FLORIDA LOOKS AT DELIVERY UNDER P.L. 86-272

By Tricia Plank, CPA, and Sharon Bishop, CPA, Coopers & Lybrand L.L.P.

The Florida Department of Revenue (DOR) has just issued a harsh nexus ruling to an out-of-state corporation that sells products to Florida customers. Although the company had established corporate income tax nexus with Florida through other activities conducted in the state, a ruling was requested as to whether the mere delivery of the company's products on its own trucks created income tax nexus. For purposes of the ruling, the DOR ignored the company's other activities and focused only on the issue of the delivery of the product. This gives the ruling potential for a more expansive application.

The DOR ruled that the company established income tax nexus through the regular and systematic delivery of goods into Florida using the company's own trucks. In this instance, the drivers of the company's vehicles were independent contractors whose only responsibilities were the delivery of the products.

The DOR reasoned that the company lost the P.L. 86-272's protection under three sections of its nexus regulation:
* Owned or leased tangible personal property was present in the state: The company's trucks used for delivery constituted tangible property owned in the state.

* Employees present in the state performed activities other than sales solicitation: Ignoring the word "employees" in the rule, the drivers of the vehicles (who were not employees) were viewed as representatives the company performing functions other than solicitation (i.e., delivery).

* Services were performed within the state: The company performed services (delivery) within the state.

The company argued that because all Florida orders were approved outside the state and shipped from a location outside the state, the sales of product should be protected by P.L. 86-272. This law protects companies whose activities in a state are limited to solicitation of tangible personal property and that sell and deliver goods from a stock of goods maintained outside the state.

Unfortunately, the Federal law is silent as to whether delivery from outside the state must be made by common carrier or whether delivery by any means is sufficient to come within the parameters of the law.

The main issue discussed in the ruling is whether the terms "shipment and delivery" as used by Congress in the law were meant to encompass delivery into a state via the seller's own mode of transportation. The ruling concludes that any available guidance which might be of assistance is unclear and no conclusion is reached in the analysis. Therefore, because of this lack of guidance, Florida will continue its policy to treat the shipment and delivery of goods by company-owned vehicles as an activity which is not protected by P.L. 86-272.

The DOR's analysis raises some valid points: The company does have property in the state, it is performing services other than solicitation within Florida, and views do vary on the delivery issue. It seems, however, that the DOR has construed Public Law 86-272's protection rather narrowly. In light of the other restrictions that Congress placed on a company's in-state activities, it seems that a mode of delivery would have been specified if Congress had intended that companies only use common carriers to remain non-taxable. Unfortunately, this issue likely will not be resolved any time soon by the courts. It is rare to find a fact pattern where the only questionable activity that an out-of-state company is doing within the state is delivery in company-owned vehicles to Florida customers. As such, it will be difficult to have judicial review of the DOR's position on delivery in company-owned vehicles. *

This article was originally reproduced on Coopers & Lybrand L.L.P.'s Tax News Network.

MASSACHUSETTS APPORTIONMENT REGULATIONS CAUSE PROBLEMS

By Joseph Donovan, Esq., and Barbara Colucy, Esq., Coopers & Lybrand, L.L.P.

The recently released Massachusetts final corporate apportionment regulations may create significant net worth taxes for corporate real estate investment trusts (REITs) doing business in Massachusetts.

The Department of Revenue (DOR) took a 180-degree turn between the first draft of the regs and the final regs that were just released. The first draft of the corporate apportionment regulation released last year allowed the "look-through" approach for corporate REITS with investments in partnerships. The final regulation, however, requires that a majority interest in a partnership be recast as an equity investment in certain circumstances. It is this change that could create tax problems for REITs that own real estate through partnership interests rather than directly.

Massachusetts generally imposes a "balance sheet" tax at the rate of $2.60 per $1,000 of apportioned net worth or Massachusetts tangible property not subject to local property taxes. Investments in real property are excludable from the tax measure. Futhermore, Massachusetts has traditionally taken the position that a GAAP balance sheet should be used for purposes of calculating the balance sheet tax.

For corporate REITs that own a majority interest in a partnership, GAAP generally requires that the REIT and the partnership prepare consolidated financial statements which treat the assets and liabilities of the partnership as direct assets and liabilities of the REIT with an offsetting liability owed to the minority partners. By "looking through" the partnership, the REIT is likely to own mostly real property which is excludable from the tax base. Thus, corporate REITs typically would have low Massachusetts net worth tax liabilities.

Under the final regulations, any corporation that is required to be included in a consolidated financial statement with another corporate entity must deconsolidate not only its investment in other corporate entities for purposes of the Massachusetts balance sheet tax, but must also deconsolidate its investment in a partnership and reflect such investment as an equity investment. This approach likely creates a sizable intangible asset on the corporate REIT's books that will be subject to the Massachusetts tax. Only those corporations that are not required to be included in a consolidated or combined financial statement with another corporate entity are permitted to use the GAAP "look-through" approach.

Corporate REITs that own a majority partnership interest should review their operations and structure to determine the regulation's effect. Depending on the situation, some REITs may be able to minimize their future net worth liabilities by restructuring their operations. As for past liabilities, it is unclear at this time whether the DOR will attempt to apply the rule to tax years prior to 1996 *

This article was originally reproduced on Coopers & Lybrand L.L.P.'s Tax News Network.

THE STORY OF A STATE TAX AUDIT

By John E. Markey, Jr., CPA

In response to the question of "had a state tax audit recently?" posed by The CPA Journal in the September 1995 issue, I wish to respond. International Technidyne Corporation (ITC) which is located in New Jersey is a wholly-owned subsidiary of Thermo Electron Corporation (Thermo) of Waltham, Massachusetts. ITC is a manufacturer of medical instruments and incision devices. ITC primarily sells its products to dealers and distributors in the U.S. and in approximately 70 different countries throughout the world. The dealers, in turn, sell the products to end users such as hospitals, doctor's offices, group practices and health clinics, and labs. A small percentage of ITC's sales are on a direct basis to the end users.

Among the significant issues ITC contested with the auditor's findings, two in particular may be of interest to the readers of The CPA Journal.

The first contested issue had to do with ITC's distribution of product samples. As with any medical or pharmaceutical company, a key marketing strategy is to provide the end users with samples and promotional products in the effort to stimulate future business. This factor is quite prevalent, especially in New Jersey since it is the home of many medical and pharmaceutical companies. For example, if a doctor receives our product sample, he or she may be inclined to suggest to the hospital, at which he or she is staffed, to buy the products. The auditor contended that all samples which are distributed from our New Jersey office, including foreign samples, qualified as a taxable use to ITC rather than just samples in New Jersey.

As it seemed to be the potential for a large liability of use tax to ITC, I was quite surprised when the auditor informed me of a tax court case appealing such matters‹Cosmair vs. the State of New Jersey. The case states, in part, that‹

Cosmair argued that the samples are not subject to the use tax since the definition of "use" contained in N.J.S.A. 54:32B-2(h), by its terms, limits its definition to a "purchaser." Cosmair maintained that the phrase refers to "the exercise of any right or power over tangible personal property by the purchaser."

Among other arguments, Cosmair contended that its activities with regard to its samples fall within the "mere storage, keeping, retention, or withdrawal from storage of tangible personal property by the person who manufactured such property" and therefore shall not deemed a taxable use.

New Jersey argued back that the samples are "used" in New Jersey and that the manufacturer's exemption would be denied. Cosmair, however, firmly stood its ground as noted in the case stating as follows:

Cosmair's activities in this case‹packaging, sorting, assembling, and labeling‹were incidental to the withdrawal from storage of the samples. These tax-neutral activities arise whenever a manufacturer moves its inventory. If the incidental activities performed by Cosmair with respect to the samples render the exemption inapplicable, it is difficult to see how manufactured goods could ever be withdrawn from storage without losing the use tax exemption. Such an interpretation comes close to rendering the exemption meaningless and produces the anomaly of providing an exemption for which no manufacturer can qualify. We reject an interpretation of N.J.S.A. 54:32B-6 that would render it virtually meaningless.

After the ITC's auditor reviewed the case, he backed off on the notion of worldwide samples being subject to use tax. We mutually agreed that only samples in the state of New Jersey would be subject to use tax since ITC becomes the "user" by means of a marketing strategy. We then further argued that if we distribute the bulk of our samples to nonprofit hospitals, would they then qualify for an exempt use? ITC was unsuccessful in this attempt whereby the auditor stated that ITC, not the tax-exempt hospital, was the user.

The second contended issue with the state, dealt with corporate income tax. New Jersey is unlike many other states in that a corporation can only allocate its income to other states if it has property located outside New Jersey. Otherwise, the corporation is only entitled to a tax credit. ITC maintains a U.K. office for sales within the U.K. The ambiguities surrounding this issue are that ITC rents the space from a Thermo affiliate and that ITC's U.K. employees are physically on the payroll of the affiliate. But the cost of payroll and fringes are reimbursed by ITC to the affiliate. The auditor argued that this physical presence would be denied for the purposes of allocating income away from N.J. since the occupancy was just a matter of convenience and the employees actually belong to the affiliate. ITC rejected the position and provided the following proof that our U.K. operation is a legitimate out-of-state location.

ITC-U.K. maintains title to the assets of cash, accounts receivable, inventory, and fixed assets located in the U.K. The U.K. branch is registered to collect VAT and, files VAT returns quarterly. Concerning the site, the U.K. office receives and ships goods, bills customers, makes collection efforts, solicits sales, has a separate phone line and is listed in a professional medical directory. On the issue of employees, ITC- U.S. makes written offers of employment, directs all employees, reimburses their T&E expenses, and gives annual performance reviews. For the state to say that our U.K. operation is a matter of convenience and that the employees are not ours is outlandish. Just because the payroll reimbursement and rent from an affiliate make economical sense to ITC, it should not undermine the facts of the circumstances that the U.K. operation is legitimate. This issue is still under debate with the state.

I trust this information will be of interest to you and the many readers of The CPA Journal. My hope is that others in these circumstances can benefit from my experience. *

State and Local Editor:
Kenneth T. Zemsky, CPA
Ernst & Young LLP

Interstate Editor:
Marshall L. Fineman, CPA
David Berdon & Company LLP

Contributing Editors:
Henry Goldwasser, CPA
M.R. Weiser & Co. LLP

Leonard DiMeglio, CPA
Coopers & Lybrand L.L.P.

Steven M. Kaplan, CPA
Konigsberg Wolf & Co., PC

JANUARY 1996 / THE CPA JOURNAL

FENWICK

1/2 ISL. PAGE

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