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June 8, 2015
Wynne, Cloud Computing, and a State's Deference to Another
by Arthur R. Rosen

Full Text Published by Tax Analysts®

In this edition of The Art of SALT, Rosen analyzes the U.S. Supreme Court's decision in Wynne and how it could affect New York's residency statute.
* * * * *

I. U.S. Supreme Court's Wynne Decision Puts
New York's Residency Statute in Peril

On May 18 the U.S. Supreme Court issued its decision in Comptroller of the Treasury of Maryland v. Wynne.1 In short, the Court, in a 5-4 decision written by Justice Samuel A. Alito Jr., handed the taxpayer a victory by holding that the county income tax portion of Maryland's personal income tax scheme violated the U.S. Constitution's dormant commerce clause.

Specifically, the Court concluded that the county income tax imposed under Maryland law failed the internal consistency test under the dormant commerce clause because it is imposed on both residents and nonresidents, with Maryland residents not getting a credit against that local tax for income taxes paid to other jurisdictions. (Residents are given a credit against the Maryland state income tax for taxes paid to other jurisdictions.)

The Supreme Court emphatically held -- as emphatically as it can in a 5-4 decision -- that the dormant commerce clause's internal consistency test applies to individual income taxes. The Court's holding does create a perilous situation for any state or local income taxes that either do not provide a credit for taxes paid to other jurisdictions or limit the scope of such a credit in some way.

The internal consistency test, one of the methods the Court uses to examine whether a state tax imposition discriminates against interstate commerce in violation of the dormant commerce clause, starts by assuming that every state has the same tax structure as the state with the tax at issue. If that hypothetical scenario places interstate commerce at a disadvantage compared with intrastate commerce by imposing a risk of multiple taxation, the tax fails the internal consistency test and is unconstitutional.

Although the Wynne decision does not address the validity of other taxes beyond the Maryland county personal income tax, it does create significant doubt as to the validity of some other state and local taxes, such as the New York state personal income tax, in the way it defines the term "resident." New York state imposes its income tax on residents on all of their income and on nonresidents on their income earned in the state; that is similar to the Maryland county income tax at issue in Wynne.

"Resident" is defined as either a domiciliary of New York or a person who is not a domiciliary of New York but who has a permanent place of abode in New York and spends more than 183 days there during the tax year.2 Thus, a person may be taxed as a statutory resident solely because he maintains living quarters in the state and spends more than 183 days there, even if those days have absolutely nothing to do with the living quarters; this category of non-domiciliary resident is commonly referred to as a "statutory resident." As such, under New York's tax scheme, a person can be a resident of two states -- where domiciled and where a statutory resident -- and thus be subject to taxation on all of his income in both states.

Although New York state grants a credit to residents for taxes paid to other jurisdictions, that credit is only for taxes paid "upon income derived" from those other jurisdictions.3 Therefore, New York state does not grant a credit for taxes paid to another jurisdiction on income earned from intangible property such as stocks, bonds, and similar investments because that income is not derived from any specific jurisdiction.

For example, suppose an investment banker is unquestionably a domiciliary of New Jersey and has an apartment -- that is, a permanent place of abode -- in New York that he uses only occasionally. Further suppose that the investment banker spends more than 183 days in New York during a year by going to his office in New York on most workdays. In that case, the investment banker is a resident of both New Jersey and New York and is subject to tax as a resident in both states on his entire worldwide income. New York does not give a credit for taxes paid to New Jersey on income derived from intangible property; therefore, the investment banker pays tax on that income twice -- once to New Jersey and once to New York -- clearly disadvantaging interstate commerce and resulting in double taxation; what New Jersey actually does is irrelevant in an internal consistency analysis because the analysis is a hypothetical situation focusing only on New York law.

This is not some hypothetical example. This is the actual fact pattern in In the Matter of John Tamagni v. Tax Appeals Tribunal of the State of New York.4 In that case, the New York Court of Appeals, New York state's highest court, held that the state's tax scheme did not violate the dormant commerce clause and did not fail the internal consistency test. The validity of the high court's decision is now seriously called into question under Wynne.

The court of appeals, relying on Goldberg v. Sweet,5 held that the dormant commerce clause did not apply to residency-based taxes because they were not imposed on commerce, but rather a person's status as a resident. However, not only did the U.S. Supreme Court's decision in Wynne repudiate the very dicta from Goldberg v. Sweet cited by the New York Court of Appeals in Tamagni, but the U.S. Supreme Court also determined that even if a state has the power to impose tax on the full amount of a resident's income, "the fact that a State has the jurisdictional power to impose a tax [under the due process clause of the Constitution] says nothing about whether that tax violates the commerce clause."6 After Wynne, it is clear that the dormant commerce clause applies to residency-based personal income taxes.

The second reason that the vitality of the Tamagni decision is in question is its application of the internal consistency test. The court of appeals held that even if the dormant commerce clause applied, the internal consistency test was not violated, because the tax at issue was imposed on a purely local activity and thus could not violate the four-prong Complete Auto test. However, as discussed above, New York state's lack of a credit for taxes paid to other jurisdictions mirrors the lack of a credit under Maryland's county income tax scheme.

New York state taxpayers should be cognizant of the Wynne decision and should consider filing refund claims if they have paid -- or will pay -- tax to New York state as a statutory resident (that is, not as a New York domiciliary). One would expect the New York State Department of Taxation and Finance to be quite resistant to granting such refunds, and it will likely vigorously defend the existing taxing scheme.

It is worthwhile to note that this problem of double taxation was acknowledged and addressed in an agreement executed in October 1996 by the heads of the revenue agencies of Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New Jersey, New York, Pennsylvania, Rhode Island, and Vermont. Under that agreement, the statutory residence state would provide a credit for the taxes paid by the individual on his investment income to his state of domicile. Unfortunately, that agreement was never implemented through legislation. Maybe now is the time for that to be done.

Finally, a word about New York City. New York City imposes a personal income tax on residents, allowing no credit for taxes paid to other jurisdictions. However, it does not impose a tax on nonresidents, making its personal income tax different from the Maryland county income tax. Thus, the constitutionality of the New York City personal income tax is not specifically addressed by the U.S. Supreme Court's decision. However, similar to the New York state definition of resident, a person can be a resident in two different jurisdictions under New York City's definition of resident. Therefore, under New York City's definition, personal income tax can be imposed twice if the taxpayer is a domiciliary of one state and a statutory resident in another. Thus, the tax potentially fails the internal consistency test.

II. Developments in Cloud Computing

Several state revenue agencies continue to assert that providing a service through electronic, telecommunication, or Internet media is a license or sale of prewritten software subject to sales and use tax even though their states' case law makes clear that the transaction is not, in fact, subject to tax.

The case law imposes tax only when there has been a transfer of possession (or title, which technically does not occur for software). It makes clear that the extent of control exercised by a customer over the software being used by its cloud service provider is dramatically less than necessary to constitute a taxable transfer of possession. There is ample case law to demonstrate this from Colorado,7 Indiana,8 Massachusetts,9 Michigan,10 Pennsylvania,11 Utah,12 and Vermont.13

Two recent developments warrant comment. First, the Arizona Department of Revenue is continuing to take the untenable position that the requisite degree of control has been transferred in these cases. In Office of Administrative Hearings Decision 14C-2014001975-REV, a cloud provider of research services was found to have transferred possession of research and data content, which were deemed to constitute tangible personal property. The conclusion regarding the transfer of possession flies in the face of at least two Arizona court cases that require, for a transaction to be taxable, almost infinitely more contact by the customer than was exercised by the customer in the case at issue.14

On the brighter side is a glimmer of hope from New York (even a glimmer is bright when compared with darkness). In Advisory Opinion TSB-A-15(2)S (April 14, 2015), the Department of Taxation and Finance opined that sales of a cloud computing service, including memory, central processing units, storage, and operating systems, are not subject to tax. The department reached this conclusion because it determined that "a customer does not subscribe to Petitioner's Cloud Computing product in order to use the operating system. . . . Rather, it subscribes to the product in order to run an application of its choosing using Petitioner's computing power." That is extremely noteworthy because New York has been the leader in seeking to impose tax on a host of cloud computing services, even though in that case there has been a virtually identical customer motive -- that is, to receive a service, not to possess (or use) prewritten application software.15 Perhaps more important, the degree to which possession of the items used by the service provider in that advisory opinion was transferred to its customers is no different than in any of the other situations in which the department arrived at the opposite conclusion. One would hope this marks the beginning of New York's realization that its prior position on cloud service taxability went too far afield from established legal principles. One would also hope that the department will start respecting the plethora of New York court cases that made clear that there must be an actual transfer of exclusive possession for a transaction to be taxable.16

III. Partial Faith and Credit

While it seems clear that Aretha Franklin, Rodney Dangerfield, and Otis Redding have all understood the importance of respect, it's far from clear that state courts always do. The extent to which one state's tax imposition should depend on another state's tax statutes or actual tax collection is an issue that arises around the country regularly. A recent New York decision illustrates this issue well.

A. Constitutional Framework

The U.S. Constitution provides that "Full Faith and Credit shall be given in each State to the public Acts, Records, and judicial Proceedings of every other State."17 A line of Supreme Court cases, however, make clear that this "respect" is not required when giving it would be contrary to the public policy of the forum state.18 The ambiguity of this "contrary to public policy" standard has prevented the development of any clear demarcation that can be used in the state and local tax world.

B. Recent Case

The recent New York State Tax Appeals Tribunal decision in Frog Design Inc.19 brought this all to mind. New York -- for decades -- imposed an annual license fee on each foreign (that is, non-New York) corporation for the right to exercise its corporate franchise in the state; the fee was 0.0005 percent of the par value of the corporation's issued shares employed in New York or, if its shares carried no par value, 5 cents per share. The fee was subsumed by the corporation tax when that tax was due and paid. The articles of incorporation of Frog Design, a California corporation, did not state any par value of the common stock; under California law, such a statement would have had no force or effect at all. A California statute did provide, however, that "for the purpose of any statute in regulation imposing any tax or fee based on the capitalization of a [California] corporation," the par value "shall be deemed to be have a . . . par value of one dollar ($1) per share." The division of taxation asserted that the 5-cent-per-share rate was applicable since Frog Design's articles of incorporation made no mention of par value. In response, Frog Design argued that the California statute deeming the par value to be $1 per share was controlling, and so the 0.0005 percent rate should apply. In other words, the taxpayer argued that the California statute should be respected for New York tax purposes, while the division argued the opposite. The tribunal decided in the taxpayer's favor, basing its decision on the division of taxation's "concession" that if the articles of incorporation had stated a par value, that would have been respected by New York, and so California law, both in its rendering such statements as meaningless and in providing for an assumed par value for tax purposes, was effectively equivalent to what the division thought was required.

The facts, law, and conclusion in this case are really no different from those in an older case wherein the Michigan franchise fee was being imposed on a Delaware corporation.20 There, the Michigan Supreme Court held that "the State of Delaware could prescribe the terms and conditions under which corporations might be there organized. Such terms and conditions as it saw fit to prescribe regulated and controlled such corporations, and became in effect a part of their charters."

To avoid confusion, it is important to remember that this issue of interstate deference is separate and distinct from the one that arises when two states seek to tax a decedent's entire estate, each claiming that the decedent had been domiciled in its state. These disputes are often more in the nature of an interpleader action and arise when there are conflicting findings of fact.21


1 No. 13-485 (2015).

2 N.Y. Tax Law section 605. New York City has a comparable definition of resident in N.Y.C. Admin. Code section 11-1705.

3 N.Y. Tax Law section 620.

4 91 N.Y.2d 530 (1998).

5 488 U.S. 252 (1989).

6 Comptroller of Treasury of Maryland v. Wynne, 135 S. Ct. 1787 (2015). See also, e.g., Barclays Bank PLC v. Franchise Tax Bd. of Cal., 512 U.S. 298 (1994) (separately addressing due process and commerce clause challenges to a tax).

7 Board of County Commissioner v. Vail Associates Inc., 19 P.3d 1263 (Colo. 2001).

8 Indiana Dep't of Revenue v. Indianapolis Transit System Inc., 356 N.E.2d 1204 (Ind. T.C. 1976); Mason Metals Co. Inc. v. Indiana Dep't of Revenue, 590 N.E.2d 672 (Ind. T.C. 1992).

9 TRM Copy Centers (USA) Corp. v. Commissioner of Revenue, Mass. Tax. App. Bd. 2001; New York Times v. Commissioner of Revenue, 693 N.E.2d 682 (Mass. 1998).

10 WPGPI Inc. v. Michigan Dep't of Treasury, 612 N.W.2d 432 (Mich. Ct. App. 2000); NACG Leasing f/k/a Celtic Leasing LLC v. Michigan Dep't of Treasury, No. 306773 (Mich. Ct. App. 2012); Kelly Properties Inc. and Kelly Services Inc. v. Michigan Dep't of Treasury, Nos. 319360, 319361 (Mich. Tax Trib. 2010).

11 Commonwealth v. Sun Shipping & Dry Dock Co., 75 Dauph. 1 (Pa. Common Pleas 1960); In re J&R Transport Co. (Pa. 1962); House of Lloyd v. Commonwealth, 604 A.2d 213 (Pa. Commw. 1996), aff'd, 694 A.2d 375 (Pa. Commw. 1997); Philadelphia v. Philadelphia Tax Review Board, 37 A.3d 15 (Pa. Commw. 2012).

12 Snarr Advertising Inc. v. Utah State Tax Commission, 432 P.2d 882 (Utah 1967).

13 In re Merrill Theatre Corp., 415 A.2d 1327 (Vt. 1980).

14 State Tax Commission v. Peck, 476 P.2d 849 (Ariz. 1970); Energy Squared Inc. v. Arizona Dep't of Revenue, 556 P.3d 686 (Ariz. Ct. App. 2002).

15 See, e.g., N.Y. Department of Taxation and Finance, TSB-A-11(17)S (June 1, 2011); TSB-A-10(44)S (Sept. 22, 2010); TSB-A-10(2)S (Jan. 20, 2010); and TSB-A-09(19)S (May 21, 2009).

16 In re Darien Lake Fun Country Inc. v. N.Y.S. Tax Commission, 496 N.E.2d 217 (N.Y. 1985); In the Matter of the Petition of Smarte Carte, No. 812942 (N.Y. Tax App. Trib. 1996); American Locker Co. v. New York City, 125 N.E.2d 421 (N.Y. 1955); Shanty Hollow Corp. v. N.Y.S. Tax Commission, 111 A.D.2d 968 (N.Y. App. Div. 1985); Bathrick Enterprises Inc. v. N.Y.S. Tax Commission, 27 A.D.2d 215 (N.Y. App. Div. 1967); Bathrick Enterprises Inc., 27 A.D.2d 215 (N.Y. App. Div. 1967), aff'd, 23 N.Y.2d 664 (1968).

17 U.S. Const. Art. IV, section 1.

18 See, e.g., Converse v. Hamilton, 244 U.S. 243 (1912); and Bradford Electric Co. v. Clapper, 286 U.S. 145 (1931).

19 No. 824375 (Apr. 15, 2015).

20 Detroit Machinery Corp. v. Vaughn, 211 Mich. 320 (1920).

21 See, e.g., California v. Texas, 437 U.S. 601 (1978); Texas v. Florida, 306 U.S. 398; and In re Dorrance, 309 Pa. 151, cert. denied, 288 U.S. 617 (1932).

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