The NESTOA-sponsored Corporation Tax Working Group/ Training Session was held on November 12, 13, 1998 in Hartford, Connecticut. NESTOA Representatives met for two days to address Corporate Business Tax Issues viewed as being current areas of concerns amongst the members. The agenda consisted of the following six topics:

1. States' Updates. (Session moderated by George Boyajian, Connecticut)

• Each state interactively discussed new tax legislation, administrative announcements, recent court cases, and other activities and issues in their state. Fifteen minutes were allotted to each state. The discussions, which covered various areas, concerns, issues and problems, were informative and generated many questions.

2. Taxation issues and revenue impact as a result of Utility/Electricity     Deregulation. (Session moderated by Greg Skotnicki, Pennsylvania)

• Discussions commenced with a round robin status report given by those states that have experienced deregulation. New Hampshire and Rhode Island reported that aside from utility company efforts to resolve the issue of recovering stranded costs, deregulation is effectively in place. Certain issues require the guidance and resolve of the court and appellate process. Many states have deregulated all types of utilities, (i.e. electric, gas, water, telecommunications); and some states have implemented a single tax which applies to all utilities; such as gross receipts tax.
  
  
• Some states, while drafting their deregulation statutes, have modernized the language in their new tax laws as follows: Old statutes which used the historical definition of telephone and telegraph were reengineered to broaden and encompass the modern world of technology (telephone, cellular, satellite). References to heat, power, and steam terminologies were replaced by BTU or energy unit measurements.
  
  
• Electricity is treated as a tangible item in some states and as an intangible in others. A consistent definition may be forced upon the states with the increase of interstate production, delivery, and relaying of electricity.
  
  
• Pennsylvania entered the deregulation arena with the electric industry first. Deregulation commenced November 1997 with a limited-pilot program and provided Pennsylvania consumers a "choice". Activity increased in 1998 with the arrival of new companies attracted to the Pennsylvania market. Uncertainty about tax revenues has impacted the deregulation statute, which required "revenue neutrality" during the transitionary years. An annual analysis was used to regulate a varying millage rate for the electric utility gross receipts taxes in order to guarantee a minimal revenue yield from the tax types typical to the electric industry.
  
  
• Utility companies are taxed in several ways; (i.e. Capital Stock, Corporate Net Income, Utilities Gross Receipts, and Public Utility Realty Tax). Depending on the type of utility (i.e. telephone vs. electric), Pennsylvania applies different Gross Receipts Tax rates; unlike some states that have a singular Gross Receipts Tax rate.
  
  
• There is a unique aspect in Pennsylvania regarding utility realty taxation; the local governments/taxing authorities do not levy real estate taxes against utility property. Instead a separate tax, the Public Utility Realty Tax ("PURTA"), is assessed against the state taxable value of assets (Net Book Value). Because local-taxing levels can not assess real estate taxes for utility owned property, local governments and school districts must annually report to the Pennsylvania Department of Revenue their loss in real estate revenues (Known as "Realty Tax Equivalent").
  
  
• Pennsylvania deregulation's transitionary period is from November 1997 through January 1, 2000. During this transition, electric generation facilities will no longer remain regulated by the Pennsylvania Public Utility Commission. As a result, their taxable status for real estate assets will change from the state level to being directly taxable locally.
  
  
• By law, Pennsylvania must levy an additional assessment against all utilities to collect the shortage. This aspect of PURTA and deregulation has caused excitement at the state, county, and local levels. The PURTA tax program, in theory, assesses a 30 mill tax against utility values, and then through an independent formula, (based upon information furnished from local government) distributes the Realty Tax Equivalents throughout the Commonwealth. During 1998, $167.5 million was distributed through the program, although only $96 million was collected in tax from the utilities.
  
  
• Utility deregulation is affecting a variety of taxes and their respective tax bases. Major write-downs in the values of certain assets affects the tax yield detrimentally or negatively, which subsequently affects the amount of additional assessments necessary across all utility types.
  
  
• The tax year 1998 will be the first full year to measure the impact that deregulation has brought. Pennsylvania is awaiting the spring of 1999, when many of the tax reports associated with the electric community are filed.

  Suggestions/Recommendations

• Isolate and address apportionment and nexus issues at future NESTOA workshops.
  
  
• Develop a uniform position regarding the assignment of receipts and tangible property for state apportionment purposes.

3. Taxation of Passive Investment Companies. (Session moderated by Stuart      Gollinger, Connecticut)

• The 1998 Connecticut legislature enacted Public Act 98-110, entitled "An Act providing for reductions in taxes for individuals and businesses". Section 12 of this Act provides the requirements for the formation and operation of a Passive Investment Company (PIC). A PIC is not subject to the Connecticut Corporation business tax. A qualifying PIC is a corporation which is a "related person" to a "Financial Service Company" or to an "Insurance Company", and must employ not less than five full-time equivalent employees in the State, maintain an office in the State, and confine its activities to the purchase, receipt, maintenance, management, and sale of its intangible investments, and the collection and distribution of the income from such investments. This law is effective for income years beginning on or after
  January 1, 1999.
  
  
• Part-time or dual employees may be used in calculating the number of full-time equivalent employees. In addition, time allocations of twenty-five full-time employees will also be permitted.
  
  
• Allocations of expenses and employees' costs to a PIC may be made on any reasonable basis permitted under Internal Revenue Code Section 482. There are two "safe harbor" elections which will protect the taxpayer from audit adjustments under Connecticut General Statutes Section 12-226a: (1) Percentage of Time Method, in which PIC-related expenses and employee costs are allocated on the basis of the ratio of the number of PIC employees to the total number of employees in the Financial Service Company, and (2) Percentage of Loan Method, in which the allocations are based on the ratio of the number of PIC loans to all loans serviced by the taxpayer.
  
  
• The statutory requirements for a Connecticut PIC are similar to the requirements for a Rhode Island PIC, with one major difference: the only permitted investments for a Connecticut PIC are loans secured by real property, the collateral or interest in the collateral that secured such loans and short-term investments of cash.

4. Taxation of Electronic Commerce. (Session moderated by Bill Bryan, New Jersey) ·

• A packet of E-Commerce articles was compiled and disseminated to the work group. These articles formed the foundation of the discussion.
  
  
• Reviewed an e-commerce transaction example from a NY Times article "The Nation; Danger: Tangled Web of Taxes". Specifically, which State(s) should be entitled to receive the benefit of any tax when an end user has made a purchase over the Internet. And, the potential of States' losing revenue. According to the article, "By early in the next decade, states could be losing up to $12 billion a year, according to the National Governors' Association."
  
  
• A state-by-state summary relative to Internet Taxation was provided as an update to last years' CCH chart.
  
  
• Reviewed an Internet article "Roadblocks Stall Electronic Commerce:" Specifically, the term "electronic commerce", a brief history of the development of e-commerce, cyberspace is borderless, and legal obstacles were discussed.
  
  
• New terminology was discussed: EMOP (electronic method of payment) Transactions - Debit Cards, Smart Cards, Electronic Cash (e-cash), and Electronic Checks (e-checks)
  • Discussed the following articles from E-Commerce Tax News. (www.mshb.com/ec/news.htm). · E-Commerce Estimated at $3.2 Trillion by 2003, dated Nov. 9, 1998.
  • Treasury Comments on International Taxation of Digital Products, dated
    Nov. 9, 1998.
  • Tax Issues in Electronic Commerce, dated Oct. 5, 1998.
  • Taxing Electronic Commerce, dated Sept. 12, 1998
    
    
• Considered and discussed the following statements:

  "Electronic commerce has the potential to be one of the great economic developments of the 21st Century. The information and communication technologies, which underlie this new way of doing business, open up opportunities to improve global quality of life and economic well being. Electronic commerce has the potential to spur growth and employment in industrialized, emerging and developing countries. Revenue authorities have a role to play in realizing this potential. Governments must provide a fiscal climate within which electronic commerce can flourish, weighed against the obligation to operate a fair and predictable taxation system that provides the revenue required to meet the legitimate expectations of citizens for publicly provided services..."

  "State tax administrators and policy-makers, alarmed at the prospect that their tax bases will disappear into cyberspace, are seeking means to accommodate their taxing regimes to the new technological environments (Fuchs 1997, p. 281). The business community, on the other hand, has voiced fears that state legislative or administrative action in this domain could lead to extensive - and potentially destructive - taxation of electronic commerce." These concerns have already led to . . . the Internet Tax Freedom Act . . . which was passed "to establish a national policy against state and local government interference with interstate commerce on the Internet or interactive computer services, and to exercise congressional jurisdiction over interstate commerce by establishing a moratorium on the imposition of exactions that would interfere with the flow of commerce via the Internet."

• Discussed the Internet Tax Freedom Act ("ITFA") which was passed by Congress on October 21,1998.
  
  
• Specific taxability issues were discussed:
  • Shrink-wrap and/or Click Licenses: Do they give rise to nexus?
  • A newsletter subscription, which is subject to Sales Tax when purchased by the subscriber and delivered in printed format, is also sold at a reduced price and is delivered by facsimile or e-mail. Is the subscription still subject to Sales Tax? ·
  • Merging technologies and the ITFA create new tax issues. A state pre-October 1, 1998 imposes a sales tax on telecommunication services. Telephone and Internet technologies merge in that Internet Service Providers (ISP) are preparing for the future of "Internet Telephony." Does the sales tax extend to the ISP's Internet Telephony charges since there was a preexisting and actively enforced sales tax imposed on telecommunications charges or would the imposition of sales tax be preempted by the ITFA?
    
    

  Suggestions/Recommendations

• Forming a sub-working group to monitor and report on current events which impact State taxation in the area of e-commerce. NESTOA should be the clearinghouse for State tax cases, laws, regulations, rulings, etc. that relates to e-commerce.
  
  
• To make contact with the "IFTA Advisory Commission" to establish a method of monitoring the recommendations being considered and to offer input on such recommendations that will impact state and local taxation. The Commission's mandate is to study and make recommendations on a broad range of e-commerce tax issues, including federal taxation, cross-border taxation, taxation in other countries, and state and local taxation. A key issue will be the Commission's consideration of whether the States may compel out-of-state vendors, both Web-based and traditional mail-order, to collect sales and use tax.

5. Taxation of "Qualified Subchapter S Subsidiaries" (hereafter QSSS). (Session     moderated by Steve Gavrilles, Massachusetts)

• Beginning in 1997, Federal legislation made it easier for corporations to qualify as Federal S corporations and to remain eligible for Federal S Corporation treatment. S corporations were also allowed to own qualified S Corporation subsidiaries. (For Federal purposes, the QSSS is not treated as a separate corporation.)
  
  
• Most states have written public pronouncements explaining their QSSS position. The state tax law and tax treatment varies from State to State, which makes it difficult to have conformity among the NESTOA States. This situation provides tax-planning opportunities for taxpayers.
  
  
• The issue of greatest concern to the member States that have adopted the Federal approach is the nexus issue. The activities of the QSSS must be taken into account to determine if the parent has nexus. Even though the parent does not conduct business in a particular state, the activities of the QSSS may cause the parent to have nexus and be subject to tax in that state. In addition, if the parent reports a net loss, they can utilize this loss against the net profit of the QSSS.
  
  
• New York appeared to be the only state to have a specific QSSS form, which the taxpayer must attach to its New York tax return (Form CT-60-QSSS).
  
  
• Tracking and identifying these entities will be problematic. The consensus believed that confusion would exist in processing these returns.
  
  
• For audit selection purposes, states could identify non-filers through the examination and identification of shareholders with an address in their state on Forms 1120S' and K-1's.

  Suggestions/Recommendations ·

• Prepare clear written policies.
  
  
• Develop specific form(s) for QSSS. Develop form similar to New York (Form CT-60-QSSS).
  
  
• States should contact the IRS to see what forms they use to identify these entities.
  
  
• Establish desk-type group to review S Corporation tax returns.
  
  
• Work with Selection and processing unit to develop better identification methods for these entities.
  
  
• Designate a telephone contact within each state to answer and exchange information.

6. Open discussion of State Tax Issues and problems. (Session moderated by
    John King and George Boyajian, Connecticut)

• Elective Consolidation/one Company approach VS Separate/Unitary/Nexus Consolidation.
  
  
  • States were asked if they have considered legislation that would give a taxpayer the option of filing on a consolidated basis, known as the elective consolidation/one company approach. This elective approach allows the taxpayer to file one state return that aggregates the income and operations of all its affiliates. The elective group must be identical with the federal election. In other words, the state return would mirror the Federal consolidated return in regards to computing taxable income (loss). All intercompany transactions between consolidated members would be eliminated.
    
  • This would replace the other types of combination that are currently allowed. If an election were not made, taxpayers would have to file on a separate company basis.
    
  • States such as Alabama, Florida, Arizona, and Kentucky have recently enacted consolidated filing options. The elective consolidated basis/one company approach is seen as one that provides revenue stability, certainty of law, and administrative ease. Many states currently require the so-called separate reporting approach.
  • This elective approach has its advantages over the other combined reporting options available to taxpayers because:
    • The unitary method is often left to judicial interpretation presenting problems to both taxpayers and tax administrators.
    • Under nexus consolidation methods taxpayers can manipulate their state tax liability and taxpayers fear that State Revenue Departments will assert nexus over a corporation without any nexus to its state.
  • This elective approach also has its disadvantages. The initial change to consolidation may mean less revenue to the State. Also, taxpayers may/may not elect when beneficial to them, resulting in less revenue to state.
  • For more information about the elective consolidated basis/one company approach refer to Mr. William A. Raabe's report titled Combined and Consolidated Reporting for the Alabama Corporate Income tax published in the State Tax Notes, January 5, 1998.
    
    
• Apportionment Formulas, Net Operating Losses, and Tax Credits.
  
  
  • The apportionment formulas relating to specific industries were discussed. Most states generally apportion income using three factors; tangible property, wages, and gross receipts. Sales of tangible property are assigned by destination and services are assigned to the location where the service was performed. Some states had specific apportionment formulas. New Hampshire expanded on its specialized industry apportionment provisions.
  • Each States' Net Operating Loss and Tax Credit provisions were discussed. States expressed difficulty in administering these provisions and noted that there are currently more tax credits provided to taxpayers than in the past. Some states have provisions in regards to the "ordering" of the tax credits.

This forum provided the States the opportunity to discuss topics, ask questions, and exchange information. The discussions covered many areas, were informative, and provided the attendees an opportunity to explore many areas.

Suggestions/Recommendations Summary

Taxation issues and revenue impact as a result of Utility/Electricity Deregulation. ·

• Isolate and address apportionment and nexus issues at future NESTOA workshops.
  
  
• Develop a uniform position regarding the assignment of receipts and tangible property for state apportionment purposes.

Taxation of Electronic Commerce.

• Forming a sub-working group to monitor and report on current events which impact State taxation in the area of e-commerce. NESTOA should be the clearinghouse for State tax cases, laws, regulations, rulings, etc. that relates to e-commerce.
  
  
• To make contact with the "IFTA Advisory Commission" to establish a method of monitoring the recommendations being considered and to offer input on such recommendations that will impact state and local taxation. The Commission's mandate is to study and make recommendations on a broad range of e-commerce tax issues, including federal taxation, cross-border taxation, taxation in other countries, and state and local taxation. A key issue will be the Commission's consideration of whether the States may compel out-of-state vendors, both Web-based and traditional mail-order, to collect sales and use tax.

Taxation of "Qualified Subchapter S Subsidiaries" (hereafter QSSS).

• Prepare clear written policies.
• Develop specific form(s) for QSSS. Develop form similar to New York (Form CT-60-QSSS).
• States should contact the IRS to see what forms they use to identify these entities.
• Establish desk-type group to review S Corporation tax returns.
• Work with Selection and processing unit to develop better identification methods for these entities.
• Designate a telephone contact within each state to answer and exchange information
  

1. OECD (Organization for Economic Co-operation and Development) (www.oecd.org) Electronic Commerce: Taxation Framework Conditions, A Report by the Committee on Fiscal Affairs, 8-Oct-1998, p4.
2. Hellerstein, Walter. Electronic Commerce and the Future of State Taxation. Chapter Twelve of "The Future of State Taxation," David Bunori, editor. The Urban Institute Press, 1998, p. 207.