TEI Wisconsin Chapter – Wisconsin Department of Revenue liaison meeting

TEI Wisconsin Chapter – Wisconsin Department of Revenue liaison meeting – Tax Executives Institute

On October 18, 1994, the Wisconsin Chapter of Tax Executives Institute held a liaison meeting with officials of the Wisconsin Department of Revenue. Reprinted below are the written responses prepared by the Department to the questions discussed during the meeting. The answers reflect the Department’s views as of the date of the meeting.

1. Explain how the Department applies the tax benefit rule in the following situation:

Assume there are two separate Wisconsin corporate taxpayers, A & B. They each invest $100 in non-Wisconsin partnerships, X & Y, respectively, in 1980. In 1981, X sustains a $100 loss and Y has a $200 profit, neither of which affects A’s & B’s apportionable Wisconsin taxable income because the partnerships had no Wisconsin activity and the Department treated the partnership income as nonapportionable income. For federal income tax purposes, A’s basis in X is reduced to $0, and B’s basis in Y is increased to $300. In 1982, A & B sell their partnership interests. A sells its interest for $75 and B sells its interest for $250. The economic reality is that A sustained a loss on the sale and B realized a gain. What is the gain or loss that is taxable for Wisconsin purposes for A and B? Please explain the rationale for your determination.

The gain or loss for Wisconsin purposes will be the same as the federal gain or loss. The income (loss) of partnerships X and Y was included in the computation of the net income of corporation A and B in 1981. Therefore, the basis of partnerships X and Y as held by corporations A and B should be adjusted by income (or loss) reported. The fact that the income or loss was directly allocated to another state pursuant to sec. 71.07(1m), Wis. Stats. (1981), has no bearing on a corporation’s basis in a partnership.

With the law change effective for the 1982 tax year, the gain or loss on the sale of the partnership interest results in apportionable income or loss. There were no transitional provisions provided with this law change. Accordingly, there is no authority to adjust the Wisconsin basis in the partnerships. Please note that the 1982 treatment of the gain or loss would be the same if the partnerships had been located in Wisconsin or if Corporations A and B first had nexus in Wisconsin for 1982.

2. What is the current status of updating apportionment rules for specialized industries?

The Department is currently studying rule Tax 2.49 (Apportionment of Interstate Finance Companies) in conjunction with the Multistate Tax Commission’s review of this issue and its just released proposed regulation Uniform Apportionment of Net Income From Financial Institutions.” Revised department regulations will most likely be recommended to more accurately reflect the changing financial industry. None of the Department’s other special apportionment rules (Interstate Air Carriers, Motor Carriers, Pipeline Companies, Railroads, etc.) is being revised at this time. Taxpayers should feel free to contact the Department with any suggestions, concerns, etc., regarding any specialized apportionment rule.

3. What is the status of the tax release on Wisconsin treatment of Foreign Sales Corporation and is the Department going to follow the IRS pricing safe harbors for FSCs?

The tax release on Wisconsin’s treatment of Foreign Sales Corporations FSCs) is scheduled to be included in the January 1995 Wisconsin Tax Bulletin.

Under sec. 71.26(3)(r) Wis. Stats., sections 921 and 927 of the Internal Revenue Code (IRC) (relating to foreign sales corporations) are excluded in computing Wisconsin income. Accordingly, Wisconsin is not legally bound by the transfer pricing rules under IRC [section] 925. This issue has not come up previously nor been studied by the Department. The Department may very well decide to follow the federal pricing safe harbor rules.

4. What is the effect of the Manpower decision on the Department’s position on sales tax on software? Please discuss the effect at the field audit level as well as at appeals.

The Manpower decision has not changed the Department’s position on computer software. The Department has appealed the Manpower decision to the Circuit Court and is maintaining its policy that canned software is taxable and custom software is exempt. (Effective May 1, 1992, sec. 77.51(20), Wis. Stats., was amended to clarify that tangible personal property includes computer programs, except custom computer programs.) The field audit and appeals process has not changed in light of the Wisconsin Tax Appeals Commission decision in Manpower.

5. Regarding the recent decision in Manpower International, Inc. v. Wisconsin Department of Revenue (Dkt. No. 93-S-255), will the State allow taxpayers to file standardized protective refund claims similar to the procedures used for the NCR Corporation case?

At this time, the Department does not have a standardized protective refund for Manpower claims. A claim similar to the procedures used for the NCR case is being developed, but it will not be available for awhile. In the interim, normal refund claim procedures should be followed, i.e., filing Form ST-12X with a complete explanation and noting of the items for the refund claim.

6. Wisconsin Tax Bulletin No. 87 (May 1994), page 6, states that The following … provision(s) of federal Public Law 103-66 do(es) not apply for Wisconsin: a. the extension for the period July 1, 1992, through December 31, 1993, of IRC [section] 127 relating to the exclusion from gross income for up to $5,250 of educational assistance benefits furnished by an employer under an educational assistance program.”

Since the above only limits the Wisconsin nonapplicability of IRC [section] 127 through December 31, 1993, does Wisconsin follow Section 127 for 1994, since the 1993 Tax Act extended the exclusion through December 31, 1994?

Yes, Wisconsin follows IRC [section] 127 for 1994 and the education assistance benefits are excludable for Wisconsin. Only the retroactive portion of Public Law 103-66 was not adopted by 1993 Wisconsin Act 437.

7. What is the current status of the taxation of deferred compensation from a nonqualified plan paid to nonresidents who were Wisconsin residents at time of deferral?

The Department’s position remains that payments made to nonresidents in the form of nonqualified retirement benefits and nonqualified deferred compensation are taxable in Wisconsin if attributable to personal services performed in Wisconsin. The Department’s position is based on the principle that the State in which income is earned has the primary right to tax such income. The Department’s position is explained in Wisconsin Tax Bulletin No. 82 (July 1993).

The Department has explained in Wisconsin Tax Bulletin No. 88 (July 1994) that the interest income portion of a nonqualified deferred compensation plan distribution is not taxable to Wisconsin when received by a nonresident of Wisconsin. Only the portion of the distribution attributable to payment for personal services performed in Wisconsin is taxable to Wisconsin when received by a nonresident of Wisconsin. The Wisconsin Tax Bulletin No. 88 article provides a formula for calculating the nontaxable interest income portion of a distribution from a nonqualified deferred compensation plan.

A tax release is being prepared on the withholding and information return requirements for payments made to nonresidents in the form of nonqualified retirement benefits. Employers are required to withhold state taxes from “wages,” and “wages” are defined as all remuneration for services performed by an employee for an employer. There is a statutory exception for “retirement, pension and profit – sharing benefits, received by nonresidents after retirement from the employ of the employer for whom such personal services were performed” (Sec. 71.63(6)(k), Wis. Stats. (1991-92)).

If nonqualified retirement benefits fit within the statutory exception for retirement, pension and profit sharing benefits, an employer is not required to withhold state taxes from payments. In this case, remuneration of $600 or more is reported on Wisconsin Form 9b. If nonqualified retirement benefits do not fit within the statutory exception to withholding state taxes (e.g., nonqualified deferred compensation), the employer is required to withhold state taxes and the remuneration and withholding are reported on Form W-2 or Form 1099R, as appropriate.

8. What is the current thinking of the Department regarding the payment of franchise taxes by electronic funds transfer?

The Department is currently planning to accept 1995 corporation franchise/income estimated tax payments by electronic funds transfer. Information will be sent with 1995 estimated tax vouchers in January 1995. The Department is also revising our Publication 188 on electronic funds transfer to include all business taxes the division administers.

9. The corporate buzzwords for the 1990s are “electronic data interchange” – EDI The overall EDI issue involves moving business to a largely paperless business environment. How will audits be performed once a company implements EDI and paper records are, for the most part, not available?

The Department does not anticipate that its methods of auditing businesses using EDI will change dramatically. However, the source documentation that is reviewed during an audit may change as businesses utilize EDI to a greater extent (this has already occurred with microfilm/microfiche records instead of paper records).

As EDI becomes more prevalent, the Department anticipates that all interested parties (corporations, IRS, state revenue departments, AICPA, etc.) will work together to promulgate rules and regulations to meet the needs of all involved. Presently, the Department expects that all machine – sensible records material to the determination of a company’s tax liability will be made available upon audit and that the records and record retention requirements outlined in rule Tax 11.92 will be followed.

10. What is the current status of the filing of combined returns in Wisconsin for unitary groups? If forthcoming, will the combined return filing be voluntary or mandatory?

Current Wisconsin law (as of 10/27/94) does not authorize filing of combined Wisconsin franchise/income tax returns. It is unknown as of 10/27/94 whether legislation will be proposed in 1995 to require combined returns. The Department’s position is that if legislation is proposed, filing of combined returns should be mandatory for those entities that are determined to be part of the unitary group.

11. Early in the year, the U.S. Supreme Court declined to review the South Carolina Supreme Court’s decision in Geoffrey, which held that the Commerce Clause jurisdictional prerequisite of “substantial nexus” required mere economic presence (as opposed to physical presence). Does the State of Wisconsin propose any “nexus interpretation” changes as a result of this South Carolina decision? What is the “existing Department policy” regarding nexus for corporate income tax purposes as a result of the Geoffrey decision? Also, is this current policy subject to change soon?

The Department of Revenue follows the Geoffrey decision. Also, rule Tax 2.82(4)(a)9 states that “licensing of intangible rights for use in Wisconsin” constitutes nexus in Wisconsin. In view of the current language in rule Tax 2,82(4)(a)9, no “nexus interpretation” changes are anticipated at this time as a result of the Geoffrey decision. The Department of Revenue is currently drafting a tax release, which will include examples of how the Geoffrey decision applies to various situations.

12. Wisconsin repealed sec. 77.51(19), the temporary storage use tax exemption, effective October 1, 1991. In addition, the sales and use tax exemption for manufacturing machinery and equipment under sec. 77.54(6r) has been modified, and now provides that the exemption “shall be strictly construed.” In light of these two changes, what is the Department’s position regarding the exemption from Wisconsin sales and use tax of manufacturing equipment and spare parts in the following situations:

A. Manufacturing equipment and spare parts are purchased and shipped to a warehouse in Wisconsin. The equipment and parts could be used in the manufacturing process in Wisconsin, but, in fact, they are shipped from the Wisconsin warehouse to an out-of-state production facility.

B. Same facts as A, except the equipment and spare parts shipped to the Wisconsin warehouse could not be used in-state (because they are components of a customized manufacturing not located in Wisconsin). As in A, the items are eventually shipped from the warehouse to an out-of-state production facility.

C. Does it make any difference in A or B above that the purchases are made from in-state or out-of-state vendors?

A. The taxpayer can purchase the equipment and spare parts ex-tax using a manufacturer’s exemption certificate. The taxpayer is not required to report Wisconsin use tax on those items of equipment and spare parts that are stored in Wisconsin, but are subsequently shipped out of state, so long as the equipment continue to qualify as machines and specific processing equipment used directly and exclusively in manufacturing tangible personal property. The manufacturing facility does not have to be located in Wisconsin in order to qualify for the manufacturer’s exemption.

B. Same answer as A. Whether or not the equipment and spare parts could or could not be used in-state does not change the answer.

C. No, the answer is the same regardless of whether or not the vendors are in-state or out-of-state.

13. Regarding the equipment and parts referred to in Questions 12A and 12B, does the Department consider the January 1 inventories or these items to be exempt from Wisconsin property tax under sec. 70.11(27)?

If the phrase “could be used in the manufacturing process in Wisconsin” means the equipment and spare parts serve as potential repair parts and replacement machines for Wisconsin plants as well as out-of-state plants, the parts would be exempt regardless of where the final destination of a particular piece of equipment may be. In other words, if a substantial amount of the equipment goes to Wisconsin plants, when a particular piece of equipment is sent out-of-state, the Department will not go back and assess that piece as omitted property. However, if the manufacturer is not storing them in the Wisconsin warehouse as potential repair parts and replacement machines for Wisconsin plants, they would be taxable. Actual practice could be compared to the manufacturer’s stated intent to check this. In other words, if records show equipment always goes out of state, that would be strong evidence there is no intent to have this equipment serve as replacement equipment for Wisconsin plants and it would all be taxable.

14. In light of the continuing decrease in the prices of new and more powerful personal computers, is the Department considering adjusting the tables it uses in determining assessed values for personal computers?

The Manufacturing Section uses six-year life tables for valuing computers based on IRS Publication 534. The Wisconsin Association of Assessing Officers (WAAO) also recommends using a six-year life. The Department has a copy of a study done by the Colorado State Division of Property Taxation that recommends a four-year life. The Department will maintain a six-year life until further evidence that it should be reduced is obtained.

15. Please update us on any conclusions made so far from the meetings held around the State in the methods used to assess real and personal property.

The study committee has compiled the results of their survey and now has six subcommittees working on data for specific issues, such as use-value assessment for farmland. Recommendations to the Governor will be submitted on December 31, 1994.

16. In a use tax audit that involves the use of a computer-assisted sample or stratified random sample, does the Department project the credit in instances where the taxpayer has self-assessed the tax in error, or does the Department consider the erroneous self-assessment as a “one-for-one” credit against the audit deficiency if the taxpayer requests a refund for the error? If the answer is that it is treated as a “one-for-one” credit, please explain the equability of projecting errors that favor the State while ignoring errors that favor the taxpayer and the statistical validity of such an approach.

In any sampling, the universe from which the sample is being drawn must be defined. That universe can contain all transactions represented physically by pieces of paper in a set of storage containers or by transactions recorded on magnetic media. Just because transactions are physically present (or represented on magnetic media) does not mean that they all must be included in the sample’s universe. The Department does extensive stratification before drawing a sample. In an audit of purchases, The Department will attempt to identify accounts that are unlikely to contain taxable transactions and eliminate them from the universe from which the sample will be drawn and do no further examination of those transactions. There are other times that the Department defines a class of transactions that will be eliminated from the universe from which a sample will be drawn and examine 100 percent of those transactions. Neither situation affects the statistical validity of the sample. This restriction of the universe from which the sample is drawn improves the statistical precision of the results given the same sample size or reduces the sample size needed to obtain the same precision. As to the specific question regarding “erroneous self-assessed use tax,” if there are significant amounts of (counts and amounts) of self-assessments, then the universe of the sample can be defined to leave them in the universe. If there are not a significant number of these types of transactions, then it would be more appropriate to define them out of the universe. In practice, the Department almost always includes these items in the universe of the sample. Neither situation biases the results; they are just two different sample designs with different objectives.

17. How does the Department justify introducing a “bias” into its statistical samples by excluding transactions (credits) that are favorable to the taxpayer? If the Department maintains that the transactions are not traceable, does not that invalidate the entire sampling technique?

Credit items are not included in the universe of the sample as separate items because they are automatically included when the associated transaction is chosen. To include the credit items separately would mean that if a purchase was selected for the sample and the item was returned but that return transaction was not also selected for the sample, the Department would be required to assess tax on that transaction even though it was returned. On the credit side, if a credit transaction was selected for the sample and the purchase was taxable but untaxed, the Department would have to refund tax on a transaction even though the Department had never received the tax from the purchase. The matching up of a credit transaction with its associated purchase transaction is a recordkeeping question that is the taxpayer’s responsibility.

18. Given that the Department unilaterally has chosen the mid-point of the confidence interval for projecting assessments, how does the Department justify shifting additional risk of over assessment to the taxpayer by reducing the sample size?

Increasing the sample size reduces the risk of either over- or under-estimating the tax liability with the midpoint being the point at which there is equal likelihood of either over or under estimating the tax liability. The sample sizes are determined on a case by case basis. Since The Department is unaware of any underlying policy to reduce the sample sizes, the suggestion that the Department is “reducing the sample size” is unclear.

19. Will Wisconsin follow the rationale provided in Rev. Proc. 94-60, 1994-39 I.R.B. 10, which describes how interest is computed on an underpayment where a taxpayer has previously received a tax refund with interest for the same tax year?

Example: A calendar-year corporate taxpayer files its 1993 tax return on March 15, 1994, showing a total liability of $1,000,000. On November 1, 1994, taxpayer files an amended return showing a revised liability of $900,000, yielding a refund of $100,000. On December 15, 1994, WDR sends a refund check of $106,750 consisting of $100,000 tax and $6,750 interest (computed at 9 percent from March 15, 1994, through December 15, 1994). On June 15, 1995, WDR finalizes an office audit showing a corrected liability of $950,000, yielding an underpayment of $50,000.

Using the rationale under Rev. Proc. 94-60, WDR should charge interest of 9 percent for the period of March 15, 1994, through December 15, 1994, and 12 percent interest for the period of December 16, 1994, through June 15, 1995.

Wisconsin will not follow the rationale of Rev. Proc. 94-60. Wisconsin law clearly provides that interest at 9 percent is paid on overpayments and interest at 12 percent is assessed on underpayments. The taxpayer in the example presented is no more disadvantaged than other taxpayers receiving assessments and being billed interest at 12 percent from the original due date of the return to the billing due date. The fact that a refund had been claimed and issued along with interest at 9 percent covering a portion of the subsequent assessment period does not create any injury to the taxpayer.

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