Tax Policy and Legislative Update May 18 2017

Tax Policy and Legislative Update May 18, 2017

2016 election outcomes Pw. C 2

Post-2016 elections balance of power provides opportunity for comprehensive tax reform in 2017 2016 electoral college results (270 required to win): Trump 306 Pw. C Clinton 232

US tax policy outlook for 2017 and beyond Pw. C 4

Prospects for tax reform in 2017 and beyond Comprehensive or incremental reform? Corporate Share of Business Income Comprehensive Business Corporate Largest Business Tax Expenditures International Pw. C 5

Legislative paths available for tax reform in 2017 Regular legislative process Benefits Limitations • • Legislation can be enacted permanently No artificial restrictions on which measures can be included • 60 votes needed at every step in the Senate (i. e. , to begin debate, vote on amendments, vote on passage, to conference, etc). Budget reconciliation process • Benefits • • Key Limitations Pw. C • • Requires only simple majority vote at every step in the Senate (no filibuster allowed) Expedited consideration (time limits for amendments and overall debate) Legislation has to sunset if it is projected to lose revenue beyond the budget window (typically 10 years) 60 -vote Senate super-majority required to waive sunset rule Senate rules also require reconciliation to be used only to enact measures that have a fiscal effect on the federal budget 6

Comparison of Republican tax reform proposals Major business provisions excluding border tax adjustment Proposal Current law Corporate tax rate 35% International tax regime 2014 Camp bill (H. R. 1) White House 20% 15% ‘Worldwide’ system with ‘Territorial’ system deferral 95% foreign Foreign tax credits to mitigate dividend exemption double taxation ‘Territorial’ system 100% dividend exemption system ‘Territorial’ system (original campaign proposal was for worldwide taxation without deferral) “Deemed” repatriation N/A Previously untaxed foreign earnings: 8. 75% cash & cash-equivalents 3. 5% non-cash assets Paid over 8 years; assume reduction in foreign tax credits Same as H. R. 1 One-time tax on previously untaxed foreign earnings (rate not specified; campaign proposal had 10% rate) Cost recovery (full expensing) Recover the investment’s applicable life (50% bonus depreciation for equipment in 2017, phasedout by end of 2019) Repeal MACRS; implement ADS type system, with inflation Full expensing for investments (tangible and intangible) excluding land No proposal (campaign proposal allowed manufacturers to elect full expensing for investments) Business interest expense Deductible as incurred Limit for thin capitalization Deductible only against net No proposal (campaign interest income; special rules proposal required for financial services manufacturers electing full expensing to forego interest expense deduction) Top individual tax rate 39. 6% plus 3. 8% ACA tax and 1. 2% income-based phase-out of itemized deductions 25% 33% 35% Pass-through businesses Taxed at individual rates Same as current law Taxed at individual rates not to exceed 25% 15% (unclear if distributions from large pass-through entities subject to additional dividend tax) Pw. C 25% (phased in over 5 years) 2016 House GOP blueprint 7

Additional Congressional tax reform proposals Sen. Hatch Corporate Integration • Treat dividends like interest (i. e. , deductible payments) but impose withholding tax at corporate on both to ensure one level of US tax on both interest and dividend income Sen. Wyden • • Tax Reform Discussion Drafts Replace current depreciation rules with pooling cost recovery system with 6 asset pools Derivatives – Require mark-to-market and ordinary income tax treatment for all derivative contracts Retirement savings – Expand savings opportunities and address perceived abuses International tax reform – Address corporate inversions and other international tax planning (pending) Sen. Cardin Progressive Consumption Tax Act • Adopt 10% credit-invoice value-added tax with comprehensive earned income rebate • Reduce corporate tax rate to 17% • Reduce individual income tax rate brackets from 7 to 3: 15%, 25%, and 28% Rep. Renacci Simplifying America’s Tax System • Replace corporate income tax with 7% value-added tax (VAT) • Reduce individual income tax rate brackets from 7 to 3: 10%, 25% and 35% • Mandatory (deemed) foreign repatriation (8. 75% cash and 3. 5% other) Pw. C 8

Senate Finance Committee Chairman Orrin Hatch (R-UT) focused on ‘corporate integration’ Expected dividend paid deduction (DPD) specifications • DPD — C-corps. may deduct dividends paid • Withholding tax — 35% rate on dividends • Shareholder taxation of dividends: - Individuals. —Taxed at ordinary rates with nonrefundable credit for w/h tax - Corporations. —DRD is repealed? Carryover excess withholding tax credits? - Foreign shareholders. —Override treaties? - Tax exempts, pension funds. —W/h tax is not creditable against tax on UBTI • Redemptions and sale of shares. –Same as present law • Net investment income tax. —Same as present law • Interest withholding. —To pay for DPD, a 35% nonrefundable withholding tax could be imposed on interest paid by C-corps Pw. C 9

Other factors driving US tax policy Pw. C 10

President-elect Trump’s first 200 days agenda The administration has identified an ambitious set of priorities • Tax reform • Health care reform (ACA repeal and replace) • Infrastructure • Trade (NAFTA, Trans-Pacific Partnership) • Financial regulation (D 0 dd-Frank) • Energy (Keystone pipeline) • Environmental de-regulation • Immigration Pw. C

There will be several “action-forcing” deadlines in 2017. . . • Debt ceiling – statutory limit resumed March 15, 2017 • Government funding – current funding ends Sept. 30, 2017; “sequestration” spending caps currently scheduled to return in FY 2018 • FAA reauthorization – extended until September 30, 2017 … against a backdrop of many other legislative requirements and priorities • Administrative nominations • Supreme Court nomination • Affordable Care Act repeal and replace • Budget resolution Pw. C 12

Concerns over growing federal deficits Spending and revenues as a percentage of GDP 2046 2016 30. 0 [SERIES NAME] 5. 8% Share of GDP 25. 0 [SERIES NAME] (8. 8%) 20. 0 [SERIES NAME] 1. 4% 15. 0 Other Noninterest Spending 9. 2% Deficit (2. 9%) [SERIES NAME] 1. 7% [SERIES NAME] [VALUE]% Corporate Tax 1. 6% Corporate Tax [VALUE]% Payroll Tax [VALUE]% 10. 0 [SERIES NAME] [VALUE]% Payroll Tax [VALUE]% [SERIES NAME] [VALUE]% 5. 0 [SERIES NAME] [VALUE]% Individual Tax [VALUE]% 0. 0 Spending Revenues Source: Congressional Budget Office, The 2016 Long-Term Budget Outlook (July 2016). Pw. C 13

www. pwc. com Hot Topics in State Corporate Income Tax

Federal Reform – State considerations Pw. C 15

Federal Reform Proposals • With Republican control of Congress and White House, comprehensive federal tax reform is likely. • Key recommendations of the House Republican plan lowering the top U. S. corporate tax rate from 35% to 20%, enacting a new pas-through business income tax system with a top rate of 25%, eliminating corporate tax deductions, providing full expensing for business costs (with no deduction for net business interest expense), and moving the United States from a worldwide international tax system to a territorial dividend exemption system. There could also be a limitation on the use of net operating losses to offset up to 90% of net taxable income in any given year with an unlimited carryforward, a onetime mandatory repatriation of foreign earnings, and border adjustments that would exempt export sales from taxable income and preclude foreign costs of goods sold expense from being deducted. • Trump’s tax plan includes reducing the top U. S. corporate tax rate to 15%, permitting passthrough businesses to elect to be taxed at 15%, taxing capital gain at a maximum of 20% and previously untaxed foreign earnings subject to U. S. income tax at 10%, and allowing taxpayers engaged in manufacturing in the United States to elect full expensing of capital investment (while losing the deductibility of corporate interest expense). Pw. C 16

Federal Reform Proposals – State considerations • Based on those proposed federal rate decreases, state effective tax rates, should they remain unchanged, would immediately become more material to taxpayers’ overall U. S. tax footprint. • States generally conform to the IRC in one of four ways: state taxable income begins with federal taxable income, fixed date conformity, rolling date conformity, or adoption of some IRC sections. • A relevant consideration for states that conform to federal taxable income as the starting point for determining state taxable income or that have rolling date conformity may be whether to decouple from the new law, whereas states that have fixed date conformity or specific IRC adoption will have to consider whether and when to conform. Conformity generally revolves around federal taxable income, before NOLs and special deductions (line 28) are taken. Thus, if a state were to automatically conform to the blueprint’s provisions that impact line 28, it would be required to enact legislative changes to adopt any blueprint provisions that deal with other provisions, such as NOLs and the taxation of flow-through entities. Pw. C 17

Combined Reporting Pw. C 18

Combined Reporting - 2001 WA MT ME ND MN OR ID WI SD VT NH MA NY CT RI MI WY NV CA UT PA IA NE IL WV CO KS MO OK NM SC MS TX HI DC NC AR AK VA KY TN AZ NJ DE MD OH IN AL GA LA FL Combined Reporting Proposals Unitary/Combined States Remaining Separate Entity or Elective Consolidated Reporting/Other Pw. C 19

Combined Reporting – 2016 WA MT ME ND MN OR ID WI SD MI NY* CT WY NV CA IL WV MO OK NM* SC MS TX HI DC NC AR AK VA KY TN AZ NJ DE MD OH IN CO KS RI PA IA NE UT VT NH MA AL GA LA FL Combined Reporting Proposals Considered Recently and/or Currently Proposed Unitary/Combined States (now including the Ohio CAT, Texas Margin) Remaining Separate Entity or Elective Consolidated Reporting/Other *New Mexico requires certain unitary large retailers to file combined returns (2014). Pw. C 20

Cases - California Com. Con Prod. Services I, Inc. v. California Franchise Tax Bd. ; B 259619 (12/14/2016) • The California Court of Appeal concluded that Comcast and QVC were not vertically integrated, lacked a centralized management, generated no economies of scale, and produced no other flow of values that justified a unitary relationship. • The Court also affirmed the lower court’s decision that a termination fee related to a failed merger was business income for Comcast, because the transaction was similar to other cable acquisition transactions that Comcast had engaged in many times over the years as a regular part of its business. Pw. C 21

Cases - Iowa Myria Holdings Inc. & Subs. , v. Department of Revenue, Iowa Supreme Court, No 15 -0296, 3/24/17 • The Iowa Supreme Court concluded that an out-of-state parent corporation could not join in a consolidated tax return with its subsidiaries that did business in the state because it lacked taxable nexus with the state and its activities were limited to owning and controlling the subsidiaries. • Although the Iowa Supreme Court ruled in favor of the Department of Revenue in this case, the opinion might prove instructive for parent companies challenging nexus assertions by the state. Pw. C 22

Cases – Texas Hearing 111, 577 and 111, 578, released April 2016 • Two companies with common ownership were not required to file a combined return • The state argued that the companies should be combined because they were both wholly owned by the same individual and they had shared centralized management (they shared a common administrator, common payroll, and common software) • The ALJ found that the shared administrative functions of accounting and overseeing (in a very general manner) purchasing activities and other common functions did not amount to centralized management, much less strong centralized management • Accordingly, the companies did not operate as a unitary business and were not required to file combined returns Pw. C 23

Tax havens • Some states provide for inclusion of entities incorporated or doing business in “tax haven” countries in the water’s-edge combined group • States that have adopted such provisions include Alaska, Connecticut, Montana, Oregon, Rhode Island, and West Virginia • The MTC model combined reporting statute permits water’s-edge reporting by election and includes the entire income and apportionment factors of any member doing business in a tax haven • Most states have chosen to go with one of two approaches, either defining a “tax haven” on the basis of a list of foreign jurisdictions (commonly referred to as a “blacklist” approach) or by employing a facts and circumstances test modeled after the MTC’s “tax haven” definition Pw. C 24

Tax havens 2015 – 2016 enacted and proposed legislation • There have been many state legislative proposals in recent months that impact international business organizations doing business in the US. Various forms of tax haven laws are already enacted in Alaska, DC, Montana, Rhode Island, Oregon, and West Virginia. • In 2015 Connecticut enacted and then modified a new tax haven law, Oregon broadened its tax haven laws, and DC modified the blacklist in its existing tax haven law. • The 2016 legislative session has been very active, with Alabama, Colorado, Kansas, Kentucky, Louisiana, Maine, and New Jersey introducing new tax haven bills. Pw. C 25

Tax haven legislative map Pw. C

Alaska approach Alaska utilizes neither the “blacklist” nor the MTC approach, but instead has developed its own definition of a “tax haven” that is facts and circumstances driven In Alaska, a “tax haven” jurisdiction is a country that does not impose an income tax, or that imposes an income tax at a rate lower than 90% of the U. S. rate Further, in order for the Alaska “tax haven” provision to apply, the foreign corporation must either: • • Have 50% or more of its sales, purchases, or payments of income or expenses, exclusive of payments for intangible property, made directly or indirectly to one or more members of the unitary return; or Not conduct any significant economic activity Pw. C 27

MTC approach • Many states, including RI, WV, and DC, have leveraged the “tax haven” definition provided in the MTC’s model combined reporting statute, which designates the following traits: • No or nominal effective tax on the relevant income and • Has laws or practices that prevent effective exchange of information for tax purposes with other governments; • Lacks transparency; • Facilitates the establishment of foreign-owned entities without the need for a substantive local presence; • Excludes resident taxpayers from the tax regime’s benefits or prohibits businesses that benefit from operating in the local market; or • Has created a tax regime which is favorable for tax avoidance, including whether the jurisdiction has a significant untaxed offshore financial or other services sector relative to its overall economy Pw. C 28

Blacklist approach • Montana and Oregon are the only states that currently have adopted a statutory “blacklist” approach that identifies specific countries as “tax havens” • On November 23, 2015, the District of Columbia repealed a statutory blacklist that had been previously adopted • Connecticut Commissioner was to publish “blacklist” by regulation by 9/30/2016. This provision was repealed by SB 1601, which also excludes jurisdictions that have entered into a comprehensive income tax treaty with the United States. • “Tax haven” is based on whether the foreign corporation is incorporated in or doing business in a listed jurisdiction • Lists typically include around 40 -plus foreign countries • Luxembourg is notably on the “tax haven” list for MT & OR Pw. C 29

Blacklists compared Montana Blacklist - 40 Andorra, Anguilla, Antigua and Barbuda, Aruba, Bahamas, Bahrain, Barbados, Belize, Bermuda, British Virgin Islands, Cayman Islands, Cook Islands, Cyprus, Dominica, Gibraltar, Grenada, Guernsey, Isle of Man, Jersey, Liberia, Liechtenstein, Luxembourg, Malta, Marshall Islands, Mauritius, Monaco, Montserrat, Nauru, Netherlands Antilles, Niue, Samoa, San Marino, Seychelles, St. Kitts and Nevis, St. Lucia, St. Vincent and the Grenadines, Tonga, Turks and Caicos, US Virgin Islands, Vanuatu Pw. C EU Blacklist - 30 Andorra, Anguilla, Antigua and Barbuda, Bahamas, Barbados, Belize, Bermuda, British Virgin Islands, Brunei, Cayman Islands, Cook Islands, Grenada, Guernsey, Hong Kong, Liberia, Liechtenstein, Maldives, Marshall Islands, Mauritius, Monaco, Montserrat, Nauru, Niue, Panama, Seychelles, St. Kitts and Nevis, St. Vincent and the Grenadines, Turks and Caicos, US Virgin Islands, Vanuatu 30

Rhode Island approach • Excludes treaty-protected income of non-US corporations, but disqualifies “tax haven” countries from this treaty exclusion • However, provides safe harbors: • Transactions at arm’s length and not with the principal purpose to avoid the payment of taxes; or • The taxpayer establishes that inclusion of such net income in the combined group is unreasonable Pw. C 31

Fixing the list: Oregon proposal • Tax haven inclusion limited to effectively connected income • If ECI, safe harbors still apply: • Less than 20% U. S. property, payroll & sales factors; • Income subject to a federal income tax treaty; or • Transactions at arm’s length without the principal purpose to avoid the payment of taxes Pw. C 32

2015: Oregon legislative expansion • OR expands statutory tax haven list (S. B. 61); effective for tax years beginning on or after 1/1/16 • Adds Guatemala & Trinidad and Tobago to the list • Specifically provides that either the taxpayer or the DOR may invoke Oregon’s version of UDITPA Sec. 18 (alternative apportionment) • However, the bill also appears to remove the provision requiring factor representation for tax haven included income from ORS Sec. 317. 715(4)(b) • Legislation requires the Legislative Revenue Officer, after consulting with the DOR, to provide a report regarding the “cost-effectiveness” of Oregon’s tax haven law Pw. C 33

Nexus Pw. C 34

Cases – Ohio Crutchfield Corp. v. Testa; No. 2015 -0386; Slip Opinion No. 2016 -Ohio-7760 (11/17/2016) • The Ohio Supreme Court held that the state's commercial activity tax (CAT) economic threshold created substantial nexus for an online retailer. • On appeal from a 2015 Board of Tax Appeals (BTA) decision, the Court ruled that physical presence is not a necessary condition for imposing the CAT because the statutory $500, 000 sales-receipts threshold is an adequate quantitative standard that satisfies the dormant Commerce Clause’s substantial nexus requirement. • In addition, the Court ruled that the burdens imposed by the CAT on interstate commerce are not clearly excessive in relation to fair taxation for both in-state and out-of-state sellers. Pw. C 35

Tax Base Pw. C 36

Nationwide Trends – Related Party Addbacks WA MT ME ND MN** OR VT ID WI SD MI NY WY NV UT CA PA IA NE IL MO WV VA KY OK NM AR TX HI Related member expense addback required (including DC, NYC) Related member expense addback legislative proposals considered in recent years No related party addback provisions imposed Repealed in OR eff. 1/1/13 and in RI eff. 1/1/15 Pw. C SC* MS AK DC NC TN AZ NJ DE MD OH IN CO KS NH MA CT RI AL GA LA FL *South Carolina disallows deductions for an expense between related parties where a payment is accrued, but not actually paid and on interest deductions on obligations issued as a dividend or paid instead of a dividend **Minnesota requires addback of interest and intangible expenses, losses, and costs paid, accrued, or incurred by any member of the taxpayer's unitary group to a foreign operating corporation that is a member of the taxpayer's unitary business group, 37

Cases - Alabama The Sherwin-Williams Co. v. Dep't of Revenue; Docket No. BIT. 13 -359; Docket No. BIT. 11 -741 (11/30/16) • The Alabama Tax Tribunal held that the domestic production activities deduction limitation (DPAD), which is calculated on a consolidated basis for federal income tax purposes, should be calculated for Alabama purposes based on the amount of federal taxable income as determined by the proforma separate federal tax return required by Alabama law, before any state modifications. • Therefore, the DPAD limitation should be based on proforma separate federal taxable income, and not Alabama taxable income. Pw. C 38

California FTB Technical Advice Memorandum No. 2017 -03 (4/6/17) • The FTB has released a technical advice memorandum regarding the application of IRC Code Sec. 382 – 384 for California tax purposes for apportioning taxpayers: 1) the limitation provided for in Code Sec. 382(b)(1) is applied on a preapportionment basis; 2) the recognized built-in gains / losses (RBIGs / RBILs) provided for in Code Sec. 382(h)(2) are determined on a post-apportionment basis; 3) the net unrealized built-in gains / losses (NUBIGs / NUBILs) provided for in Code Sec. 382(h)(3) are determined on a post-apportionment basis; 4) the limitation on the use of excess credits provided for in Code Sec. 383(a)(1), is applied on a pre-apportionment basis; 5) when using the examples in Treas. Reg. § 1. 383 -1(f), the CA corporate franchise tax rate provided in Cal. Rev. & Tax. Cd. § 23151 and 23186 should be substituted for the applicable federal corporate income tax rate referenced in those examples; and Pw. C 6) the RBIGs provided for in Code Sec. 384(a)(2) are determined on a postapportionment basis when considered for purposes relating to preacquisition losses. 39

Cases – Pennsylvania RB Alden Corp. v. Commonwealth of Pennsylvania, Pa. Comm. Ct. , No. 73 F. R. 2011 (06/15/2016) The Commonwealth Court of Pennsylvania held that the net loss carryover (NLC) deduction allowed for purposes of the Pennsylvania corporate net income (CNI) tax, violates the Uniformity Clause of the Pennsylvania Constitution. • Consistent with its November 2015 decision in Nextel Communications of Mid-Atlantic, Inc. v. Commonwealth of Pennsylvania, 129 A. 3 d 1 (Pa. Cmwlth. 2015). • The court concluded the NLC deduction creates classes of taxpayers according to their taxable income and that such classification is unconstitutional. It is significant that the court in Alden permitted the taxpayer to reduce its taxable income to zero, an outcome that matches the remedy applied in Nextel. • The court also analyzed whether the gain on the sale of a partnership interest is nonbusiness income and, to the extent business income, whether the gain should be sourced to Pennsylvania, among other issues. Pw. C 40

Cases – Pennsylvania Nextel Communications of the Mid-Atlantic, Inc. , v. Commonwealth of Pennsylvania, Pa. Commonwealth Court, No, 98 F. R. 2012, November 23, 2015 • The Commonwealth Court of Pennsylvania held that the net loss carryover (NLC) deduction allowed for purposes of the Pennsylvania corporate net income (CNI) tax, as applied to Nextel Communications, violates the Uniformity Clause of the Pennsylvania Constitution. • The court concluded the NLC deduction creates classes of taxpayers according to their taxable income. • Taxpayers with taxable income in excess of $3 million could not reduce their CNI liability to zero whereas similarly-situated taxpayers with $3 million or less in taxable income could reduce their CNI liability to zero. • The court found such classification unreasonable and not related to any legitimate state purpose. Pw. C 41

Allocation and Apportionment Pw. C 42

Nationwide Trends – Allocation and Apportionment • Apportionment Trends - Shift in factor weighting - Sales factor ◦ Gross versus net ◦ Market source versus cost of performance - Use of discretionary authority to adjust formula (UDIPTA Sec. 18) Pw. C 43

Apportionment Formulas* - 1998 WA MT ME ND MN OR VT ID NH WI SD MI NY CT WY NV PA IA NE IL UT CA IN MD WV MO VA KY DC NC TN AZ OK NM AR SC MS AK TX HI RI DE OH CO KS NJ MA AL GA LA FL Equally weighted three factor formula *Does not address industry-specific or optional formulas Double weighted sales factor Triple or greater weighted or single sales factor Pw. C 44

Apportionment Formulas* - 2003 WA MT ME ND MN OR VT ID NH WI SD MI NY CT WY NV PA IA NE IL UT CA OH IN MO OK NM KY DC NC AR SC MS AK TX HI DE VA TN AZ RI MD WV CO KS NJ MA AL GA LA FL Equally weighted three factor formula *Does not address industry-specific or optional formulas Pw. C Double weighted sales factor Triple or greater weighted or single sales factor 45

Apportionment Formulas* - 2017 WA MT ME ND MN OR VT ID NH WI SD MI NY CT WY NV CA PA IA NE UT OH IN IL KS MO OK NM KY DC NC AR SC MS AK TX HI DE VA TN AZ** RI MD WV CO NJ MA AL GA LA FL Equally weighted three factor formula *Does not address industry-specific or optional formulas Double weighted sales factor **Taxpayers can elect single sales factor Triple or greater weighted or single sales factor Reflects changes enacted in 2016 that might take effect later Pw. C 46

Gillette and the MTC Election State Michigan Case Summary of Status IBM -July 14, 2014 - Michigan Supreme Court held IBM was entitled to use MTC threefactor apportionment formula. -April 28, 2015 - Michigan Court of Claims ruled IBM could not make the MTC election due to the 2014 retroactive compact appeal effective January 1, 2008. Gillette Commercial Operations -September 29, 2015 - Michigan Appellate Court upheld the state’s retroactive repeal of the MTC compact, finding the legislature had a legitimate purpose for retroactive appeal. Further, the court found the Compact was not a binding contract under state law so it did not violate state or federal contract clauses. AK Steel -February 25, 2016 – Michigan Appellate court held that MTC three factor apportionment election was not impliedly repealed for SBT purposes. Minnesota Kimberly-Clark - June 19, 2015 - Minnesota Tax Court ruled that state’s repeal of the Compact does not violate the US or MN contract clause constitutional provisions. - June 22, 2016 – Minnesota Supreme Court ruled that the legislature’s repeal in 1987 of the equally weighted three factor apportionment election found in Articles III and IV on the Multistate Tax Compact was permissible. Oregon Health Ne -September 9, 2015 - Oregon Tax Court ruled the taxpayer could not use the MTC three -factor apportionment formula and the Compact did not constitute a binding state contract. -Health Net has appealed this matter to the Oregon Supreme Court. Texas Graphic Packaging -July 28, 2015 - Texas Court of Appeals determined Texas Franchise Tax is not a tax imposed on net income for MTC purposes and therefore, the MTC three-factor apportionment provisions were not available to the taxpayer. -December 14, 2015, Graphic Packaging petitioned the Supreme Court of Texas for review. Slide 47 Pw. C (for internal use only)

Gillette and the MTC Election California • California was a signatory state to the Multistate Tax Compact, which includes a provision that obligates member states to offer taxpayers the option of using an equally weighted three factor apportionment formula or the state’s alternative formula. • California adopted a double weighted sales factor in 1993. Gillette elected to use the equally weighted three factor apportionment formula. • California Court of Appeal held California is bound by the Compact and the election provision unless it withdraws from the Compact. • On December 31, 2015, the California Supreme Court held that California law precludes taxpayers from relying on the Multistate Tax Compact’s equallyweighted three-factor apportionment election provision. The Court reasoned the Compact was not a binding reciprocal agreement and the California Legislature was not required to allow the Compact’s election provision. • See, The Gillette Co. v. Franchise Tax Board, Cal. Sup. Ct. , No, S 206587 (12/31/15) Pw. C (for internal use only) Slide 48

Gillette and the MTC Election California (cont’d) • On November 1, 2016, the California Franchise Tax Board (FTB) issued Notice 2016 -03 to provide the intended courses of action on Multistate Tax Compact election cases. • The FTB will be shifting claims for refund administrative protests back into ‘active’ status and will start to address them in the normal course of business. Taxpayers can expect to receive formal notices about their claims and protests in the upcoming months. • The FTB advises taxpayers that they should make tax deposits or pay proposed deficiency assessments to stop the accrual of interest. Finally, the FTB indicated that penalties will be imposed as appropriate on a case-bycase basis. Pw. C 49

Gillette and the MTC Election Michigan • On February 25, 2016, the Michigan Court of Appeals held that the Multistate Tax Compact’s equally weighted three-factor apportionment election was not impliedly repealed for purposes of apportioning income under Michigan’s Single Business Tax (SBT). • The court recognized the conflict between the SBT’s apportionment language and the Compact’s election. However, the court harmonized the two provisions and found that taxpayers had a choice: they could elect to apportion under the Compact or, failing to elect, they would be required to apportion under the SBT apportionment provisions. • The Court of Claims’ orders granted summary disposition in favor of the Department finding that the SBT apportionment provision impliedly repealed the Compact election. The Court of Appeals, on de novo review, reversed these orders and remanded the cases back to the Court of Claims. • See AK Steel v. Department of Treasury, Mi. App. Ct. , No. 237175 (2/25/16) Pw. C (for internal use only) Slide 50

Gillette and the MTC Election Utah • S. B. 247 repeals Compact provisions from Utah law and temporarily reinstates most provisions of the Compact, but not Article III (allowing taxpayer to elect to apportion under the laws of the state or in accordance with the Compact provisions) or Article IV (apportionment provisions). District of Columbia • FY 14 budget, enacted 7/30/13, repeals and re-enacts provisions of the Multistate Tax Compact (Section HH); and (3) makes other tax changes. The re-enacted Compact provisions do not include Article III (allowing taxpayers to elect to apportion under the laws of the District or in accordance with Compact provisions) or Article IV (containing the apportionment provisions). Pw. C 51

Gillette and the MTC Election Minnesota • H. F 677, signed on May 23, 2013 - Repeals Minn. Stat. sec. 290. 171, which enacts the Multistate Tax Compact. - Authorizes the commissioner to participate in audits performed by the Multistate Tax Commission. - Because the bill provides no specific effective date, the Compact repeal takes effect on August 1, 2013. - Remains unclear to which taxable year the repeal applies. Pw. C 52

Gillette and the MTC Election Minnesota • Kimberly-Clark Corp. v. Commissioner of Revenue, A 15 -1322 (June 22, 2016) - Minnesota Supreme Court ruled that the legislature’s repeal in 1987 of the equally weighted three factor apportionment election found in Articles III and IV on the Multistate Tax Compact was permissible. - At issue before the Court was the fundamental question of whether the Minnesota legislature’s enactment of the Compact in 1983 formed a binding contract that, until the state withdrew from the Compact, prevailed over any conflicting state law. - The Court stated that “articles III and IV clearly provide for the apportionment election, but do not contain a separate and distinct promise that the State would not alter or repeal the election. ” Pw. C 53

Gillette and the MTC Election S. B. 2292, signed on April 20, 2015 • Effective for taxable years beginning after December 31, 2014, taxpayers are allowed to make an election to apportion business income with a sales factor that phases into a single-sales factor over a five year period. • Additionally, certain provisions of the Multistate Tax Compact. For example, Article III of the Compact, which allows taxpayers an election to apportion under the laws of the state or in accordance with Compact provisions, was repealed. Pw. C 54

Gillette and the MTC Election Oregon • S. B. 307 signed on June 13, 2013, repeals all provisions of ORS 305. 665, which includes the Multistate Tax Compact, and then reenact most provisions of the Compact excluding Article III (allowing taxpayers to elect to apportion under the laws of the state or in accordance with Compact provisions) and Article IV (containing the apportionment provisions). • The bill is effective for tax years beginning on or after January 1, 2013. Pw. C 55

Market-Based Sourcing WA MT ME ND MN OR VT ID WI SD MI NY CT WY NV UT CA* PA# IA NE IL OH IN KS MO@ VA KY OK NM AR TX HI DC SC MS AK DE NC TN AZ** RI NJ MD WV CO## NH MA AL GA LA FL *Effective in 2011, for taxpayers that elect single sales factor only, but see Prop. 39 **Elective for deemed multistate service providers @For taxpayers that elect single sales factor #service receipts only effective in 2014 ## intangible property receipts only Pw. C 56

Legislation – Delaware H. B. 235 , signed on January 27, 2016 • H. B. 235, “The Delaware Competes Act of 2016, ” provides a four year phase-in to single sales factor apportionment, beginning in 2017. • The Act grants an option for telecommunications corporations, and companies with their world headquarters and significant capital investment in Delaware to make an annual election to use either single sales factor or three-factor apportionment starting in 2017. • Effective for tax periods beginning after December 31, 2015, non-US corporations include only US property and payroll when calculating the denominator for each factor. The Act does not have a similar requirement for the sales factor. • This phase-in does not apply to asset management corporations, which remain subject to a single sales factor apportionment. Pw. C 57

Legislation - Indiana S. B. 440, signed on April 13, 2017 • Effective July 1, 2017: • The taxpayer petitioning for, or the department requiring, alternative apportionment bears the burden of proof that 1) the apportionment provisions as enacted do not fairly represent the taxpayer's income derived from sources within this state AND 2) the alternative apportionment method is reasonable. Pw. C 58

Cases - Maryland Petition of Staples Inc. and Staples the Office Superstore, LLC, and the Decision of the Maryland Tax Court; Anne Arundel County Circuit Court, No. C-02 -CV-15 -002009, December 30, 2016 • The Circuit Court also upheld the tax court’s decision allowing the Comptroller of Maryland to apply an alternative apportionment formula. • The court found that out-of-state entities failed to carry their burden of proving that the Comptroller’s non-statutory formula “produced a tax liability out of all appropriate proportion to the business transacted in Maryland or led to a ‘grossly distorted result. • The method applied by the Comptroller is described as “captur[ing] the royalty and interest expenses of [Maryland Affiliates] that simultaneously constituted the income of [Petitioners]. ” • The Circuit Court reasoned that Petitioners “offered little proof demonstrating that the Comptroller’s formula – which it had ‘wide latitude’ to apply - produced a disproportionate, distorted, arbitrary, or unreasonable” tax liability Pw. C 59

Cases - Massachusetts Genentech, Inc, v. Commissioner of Revenue, No. SJC-12083, (01/12/2017) • The Supreme Judicial Court of Massachusetts affirmed an Appellate Tax Board decision that a drug producer was a qualified manufacturer and was required to use the state’s single-sales factor apportionment formula. • In determining that the drug producer’s manufacturing receipts were substantial, as is required under state law for a taxpayer to qualify as a manufacturer, the Court declined to include receipts from the redemption of short-term investments by the company’s treasury department. • Additionally, the Court found that application of the single-factor formula did not create an unconstitutional discrimination against interstate commerce. • This decision potentially opens the door to a new area of economic activity that might be considered ‘manufacturing’ for Massachusetts. Pw. C 60

Other Nationwide Developments Pw. C 61

US Supreme Court Comptroller of the Treasury of Maryland v. Wynne, U. S. Supreme Ct. , No. 13 -485 107, May 18, 2015 • In a 5 -4 decision, the United States Supreme Court found that the absence of a credit against the local portion of the state's personal income tax, with respect to tax paid to another state on pass-through income from an S corporation, was unconstitutional. • The tax failed the dormant Commerce Clause’s internal consistency test because if every state adopted Maryland’s tax scheme, interstate commerce would be taxed at a higher rate than intrastate commerce. • The Court noted that a Maryland resident earning income outside the state would experience double taxation due to paying tax in his state of residence and in the state where income is earned. • The Court further held that the tax is inherently discriminatory and operates as a tariff. • The Court rejected assertions that it reach a different result because applicable Supreme Court dormant Commerce Clause authority involves corporate gross receipts taxes. The Court provided that its conclusion was not affected by the fact that the instant case involved a state’s personal income tax. Pw. C 62

US Supreme Court First Marblehead Corp. v. Comm’r of Revenue , Mass. , No. SJC-11609, 8/12/16 • On October 13, 2015, the U. S. Supreme Court accepted review of a Massachusetts internal consistency case, vacating a state high court ruling and remanding the case for further consideration in light of the Court's decision in Comptroller of Treasury of Maryland v. Wynne. • On August 12, 2016, the Massachusetts Supreme Judicial Court held on remand that the state's apportionment of loan income to the state did not violate the internal consistency test of the dormant commerce clause because if every state enacted an identical statute, it would not lead to more than 100 percent of a unitary business's income being taxed. • On December 15, 2016, First Marblehead Corp. asked the U. S. Supreme Court to review the decision, arguing that the Massachusetts property factor financial institutions -- as construed by the Massachusetts Supreme Judicial Court -- gives rise to double taxation for financial institutions that outsource the servicing of their loans, and captures tax revenue rightly belonging to other jurisdictions. • On February 12, 2017, the U. S. Supreme Court denied cert. Pw. C 63

Amnesty programs State Amnesty period Program summary / benefti Pennsylvania 4/21/17 – 7/19/17 - 100% penalty and 50% of interest waiver - Applies to any tax administered by the DOR on which a taxpayer is delinquent as of 12/31/15 - A taxpayer with unknown liabilities reported and paid under the program and that complies with all other requirements will not be liable for any taxes of the same type due prior to 1/1/11 Virginia A 60 to 75 day period between 7/1/17 – 6/30/18. Exact dates TBD. - 100% penalty and 50% of interest waiver - Applies to any tax administered by the Tax Department, except income tax liabilities (for corporations, individuals, and estates and trust) attributable to tax years beginning on or after January 1, 2016. Pw. C 64

California A. B. 154, signed September 30, 3015 • Effective for tax years beginning on or after January 1, 2015, unless otherwise noted, the following changes to the large corporate understatement penalty were made: • an increase in tax from a proper election under IRC sec. 338 as reported on the first amended return • an understatement attributable to either of the following: • the Franchise Tax Board's (FTB) imposition of an alternative apportionment or allocation method under the authority of Revenue and Taxation Code (R&TC) Section 25137 (operative for any taxable year with an open statute of limitations as of the effective date of A. B. 154) • a change to the taxpayer's federal method of accounting where the due date of the return is before the Secretary of the Treasury's determination to change the accounting method. • California tax law conforms to relevant sections of the Internal Revenue Code for taxable years beginning on or after January 1, 2015 Pw. C 65

Louisiana 2017 Budget Stabilization Plan, Office of the Governor (3/29/2017) • In response to the state’s $1. 3 billion fiscal cliff, Louisiana Governor John Edwards proposed several tax changes, including: • a gross receipts tax on businesses, • expansion of the sales tax base to certain services, • the phase-out of the corporate franchise tax, • a reduction in rate for the corporate and personal income tax and the sales tax, • the elimination of the deduction for federal income tax paid, and • making permanent the reduction of certain tax credits and incentives Pw. C 66

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