34855 (Denver Dist. Ct. Feb. 18, 2014) A Colorado state district court issued a preliminary injunction preventing the Colorado Department of Revenue from enforcing Colorado s out-of-state seller use tax reporting statutes and related regulations. Previously, the Tenth Circuit Court of Appeals dismissed a federal district court s grant of a permanent injunction against the Colorado Department of Revenue that prevented the Department from enforcing Colorado s use tax notice and reporting requirements. Direct Mktg. Ass'n v. Brohl, 2013 U.S. App. LEXIS (10th Cir. Aug. 20, 2013). 5

6 Economic Nexus Are Quantitative Thresholds Constitutional? L.L. Bean, Inc. v. Levin, No (Ohio Bd. Tax App. Mar. 7, 2014) The Ohio Board of Tax Appeals sustained the Department of Taxation s assessment of L.L. Bean for the commercial activity tax based on the statutory bright-line presence test (taxable gross receipts of at least five hundred thousand dollars), even though L.L. bean had no physical presence in Ohio. Decision has been appeal to the Ohio Supreme Court. Does the U.S. Supreme Court s continuous and systematic (Goodyear Dunlop, (131 S.Ct (2011)) and purposefully directed activity (J. McIntyre Machinery, 131 S.Ct (2011)) requirements allow for only a quantitative threshold? 6

7 Due Process Clause Daimler AG v. Bauman, No , 2014 U.S. LEXIS 644 (2014) U.S. Supreme Court recently held that due process prevents a state court from exercising general personal jurisdiction over a foreign corporation based solely on the business activities performed in the forum state by a U.S. subsidiary on behalf of the foreign parent. Although there are no direct state tax implications in this case, the decision, along with the Court s recent opinions in Goodyear Dunlop Tires Operations S.A. v. Brown, 131 S. Ct (2011), and J. McIntyre Machinery LTD v. Nicastro, 131 S. Ct (2011), and the state court holdings in Griffith v. ConAgra Brands Inc., 728 S.E.2d 74 (W.Va. 2012), and Scioto Insurance Co. v. Okla. Tax Comm n, 279 P.3d 782 (Okla. 2012), might be the start of a trend to revitalize the Due Process Clause. 7

8 Due Process Clause Caprio v. N.Y. State Dep t of Taxation & Fin., No /11, 2014 WL (N.Y. App. Div. Apr. 8, 2014) A New York appellate court held that the Department of Taxation and Finance could not retroactively apply a 2010 amendment to the Tax Law to a transaction entered into by a Florida couple nearly four years earlier because the retroactive application would violate the taxpayers due process rights. Balancing the equities, the Appellate Division found that the taxpayers had no actual forewarning of the 2010 change in law at the time they entered into the transaction, and they structured the transaction in reasonable reliance on the Tax Law as it existed in The court also found the three-and-a-half year retroactive period was excessive. 8

9 TRANSACTION TAX CASES 9

10 Louisiana Local Sales Tax Litigation Cox Communications Louisiana LLC v. Jefferson Parish Bureau of Rev. & Tax Taxpayer, a provider of cable and broadband services, challenged the applicability of the local sales tax to Videoon-Demand services. Local tax applies to tangible personal property and certain enumerated services. Parish assessed taxpayer claiming that VOD services are taxable TPP because it is perceptible to the senses. 10

11 Pennsylvania Sales Tax Litigation PA exempts form sales tax sales of tangible personal property used in producing of mobile telecommunications services. Wireless service providers have requested refunds of taxes paid on purchases of equipment including machinery, equipment, parts and supplies that was necessary for the provision of wireless telecommunications services to its customers. The PA DOR has denied providers refund requests claiming that providers were not able to demonstrate that any particular purchase of equipment was specifically related to the provision of mobile telecommunications (voice) services. 11

12 Revival of the FET IRS v. WorldCom, (2nd Cir. July 22, 2013) The Second Circuit Court of Appeals held that WorldCom s purchases of dial-up Internet service from local telephone companies were purchases of a local telephone service that provided access to a local telephone system and thus, were subject to the Federal Excise Tax. WorldCom has filed a petition for writ of certiorari. 12

13 Taxability of Prepaid Wireless Services Beauty & More, Inc. v. Alabama Dep t of Rev., No. S (Ala. Admin. Law Div. June 10, 2013) Taxpayer operated a beauty supply store and also sold prepaid cellular telephone minutes and other cellular services (texting, itunes, Internet access). The DOR claimed that receipts from sales of cell phone minutes and other services were subject to sales tax. The ALD ruled that the cellular telephone minutes and services sold by the taxpayer were not taxable because they did not exist when the applicable law was enacted in The ALD agreed with the DOR that the cell phone minutes and other services sold by the taxpayer are subject to the cellular telecommunications service tax; however, the issue of who should collect the tax was not before the ALD. 13

14 ITFA Litigation j2 Global Communications, Inc. v. City of Los Angeles, Los Angeles County Super. Ct. No. BC (Cal. App. 2 nd July 26, 2013) The California Court of Appeal held that the taxpayer s purchases of telecommunications services were not exempt from the City of LA s communication users tax (CUT) under ITFA. Taxpayer purchased telephone numbers from third-parties to provide its efax service that allows users to receive faxes in their inboxes. Taxpayer filed a refund claim for CUT imposed on the telephone numbers, arguing that ITFA preempts the CUT because the numbers were used to provide Internet access. 14

15 ITFA Litigation (cont d) The j2 Global court found that, although the efax service requires taxpayer s customers to connect to the Internet to obtain the efax service, the taxpayer must acquire Internet access from a third-party provider; because the taxpayer itself does not provide Internet access, the telecom was not purchased, used, or sold to provide Internet access. The court opined that the taxpayer s broad interpretation of ITFA s purchased, used, or sold language would render it essentially meaningless. 15

16 Sales & Use Tax: Taxability Verizon Bus. Network Servs., Inc. v. Combs (Tex. Ct. App., Apr. 3, 2013) Feature enhancements to previously installed custom software was subject to sales and use tax. Taxpayer purchased feature enhancements to existing operating software used to increase call capacity on digital switch network. Feature enhancements were tested first at taxpayer s lab in Texas, then copies installed at switching stations around the country. Court viewed feature enhancements as sales of software because they altered the operating system s original capacity and increased functionality. Court also noted that the true object of the transaction was to obtain the computer software program itself rather than maintenance or installation services. Because first use was in Texas, tax was due on total sales price; no apportionment was allowed. 16

17 Sales & Use Tax: Taxability IBM Corp. v. Farr, M COA-R3CV, 2013 WL (Tenn. Ct. App. Sept. 24, 2013), appeal denied (Feb. 13, 2014) Appeals Court held that the WAN service was not a taxable telecommunications service because communication between users of the service was not the primary purpose of the service. [T]he issue of whether a service is taxable as a telecommunication service does not turn on whether or not a service provides the transmission of information, but whether communication between users of the service was the primary purpose of the service. 17

18 Sales & Use Tax: Taxability Verizon Pennsylvania, Inc. v. Commonwealth, No. 266 F.R (Pa. Commw. Ct. July 5, 2013) The Commonwealth Court of Pennsylvania held that nonrecurring service charges including telephone line installation, moves of or changes to telephone lines and service, and repairs of telephone lines were not subject to Pennsylvania s gross receipts tax on telephone companies because: (1) the services did not include a transmission of telephone messages; (2) the services were separately billed to customers; and (3) where inside wiring was required, the work did not have to be done by Verizon (i.e., it could be completed by the customer or through a third party). The court distinguished these nonrecurring services from Verizon s provision of private telephone lines and directory assistance services, which the court held were taxable. 18

19 Sales & Use Tax: Taxability Level 3 Communications, LLC v. Richard Roberts, Comm r of Revenue, No. M COA-R3-CV (Tenn. Ct. App. Sept. 20, 2013) The Tennessee Court of Appeals held that a taxpayer s wholesale service of converting end-user information into Internet protocol was an enhanced service for which the true object or primary purpose was to provide the non-taxable service of Internet access and not the taxable service of telecommunications. 19

20 South Carolina - Definition of Telephone Company Alltel Comm ns, Inc. v. South Carolina Dep t of Rev., Op. No (S.C. 2012) The South Carolina Supreme Court held a wireless communications provider did not constitute a telephone company and was, therefore, not subject to South Carolina s heightened license fee. Telephone company was not defined. 20

21 NJ Standing for Refund Claims New Cingular Wireless PCS, LLC v. Director, Div. of Taxation, No , 2014 WL (N.J. Tax Ct. Feb. 21, 2014) The New Jersey Tax Court held that a mobile telecommunications service provider was not required to reimburse its customers before seeking a $32 million refund of erroneously collected sales tax because New Jersey law requires only that a provider reimburse its customers before any refund is paid. 21

22 CA Standing for Refund Claims Sipple v. City of Hayward, No. B242893, Cal.App.4th (Cal. App. 2014) California Court of Appeal held that a mobile telecommunications service provider could pursue refund actions against local taxing authorities in California without first having to refund the disputed taxes to its customers. The court s opinion is consistent with the New Jersey Tax Court s recent opinion in New Cingular Wireless PCS, LLC v. Director, Div. of Taxation. 22

23 BILL PRESENTMENT/ ABSORPTION 23

24 Pass-through of Taxes Riensche v. Cingular Wireless, LLC, No (9th Cir. Oct. 24, 2012) The Ninth Circuit Court of Appeals held that businesses may not recoup Business & Occupation (B&O) tax as a monthly bill surcharge. The Court found that, contrary to Cingular s argument, WA law was not preempted by the Federal Communications Act. The Court s decision raises First Amendment Concerns. Decision also potentially conflicts with the holding of the United States Court of Appeal for the Sixth Circuit in Bellsouth Telecommunications v. Farris. OH and TX have issued rulings permitting the passing through of the CAT and the TMT. 24

25 INCOME TAXES 25

26 Tennessee Income Tax Apportionment Vodafone Americas Holdings, Inc. v. Roberts, No IV (Tenn. Chancery Ct. Mar. 19, 2013) Vodafone filed TN franchise tax returns sourcing receipts from mobile telecommunications services based on PPU, based on customer location. Vodafone later filed refund claims asserting that it should have sourced service receipts based on COP, as required under TN law. Commissioner issued a variance letter invoking its authority to require the use of an alternative apportionment. Court held it was reasonable for the Commissioner to conclude that the use of COP methodology did not fairly reflect the extent of Vodafone s activities in TN. 26

27 California ComCon QVC ComCon Production Services I, Inc. v. California Franchise Tax Bd., Los Angeles Superior Ct Case No. BC The L.A. Superior Court held that Comcast did not establish a unitary relationship with its 57% owned subsidiary The Court found for Comcast and held that the evidence presented at trial demonstrated that none of the unitary tests were satisfied. The Court also found for the State and held that Comcast s receipt of a $1.5 billion termination fee constituted business income. 27

28 Texas Sales Factor Comptroller s Decision No. 104,224 (May 17, 2013) Comptroller ruled that receipts derived from satellite service should be sourced to location of set top box, because customers contract with provider to receive video programming in their homes. For receipts to be taxable by Texas, the act done or the property producing the income must be located in Texas; it is the localization of the transaction in Texas and not the place of physical handing over or receiving of money that is significant. The focus should the on the specific, end-product acts for which the customer contracts and pays to receive, not on non-receipt producing, albeit essential, support activities. 28

29 Texas COGS Deduction Comptroller Hearing No. 108,115 (July 6, 2013) Prepaid vendor was not entitled to deduct cost of goods sold from taxable margin because the receipts from prepaid cards derived from intangible property, not from eligible tangible personal property ALJ rejected the taxpayer s argument that it is unfair and unreasonable to characterize prepaid cards as intangible property for the TMT but tangible property for sales and use tax purposes Instead, the ALJ relied on clear cut statutory distinction drawn between prepaid telephone calling cards sales tax purposes and franchise tax purposes and deferred the taxpayer s remedy to the legislature 29

30 Massachusetts AT&T Guidance Mass. TIR (Aug. 20, 2013) Department cautions taxpayers that despite the AT&T decision, there may be instances where the so-called transactional approach to applying the income-producing activity test is appropriate. In AT&T, the Massachusetts appeals court adopted the operational approach and held that the taxpayer s relevant income producing activity was providing long distance transmission services by means of operating a complex and comprehensive network that routed and completed these transmissions. The Department had argued for a transactional approach, which resulted in receipts from calls originating in Massachusetts being included in the sales factor numerator. 30

31 PROPERTY TAXES 31

32 Iowa Qwest Litigation Qwest Corp. v. Iowa State Bd. of Review, Case No (Iowa 2013) Iowa Code section subjects every telegraph and telephone company operating a line to central assessment. Wireless is not a telephone company and is assessed locally, where personal property is exempt. Competitive long distance telephone companies (CLDTCs) statutorily exempt after Telephone company property is considered real property and therefore assessable. Qwest challenged an assessment before the ALJ based on fact that similarly situated taxpayers are not being taxed equally. ALJ denied all of Qwest s claims. 32

33 Iowa Qwest Litigation (cont d) District Court applied standard of proof that property tax scheme was clearly, palpably, and without doubt unconstitutional, a very heavy burden. District Court concluded Qwest and long distance companies use the same or similar equipment, and invalidated Qwest s assessment. Iowa Supreme Court rejected Qwest s challenge to the constitutionality of the state s tax regime. The Court held that a rational basis existed for relieving new market entrants like CLDTCs of certain barriers to entry, such as a tax on personal property. The court also held that a rational basis existed for treating wireless service providers differently than ILECs because the two could be viewed as operating in distinct markets. 33

34 Colorado Qwest Litigation 34 Qwest Corp. v. Col. Div. of Property Taxation, No. 11SC669 (Colo. June 24, 2013) Colorado subjects public utilities, including telecommunications service providers, to central assessment while cable companies are locally assessed. Public utilities are not entitled to the intangible property exemption to cost cap valuation method afforded to locally assessed taxpayers. Qwest argued that Colorado s property tax regime violated the federal and Colorado Equal Protection Clauses and the Colorado Uniformity Clause. Colorado Supreme Court rejected Qwest s challenge and held that the differential tax treatment has a rational basis for equal protection purposes and is not the type of differential taxation that the Colorado Uniformity Clause prohibits.

35 Arizona Cable One Litigation Cable One, Inc. v. Ariz. Dep t of Revenue, Cause No. 1 CA-TX (Ariz. Ct. App. June 11, 2013) The Arizona Court of Appeals held that Cable One, Inc. was subject to central assessment as a telecommunications company because of its Voice over Internet Protocol (VoIP) service offering. The court found that Cable One, which provided cable television, Internet access and VoIP services, met the statutory definition of a telecommunications company because it owned communications transmission facilities and provided telecommunications exchange and inter-exchange access. The latter finding marked a significant departure from the lower court s decision, which held that Cable One did not provide telecommunications exchange and inter-exchange access because it did not connect its VoIP subscribers to an exchange. The appellate court, in contrast, reviewed the legislative history and determined that telecommunications exchange and inter-exchange access mean local telephone service and long-distance telephone service, respectively. 35

36 CLASS ACTIONS 36

37 DC Cir. FET Decision In re: Long-Distance Telephone Service Federal Excise Tax Refund Litigation - MDL 1798, No (D.C. Cir. 2014). Class action lawsuit to recover improperly collected FET amounts on long-distance service. In 2006, the IRS issued Notice , which established a procedure for taxpayers to request a refund of the illegally collected excise taxes. The Notice was invalidated because it was not properly noticed under the APA. The IRS, however, never issued another refund procedure. The D.C. Circuit ruled that the plaintiffs who challenged the IRS s illegal tax on long-distance telephone calls can't force the agency to issue a new procedure for refunding its gains after its initial procedure was invalidated on procedural grounds. 37

38 Third Party Enforcement Actions Approximately 30 jurisdictions currently have False Claims Acts A number of state FCA statutes contain explicit tax bars prohibiting qui tam actions for allegedly false tax claims (e.g., CA, DC, HI, MA, NM, NYC, NC, TN, VA). Some states impose a tax bar only with respect to income tax matters (e.g., IL, IN, RI). A number of states do not appear to restrict the action to a particular subject matter (e.g., DE, FL, NV, NH, NJ). Because of the increased risk and pressures of False Claims Acts suits legislation to expand and/or narrow the scope of False Claims Acts is expected in

39 False Claims Act Lawsuit (NY) People v. Sprint Nextel Corp., No /2011 (N.Y. App. Div. Feb. 27, 2014) New York Attorney General Schneiderman took over a whistleblower lawsuit that alleged that Sprint Nextel had failed to collect $100 million in telecommunications sales taxes after unbundling its wireless services. The New York Supreme Court, Appellate Division, affirmed a 2013 trial court ruling denying Sprint Nextel Corporation s motion to dismiss the attorney general s False Claims Act complaint. The case will proceed to trial before the New York Supreme Court unless Sprint appeals the decision to the New York Court of Appeals. 39

40 False Claims Act Lawsuit (DC) Phone Recovery Services LLC v. Verizon Washington DC Inc., No (D.C. Sup. Ct. 2014) Complaint recently filed in a Qui Tam (whistleblower) action on behalf of the District of Columbia against several telecommunication service providers for failure to pay all 911 taxes on all active service lines provided in the District. Providers were sued by Phone Recovery Services LLC in District of Columbia Superior Court for failing to pay over $29 million in 911 taxes. The complaint states that small telephone service providers typically do not pay 911 tax at all, while other companies classify telephone services in a way that evades the tax. 40

41 Questions? Maria Biava Associate General Counsel, State and Local Tax Verizon Eric Tresh Partner Sutherland Asbill & Brennan LLP