Tax Practice
State and Local Tax Report
April 2010
In This Issue
Charitable Care Policy By Itself Is Not Sufficient to Secure Charitable Exemption
In a decision that could greatly affect hospitals and other nonprofit healthcare entities claiming charitable exemptions, the Supreme Court of Illinois, on March 18, 2010, denied a charitable property tax exemption to a non-profit hospital, Provena Covenant Medical Center (PCMC). Provena Covenant Med. Ctr. v. The Dep’t of Revenue, 2010 WL 966858 (Ill. 2010). The Court reached this conclusion despite the fact that “a charity care policy was in place at [PCMC]” and PCMC “did not condition the receipt of care on a patient’s financial circumstances, treatment was offered to all who requested it, and no one was turned away by PCMC based on their inability to demonstrate how the costs of their care would be covered.” Provena Covenant Med. Ctr.‚ 2010 WL 966858 at 6‚ 22.
Substantive Charitable Care Must In Fact Be Provided to the General Public
PCMC claimed a property tax exemption under Illinois Property Tax Code‚ Sec. 15-65 [35 ILCS 200/15-65]‚ which exempts real property owned by public charity institutions from tax, when the property is used for “charitable or beneficent purposes.” The Court considered two main questions: whether the institution that owns the property is charitable and whether the property is used for charitable purposes. The Court ruled against PCMC on both issues. To support its decision on the first issue the Court looked to the fact that the bulk of PCMC’s income came from charges of medical services instead of charitable donations‚ that PCMC did not actually dispense charitable care to all who needed and applied for it, and that it failed to advertise its charity program‚ while simultaneously pursuing collections. To make its determination on the second count‚ the Court looked at the fact that both the number of patients and dollar value of the free care (0.7 percent of the hospital’s revenues) were miniscule as compared to PCMC’s patient population and hospital revenue. As a result, the Court held there was “little to distinguish the way in which [PCMC] dispensed its ‘charity’ from the way in which a for-profit institution would write off bad debt” and thus PCMC did not provide enough charitable care in its facilities to qualify for the property tax exemption. Provena Covenant Med. Ctr., 2010 WL 966858 at 22.
Unanswered Question: What Level of Charitable Care Is Sufficient to Claim Exemption?
Following this decision, the question for hospitals and healthcare providers becomes: what is enough charitable care to qualify for tax exemption? PCMC, like other Illinois non-profit hospitals claiming the exemption‚ relied in part on care it provides under Medicare and Medicaid programs. PCMC argued that treatment of Medicare and Medicaid patients should be considered charitable care because the government payments received for treating these patients does not cover the full costs of that care. The Court in PCMC‚ however‚ rejected this argument, pointing out that Medicare and Medicaid programs are optional‚ that hospitals reap federal tax breaks by participating in them‚ and that hospital facilities benefit from being more fully utilized by accepting patients under these programs. The Court also refused to consider community services‚ including volunteer initiatives‚ in determining whether PCMC had dispensed sufficient charitable care to qualify for the charitable property tax exemption.
Unfortunately‚ the PCMC ruling does not provide clarity or direction in determining precisely what is necessary to meet the charitable care requirement. Indeed‚ this ruling may serve as a catalyst for protracted debate on this issue. Illinois lawmakers may eventually be forced to follow in the footsteps of Utah‚ Texas‚ and Pennsylvania in enacting an amendment to the state’s property tax statute that establishes a minimum level of charitable care required to qualify for the exemption.
Practical Considerations: Non-Profit Hospitals Must Be Proactive in Securing Continued Entitlement to Charitable Tax Exemptions
United States Senator Charles Grassley‚ in commenting on the PCMC decision, emphasized that this decision holds non-profit hospitals accountable for demonstrating that the level of charitable care they provide justifies continued entitlement to state property tax exemptions. He stated that as a member of the U.S. Senate Finance Committee he will similarly “continue working to hold tax exempt hospitals accountable for the federal tax benefits they receive.” 2010 STT 53-2 (March 18‚ 2010). In light of the Illinois Supreme Court ruling in PCMC‚ and the changes related to health care issues at both the state and federal level‚ hospitals and other nonprofit healthcare entities should be prepared defend their continued entitlement to charitable tax exemptions. With respect to the Illinois charitable property tax exemption‚ and the charitable sales/use tax exemption on purchases‚ which adopts a similar standard‚ nonprofit hospitals should act proactively to increase public awareness of their charity care policies‚ carefully identify and record all charitable care they provide‚ and monitor future legislative and judicial developments in this area.
B. DEALING WITH CALIFORNIA’S QUESTIONABLE E-WASTE FEE
Many states have, over the past decade, adopted e-waste fees of various kinds. In 2003, California enacted the Hazardous Electronic Waste Recycling Act (“Act”) for the purpose of providing sufficient funding for the safe, cost-free, and convenient collection and recycling of 100 percent of the covered electronic waste discarded or offered for recycling in the state. Cal. Pub. Res. Code § 42461(h). The Act also was intended to eliminate electronic waste stockpiles and legacy devices by December 31, 2007, end the illegal disposal of covered electronic devices, establish manufacturer responsibility for reporting efforts to phase out hazardous materials in electronic devices and increase the use of recycled materials, and to ensure that electronic devices sold in the state do not violate certain regulations adopted by the Department of Toxic Substances Control. Id.
Although the Act has many significant provisions, one of the most controversial is the electronic waste recycling fee (“E-Waste Fee”) that was created as part of the Act. Beginning on January 1, 2005, whenever a consumer purchases a new or refurbished covered electronic device (“CED”) “in a transaction that is a retail sale or in a transaction to which a use tax applies,” the consumer is required to pay an E-Waste Fee based on the screen size of the device. Cal. Pub. Res. Code § 42463(d).
The Problem
As a practical matter, many large taxpayers doing business in California acquire and dispose of their CEDs outside of the state. For example, a corporation headquartered in Illinois may have operations across the country, including in California, which utilize CEDs that are purchased, stored, and distributed from the corporation’s Illinois headquarters. In this type of operation, when a CED breaks, it typically is shipped back to the headquarters, where a third-party vendor either refurbishes the device or disposes of it locally. Thus, although the CED is used in California, because these units are neither purchased nor disposed of in California, the E-Waste Fee is not collected by the suppliers. Nevertheless, when the business is audited, the state picks up the fact that the CEDs were purchased without payment of the fee, and a notice of determination is issued alleging that the business either failed to report, or underpaid, the E-Waste Fee.
Unfortunately, unlike other California hazardous waste fees, the Act contains no express provision explaining how CEDs used in the state, but purchased and disposed of out-of-state, should be handled. The Act also contains no express provision giving credit for fees paid to other states for the disposal of CEDs used in California. Thus, on the surface, it would appear that the E-Waste Fee is constitutionally infirm.
As many practitioners are aware, in order for a fee to be valid, it must be reasonably related to benefits conferred. The courts have held that charges allocated to a payor must bear a fair or reasonable relationship to the payor’s burdens on, or benefits from, the regulatory activity. See e.g., Northwest Energetic Services, LLC v. California Franchise Tax Bd., 159 Cal. App. 4th 841 (2008); Sinclair Paint Co. v. State Bd. of Equalization, 15 Cal. 4th 866 (1997); Collier v. City and County of San Francisco, 151 Cal. App. 4th 1326 (2007); Bay Area Cellular Telephone Comp. v. City of Union City, 162 Cal. App. 4th 686 (2008). In the scenario illustrated above, however, there is no relationship or nexus between the fee paid and the benefit conferred because the subject CEDs are disposed of outside the state.
Practical Considerations
Certainly, one could argue that the Act must have an implied fee exemption for out-of-state disposals, or an implied offset for fees paid to other states, because, without such provisions, the law is invalid as a violation of the due process and commerce clauses. See e.g., Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977); General Motors Corp. v. Tracy, 519 U.S. 278 (1997); Miller Bros. Co. v. Maryland, 347 U.S. 340 (1954); Moorman Mfg. Co. v. Bair, 437 U.S. 267, 273 (1978). Nevertheless, in a recent hearing, the State Board of Equalization has rejected this interpretation and chosen simply to enforce the facially invalid fee on the grounds that it cannot refuse to do so until an appellate court holds that the statute is unconstitutional. Consequently, businesses that receive a notice of determination under the aforementioned facts are faced with the unenviable choice of either: 1) paying a fee that is constitutionally infirm; 2) seeking a less than satisfactory resolution through settlement; or, 3) challenging the validity of the fee in court. Fortunately, however, the courts have occasionally awarded attorneys’ fees in cases where similar unconstitutional fees have been struck down. See e.g., Northwest Energetic. So taxpayers opting to challenge the E-Waste Fee in court may not have to incur the entire cost of litigation.
C. CITY OF CHICAGO v. EBAY, INC. REAFFIRMS PRINCIPLE OF PREEMPTION
The dismissal of the City of Chicago’s complaint in the U.S. District Court for the Northern District of Illinois in Chicago v. Ebay, Inc. (N.D. Ill.‚ no. 08C3281‚ 12/21/09) reaffirms the role of state preemption in local taxation.
The Chicago v. Ebay dispute relates to a conflict between the local amusement tax ordinance and state statutes governing the scope of amusement taxes in Illinois. An amusement tax is imposed upon the patrons of every “amusement” in the City of Chicago (“City”) at a rate of 9 percent. When a ticket is resold for more than the original purchase price‚ the reseller is generally required to collect tax based on the difference between the original purchase price and the resale price. In this case‚ the City tried to collect the incremental tax on resold tickets directly from Ebay‚ claiming that under its local ordinance, Ebay was a “reseller’s agent” because it facilitated the sale of thousands of tickets to amusements taking place within the City. Ebay argued that while it may be a “reseller’s agent” under the City’s code‚ the Illinois state law specifically excludes it from being considered a reseller’s agent. Therefore‚ it was argued‚ the local ordinance was preempted. The Court agreed with Ebay‚ holding that the plain language of the Illinois state statute‚ which comported with expressed intent of the state legislature‚ preempted the City’s definition of reseller’s agent and therefore Ebay was not required to collect or remit the City’s amusement tax.
Many taxes are authorized or otherwise governed by state law‚ but are also actually administered or collected by local government. An obvious example in many states is the documentary or real estate transfer tax. Many states also have property and excise taxes that work this way. The Chicago v. Ebay decision represents just one of a long line of cases in which a locality attempts to overreach its authority with respect to a state law. In this decision‚ the answer was easier for the court than in most. The state legislature had specifically acted on not only the tax‚ but the precise issue in question.
But what happens when local laws do not obviously conflict with state law? For example, the voters of the City of Oakland‚ California recently passed a law that purports to impose documentary transfer or real estate transfer tax on certain transfers of stock interests in legal entities that own real estate. Does state law preempt this local law? After all‚ the original state authorization in California‚ as in most states‚ contemplates only the taxation of recorded deeds. Be on the lookout, as many of our clients are facing these issues on a regular basis‚ with cash-strapped localities reaching to fill budget shortfalls and to extend their tax regimes to modern business models.
In a significant victory for multistate taxpayers, the Oregon Tax Court in Oracle Corporation v. Department of Revenue‚ TC MD070762C‚ (Feb. 11‚ 2010)‚ recently issued a decision which acknowledged that taxpayers may be forced to take conflicting tax return filing positions in different states based upon differing judicial interpretations of similar tax laws adopted by those states. The court held that the Oregon Department of Revenue (“Department”) could not use a taxpayers’ conflicting tax return filing position in California to force the taxpayer to take a similar filing position in Oregon. The court ruled that only Oregon tax law governs how Oregon taxpayers must report their income on Oregon corporate income tax returns.
Uniform State Tax Laws
State corporate income tax laws require taxpayers to determine total taxable income‚ and then attribute that portion of total income taxable by a particular state based upon business operations conducted within the state. For this purpose‚ many states have adopted common apportionment provisions promulgated over 50 years ago as part of the Uniform Division of Income for Tax Purposes Act (“UDITPA”). UDITPA divides income into two types of income‚ nonbusiness income and business income. Business income is defined to include income generated from assets acquired‚ managed and disposed of as an integral part of a taxpayers’ regular trade or business operations. Nonbusiness income is defined as all other income. Nonbusiness income is allocated to states in which the property generating the income is physically located‚ or in the case of intangible property‚ to the taxpayer’s headquarters state. Business income is apportioned to the various states in which the taxpayer conducts business based on a three-factor payroll‚ property, and sales apportionment formula.
Differing Judicial Interpretations of Common State Tax Laws
In the more than 50 years since UDITPA was drafted‚ state courts have adopted sometimes conflicting interpretations of its provisions. One such conflicting and widely litigated interpretation is the distinction between business and nonbusiness income. State courts frequently have interpreted gain from the liquidation of a taxpayer's business (generically the “liquidation exception”) as excluded from the definition of business income because disposition of the assets is outside the course – i.e. in termination – of a taxpayer’s regular business operations. However‚ state courts have differed on what they consider as constituting business liquidation for this purpose‚ and at least one state – California – has rejected entirely the liquidation exception. The California Appellate Court in Jim Beam Brands Co. v. Franchise Tax Board, 133 Cal. App. 4th 514 (2005), interpreted UDITPA’s definition of business income to treat gain from the sale of essentially all business assets as business income.
Taxpayer’s Conflicting Tax Return Filing Positions
Oracle‚ which is headquartered near Redwood City‚ California‚ liquidated certain corporate stock holdings and other businesses. Oracle reported gain from the liquidation on its California income tax return as business income under the California Appellate Court’s decision in Jim Beam. As business income, just a portion of Oracle’s gain was apportioned to California under the state’s three-factor sales‚ property, and payroll apportionment formula. By contrast‚ Oracle reported the gain as nonbusiness income on its Oregon corporate income tax return. As nonbusiness income, the gain was not attributed to Oregon because Oracle’s corporate headquarters was located in California.
Department’s Motion for Summary Judgment
The Oregon Department of Revenue issued an assessment against Oracle asserting that the gains generated from the liquidation of Oracle’s assets should have been reported to and taxable by Oregon as apportionable business income. The Department filed a motion for summary judgment. The motion asserted that Oregon and California had essentially identical definitions of business income, and a goal of UDITPA is to promote uniformity among states in apportioning income — a goal that the Oregon Supreme Court has recognized must be considered in the interpretation of Oregon’s UDITPA–based apportionment provisions. The Department’s motion‚ therefore, asked the Tax Court to rule that on its Oregon return, Oracle was legally precluded from taking a contrary position from that taken on Oracle’s California return, which was that the gain at issue was apportionable business income.
Court Ruled That California Return Had No Effect on Oregon Return
The Tax Court ruled against the Department’s motion. In rejecting the motion‚ the Tax Court stated that if it granted the motion‚ it would be forced to “become an expert in the laws of 49 other states as they pertain to the definition of business and nonbusiness income‚ not only as set forth in the various states’ statutes‚ but as those statutes are refined and clarified by years of judicial opinions.” The court also observed the Department clearly was cherry-picking — that if California had adopted an interpretation of business income that was consistent with Oregon’s interpretation‚ then Oregon would not be asserting that Oracle should be bound by Oracle’s California filing position. The Tax Court accordingly ruled that Oracle could not be precluded from characterizing the gain at issue as business income on its Oregon return by Oracle’s contrary California filing position.
State tax returns frequently ask taxpayers how they have applied common statutory apportionment provisions in other states. See e.g., California Franchise Tax Return‚ Form 100‚ Schedule R-2‚ Line 5 (asking if nonbusiness income consistently reported by taxpayer in all states); and New Jersey Corporate Business Tax Return, Form CBT –100‚ Schedule O‚ Part II (asking about nonbusiness income treatment of gain by taxpayer in other states). States will attempt to assert that a taxpayer should take consistent filing positions in all states – that is‚ at least when to do so would accrue to the state’s benefit. The Oregon Tax Court’s decision in Oracle gives taxpayers ammunition with which to combat the failure of states to recognize that similar laws may be interpreted differently in different states. The Oregon Tax Court’s decision acknowledges that ultimately‚ application of a state’s tax laws must depend upon how those tax laws have been interpreted by that state’s courts and cannot be bound by interpretation of similar laws in other states in which the taxpayer conducts business.
Winston & Strawn successfully represents its clients in business/nonbusiness income disputes at all levels of state tax appeals.
E. NEW USE TAX COLLECTION EFFORTS AFFECTING CALIFORNIA’S NON-RETAIL BUSINESSES
Effective January 1‚ 2010‚ “qualified purchasers” are now required to register‚ report‚ and pay use tax directly to the Board of Equalization (BOE). Through enactment of ABX4 18‚ the Legislature cast a very wide net on the number of businesses now required register with the BOE. As set forth in section 6225 of the California Revenue and Taxation Code‚ a qualified purchaser is any business that meets the following tests:
• Is not required to hold a seller’s permit with the BOE;
• Is not required to be registered with the BOE for use tax collection purposes (Rev. & Tax. Code, § 6226);
• Is not a holder of a use tax direct payment permit (Rev. & Tax. Code, § 7051.3);
• Receives at least $100‚000 in gross receipts per year from business operations; and‚
• Is not otherwise registered with the BOE to report use tax.
Thus‚ many service providers‚ not previously required to file sales and use tax returns‚ will be affected by the new law. The return for 2009‚ along with payment‚ is due by April 15‚ 2010. Registrants also are being asked to report purchases for 2007 and 2008.
It is important to note‚ however‚ that the provisions of this bill do not change the due date for use tax liabilities from prior years. Therefore‚ returns for purchases made in 2007 and 2008‚ unless timely made‚ will be assessed penalties and interest.
F. California State–Assessed Property Valuation Work Underway at State Board of Equalization
The California State Board of Equalization (“SBE”) is responsible for assessing property tax on property owned or used by telephone companies‚ companies selling or transmitting gas or electricity‚ and other specified companies operating in California. Although final state assessments are still months away‚ the SBE has already started laying the groundwork for its assessments.
On February 5‚ 2010‚ the SBE distributed its annual Expected Remaining Life and Condition Percent Factors for 2009. The SBE also has already held hearings on and established capitalization rates for this year’s assessments. Most state assessed taxpayers completed the filing of the taxpayer’s Annual Property Statement by March 1.
Taxpayers who are subject to state assessment‚ regardless of whether they anticipate appealing their assessment‚ should be involved in the SBE’s assessment process even before the SBE makes a final valuation decision. Many of the factors affecting their valuation will be decided well before the taxpayer is given notice of their assessed value.
Some of the other important upcoming events include:
On April 13 taxpayers will make presentations to the SBE on factors affecting 2010-11 valuation of state-assessed properties.
Following the April 13 meeting‚ primarily in May‚ SBE staff will meet with state assessees to discuss value indicators and supporting data for valuation.
On or before May 31‚ the SBE will set unitary values for all state assessed property.
July 20 is the last day to file a petition for unitary value reassessment and/or a petition for correction of allocated assessment.
Winston & Strawn LLP’s State and Local Tax Group represents state–assessed property owners in California and other states. Please contact a member of our group if you would like assistance with your annual assessment or have questions about this process.
G. PENNSYLVANIA AMNESTY PROGRAM SET TO BEGIN IN APRIL
The Pennsylvania Department of Revenue recently issued its 2010 tax amnesty program guidelines. In general, all taxes administered by the department are eligible for amnesty. Eligible periods are those where a known or unknown delinquency exists as of June 30‚ 2009. Unpaid taxes‚ penalties, and interest from periods subsequent to June 30‚ 2009‚ are not eligible for the Amnesty Program.
The program period begins April 26‚ 2010‚ and ends on June 18‚ 2010. To participate‚ taxpayers are required to file an online amnesty return‚ file all delinquent tax returns‚ and make the required payment within the amnesty period. The benefit of participating is that all penalties and one-half of the interest due will be waived.
For more information‚ please review PA Bulletin‚ Doc. No. 09-2237 or contact a member of the Winston & Strawn State and Local Tax Practice Group.
If you have any questions regarding the contents of this newsletter, please contact the following attorneys in the firm’s State and Local Tax Practice Group:
| Chicago | ||
| Robert F. Denvir | (312) 558-5765 | |
| Alan Lindquist | (312) 558-6324 | |
| San Francisco | ||
| Charles J. Moll III | (415) 591-1582 | |
| Troy M. Van Dongen | (415) 591-1546 | |
| Bradley R. Marsh | (415) 591-1585 | |
| Jocelyn M. Wang | (415) 591-6895 | |
| Dina M. Bronshtein | (415) 591-6893 |
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