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27th Annual
Tuesday & Wednesday, January 23‐24, 2018 Hya Regency Columbus, Columbus, Ohio
Oh
io T
ax
Workshop OO
Basic: Ohio CAT … Common Audit Issues & Developments
Wednesday, January 24, 2018 2:00 p.m. to 3:00 p.m.
Biographical Information
Geoffrey A. Frazier, Tax Director - State and Local Tax Services, Grant Thornton LLP 3825 Edwards Road, Suite 430, Cincinnati, OH 45209
513-345-4620 Fax 513-241-6125 [email protected]
Geoffrey Frazier specializes in state and local tax matters and tax planning. He has more than 25 years of experience in federal and state & local taxation. Geoff has experience in both public accounting and industry. In industry, he was tax manager at a large public retail company which had department stores located in eighteen states. In public accounting, he has focused on state and local tax consulting. Geoff helps large and midsize multi-state organizations manage their state and local tax liabilities. He has experience in numerous industries including retail, manufacturing, consumer products, construction, and services. He has broad experience in the areas of state income and franchise tax, municipal income tax, personal and real property tax, sales and use tax, payroll taxes including unemployment tax, procuring tax credits and incentives, gross receipts, and other miscellaneous taxes. He has assisted clients with state & local tax compliance and planning, nexus determinations and related voluntary disclosure and amnesty filings, tax audits, incentive negotiations, business acquisition/disposition due diligence and tax accounting issues. Geoff is a member of the AICPA, the Indiana CPA Society and the OSCPA, as well as the Indiana CPA Society Tax Resource Advisory Council and the Indiana Chamber of Commerce Tax Committee. Geoff is a graduate of the University of Cincinnati with a Bachelor of Business Administration – Accounting.
John R. Trippier, CPA, Director (non-attorney professional), Zaino Hall & Farrin LLC 41 South High Street, Suite 3600, Columbus, OH 43215
[email protected] 614-349-4815 Fax: 614-754-6368
John is Director of Multistate Tax and serves clients with more than 25 years of experience in government, public accounting/law firm and industry. He assists clients with evaluating current multistate tax positions to identify refund opportunities and to mitigate potential exposures. John also uses his previous Dept. of Taxation experience to defend clients throughout the audit process, which helps to ensure the client pays the minimum due. John is a certified public accountant who served as the Administrator of the Ohio Department of Taxation’s Audit Division for over eight years beginning in 2003. At the Ohio Department of Taxation, John was responsible for developing and implementing audit policy for the sales, use and commercial activity taxes. He was the architect for the commercial activity tax audit process and the audit tools that are used by auditors and managers to research taxability issues. John also spent two years as an income/franchise tax and sales/use tax auditor in the Department’s Chicago office. John has worked over 10 years in public accounting as a state and local tax consultant for Coopers & Lybrand, KPMG Peat Marwick and RSM McGladrey, Inc. As a consultant, John assisted clients with multistate sales/use, income/franchise, personal/real property, intangible and unclaimed property tax audits and appeals. John also assisted clients with multistate refund reviews, corporate restructuring, compliance studies, nexus studies, voluntary disclosures and sales tax software implementations. John also worked 9 months for the law firm of McDonald Hopkins where he was director of Multistate Tax Services. John worked in industry as a state and local tax manager of a telecommunications company responsible for audits, appeals and state and local sales/use, personal/real property and income/franchise tax compliance. John is a frequent presenter on Ohio sales, use and commercial activity taxes for the Ohio Society of CPAs, Ohio Tax Conference and various other associations throughout Ohio.
2018 Ohio Tax Conference: Workshop OO
January 24, 2018
Geoffrey A. Frazier, Grant Thornton LLPJohn R. Trippier, Zaino Hall & Farrin LLC
Ohio CAT: Common Audit IssuesAnd Developments
Agenda
• Statute of Limitations• Amnesty and Voluntary Disclosure• Audit Selection Criteria and Approach• Filing Methods• Gross Receipts, Cash Discounts • Agency• Situsing
2
Statute of Limitations
• Statute of limitation is 4 years after the later of the due date or date filed for the return.
• Am. Sub. S.B. 181 (Effective September 13, 2010) permits ODT and taxpayer to waive statute of limitations.
• Statute of Limitations– Audit practice: if no filing, then audit period starts with 7 year look‐back or tax liability start date
3
Statute of Limitations
• Polling question facts:– A, B and C are all owned 100% by D. – D has no one owner that owns more than 20%.– A has filed returns including only A’s taxable gross receipts since the enactment of the CAT.
– B, C and D all have taxable gross receipts back to 7/1/2005.
• Does the 4 year statute of limitations apply to B, C and D?
4
Statute of Limitations
• A. No, the Department will be able to go back as far as 2005 since B, C and D’s taxable gross receipts have not been reported.
• B. No, the Department will be able to go back 10 years since R.C. 5703.58 limits the Department to only assess for 10 years.
• C. Yes, since A filed a return, the statute applies to all taxable gross receipts of the group.
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Statute of Limitations
• Polling question link
6
Amnesty and Voluntary Disclosure
• If you haven’t filed or have underreported, how can you resolve the liability?– Tax Amnesty– Voluntary Disclosure
7
CAT Audit Selection ‐ Historical
• Audit selection criteria– Various system queries & comparisons– Nexus leads– Random selection– Common areas of noncompliance– Auditor Input
8
CAT Audit Selection ‐ Current
• Audit selection criteria– Predictive and Trending Analytical Models
• Cross tax comparisons• Peer group comparisons• Tax filing trends• Misc.
9
Common Pre‐audit Research by the Department
• Review Registration– Type of entity– Ownership filing method– Schedule B – CAT registration members of a group– NAICS
• Review Returns ‐ estimation vs. actual• Audit Period
– Typical look back period 2‐3 years (nexus discovery audit would have a 7 year look‐back)
– Statute waiver may be needed• VDA may be available to taxpayers who have not been
previously contacted by the department
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Audit Activity related to Substantial Nexus (R.C. 5751.01(H))
• Audit Division is pursuing companies who exceed the bright line nexus thresholds and are not registered.– List of registered taxpayers can be found on the Ohio Department of Taxation website• There are 184,656 registered taxpayers
– 160,104 Separate– 7,583 Consolidated– 16,969 Combined
– Continuing to look at Non‐Ohio and Non‐U.S. companies selling into Ohio
– 2016 Supreme Court Decisions‐ (Crutchfield, Mason, Newegg)
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CAT Audit Selection
• Managed CAT Audit– Can work similar to a VDA
• No penalties– Great for follow up audits or “catch up” periods
12
Filing method requirements/elections
Combined Group Consolidated Elected Opt Out Member
• Automatic if more than50% common ownership
• Include entities with Ohio CAT nexus only
• Does not allow for elimination of inter‐company receipts
• R.C. 5751.012
• At least 50% (or 80%) common ownership
• Must include all entities regardless of nexus with Ohio
• Option to include or exclude non‐US entities
• Gross receipts between members are excluded
• R.C. 5751.011
• Combined Group member may request to file separately from the group
• Separate member not entitled to $1M annual exclusion.
• Member remains jointly and severally liable
• Information Release 2005‐12
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Common Ownership Example
A
B
60%
60%
C
• Partnership A owns 60% of Corporation B, which in turn owns 60% of Corporation C
• Partnership A, Corporation B, and Corporation C are all members of the same taxpayer group
– This is because corporation B’s 60% ownership of Corporation C continues the vertical chain to include Corporation C
– It does not matter that Partnership A only owns 36% of Corporation C constructively through Corporation B
14
Common Ownership Audit Example
After Audit Review1.Entire group is combined except for K2. Result could be different depending on consolidation election
Taxpayer initial groupsGroup 1 – J, E, M, TGroup 2 – S, OGroup 3 – Y, Z, A
J
ME
K
Y
Z
100%100%75%25%
A
100%
100%
S
T
100%
75%
25%
O
100%
15
Common Ownership Polling Question
• If J makes the election to file at 80% CET, how many groups are there and who is in the group?
16
Common Ownership
• A. 1 group and everyone but K is in the group.• B. 2 groups – 80% CET – JEMTSO, Combined ‐JYZA.
• C. 3 groups – 80% CET – JEMT, Combined #1 –YZA, Combined #2 – SO.
• D. 1 Group and everyone is in – the more the merry!
17
Statute of Limitations
• Polling question link
18
Combined / Consolidated Ownership ‐Audit Issues
• Individuals (human beings) can be common owners
• Constructive ownership• Vertical ownership and control test for consolidated elected and combined taxpayer groups– I.R.C. section 318 (family) attribution rules do NOT apply
• Election to file consolidated– what to do with the other potential Ohio filers– foreign entities
19
Combined / Consolidated Ownership ‐Audit Issues
• Requests for retroactive consolidation generally not allowed– Original election – correction of group election – or potential invalid election?
20
Combined / Consolidated Ownership –Equity Group Audit Issues
• Equity ownership group issues– Ohio looks principally at the control (voting rights) for determination of the combined group
– GP has control, LLC managing member has control– LLC and LP ownership addressed in OAC 5703‐29‐02(D)(3)
– Trace the ownership up to the partners (Human Beings)
• The real exposure…the exclusion amount for each entity or the minimum tax and the inter‐member exclusion
21
Combined / Consolidated Ownership –Equity Group Audit Issues
• Possible solutions– Request to file separate– Portfolio group consolidated group opt out NOT an option
• Challenges – Portfolio companies added and sold–What if you do not know the ownership structure
22
Audit Issue – Statute v. Rule
• R.C. 5751.011 (A)(1) provides that a CET group must:
– “include all persons having at least 80%, or having at least 50%, of the value of their ownership interests owned or controlled, directly or constructively through related interests, by common owners during . . . the tax period, . . . together with the common owners.”
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Audit Issue – Statute v. Rule
• O.A.C. 5703‐29‐02(A) provides:
– Consolidated elected and combined taxpayer groups. . . are required to file as one taxpayer if persons in the group meet certain requirements. One of those requirements is that the persons have a specified portion of the value of their ownership interest owned and controlled by “common owners” included in the group.
24
Comparison – Statute v. Rule
• R.C. 5751.011 (A)(1):
. . . of the value of their ownership interests owned or controlled, . . ., by common owners . . ..
• O.A.C. 5703‐29‐02(A):
. . . of the value of their ownership interest owned and controlled by common owners . . ..
25
Rule Also Adds More Limits
• O.A.C. 5703‐29‐02(A) provides:
– In addition to an ownership interest, the higher‐tiered entity must have the ability through its voting rights to control the operations of the lower‐tiered entities at each level of the vertical chain.
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Is JV a Member of A Corp’s CAT Group?
27
Public Public Public
60% 20%20%
A Corp C CorpB Corp
JV
Is JV a Member of A Corp’s CAT Group?
• Facts– A Corp filed as a Combined Taxpayer.– A Corp owns more than 50% of the JV (i.e., 60%).– The Board of Directors of the JV control and vote in proportion to ownership.• However, need 67% majority to decide anything.
• Dilemma: – Statute – JV must be included in A Corp’s CT Group.– Rule – JV cannot be included in A Corp’s CT Group.
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Is JV a Member of Y Corp’s CAT Group?
29
Public Public
60% 40%
Y Corp Z Corp
JV
Is JV a Member of Y Corp’s CAT Group?
• Facts– Y Corp made an 80% CET election.– Y owns more than 50% of JV.– Each JV Partner chooses 3 members of the six member board of
directors, which controls the JV.– Although Y Corp owns more than 50%, it does not “control”
more than 50%.
• Dilemma: – Statute – JV must be included in a Combined Taxpayer (CT)
Group with Y Corp as the parent (not the CET Group) .– Rule – JV cannot be included in Y Corp’s CT Group and should
file separately.
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Which Provision Controls?
• It seems obvious that the Statute should “control,” not the Rule. (Pardon the pun)
31
Gross Receipts
• RC 5751.01(F) defines gross receipts:– the total amount realized by a person,– without deduction for the cost of goods sold or
other expenses incurred, – that contributes to the production of gross
income of the person, – including the fair market value of any property
and any services received, and– any debt transferred or forgiven as
consideration.
32
Gross Receipts
• Gross income is not a defined term in Chapter 5751.– R.C. 5751.01(K) provides that if a term is not defined in Ohio’s code, then may look to an IRC definition if the term is used in a like manner.
• See Information Release CAT 2005‐17• Federal income tax method of accounting is followed for CAT (R.C. 5751.01(F)(4))
33
Gross Receipts Polling Question
• You are starting to prepare the CAT return for your company ‐ where do you start?– Federal numbers– GAAP numbers– Sales tax numbers– State income tax apportionment numbers
34
Common Ownership
• A. Federal numbers since CAT statute uses gross income.
• B. GAAP numbers since these numbers tie to financial statements.
• C. Sales tax numbers since numbers should tie.
• D. The Department doesn’t care where you start, need to determine if it is a gross receipt.
35
Statute of Limitations
• Polling question link
36
Gross Receipts
• Taxpayer workpaper reconciliation– State apportionment– CAT receipts– Federal tax returns– Trial balance
37
CAT Exclusions/Discounts
• Deductions were moved to exclusions 5751.01(F)(2)(bb) through (ee) effective 7/1/09– Cash discounts– Returns & allowances– Bad debts– Sale of accounts receivable
• See also 5703‐29‐14
38
CAT Exclusions/Discounts
$10 discount
$40 discount
$10 discount
39
CAT Exclusions
• Credit card fees are NOT deductible
• $1M exclusion now applied to first $1M of CAT receipts effective for 1/1/2013 ‐ prior to 1/1/13 the $250K was deducted quarterly
40
Gross Receipts, Additional Thoughts
• Rebates/Allowances meant for the purchaser’s customer not the purchaser
• Different taxpayers use different terminology for the same concepts
• Different types of transactions going through one account– Have enough accounting detail to differentiate multiple items• Product sales• Advertising• Slotting allowances• Vendor allowances
Agency Exclusion
• Statutory Exclusion. R.C. 5751.01(F)(2)(l) excludes from the definition of “gross receipts” all “[p]roperty, money, and other amounts received or acquired by an agent on behalf of another in excess of the agent’s commission, fee, or other remuneration.” (emphasis added).
42
Agency Exclusion
• Definition of Agent. "Agent" means a person authorized by another person to act on its behalf to undertake a transaction for the other, including any of the following…A person retaining only a commission from a transaction with the other proceeds from the transaction being remitted to another person.” R.C. 5751.01(P).
43
Agency Exclusion• Regulation. O.A.C. 5703‐29‐13 provides additional guidance
on the definition of an “agent” for purposes of the exclusion.– Common law definition.– Party claiming agency relationship exists bears burden of proof.
– Strict construal against exemption.– “. . . the agency relationship should be explicitly stated in a contract that is available to the tax commissioner to inspect. Absent such proof, it will be presumed that no agency relationship exists . . . .” (emphasis added).
• Look beyond contractual language to actual facts and circumstances.
44
Agency Exclusion
• Common Law Definition. OAC 5703‐29‐13 states that determining whether a principal‐agent relationship exists for purposes of the CAT agency exclusion is to be made under the common law definition of agency.
• An agency relationship contains three essential attributes:– Power to Alter (Bind)– Fiduciary– Right to Control
45
Agency Exclusion
• Similarly, the Supreme Court of Ohio has stated that an agency relationship exists when there is “a consensual fiduciary relationship between two persons where the agent has the power to bind the principal by his actions, and the principal has the right to control the actions of the agent.” Cincinnati Golf Mgt., Inc. v. Testa, 2012‐Ohio‐2846, ¶ 20, 132 Ohio St. 3d 299, 303, 971 N.E.2d 929, 933 [citations omitted]. (emphasis added).
46
• Written and Oral Contracts?– Statutory Language – Written Contract Required?– Regulation provides that the agency relationship should be explicitly stated in a contract. (OAC 5703‐29‐13(C)(2)(a)).
Agency Exclusion
47
• Regulation provides that “The commissioner will look beyond the wording of the contract to the actual facts and circumstances of the situation to determine whether an agency relationship actually exists” (citing to H.R. Options, Inc. v. Zaino (2004), 100 Ohio St.3d 37).
• Regulation defers to Ohio common law in determine whether an agency relationship exists.
Agency Exclusion
48
• The Ohio Board of Tax Appeals has ruled in analogous context that even where a contract is required (pursuant to statute), written contracts are not necessary and oral contracts are permitted. See e.g., Excel Temporaries, Inc. v. Tracy, (10/30/1998), Ohio BTA 97‐T‐257; Advantage Services v. Tracy, (10/30/1998), Ohio BTA 95‐T‐1391.
Agency Exclusion
49
Agency Exclusion
• Willoughby Hills Development and Distribution Inc. v. Testa, BTA 2015‐1069 (Jul. 5, 2016)– Refund claim by gasoline distributor claiming agency exclusion.
– BTA ruled in favor of commissioner and against taxpayer.
–Written contract “generically required” taxpayer to act in the purported principal’s best interest in some respects.
50
Agency Exclusion
– BTA concluded this provided insufficient evidence that the purported principal exercised control over the taxpayer as its agent.
–Written contract included standard independent contractor / disclaimer of agency language.
– BTA noted that “it would seem appropriate, if not imperative, that a witness from not only the agent's perspective, but also the principal's, be offered to support a negation of the contract language.”
51
• Corporate Services Group Holdings v. Testa, BTA 2016‐875– Notice of appeal filed July 6, 2016.– Unless case management schedule amended, scheduled for discovery to close December 5 and for hearing February 28.
Agency Exclusion
52
Agency Exclusion
• Final Thoughts on Agency– Should Apply to Buyer’s Agent and Seller’s Agent– Claim of right doctrine– Best Practice: Obviously, establish agency relationship at outset of arrangement in written contract.
– What if no written contract exists or not expressly addressed in written contract?
– Consider impact of securing exclusion upon legal relationship between parties ‐ do the parties want to have a principal/agent relationship?
– Address for future periods
53
Situsing of Gross Receipts Sale of TPP (R.C. 5751.033(E))
• Definition of TPP R.C. 5751.01(J) (Same as sales tax RC 5739.01)
• Gross Receipts are sitused to Ohio if the purchaser ultimately receives the tangible personal property in Ohio– Ultimately Received ‐ completion of the transportation to the purchaser of the product whether by common carrier or by other means
– Dock sale / customer pick‐up– Terms of sale and title passage do not impact the situs – Need to determine “when the sale occurs”
• Consider ‐ Risk of loss, billing for product, payment by customer, etc.
54
Situsing of Gross Receipts Sale of TPP (R.C. 5751.033(E))
• Ohio purchaser ships the product back outside Ohio – taxable to seller unless out of state destination is known "at the time of sale" and supported by the taxpayer’s books and records at the time of the sale (Information Release 2005‐17)
55
Situsing Gross Receipts Services (R.C. 5751.033(I))
• Gross receipts from services are sitused to Ohio in the proportion that the purchaser’s benefit in Ohio with respect to what was purchased bears to the purchaser’s benefit everywhere with respect to what was purchased.
• The 3 critical questions for situsing services:– Who is the purchaser?– What is the purchaser's benefit?– Where is the benefit received?
56
Situsing Gross Receipts – ServicesReasonable, Consistent & Uniform Safe Harbor Method
• Can request RCU method under O.R.C. 5751.033(H)• Provides a safe‐harbor from penalties if ODT disagrees with
apportionment method.• Only applies to certain services• May use a different method for different services.• Must use the same method for similar services.• The taxpayer must:
– Use a RCU apportionment method to situs its services;– Method must be supported by the provider’s business records;
and– Primary focus of the method must be on the location where the
purchaser ultimately uses or receives the benefit of the service.
57
Situsing Gross Receipts from Intellectual Property
• Trademarks, trade names, patents, and copyrights, and similar IP sourced to state based on extent of use or right to use (depending on terms)
• Commercial domicile of payer versus location of use
• Ability to document actual use versus use of population (census data)– US versus world population
58
Audit IssuesGross Receipts
• Sale of inventory in an "asset sale“• Sale of Accounts Receivable• Managed property payroll cost reimbursement• Construction allowance taxable as TGR to retailer• Shelving allowance / product placement receipts are considered TGR
• Reward point program receipts are TGR• Trade‐in received when selling product not allowed as reduction in TGR
• Pass‐through freight
59
Audit IssuesGross Receipts and/or situsing
• Contract Manufacturing• Tooling reimbursements from customers (contract manufacturing)
• Processing/service applied to TPP not owned• Management Intercompany Charges • Rebates/Allowances meant for the purchaser’s customer not the purchaser
• “Reimbursed” expenses – netting of expense accts
60
Audit IssuesSitusing
• Ultimate Destination• Employment services / location of job site not sales office
• Professional services including accounting and legal fees
• Cloud computing / SAAS
61
Questions…
Contact Information
Geoffrey A. FrazierDirector, State & Local Tax ServicesGrant Thornton LLP3825 Edwards Rd., Suite 430Cincinnati, OH 45209Office: 513‐345‐4620Mobile: 513‐504‐[email protected]
John R. TrippierDirector, Multistate Taxes (non‐attorney professional)Zaino Hall & Farrin LLC41 S. High St., Suite 3600Columbus, Ohio 43215Office: 614‐349‐4815Mobile: 614‐283‐[email protected]
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