November 9, 2009
Agenda
Tax Executives Institute, Inc. welcomes the opportunity to discuss the following issues with members of the Federation of Tax Administrators’ Board of Trustees.
I. Welcome and Introduction
II. Effect of the Economic Downturn on State Budgets and Revenue Department Resources
A. Notices. As a result of the economic downturn, both states and businesses (including their tax departments) have seen a reduction in headcount without a corresponding decrease in tax responsibilities. Perhaps as a consequence, a number of states have increased the issuance of automated notices regarding administrative errors such as the misapplication of estimated payments. Historically, states and taxpayers resolved these types of issues quickly with a few phone calls. Today, phone calls may go unanswered necessitating time-consuming written responses that often “cross in the mails.” How can taxpayers and states work together to identify best practices to resolve routine notices and other administrative issues more efficiently?
B. Regulatory Guidance. In states that require combined reporting, the development of comprehensive guidance on group membership, allocations of tax attributes, and other issues would benefit both departments of revenue and taxpayers. The State of Wisconsin, for example, recently released proposed
mandatory combined reporting regulations, which TEI addressed in written comments. TEI would like to discuss ways in which the FTA and the Institute can work together to address areas of the tax law that could benefit from additional guidance and clarification.
C. Ruling Requests. An effective state ruling request process can benefit both the state and taxpayers by increasing predictability and efficiency of administration. In recent years, however, some state departments of revenue have seemingly become more reluctant to issue published rulings. TEI would like to discuss the FTA’s views on state ruling request processes, and how the Institute can work with states to encourage and improve this process.
III. International Issues Affecting State Taxes
A. Treaties and Nexus. The definitions that states apply for purposes of corporate income tax nexus often conflict with those used under United States tax treaties. Treaties base a foreign entity’s taxability in the United States on the existence of a “permanent establishment” existing in the United States. The concept of a permanent establishment generally includes a requirement of physical presence in the United States before the foreign entity is subject to U.S. tax. Even outside of the treaty context, foreign corporations must engage in a trade or business in the United States in order to be subject to U.S. tax on their business income – a threshold necessitating physical presence in the United States. Thus, a foreign corporation will have no federal gross or taxable income from its trade or business unless it has a physical presence in
the United States. Because most states begin their calculations of state taxable income with federal gross or taxable income, a foreign corporation with no physical presence in the United States should also have no state income tax imposed on its business income.
The Wisconsin Department of Revenue recognized this issue in its recently proposed combined reporting regulations stating that income exempted from federal taxation under U.S. tax treaties would also be exempt from Wisconsin tax. TEI commended the Wisconsin Department of Revenue for clarifying this point. As a general matter, TEI believes that foreign corporations should be subject to state income tax on their business income only (1) when engaged in a trade or business in the United States, as that term is defined for U.S. federal income tax purposes (in cases where no U.S. tax treaty applies); or (2) when their presence rises to the level of a “permanent establishment” (in cases where a U.S. tax treaty does apply). This treatment also minimizes the record keeping and information processing for both taxpayers and state departments of revenue since it bases taxable income on a common starting point – federal taxable or gross income. TEI invites a discussion of state taxation and associated filing requirements of foreign businesses.
B. Public Law No. 86-272. Public Law No. 86-272 applies to interstate businesses selling tangible personal property. States view the use of the term “interstate” business as excluding solely foreign commerce. The Multistate Tax Commission’s (MTC) “Statement of Information Concerning Practices of Multistate Tax Commission and Signatory States Under Public Law 86-272” calls for member states to extend the application of this federal law to foreign commerce as well as interstate commerce. With the exception of California and Rhode Island, the member states of the MTC agreed to this application of the rule. TEI invites a discussion of the FTA’s views with respect to whether the treatment of foreign commerce vis-à-vis Public Law No. 86-272 has changed or evolved over the past decade.
IV. Uniformity of State Tax Laws
A. General. The Institute would like to discuss with the FTA ways in which the two organizations can promote uniformity of state tax laws. Such uniformity should be a goal both with respect to substantive provisions as well as to administrative procedures. For example, what can be done to encourage states to establish uniformity of method and timing in reporting federal tax adjustments?
B. Mobile Workforce Legislation. FTA Resolution 2009-6 states that the FTA opposes federal legislation regulating state taxation of wages earned by individuals working outside their states of residence. In an October 1 letter, however, the FTA indicated its support for an effort by the MTC to draft model state legislation on this issue. We would like to discuss the FTA’s role in the MTC’s model statute drafting process, and, to the extent our interests align, ways that we could work together to push this process forward.
C. Uniform Division of Income Taxes for Tax Purposes Act. Earlier this year the National Conference of Commissioners on Uniform State Laws (NCCUSL) abandoned its efforts to update the Uniform Division of Income for Tax Purposes Act (UDITPA) – a project the FTA had supported. The MTC has now taken on the task of revising UDITPA. What will the FTA’s role be in the MTC project? What is FTA’s assessment of the likelihood of states adopting any revised model statute?
V. Taxpayer Bill of Rights Issues
TEI believes strongly in the enactment of even-handed administrative legislation that vivifies basic principles of fairness and equity and reinforces the integrity of the self-assessment tax system. Uniformity in the administrative area also reduces compliance costs, minimizes confusion, and simplifies audits. Since it is unlikely that there will be enough time to address these issues at this meeting, we have attached the Institute’s views as an appendix to this agenda. We invite discussion of these items at a future meeting.
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Appendix to Meeting Agenda Dated November 9, 2009
Federation of Tax Administrators and Tax Executives Institute
Taxpayer Bill of Rights Issues
This appendix summarizes TEI’s views on various issues critical to a fair and efficient administration of state tax laws:
A. Penalties
A small number of states have either enacted or recently begun enforcing penalty statutes that effectively allow for no reasonable cause exception. California enacted a penalty applicable to large corporate understatements when a corporation understates its California tax liability by more than $1 million. Also, North Carolina recently imposed a similar penalty against a taxpayer that understated its state tax liability by more than 25%. TEI believes that automatic penalties have no place in state tax administration and
recommends that the states incorporate a “reasonable cause” exception into their penalty systems to minimize the mechanical assertion of penalties in situations where the taxpayer’s culpability is minimal or non-existent.
B. Interest Rates
TEI opposes the application of different rates of interest to assessments and refund claims. Differential interest rates may properly be characterized as punitive in nature. The Institute believes that the interest rate provisions of the tax law should be designed to recompense a party for the time value of money – nothing more and nothing less. Interest rates should not be manipulated simply to collect additional revenues or, for that matter, to encourage or discourage specific taxpayer behavior. Payment of a market rate of interest is eminently fair, and it minimizes any incentive a state may have to unduly delay the processing of refund claims.
C. Statutes of Limitations
TEI believes that since statutes of limitations define rights of parties, they should be equally applied – the time period for assessments should not be longer in duration than the time period for filing refund claims. Also, TEI submits that, unless the taxpayer has signed a waiver of the state’s statute of limitations, a state’s examination of reported federal changes should be limited to the effect of those changes on the taxpayer’s state liability. The state should not be in the position of having two bites at the examination
apple.
D. Contingent Fee Auditors
In recent years, a number of tax-assessing jurisdictions have hired contract or third-party agents to audit tax returns and records in exchange for a percentage of the increased tax collected. Although there may be some surface appeal to contingency fee audits – the states arguably have an opportunity to secure increased revenue with no out-of-pocket cost – the proffered justifications for contingency fee audits are specious and the policy objections to them are overwhelming. TEI submits that contingent fee audits are more inimical to the tax system's fairness than the use of quotas, which have been roundly and rightly condemned (and uniformly disavowed by the states).
E. Prepayment Requirements and a Meaningful Administrative Review
TEI opposes the imposition of any prepayment requirements whereby a taxpayer is required to pay a disputed amount before contesting an assessment at an informal or formal hearing. Additionally, the administrative hearing process must provide a meaningful review of the merits of the positions espoused by both tax administrations and taxpayers. Absent fair hearings, the administrative review process becomes an inefficient use of resources for both parties.
F. Creation of Independent Tax Tribunals
TEI strongly supports the creation of independent body for hearing tax appeals. These state tax tribunals would serve as forums for appealing tax disputes and would be staffed with adjudicators experienced in state tax issues. The tribunals would provide for a fair hearing prior to the taxpayer having to pay the disputed liability. This will improve the fairness of the system and the availability of an appeals system to more taxpayers.
G. Retroactive Legislation
Taxpayers can only look to existing law in researching the positions they take on their tax returns. The enactment of retroactive legislation, which is not for policy reasons relieving, undermines attempts to comply with the tax law and instills in taxpayers a perception of unfairness in the tax system. TEI strongly believes that tax legislation and regulations should have only prospective effect to better foster predictability in the tax system and the ability to rely on laws currently in effect.