EY-sales-and-use-tax-quarterly-october-2014

Issue No. 2014-4
October 2014
Ernst & Young LLP
Sales and Use Tax
Quarterly Update
Ernst & Young LLP’s Sales and Use Tax Quarterly Update provides a summary of the major legislative,
administrative and judicial sales and use tax developments for the fourth quarter of 2014.
California’s partial exemption for manufacturing equipment takes
effect
Effective 1 July 2014, California taxpayers engaged in manufacturing and certain types of research and
development (R&D) are eligible for a partial sales and use tax exemption on purchases of “qualifying tangible
personal property.” The provision, which was enacted in July 2013 as part of a legislative package that
repealed the state’s enterprise zone program, applies to businesses and establishments within businesses
engaged primarily (greater than 50% of the business) in: manufacturing; R&D with respect to biotechnology,
engineering or life sciences. The partial exemption, which will run until 30 June 2022, applies to the State
portion of the sales and use tax (4.1875 percent), and is limited to $200 million in exempt purchases per
calendar year for each taxpayer or combined reporting unit.
For purposes of the partial exemption, “qualifying tangible personal property” is defined to include the
following:
• Equipment used predominantly in any phase of manufacturing, processing, refining, fabricating or
recycling
• R&D equipment
• Pollution control devices
• Computers, data-processing equipment and computer software used in or to control the manufacturing
or R&D process
• Special purpose buildings and foundations (certain purchases by contractors of property incorporated
into a manufacturing or R&D facility)
The partial exemption does not apply to consumables, furniture, inventory, and equipment used in the
extraction process, or to equipment that is used to store finished products that have completed the
manufacturing, processing, refining, fabricating or recycling process. Equipment must have a useful life of
more than one year to qualify.
On 26 September 2014, the State Board of Equalization adopted a regulation providing definitions,
explaining when the exemption may apply, and providing the exemption certificate. As with other

exemptions, sellers of qualifying property must obtain an
exemption certificate from the purchaser at the time of
sale.
Any business that plans to make significant equipment
purchases or investments in California, or relocate
manufacturing or R&D operations to California, or that is
considering a merger or acquisition of manufacturing or
R&D operations in California needs to be familiar with the
new law.
Our observation:
The partial exemption provisions have created
significant confusion with respect to: determining
qualification; application of the partial exemption at the
entity or establishment level; the effect on businesses
that outsource; and the effect on expensing. Though
promulgation of the regulations should clarify some of
these issues, taxpayers will need to make appropriate
adjustments in their internal sales and use tax
compliance systems to account for the new law.
Other sales and use tax recent
developments
Nexus
Federal: Proposed bill (HR 5252), introduced on 29 July
2014, would prohibit a state from requiring any person to
collect from, or remit on behalf of, any other person any
state or local tax, fee or surcharge imposed on a purchaser
or use with respect to the purchase or use of a product or
service within the state, unless there is transactional nexus
between the person and the purchaser.
Colorado – U.S. Supreme Court: On 9 December
2014, the U.S. Supreme Court will hear arguments in
the Direct Marketing Association case. The Court will
consider whether the Tax Injunction Act bars federal court
jurisdiction over a suit brought by non-taxpayers to enjoin
the informational notice and reporting requirements of
a state law that neither imposes a tax, nor requires the
collection of a tax, but serves only as a secondary aspect
of state tax administration. Direct Marketing Association
v. Brohl, No. 12-1175 (10th Cir. Ct. App. 20 August
2013), petition for cert. granted, Dkt. No. 13-1032 (U.S.
Sup. Ct. 1 July 2014).
Illinois: A new law amends the state’s click-through sales
and use tax nexus provisions. Under the revised provisions,
a retailer that enters into a contract with an Illinois
resident who, for commission or other consideration
based on the sale of tangible personal property by the
retailer, directly or indirectly refers potential customers
to the retailer by providing to the potential customers a
promotional code or other mechanism that allows the
retailer to track purchases referred by such persons is
obligated to collect Illinois sales tax. Examples of such a
tracking mechanism include a link on the Illinois resident’s
internet website, promotional codes distributed via the
resident’s hand-delivered or mailed material or by the
person through the radio or other broadcast media. The
bill also makes the presumption rebuttable. Ill. Laws 2014,
Pub. Act 98-1089 (SB 352), enacted 26 August 2014.
New Jersey: The Division of Taxation issued guidance
on the new requirement for out-of-state sellers to collect
sales tax if soliciting business in New Jersey under the
click-through nexus provisions that took effect 1 July
2014. Under the new provisions, a person making
sales of tangible personal property, specified digital
products or taxable services is presumed to be soliciting
business through an independent contractor or other
representative (collectively “representative”) if the
person making sales enters into an agreement with a
representative that has a physical presence in New Jersey
and who, for commission or other consideration, directly
or indirectly refers potential customers, whether by a link
on an internet website or otherwise, to the person. These
provisions only apply if the cumulative gross receipts
from sales to in-state customers who were referred by
such representative are in excess of $10,000 during the
preceding four quarterly periods. Businesses meeting this
new requirement will have to register with New Jersey,
and collect and remit the state’s sales tax on charges for
taxable items delivered to an in-state location.
South Carolina: The Department of Revenue issued a
ruling describing nexus creating activities for sales and
use tax purposes. The ruling addresses: general activities;
property in South Carolina; activities of an employee
or third party (e.g., sales representatives, independent
contractors, affiliated companies); delivery; transactions
with in-state printers; advertising; and other issues. S.C.
Dept. of Rev., Rev. Ruling No. 14-4 (10 September 2014).
Virginia: A recent letter ruling addresses whether an outof-state
company has nexus with Virginia based on various
scenarios. An out-of-state company (Company X) is under
common ownership with Company Z, which has a retail
sales tax nexus in Virginia. Another out-of-state company
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(Company Y) purchases retail products from Company X
and resells the products to its Virginia customers via the
internet. Company X retains title and risk of loss of the
products until Company Y makes the sale to the Virginia
customers. The Virginia Tax Commissioner (Commissioner)
determined that Company X does not have affiliate nexus
with Virginia because it does not make sales into the state
and, therefore, is not a Virginia dealer. The Commissioner
noted, however, that under recently enacted affiliate
nexus provisions, if Company X sold goods to Virginia
customers and Company Z facilitated the delivery of
these products, Company X would have nexus with the
state. Assuming that Company X had nexus with Virginia,
Company X is not required to collect sales tax because
the transactions at issue were between Company Y and
its Virginia customers. In this instance, payment of use
tax rests with the customer as Company Y does not have
nexus with the state. Further, Company X is only required
to report the sales to Company Y on its Virginia out-ofstate
dealer’s use tax return, and is allowed to subtract
such sales as exempt sales for resale if supported by valid
resale certificates. Va. Dept. of Taxn., Commissioner PD
No. 14-139 (12 August 2014).
Tax base
Florida: Shipping and handling charges billed by a
company that sells tangible personal property and uses
fulfillment centers leased and operated by affiliated
entities to fulfill the orders are not subject to state sales
tax because: (1) the charges are separately stated, and
(2) the property is shipped F.O.B. origin (i.e., when title of
property is transferred to the customer at the shipper’s
location). Shipping and handling charges will not be
subject to sales tax if the charges are separately stated on
an invoice or bill of sale, and the charges can be avoided
by a decision or action solely on the part of the purchaser.
Fla. Dept. of Rev., TAA 14A-009 (3 April 2014).
Missouri: A retailer that partnered with third-party banks
to issue private label credit cards were not entitled to a
refund of sales tax under the state’s bad debt statute.
The Director of Revenue argued, based on out-of-state
persuasive authority, that the taxpayer was not eligible
for a refund because it is not the entity that incurred the
bad debt. An Administrative Law Judge (ALJ) found that
the retailer and the bank, acting as a unit, fit the definition
of “person” and since the retailer is legally obligated to
remit sales tax, the retailer and the bank, acting as a unit,
is a person that fits the definition of “retailer.” Thus, the
retailer was entitled to a refund of sales tax paid on sales
written off as a bad debt. On appeal, the Missouri Supreme
Court reversed, finding the retailers did not qualify for a
refund of sales tax under the bad debt statute because
the retailer (while the entity legally obligated to remit the
tax and the entity eligible to apply for a refund) was not
the party that suffered a loss. Rather, the bank suffered
the loss. The Court reasoned that Missouri statutory law
“does not contemplate treating two separate corporations
in a contractual relationship as a single tax entity for the
limited purpose of obtaining a sales tax refund.” Circuit
City Stores, Inc. v. Director of Revenue, No. SC93687
(Mo. Sup. Ct. 29 July 2014); Dillard’s Inc. v. Director of
Revenue, No. SC93711 (Mo. Sup. Ct. 29 July 2014).
New York: The entire charge on a medical supply
company’s invoice that bundles taxable and exempt
tangible personal property into a single line-item is subject
to sales tax. Further, the company’s use of a single lineitem
charge does not transform its customers’ purchases
of taxable tangible personal property into a sale of an
“inventory replenishment” service. Lastly, the company
cannot prorate the bundled charge according to the
taxability of each product. N.Y. Dept. of Taxn. and Fin.,
TSB-A-14(30)S (22 August 2014).
Virginia: A hotel correctly collected sales tax on the
charge for untimely cancelling a reservation for room and
meals, because the charge was contracted for, and not an
unrelated cancellation fee or penalty. Va. Dept. of Taxn.,
Commissioner PD No. 14-140 (12 August 2014).
Wisconsin: Customer convenience charges and handling
fees charged by a third-party ticket vendor as part of
the ticket price are subject to the state’s sales and use
tax because these charges and fees are part of the gross
receipts from the sale of admissions. In addition, the
Wisconsin Circuit Court held that the music theater owner
is subject to sales tax on its sales as well as those of the
third-party ticket vendor. Neja Group, LLC v. Wisconsin
Dept. of Revenue, No. 2014-CV-0131 (Wis. Cir. Ct.,
Walworth County, 22 August 2014).
Sales and use tax exemptions and refunds
Alabama: On 9 December 2014, the U.S. Supreme
Court will hear arguments in CSX Transportation. In this
case, the Court is being asked to consider whether a
state discriminates against a rail carrier in violation of
the federal 4-R Act when the state generally requires
commercial and industrial businesses, including rail
carriers, to pay sales and use tax, but grants exemptions
from the tax to the railroad’s competitors. CSX
Transportation, Inc. v. Alabama Department of Revenue,
et al., No. 12-14611 (11th Cir. Ct. App. 1 July 2013),
October 2014 — Issue 4 3

petition for cert. granted, Dkt. No. 13-553 (U.S. Sup. Ct. 1
July 2014).
Mississippi: A regulation (Miss. Admin. Code §35.
IV.7.03(302)) narrowly defining qualified use under the
state’s sales and use tax exemption for pollution control
equipment was deemed invalid by the Mississippi Supreme
Court, because the regulation is inconsistent with the
plain language of the exemption statute. Mississippi Dept.
of Revenue v. Mississippi Power Company, No. 2013-CA-
01234-SCT (Miss. Sup. Ct. 7 June 2014).
Ohio: A parts manufacturer’s purchase of a “caustic”
solution that is applied to metal dies after a manufacturing
“run” to remove aluminum residue from a stamping press
does not qualify for the sales and use manufacturing
exemption. Ohio exempts from taxation the purchase of
tangible personal property used during the manufacturing
process that is necessary for the proper functionality of a
manufacturing operation or process, but does not exempt
tangible personal property used to repair manufacturing
equipment. The Ohio Board of Appeals held that the
purchases of caustic solution are subject to tax because
the solution is applied after the metal dies were removed,
and thus, after the manufacturing process has ceased.
Perren v. Testa, No. 2013-614 (Oh. Bd. Tax App.
29 August 2014).
Tennessee: Sales of a medical device that is designed
for continuous use throughout the day and consists of a
portable pack, a wearable component and ancillary items,
qualifies for the Tennessee’s sales and use tax exemption
as a “prosthetic device for human use and repair services
and maintenance of those prosthetic devices.” In order to
constitute a “prosthetic device” under Tennessee law it
must: (1) be for human use; (2) constitute a replacement,
corrective or supportive device; (3) be worn on the body;
and (4) be used to artificially replace a missing portion
of the body. The Tennessee Department of Revenue
(Department) determined that the medical device at issue
met these requirements, further explaining that “worn on
the body” includes being “carried by the body and does
not hinder an individual’s mobility.” “Worn on the body,”
however, does not include a device that is placed on an
item of mobility that makes the device portable (e.g., a
medical item that requires a cart or pole with wheels to
move it around). In this case, the Department concluded
that the medical device is worn on the body “by virtue of
being carried by the patient.” Tenn. Dept. of Rev., Letter
Ruling No. 14-02 (18 June 2014).
Texas: The Court of Appeals affirmed a lower court’s
ruling that an oil and gas operations company failed to
meet the burden of proof to establish that equipment it
uses to bring petroleum to the ground surface qualifies
for the manufacturing exemption from sales and use tax.
In order for the exemption to apply, the property at issue
must be “used or consumed in the actual manufacturing,
processing, or fabrication of tangible personal property
for ultimate sale.” The court found that the phrase
“manufacturing, processing, or fabrication” does not
include “extraction.” The Court reasoned that based on
the definition of “manufacturing,” which includes each
stage of the process, “the extraction of oil and gas from
the ground would not seem to qualify as manufacturing.”
This determination is “consistent with the legislature’s
decision to distinguish the term manufacturing from
both mining and extraction in other contexts. ...” Lastly,
the Court found the Comptroller of Public Accounts’
interpretation of the manufacturing exemption — that
the legislature did not intend for the manufacturing
exemption to apply to the extraction of oil and gas — “not
plainly erroneous or inconsistent with the language of the
statute.” Southwest Royalties, Inc. v. Combs, No. 03-12-
00511-CV (Tex. Ct. App., 3rd Dist., 13 August 2014).
Virginia: A sales tax exemption for broadcasting,
amplification, transmission and distribution equipment
used to provide internet access services may be claimed
by an internet service provider (ISP) that exclusively
services other businesses and telecommunications
companies.
The Department of Taxation (Department) has strictly
construed the ISP exemption as applicable only to retail
ISPs, and not wholesale ISPs. Since the Fairfax County
Circuit Court in Cisco Systems, ruled the ISP exemption
applied to both retail and wholesale ISPs, the Department
held the exemption may apply to the extent the taxpayer’s
assets at issue were used for internet services in the
locality of Fairfax County, VA, regardless of whether used
in retail or wholesale activities.
Because the Department has declined to extend the
Court’s interpretation in Cisco on a statewide basis,
assets used in other localities will not receive the
same treatment; rather, the exemption will apply if the
equipment or assets are used in a “retail” capacity.
Tax must be prorated on property used in both resale
and wholesale internet service activities to reflect the
percentage of time used in exempt activities. Va. Dept. of
Taxn., Commissioner PD No. 14-92 (16 June 2014).
Virginia: A company providing waste collection services
owes sales tax on all tangible personal property used to
provide such services, including residential bins, loading
bins, trucks and other equipment, because the company
is the user and consumer of such property. Further, the
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Ernst & Young LLP Sales and Use Tax Quarterly Update

company’s recycling operation does not qualify under
the manufacturing or processing exemption because the
recycled materials collected do not undergo a process to
make them more marketable or useful. Va. Dept. of Taxn.,
Commissioner PD No. 14-153 (28 August 2014).
Transactions
Federal: New law extends the Internet Tax Freedom Act
(ITFA), which prohibits non-grandfathered states from
taxing charges for internet access or imposing new and
discriminatory taxes, through 11 December 2014. It is
anticipated that Congress will work on a longer extension
before adjourning for the year. HJR 124 was signed by
President Obama on 19 September 2014.
Illinois: An appellate court affirmed a circuit court’s
holding that Cook County’s Non-titled Personal Property
Use Tax, which is imposed upon the privilege of using
in Cook County non-titled personal property purchased
outside the County, violates the Illinois Counties Code
section 5-1009. Reed Smith LLP v. Ali, 2014 IL App (1st)
132646-U (Ill. App. Ct., 1st Jud. Dist., 4 August 2014).
Illinois: A new law provides guidelines for determining
the location where retailers are deemed to be engaged
in the business of selling tangible personal property for
purposes of the Retailers’ Occupation Tax Act, the Use Tax
Act, the Service Use Tax Act and the Service Occupation
Tax Act, and for the purpose of collecting any other local
retailers’ occupation tax administered by the Department
of Revenue. These provisions apply to particular selling
activities as described by the new section of the law
codified at 35 ILCS 120/2-12.
The selling location will be deemed the retailer’s place of
business where the retailer regularly stocks the tangible
personal property or similar items, if the property is
purchased: (1) at the retailer’s place of business, provided
the customer takes possession or has the property
delivered from the retailer’s place of business; or (2)
online, via the phone, or in writing, and the customer
takes possession of the property at the retailer’s place of
business.
Further, tangible personal property sold through a vending
machine is deemed to be sold where the vending machine
is located at the time the sale is made, provided the
machine is operated by coin, credit card, coupon or a
similar service, allowing the customer to take immediate
possession after purchase. Lastly, the sale of coal or
other minerals mined in Illinois are deemed to be sold at
the location where the minerals are extracted from the
earth. These provisions took effect upon becoming law. Ill.
Laws 2014, Pub. Act 098-1098 (SB 2612), signed by the
governor on 26 August 2014.
Michigan: New law (Pub. Act 161) reinstates a 6 percent
use tax on medical services provided by Medicaid Health
Maintenance Organizations (HMOs) and Prepaid Inpatient
Health Plans (PIHPs), effective retroactively to 1 April
2014. The use tax is imposed on the use or consumption
of medical services provided to Medicaid beneficiaries,
and the services are taxed in the same manner as tangible
personal property is taxed.
Technology
Georgia: The Department of Revenue (DOR) in a letter
ruling found that a company’s charges for providing
cloud-computing or hosting services are not subject to
the state’s sales and use tax because Georgia does not
subject such services to sales and use tax. Further, these
services do not constitute taxable retail sales because the
company’s customers do not receive title to, or receive
use or possession or control of, any hardware or software
as part of the transaction. The DOR noted that as the end
user and consumer, the company is liable for sales and use
tax on its purchases of tangible personal property that it
uses to provide these services. Ga. Dept. of Rev., LR SUT-
201405 (9 June 2014).
New York: Computer software devices primarily used
to allow disabled persons to control a computer and its
accessories is exempt from New York sales and use taxes
because it is deemed a non-taxable prosthetic device.
The Department of Taxation and Finance found that the
software replaces the disabled person’s motor skills to
type or otherwise control a computer button or mouse,
is primarily used for that purpose, and is not useful
absent the user’s disability. N.Y. Dept. of Taxn. and Fin.,
TSB-A-14(28)S (20 August 2014).
South Carolina: An out-of-state company’s charges for
cloud computing service and usage fees associated with
such services are not subject to the state’s sales and use
taxes because such services do not constitute a taxable
communication service as they are unrelated to those “for
the manner, method, or instruments for sending a signal
of the voice or of messages,” nor do they constitute the
sale of taxable tangible personal property. S.C. Dept. of
Rev., Private Letter Ruling No. 14-2 (26 August 2014).
Wyoming: The Department of Revenue issued guidance
on the taxability of sales and services related to computer
hardware, software and associated services. Wy. Dept. of
Rev., “Computer Sales and Services” (1 August 2014).
October 2014 — Issue 4 5

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For more information about any of the
developments discussed in this newsletter,
please contact one of the following
Ernst & Young LLP Sales and Use Tax practice
professionals.
National resources:
Brad Withrow
National Director
Sales and Use Taxes
Nashville, TN
+1 615 252 2050
Megan Mahony
Boston, MA
+1 617 585 1822
Michael Wasser
Boston, MA
+1 802 272 4969
Faranak Naghavi
National Director
Sales and Use Taxes
Washington, DC
+1 202 327 8033
Karl Nicolas
Washington, DC
+1 202 327 6585
Gabriel Soto
Washington, DC
+1 202 327 7164
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Chicago, IL
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Philadelphia, PA
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New York, NY — Financial Services
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Boca Raton, FL
+1 561 955 8287
Mike Woznyk
New York, NY
+1 212 773 3008
David Yerkes
Dallas, TX
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