Tax Update 

In this section of Jnet, we provide brief updates on regulatory developments in tax that may impact Japanese companies operating in the United States. Please contact your local KPMG representative or Makoto Nomoto, Partner, Tax, at or 212 872 2190 with questions.


August 2012


New York: Trial Court Invalidates MTA Payroll Tax

A trial court sitting in Nassau County found the MTA payroll tax to have been unconstitutionally enacted by the New York legislature (Mangano v. Silver, motions #013-#017 (N.Y. Sup. Ct. August 22, 2012)).


Because of a budget shortfall in the MTA, the New York General Assembly in 2009 passed legislation to impose a new MTA payroll tax. The MTA payroll tax is imposed on employers and self-employed persons engaged in business in the Metropolitan Commuter Transportation District (MCTD). The effective date of the MTA payroll tax on employee wages was generally retroactive to March 1, 2009, and for the tax on self-employment net earnings, to January 1, 2009. Revenues from the MTA payroll tax are dedicated to supporting MTA programs. The bill enacting the MTA payroll tax was approved by 60% of the Assembly and 52% of the Senate.

However, under the state constitution, a "special law" relating to the property, affairs, or government of any local government cannot be enacted without an approval by the local government, or a message of necessity from the governor coupled with two-thirds approval of the measure by each house of the General Assembly. Some of the affected counties and municipalities in the MCTD brought suit challenging the constitutionality of the MTA payroll tax.


The trial court first determined that the bill adopting the MTA payroll tax (1) related to the property, affairs, or government of local governments; and (2) was a "special law" because it applied only to certain counties rather than every county in New York State. In addition, the court found it was clear that there was no message of necessity from the governor associated with the bill and that it was not approved by two-thirds of the legislature. The trial court noted that there was an exception to the message requirement for instances when the special law "serves a substantial [s]tate concern" but found that this exception did not apply in this case because the MTA shortfall affected only counties in the MCTD and the MTA payroll tax was imposed only in the MCTD rather than throughout the state. As a result, the trial court held that the MTA payroll tax statute was unconstitutionally enacted by the New York legislature.


California: Appeals Court Issues Order for Rehearing and Vacates Gillette Decision

On August 9, the California appeals court ordered a rehearing on the court's own motion and vacated the July 24 decision on Gillette Co. v. Franchise Tax Board (No. A130803 (Cal. Ct. App. July 24, 2012)).


In July, a California appeals court held that a taxpayer could apportion its income to California using the Multistate Tax Compact's evenly weighted three-factor formula, despite statutory language mandating the use of a three-factor double-weighted sales formula for general corporations.


After the decision was issued in the case, the Franchise Tax Board (FTB) filed a petition for rehearing. Concurrently, counsel for the taxpayer filed a request to make certain modifications to the opinion. The appeals court granted neither the FTB's petition for rehearing, nor the taxpayer's request for modification. Rather, the court ordered a rehearing in the case "on its own motion and for good cause."


IRS Discontinues "Tiered Issue" Process to Manage LB&I Issues

On August 17, the IRS Large Business & International (LB&I) division issued a directive (LB&I-4-0812-010) announcing that it would no longer manage issues through the "tiered issue" process, but would develop a knowledge management network through the use of "issue practice groups" for domestic issues and "international practice networks" for international issues.


The LB&I (and preceding divisions) used the tiered issued process since 2006 to set examination priorities and address certain corporate tax issues that posed challenges to compliance. Initially, the tiered issue process was developed, in part, to address tax shelters viewed by the IRS as abusive. The tiered issue process intended to provide for consistency of treatment and uniform disposition of these and other types of cases.

According to the directive, the IRS found that the tiered issue process may have been well suited for the audit of tax shelter type issues but LB&I needed a different approach going forward to better manage compliance priorities and provide guidance to examiners. Effective with the issuance of this LB&I Directive, all Tier I, II and III issues are no longer "tiered" and are to be risk-assessed and examined in the same manner as any other issue in an audit.


Application of Specified Notional Principal Contract Rules Extended to 2014

On August 30, the Treasury Department and IRS released a correcting amendment to January 2012 temporary and proposed regulations concerning guidance to nonresident aliens and foreign corporations that hold notional principal contracts (NPCs) which provide for payments determined by reference to the payment of dividends from sources within the United States. The release extends the date for application of the rules contained in the temporary and proposed regulations concerning "specified NPCs" for one year to January 1, 2014, from the date originally provided of January 1, 2013. The correcting amendment states that the date is being extended for one year in response to "numerous comments" that the originally proposed effective date of January 1, 2013 would not allow taxpayers sufficient time to build and test the systems required to implement the withholding rules for specified NPCs and equity-linked instruments.


IRS Requests Comments on Future FATCA Individual ID and Registration Forms

The IRS requested comments concerning development of Application on Foreign Account Tax Compliance Act (FATCA) Individual Identification Number (Form 8956) and Registration for Participating, Limited, or Registered Deemed Compliant Foreign Financial Institution (FFI) Status (Form 8957). Comments are requested, among other items, as to how to enhance the quality, utility, and clarity of the information to be collected; ways to minimize the information collection burden; and estimates of the costs for operating, maintaining, and purchasing services to provide the requested information. Comments are due on or before October 15, 2012.


IRS Releases Draft Form W-8IMY for Reporting FATCA Information in 2012

On August 14, the IRS posted a draft version of Form W-8IMY, Certificate of Foreign Intermediary, Foreign Flow-Through Entity, or Certain U.S. Branches for United States Tax Withholding, to be used to comply with certain FATCA information reporting requirements for 2012. The draft form is scheduled to be finalized in December 2012 following approval by the Office of Management and Budget.


July 2012


California: Appeals Court Upholds the Use of Evenly Weighted Three-Factor Formula

A California appeals court held that a taxpayer could apportion its income to California using the Multistate Tax Compact (MTC)'s evenly weighted three-factor formula, despite statutory language mandating the use of a three-factor double-weighted sales formula for general corporations (The Gillette Co. v. Franchise Tax Board, No. A130803 (Cal. Ct. App. July 24, 2012)).


While California entered into the MTC in 1974, the state mandated the use of a double-weighted sales formula in 1993. In the state appeals court's view, when California became a signatory to the MTC, it entered into a binding agreement that requires California to offer multistate taxpayers the option of using the MTC allocation and apportionment provisions.


If courts in other MTC full-signatory states (Alabama, Alaska, Arkansas, Colorado, District of Columbia, Hawaii, Idaho, Kansas, Michigan, Minnesota, Missouri, Montana, New Mexico, North Dakota, Oregon, South Dakota, Texas, Utah, and Washington) follow this decision, it appears that any statute or regulation that mandates a different apportionment methodology other than that contained in the MTC would potentially be unenforceable. In addition to sales-factor weighting, this same line of reasoning could have relevancy to other apportionment provisions—e.g., costs of performance vs. market sourcing, special industry apportionment formulas, etc.— that mandate a treatment that departs from the methodology contained in the MTC.

It is not yet known whether the FTB will appeal the decision, although it seems likely given the amount of dollars at stake. The situation was made somewhat more complicated as a result of enactment of California's June 27, 2012 legislation (S.B. 1015) that repealed the MTC. This legislation also provides that an election affecting the computation of tax must be made on an original, timely filed return for the tax period for which the election applies and is binding, once made. According to the legislation, this "doctrine of election" does not constitute a change in law, but is merely declaratory of existing law. Further complicating matters, S.B. 1015 was adopted by a simple majority—rather than a two-thirds majority. As such, an issue has already been raised as to whether the legislation was validly enacted under Proposition 26 (which provides that "any change in state statute which results in any taxpayer paying a higher tax" is subject to the two-thirds requirement).


New Jersey: Software as a Service Not Subject to Sales Tax

The New Jersey Division of Taxation issued a ruling which addressed whether software as a service (SaaS) in a cloud computing context would be subject to New Jersey sales tax. The taxpayer at issue charged a monthly fee for the use of its web-hosted software application that enabled customers to develop puzzles based on data entered into the application by the user. The puzzles were subsequently provided to the customer in the form of a downloadable PDF file.


The Division noted that software as a service generally has certain characteristics, including that the seller retains full ownership and ability to operate the software and the server upon which it is hosted. Further, customers must access the software via the Internet and cannot download, copy, or modify the software. If these conditions exist, the Division ruled that the software as a service is not subject to sales and use tax.


Massachusetts: Department Addresses Taxability of Certain Cloud Computing Services

The Massachusetts Department of Revenue issued a letter ruling addressing  whether certain cloud computing services would be subject to sales and use tax. The taxpayer defined the cloud computing services it provided to customers as incorporating infrastructure, a platform, and software to enable customers to access the taxpayer's resources to perform a variety of activities, including, but not limited to, running software applications. In addition to the cloud computing services, the taxpayer charged customers a separately-stated fee for certain data transfers and also offered remote storage services that allowed customers to store and retrieve content, data, and software on the taxpayer's servers. To use the cloud service, customers were required to use some type of operating system. They could opt to use their own software or free, open-source software available on the Internet. A third alternative was for customers to use software licensed by the taxpayer from a third party. If the customer chose to use the third-party software, the fee for the cloud service was higher. The third-party software was not transferred to the customers, and there was no contractual sublicensing of the software.


Massachusetts sales tax regulations provide that charges for prewritten software, whether electronically downloaded or accessed by a customer on the seller's server (such as SaaS) are generally taxable. The Department first determined that sales of cloud computing where free software or the customer's own software was the means of utilizing the cloud service were not taxable because they did not involve taxable sales of prewritten computer software. Conversely, sales of cloud services where customers used the software licensed by the taxpayer were taxable because the cost of the software license was included in the charge for the cloud service. Furthermore, with respect to the data transfer fees, the Department ruled that they were taxable interstate telecommunications that would be sourced to Massachusetts if the transmission originated or was received in the state and the service was charged to a Massachusetts service address. Finally, the taxpayer's remote storage service was deemed to be a nontaxable service as the taxpayer's customers did not have direct control over the servers where the data was stored.





The views and opinions are those of the author and do not necessarily represent the views and opinions of KPMG LLP. All information provided is of a general nature and is not intended to address the circumstances of any particular individual or entity.