All Rights Reserved. This communication is for general informational purposes only and is not intended to constitute legal advice or a recommended course of action in any given situation. This communication is not intended to be, and should not be, relied upon by the recipient in making decisions of a legal nature with respect to the issues discussed herein. The recipient is encouraged to consult independent counsel before making any decisions or taking any action concerning the matters in this communication. This communication does not create an attorney-client relationship.

Broadband Tax Institute – Annual ConferenceLitigation Trends in State Taxation

October 16, 2017Tom DonnellyVice President, State & Local Tax, Comcast Corporation

Larry CusackState and Local Tax National Practice Leader, KPMG LLP

Jeff FriedmanPartner, Eversheds Sutherland (US) LLP

Thomas J. Donnelly serves as Vice President of State & Local Tax for Comcast Corporation. In this role, he is responsible for state tax planning, policy, compliance, credits, incentives, financial reporting, audits, litigation, legislation and the state and local tax aspects of mergers and acquisitions. Tom has lead Comcast’s State and Local Tax practice since joining the Company in 1994.

Prior to joining Comcast, Tom practiced tax and commercial law with the Philadelphia office of Pepper, Hamilton & Scheetz and previously worked in the Philadelphia office of Coopers & Lybrand. Tom holds a CPA & B.S. Villanova University’s Graduate Tax Program. in accounting from Villanova University. Additionally, he received M.T. and J.D. degrees from the Villanova University School of Law and is a member of the Order of the Coif, a national legal honor society for law school graduates.

Tom Donnelly─ Vice President, State & Local Tax, Comcast Corporation

Larry Cusack is a lead partner/principal of KPMG’s State and Local Tax (“SALT”) practice. The KPMG SALT practice currently consists of approximately 1,000 professionals in the US and 200 overseas in India and Hungary.

Prior to taking over leadership of the SALT practice in October 2016, Larry served in a number of leadership positions within KPMG, including:

• Tax practice Business Unit Partner In Charge (“BUPIC”), Pennsylvania

• East Region Tax Service Line Leader – SALT

• Mid Atlantic SALT Practice Leader

• National Leader – Strategic Relocation and Incentives Practice (“SRES”)

• KPMG Board of Directors Nominating Committee

Larry has nearly 30 years of experience serving clients of various sizes and industries. He has also served as an advisor to tax authorities, including serving on the Philadelphia Revenue Commissioner’s Tax Advisory Council and has, since 1999, led a team that serves as state and local tax advisor to the Team Pennsylvania Foundation and the Pennsylvania Governor’s Action Team.

Larry Cusack─ State and Local Tax National Practice Leader, KPMG LLP

Honored as “Tax Lawyer of the Year” in 2011 by State Tax Notes, Jeff Friedman provides sophisticated state and local tax planning, strategic advice and advocacy to numerous Fortune 100 and industry leading companies. His comprehensive practice includes state and local tax planning, compliance, legislation and policy, and litigation and controversy matters involving income, franchise, sales and use and property taxes. Jeff’s clients span a variety of industries, including e-commerce, energy, technology and telecommunications.A recognized thought leader on state and local tax issues, Jeff works on high-profile and precedent setting litigation and controversy matters across the country. These matters impact critical questions on nexus, apportionment, the Multistate Tax Compact and the equal protection, due process and commerce clauses of the United States Constitution. Jeff is also a well-respected advocate on issues of tax policy, including the taxation of digital economy transactions.Prior to joining Eversheds Sutherland (US), Jeff was a partner in KPMG’s Washington national tax practice; served as an attorney-adviser in the U.S. Department of the Treasury’s Office of Tax Policy, where he assisted with the development of the U.S. government's position on domestic and international electronic commerce tax issues; and served as vice president and counsel of the Committee (now Council) On State Taxation (COST).

Jeff Friedman─ Partner, Eversheds Sutherland (US) LLP

This session will highlight key trends impacting state and local tax controversy that attendees should watch out for. After this session, attendees will have an understanding of the challenges associated with the following trends:− Alternative Apportionment− Addback Exceptions− Transfer Pricing− Class Action Lawsuits & False Claims Act− Assault on Quill

• Remote Sellers• Marketplace Providers

− California Board of Equalization Restructuring− No Intervention on Retroactive Tax Legislation

Learning Objectives & Agenda

Alternative Apportionment

Corporate Executive Board v. Va. Dep’t of Taxation, No. CL16-1525 (Va. Cir. Ct Sept. 1, 2017)

Virginia – Statutory COP Method Upheld

─ The Virginia Circuit Court held in favor of the Department of Taxation’s use of the statutory COP method to apportion income from the sales of subscription-based services because use of the COP method did not lead to inequitable results and was not unconstitutional.• The court found that under the COP method, most of the

taxpayer's sales originated in Virginia and were attributable to the state.

─ The court rejected the taxpayer’s request for alternative apportionment using market-based sourcing and characterized the request as “arbitrary.”

7

Target Brands, Inc. v. Dep’t of Revenue, No. 2015CV33831 (Colo. 2nd Dist. Ct. Jan. 20, 2017)

Colorado – Improper Use of Alternative Apportionment

─ A Colorado district court found that despite lacking any physical presence in state, a subsidiary that managed company’s brands had substantial nexus in Colorado because its IP licenses were used there.

─ However, Department of Revenue’s use of its alternative apportionment authority to exclude the subsidiary’s substantial out-of-state property and payroll from apportionment factors was unreasonable.

8

Associated Bank, N.A. v. Comm’r Revenue, No. 8851-R , 2017 WL 1430657 (Minn. Tax Reg. Div. Apr. 18, 2017)

Minnesota – Alternative Apportionment Struck Down

─ The Minnesota Tax Court found that the Commissioner could not invoke alternative apportionment to include interest income and intangible property in the apportionment factor of LLCs subject to the general apportionment formula, which excludes these items from the factors. The taxpayer’s lawful business structure could not be disregarded.• The taxpayer created two LLCs to conduct business in Minnesota,

which defines a “financial institution” as a “corporation.” For the 2007 and 2008 tax periods, the taxpayer excluded the LLCs’ interest income under the general apportionment rules and avoided the LLC interest income inclusion rules applicable to financial institutions.

─ On appeal with the Minnesota Supreme Court.

─ In a special legislative session, the Minnesota Legislature amended the definition of a “financial institution” to include both “corporations” and “other business entities” effective after December 31, 2016.

9

Addback Exceptions

BackgroundStatutory Disallowance

─ Many states have adopted statutes requiring deductions created through transactions with related parties to be “added back” unless a statutory exception applies.

─ Statutory exceptions are intended to cure intrinsic overreach.

─ Exceptions vary by state and may include: • Income is subject to tax/tax paid;• Income is subject to a treaty exemption;• Conduit; and• Would be unreasonable to require addback.

─ Numerous hurdles with meeting statutory exceptions, such as:• Narrow or uncertain interpretations; and• Documentation requirements.

11

Kohl’s Dep’t Stores, Inc. v. Virginia Dep’t of Taxation, No. 160681 (Va. Aug. 31, 2017)

Virginia – “Subject to Tax” Addback

─ The Virginia Supreme Court found that only the portion of royalties that are actually taxed by another state falls within its “subject to tax” exception to Virginia’s addback statute for corporate income tax purposes. • The Court acknowledged that the plain language of the statute is

ambiguous and that both parties’ respective positions could be supported by the statute. The Court deferred to the Department’s interpretation.

─ The case has been remanded to the Circuit Court to determine the portion of the royalty payments actually taxed by another state.

12

BMC Software, Inc. v. Dir., Div. of Taxation, No. 000403-2012 (N.J. Tax Court May 24, 2017)

New Jersey – Satisfying the Unreasonable Exception

─ The New Jersey Tax Court found that a subsidiary’s intangible expenses paid to its parent qualified for the state’s “unreasonable” addback exception because the payments were substantively equivalent to an unrelated party transaction.

─ The court held that:1) The “unreasonable” exception does not require showing that the

related-party recipient paid Corporation Business Tax on the income.

2) Showing that the related-party transaction was “substantively equivalent” to an unrelated third party transaction is sufficient evidence for the addback is unreasonable.

13

Credit Suisse First Boston USA Inc. v. Ala. Dep’t. of Revenue, No. BIT. 15-1666 (Ala. Tax Tribunal, Sept. 7, 2017)

Alabama – Tax Tribunal Denies Addback Exceptions

─ The Tax Tribunal affirmed the Department’s additional 2016 business income tax assessment related to the taxpayer’s denied deductions for interest expenses paid to related members.

─ The Tribunal found:• The taxpayer failed to meet the “treaty exception” because it

failed to provide necessary documentation to show that the interest expenses paid to related companies were subject to a tax in a foreign jurisdiction that had an income tax treaty with the US.

• The taxpayer did not meet its burden to show that the transactions giving rise to the interest expenses had a substantial business purpose, economic substance, and arm’s length terms and conditions.

14

Transfer Pricing

State Use of Transfer Pricing AuthorityOverview of State Transfer Pricing Issues

─ Historically, few states have actively utilized 482 equivalent authority • States rely on formulary apportionment for determining where

corporate income is earned. By contrast, the U.S. and virtually every other nation rely on transfer pricing for sourcing cross-border income.

• States have limited experience with transfer pricing and few resources trained to apply transfer pricing rules as compared with the IRS or foreign taxing authorities.

─ States have also utilized other solutions for policing related party transactions.• E.g., asserting nexus, addback provisions, etc.

─ Rather than engaging in a substantive pricing analysis, states are increasingly either: • Disregarding intercompany transactions; or • Disallowing 100% of tax outcome by arguing that the transactions

are per se distortive.

─ Over the last few years, interest in transfer pricing has increased among the states.

16

See’s Candies, Inc. v. Auditing Div. of the Utah State Tax Comm’n, No. 140401556 (Utah Dist. Ct. 2016)

Utah – Reining in Use of State Transfer Pricing Adjustments

─ See’s Candies deducted IP royalty payments made to an insurance company also owned by Berkshire-Hathaway.

─ The Tax Commission argued that it could adjust See’s income for the royalty payments based on the state’s 482-style adjustment statute without reference to federal rules on related-company adjustments.

─ The Utah District Court found that the Tax Commission abused its discretion by denying the entire intercompany royalty expenses when the Tax Commission failed to consider federal 482 guidance and failing to look at the taxpayer’s transfer-pricing study.

─ On appeal at the Utah Supreme Court.

17

Hess Corporation, et al. v. Office of Tax & Revenue, Nos. 2012-OTR-00027, 2011-OTR-00047, 2011-OTR-00049 (D.C. Office of Admin. Hearings March 15, 2017)

District of Columbia – Chainbridge Methodology

─ In 2012, in Microsoft, the Office of Administrative Hearings (OAH) held that the Office of Tax and Revenue’s (OTR) reliance on the transfer pricing methodology employed by Chainbridge was arbitrary, capricious, and unreasonable and cannot form the basis for a determination to reallocate income between Microsoft and its affiliated businesses.• The OAH found that the methodology improperly considered all of Microsoft’s

transactions, whether controlled or uncontrolled, in analyzing its profit-to-cost ratio and failed to compare specific types of Microsoft transactions to uncontrolled transactions.

─ While Microsoft was pending, ExxonMobil Oil Corp., Hess Corp., and Shell Oil Co. were assessed additional corporate franchise tax by the OTR using the Chainbridge methodology.

─ In 2014, the OAH granted summary judgment in favor of the taxpayers holding that the OTR was collaterally estopped from re-litigating the methodology.

─ In 2016, the DC Court of Appeals held that the OAH abused its discretion and remanded the case to determine whether exceptional circumstances existed for collateral estoppel.

─ On March 15, 2017, on remand, the OAH held that exceptional circumstances did not exist for collateral estoppel.

─ Oral hearing on the merits of the case was held on September 14, 2017.18

Mississippi – Authority to Hire Third-Party Experts

─ S.B. 2973 authorizes the Department of Revenue to hire third-party consultants to help the Department with transfer pricing cases effective July 1, 2017.

─ Use of third-party auditors is not unique, but Mississippi is the only state that will pay on a contingency basis.• The bill appropriated up to $1,000,000 to fund those contingency

contracts for the current fiscal year.

19

Class Action Lawsuits & False Claims Act

Damned If You Do (Collect)Consumer Class Action Lawsuits

─ Over-collection

─ Targeting large retailers

─ Targeted transactions• Delivery fees• Coupons• Rebates• Returns

21

Damned If You Don’t (Collect)False Claims Act

─ Under-collection

─ Approximately 30 jurisdictions currently have False Claims Acts.• Some states have expanded False

Claims Act “whistleblower” actions to include tax.

─ Extremely high stakes:• Generally treble damages plus

substantial penalties for each return filed.

• Extended statute of limitations period.

• Tried in the public domain and often labeled as tax fraud.

22

─ Illinois and New York have seen the most aggressive False Claims Act litigation.• People of the State of New York, et al. v. Sprint Nextel Corp, et al.,

26 N.Y.3d 98 (N.Y., Oct. 20, 2015)

The People ex. Rel. Schad, Diamond & Shedden, P.C. v. My Pillow, Inc., No. 12L7874, 12L6782 (Ill. App. Ct. June, 15, 2017)

Illinois – No Attorneys Fees Award Allowed

─ The Illinois Appellate Court affirmed the lower court’s finding that My Pillow Inc. recklessly disregarded an obligation to collect and remit sales tax based on a failure to re-examine its collection obligations following a change in facts (requiring Illinois franchises to mail catalogs to Illinois customers) combined with its participation in craft shows, Internet, and telephone sales into Illinois.

─ The court reversed the lower court’s attorney’s fee award in part and held that Diamond, representing as both the relator and as its own counsel, can not recover both the relator share and the attorney’s fee portion.

23

The People ex. Rel. Schad, Diamond & Shedden, P.C. v. Lush Internet Inc., No. 1-16-1601 (Ill. App. Ct. Sept. 25, 2017)

Illinois – Online Orders Had No Nexus

─ The Illinois Appellate Court affirmed the lower court’s finding that Lush Internet:• Did not have a substantial nexus with Illinois because it lacked a

physical presence, and the stores, operated by a separate business entity, did not act as its agent or on its behalf; and

• Did not act with reckless disregard of its alleged obligation to collect and remit use taxes on internet and catalog sales, which was supported by the CEO’s consultations with legal and tax professionals.

─ The court also held that the trial court did not abuse its discretion in admitting certain contested evidence (related to other states’ audits), which the court found corroborated the CEO’s testimony that he used other states’ audits to assess Lush Internet’s sales tax obligation throughout the United States.

24

Estler v. Dunkin' Brands, Inc., No. 16-3762-CV, 2017 WL 2258614 (2d Cir. May 23, 2017)

New York – Exclusive Administrative Remedy

─ The Second Circuit rejected the attempted class action lawsuit that sought to hold Dunkin' Brands, Inc. liable for allegedly overcharging sales tax.

─ The court upheld summary judgment in favor of the taxpayer, finding that, under New York law, if the retailer is merely performing the ministerial act of collecting sales tax on the taxing authority's behalf, its customers' exclusive remedy is to seek a refund from the taxing authority.

25

Assault on Quill

Overview

─ In order for a state to impose a sales and use tax collection obligation on an out-of-state seller, the US Supreme Court has held that a physical presence in the state is required. Quill Corp. v. North Dakota, 504 U.S. 298 (1992).

─ The physical presence must be more than de minimis. ─ What constitutes “physical presence”?

• More than slightest presence: • Employees working in the state• Employees performing activities in the state • Lease or ownership of tangible property• Lease or ownership of real property

─ Quill has been one of states’ major impediments to the states ability to collect sales tax from remote sellers.

─ Since Quill, states have applied various approaches to limit or circumvent Quill’s physical presence requirement (e.g., affiliate nexus, intangible nexus, click-through nexus).

─ Quill is still good law.

27

Assault on Quill – Remote Sellers

South Dakota v. Wayfair, Inc., et al., No. 28160-a-GAS (S.D. Sept. 13, 2017)

Assault on Quill – Remote Sellers

─ On March 22, 2016, South Dakota enacted S.B. 106, which asserts nexus against remote sellers with $100,000 gross revenue from annual sales in the state or 200 separate transactions involving delivery into the state, effective May 1, 2016.• The law allowed expedited court proceedings to address the law’s constitutionality

and precluded enforcement until the law’s constitutionality was resolved.

─ South Dakota then filed a declaratory judgment action against remote sellers with no physical presence in the state.

─ On March 6, 2017, the South Dakota Sixth Judicial Circuit Court ruled in favor of the remote sellers because the sellers lack physical presence in South Dakota, under Quill. The court held that S.B. 106 fails to satisfy Quill’s physical presence requirement and its application of the Commerce Clause.

─ On September 13, 2017, the South Dakota Supreme Court upheld the lower court’s holding that S.B. 106 is unconstitutional under Quilland stated that “[h]owever persuasive the State’s arguments on the merits of revisiting the issue, Quill has not been overruled.”• The court saw “no distinction between the collection obligations invalidated in

Quill and those imposed by S.B. 106.”

─ Petition for a writ of certiorari filed on October 3, 2017 (No. 17-494).29

Other Statutory and Regulatory Challenges Assault on Quill – Remote Sellers

─ Alabama: Rule 810-6-2-.90.03• Newegg Inc. v. Ala. Dep’t of Revenue, No. S 16-613 (Ala. Tax

Tribunal, notice of appeal filed June 8, 2016)

─ Tennessee: Tenn. Comp. Regs. 1320-05-010.129 • Am. Catalog Mailers Ass’n v. Gerlach, No. 7-0307-IV (Tenn. Ch. Ct,

complaint filed Mar. 30, 2017)• On April 10, 2017, a Tennessee Chancery Court ordered that the Tennessee

Department of Revenue is temporarily prohibited from enforcing the regulation. • Currently in discovery.

─ Wyoming: H.B. 19• Am. Catalog Mailers Ass’n & NetChoice v. Noble, No. 188-137 (Wy.

1st Jud. Ct., complaint filed June 28, 2017)• Wyoming v. Newegg, Overstock, et al., No. 34238 (Wy. 2nd Jud. Ct.,

complaint filed July 7, 2017)• The state declined to voluntarily suspend enforcement while the law

is being challenged.

─ Indiana: H.B 1129• Am. Catalog Mailers Ass’n v. Krupp, No. 49D01-1706-PL-025964

(Ind. Sup. Ct., complaint filed June 30, 2017)

30

Remote Sellers – Other Statutory and Regulatory Challenges Assault on Quill – Remote Sellers

─ Vermont: Enacted H.B. 873 on May 25, 2016

─ North Dakota: Enacted S.B. 2298 on April 10, 2017

─ Maine: Enacted S.P. 483 on June 21, 2017

─ Ohio: Enacted H.B. 49 on June 30, 2017

─ Washington: Enacted H.B. 2163 on July 7, 2017

─ Rhode Island: Enacted H.B. 5175 on August 3, 2017

─ Massachusetts: 830 CMR 64H.1.7

31

Massachusetts – 830 CMR 64H.1.7 Assault on Quill – Remote Sellers

─ The regulation requires an Internet vendor with a principal place of business outside of Massachusetts to register, collect, and remit sales and use tax if the vendor has more than $500,000 in Internet sales into the state and 100 or more sales into the state during the previous 12 months.

─ The regulation distinguishes mail order vendors at issue in Quill and states the following activities constitute an in-state physical presence:1) Property interests in and/or the use of in-state software (e.g., apps) and ancillary

data (e.g., cookies) distributed to or stored on in-state customers’ computers or devices;

2) Contracts and/or relationships with content distribution networks resulting in use of in-state servers and other hardware and/or related in-state services; and/or

3) Contracts and/or relationships with marketplace facilitators, and/or delivery companies resulting in in-state services.

─ On September 22, 2017, the Department promulgated its final regulation, effective on October 1, 2017.

32

Assault on Quill – Marketplace Providers

OverviewAssault on Quill – Marketplace Providers

─ Marketplace collection provisions aim to require online and other marketplaces to collect and remit sales and use tax if a retailer sells products on the marketplace.

─ Types of Marketplaces:• “Standard” or “traditional” marketplaces where multiple sellers

sell products, sometimes the same products, on a single platform.

• “Referral” marketplaces is where customers may search for products and are then referred to a place to purchase those products.

34

Legislation Assault on Quill – Marketplace Providers

─ Minnesota: H.F. 1 passed on May 30, 2017, which requires sales/use tax collection obligation on “marketplace providers” that have more than $10,000 in sales into the state unless the retailer selling on the marketplace is already registered to collect Minnesota sales tax.• Effective on July 1, 2019, or sooner if Quill is overturned.

─ Washington: H.B. 2163 passed on July 7, 2017, which on January 1, 2018, requires “marketplace facilitators” whose sales to Washington consumers are $10,000 or more to either: (1)Collect sales/use tax on sales to Washington consumers; or (2)Comply with specific use tax notice and reporting requirements.

─ Rhode Island: H.B. 5175 passed on August 3, 2017, which on January 15, 2018, requires “retail sale facilitators” who have over 200 separate transactions per year into Rhode Island or have more than $100,000 in in-state annual sales are required to provide informational reporting.

35

California Board of Equalization Restructuring

California Board of Equalization Restructuring

─ On June 27, 2017, A.B. 102 was passed, which restructures the Board of Equalization (BOE) and creates two new entities: • The California Department of Tax and Fee Administration; and• The Office of Tax Appeals.

─ The BOE’s collection and administrative functions will be assigned to the California Department of Tax and Fee Administration, and its appellate function will be granted to the Office of Tax Appeals.

─ The BOE will continue to administer property tax rates and assessment adjustments.

─ Most provisions of A.B. 102 are effective July 1, 2017; however, the Office of Tax Appeals will begin hearing cases after January 1, 2018.

37

California Board of Equalization Restructuring

─ On September 16, 2017, A.B. 131 was passed providing legislative clarifications to the new California tax agencies’ roles.

─ California Department of Tax and Fee Administration:• BOE’s appeals conference rule apply, with authority given to revise, repeal, or

add rules necessary.• If request for relief is denied in the appeals conference, then the taxpayer may

request a hearing before the Office of Tax Appeals.

─ Office of Tax Appeals:• Appeals panels and appeals hearings are not construed to be, or to be

conducted by, a tax court. Non-lawyers will be allowed to appear.• All appeals proceedings will be in accordance with California’s Administrative

Procedure Act (APA).• BOE’s existing Rules for Tax Appeals will continue to apply, with authority

given to amend the rules.• New rules adopted must be consistent with the American Bar Association’s

2006 Model State Administrative Tax Tribunal Act, unless in conflict with the APA and carryover BOE rules.

─ California Superior Court:• Standard of review will be de novo.

38

No Intervention on Retroactive Tax Legislation

Background

─ Retroactivity: When the legislature amends or enacts a law and applies it retroactively (i.e., a backward fix).

─ Due Process: No person shall be deprived of life, liberty, or property without due process of law.• Procedural aspect• Substantive aspect

─ Retroactive Tax Legislation is Evolving • Questionable purposes:

• From corrective, curative legislation →• To legislation as a litigation tactic or to overturn judicial decisions

• Lengthier periods: • From one to two years/next legislative session →• To whatever period is required to fully reverse the effects of the statute• But Justice Sandra Day O’Connor’s concurrence in Carlton provides that

“[a] period of retroactivity longer than the year preceding the legislative session in which the law was enacted would raise, in my view, serious constitutional questions.” United States v. Carlton, 512 U.S. 26 (1994).

40

U.S. Supreme Court Denies Review

─ Denied Petitions• Dot Foods Inc. v. Wash. Dep't of Revenue, 185 Wash.2d 239

(Wash. 2016)• The Washington Supreme Court upheld a retroactive amendment to the

B&O direct seller tax exemption, which was originally enacted in 1983.

• Gillette Comm. Ops. N. Am. v. Mich. Dep’t of Revenue, 312 Mich. App. 394 (Mich. Ct. App. 2015), denying appeal, 499 Mich. 960 (Mich. 2016)

• The Michigan Court of Appeals upheld the enactment of Public Act 282 of 2014, which retroactively rescinding Michigan’s membership in the Multistate Tax Compact effective January 1, 2008.

• In re Estate of Hambleton, 335 P.3d 398 (Wash. 2014)• The Washington Supreme Court upheld a retroactive amendment that

occurred 37 years after the statute was originally enacted.

41

Questions?

42