By Erica Horn and Stephen Sherman
On January 13, 2014, the Kentucky Board of Tax Appeals (the “Board”) issued its amended order in the case of Chegg, Inc. v. Dept. of Revenue, Order No. K-24470. In that case, the Board considered the scope of Kentucky’s exemption from the tangible personal property tax for “goods stored in a warehouse”. Ultimately, the Board held for the Kentucky Department of Revenue (the “Department”) limiting the exemption to goods shipped out of state within six months, never to return to Kentucky.
Beginning operations in 2007, Chegg, Inc. (“Chegg”) operates an online network of textbook rentals for students. A significant portion of Chegg’s textbook inventory is rented out at the start of January and August each year. At the end of each school semester, the students return the rented books to Chegg. (Order at 1). In 2010, Chegg constructed a distribution center in Bullitt County, Kentucky, from which it ships and receives its inventory.
Chegg entered into a Voluntary Disclosure Agreement with the Department for its tangible personal property tax for tax years 2009 and 2010. (Id.). In the voluntary disclosure, Chegg classified a portion of its Kentucky inventory of textbooks as “personal property held for shipment out-of-state”. This “in-transit” classification exempts inventory from state and local tangible personal property taxation pursuant to KRS § 132.097 and § 132.099, respectively. The Department disagreed with the classification and issued notices of tax due, reclassifying the textbooks as taxable inventory. (Order at 2). Chegg sought review at the Board.
At issue in the case was the exemption contained in KRS § 132.097 (and similarly in KRS § 132.099), which states:
There shall be exempt from ad valorem tax for state purposes, personal property placed in a warehouse or distribution center for the purpose of subsequent shipment to an out-of-state destination. Personal property shall be deemed to be held for shipment to an out-of-state destination if the owner can reasonably demonstrate that the personal property will be shipped out of state within the next six (6) months.
Chegg argued that the textbooks qualified for the statutory exemption because they were rented by students and shipped out-of-state within six months of arriving at the facility. (Order at 2). The Department argued that the statutory exemption is limited to items shipped out-of-state within six months that never return to the state. Because Chegg’s textbooks were returned to the state at the end of each semester, the Department argued the exemption was inapplicable. (Id.).
The Board noted that to have a taxable situs and be subject to the tangible personal property tax, the textbooks must have a permanent location. (Order at 3 (quoting Reeves v. Island Creek Fuel & Transp. Co., 313 Ky. 400, 230 S.w.2d 924 (1950)). The Board stated that the textbooks had a “more or less permanent location” in Bullitt County, Kentucky, and further found that the statutory exemption must be construed narrowly. (Order at 3 (citing LWD Equipment, Inc. v. Revenue Cabinet, 136 S.W.3d 472 (Ky. 2004)). Thus, in the absence of language extending the exemption to property temporarily shipped out of the state, the Board found the exemption did not extend to Chegg’s textbooks. The Board concluded that the “plain and ordinary meaning of the phrases ‘shipped out-of-state’ and ‘out-of-state destination’ is that the item must be delivered out-of-state and not return to Kentucky. (Order at 4). Therefore, the Board upheld the Department’s assessment of tangible personal property tax against Chegg for the 2009 and 2010 tax years.
The Board went on to consider whether the imposition of the KRS § 132.290(3) 10% omitted property penalty was appropriate. The statute permits the imposition of the penalty for omitted property which is voluntary listed (versus 20% if the omitted property is involuntarily listed). Although the Department typically waives such penalties as part of voluntary disclosure, no waiver occurred because Chegg did not pay the tax during voluntary disclosure. (Opinion at 4). Chegg sought waiver of the penalties pursuant to the “reasonable cause” standard set forth in 103 KAR 1:040. Specifically, Chegg argued that it had sought and relied upon advice from its tax advisors regarding the filing of the tax return. (Id.). As the Board explained, to obtain a waiver of penalties due to reliance on a tax advisor, the regulation requires the taxpayer demonstrate three requirements:
Taxpayer was unfamiliar with the tax law and actually relied upon the advice of the tax advisor;
Supporting documentation showing full disclosure of all relevant facts to the tax advisor and the advice received; and
Exercise of reasonable care and prudence in determining whether to secure advice of a tax advisor. (Order at 4-5)
The Board determined Chegg failed to satisfy these requirements. The Board noted that the only evidence provided by Chegg was the names of the advisors providing the advice to them. (Opinion at 5) The Board stated that Chegg, in light of the substantial investment made, should have sought further advice and a ruling from the Department on the matter. (Id.). Due to Chegg’s failure to satisfy the requirements of the regulation, the Board upheld the imposition of the 10% penalty.