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National survey: BNA survey reports key state tax findings – Policies continue to lag in cloud computing and digital goods

Bloomberg BNA released its 2014 Survey of State Tax Departments which covered a number of important and evolving topics including: 

  • Corporate income tax nexus
  • Sales tax nexus
  • State tax add-backs
  • IRC § 338(h)(10) elections
  • Throwback/throwout rules
  • Income tax sourcing
  • Sales tax sourcing
  • Combined reporting 

The purpose of the survey was to clarify each state’s position on gray areas of state taxation, with an emphasis on nexus. According to BNA, it compiled its survey by sending questionnaires to senior state tax officials in every state, the District of Columbia and New York City. All states participated in the survey.

The survey found that state tax policies continue to lag behind new business models, such as cloud computing, as well as the shift to a more predominate services economy. We will cover a few of the report’s highlights here, but we recommend that you read the report in detail as it relates to the areas of importance to you.

Some general findings in the survey were: 

  • In the sales tax nexus for services context, most states agreed that they would not determine there was nexus where a corporation repairs tangible personal property outside a given state’s borders and then delivers such property by common carrier. 
  • Very few states claimed that sales tax nexus would result if an out-of-state corporation charges fees for access to software hosted on a server in another state. However, states were more likely to find sales tax nexus in cases where additional activities were attached to this arrangement. 
  • From a corporate income tax perspective, a growing minority of states are adopting the position that intangibles, such as cloud computing services, will be sourced to where the benefit is received, as opposed to utilizing another method in determining the source of income. 

We have found BNA’s effort on this survey to be very insightful into several emerging trends in state taxation, as well as providing a great wealth of information as far as what is “market” right now in various state department of taxation’s interpretation of U.S. Constitutional doctrines.

The BNA 2014 Survey of State Tax Departments is available here for no charge if you provide certain information or here for purchase. The Multistate Tax Update is not affiliated with Bloomberg BNA. We believe this survey emphasizes the importance of careful tax planning in an ever-evolving world of state taxation. 

Tennessee: Governor signs bill changing nursing home tax

On April 30, 2014, Tennessee Governor Bill Haslam signed H.B. 1783, revising the state’s tax on nursing homes. The new law, which will take effect on July 1, 2014, will change how the state taxes nursing homes by moving from a per-bed bases to a percentage of revenue basis. The bill initially passed the Tennessee State House of Representatives by a margin of 87-3 and subsequently received unanimous approval by the Senate.

Previously, the state taxed licensed nursing homes at a rate of $2,225 per bed annually. Now, similar to Tennessee’s tax on hospitals, nursing homes will pay a tax of 4.5 percent of the “net patient service revenue.” The new law defines “net patient service revenue” as follows: 

Gross inpatient revenues from services provided to nursing home patients less reductions for gross inpatient revenue resulting from an inability to collect payment of charges. 

This definition excludes revenue from services that are unrelated to patient care such as revenues from vending machine sales and meal sales.

Tennessee will place the revenue generated from the tax in a trust fund to be used for payments for certain TennCare services, the state’s Medicaid program. In addition, any funds received by Tennessee from the federal government pursuant to its matching program will also be placed into the trust fund to be used for payments for certain TennCare services. Generally, when a state provides Medicaid services, the federal government will match any state spending based on a state-specific rate. For Tennessee, the federal government matches almost 65 percent of any state funds Tennessee spends on TennCare. Based on the previous tax, the federal government was giving the state $1,446.25 per bed. It is unclear what the expected revenue will be as a result of the new tax basis.

Supporters have expressed their enthusiasm at the hopes that revising the manner in which nursing homes are taxed will curb the decline of nursing home beds and operate as a “fair tax.” However, the Federal Centers for Medicare and Medicaid Services must still approve the matching of funds from the new tax. If it does not approve the state’s new method, then the previous $2,225 per-bed tax will remain in place.

New York: Governor Andrew Cuomo signs major NY franchise tax overhaul into law 

On March 31, 2014, New York Governor, Andrew Cuomo, signed the New York Budget Bill, 8559-D and S. 6359-D, into law. The budget included many major changes to New York franchise taxes, including a repeal of the Banking Franchise Tax, subjecting financial institutions to the Corporate Franchise Tax, and substantial revisions to the general Corporate Franchise Tax. All of these changes, with some exceptions, will not go into effect until Jan. 1, 2015. We will summarize the major changes enacted, with the exception of specific rules for banking corporations and manufacturers.

Nexus standards expanded

New York imposes a Corporate Franchise Tax on all domestic and foreign corporations for the privilege to exist and do business in New York. The recent budget bill expanded what business activities in New York qualify as doing business for franchise tax purposes. These rules now include “deriving receipts from activity.” A corporation will be considered to be “deriving receipts from activity” in New York if it has $1 million or more in receipts from New York. If a corporation is a member of a combined group and has less than $1 million in receipts, but more than $10,000, and the combined group has $1 million or more in combined receipts, it will also be considered to be “deriving receipts from activity” in New York. The new law also provides that a corporate partner in a partnership that operates in New York will have nexus by way of its partnership interest. Finally, the bill repealed the fulfillment services exemption; corporations that have fulfillment services conducted on their behalf in New York are no longer exempt from the Corporate Franchise Tax.

New definitions of business income – Changes to tax base

New York law required corporations to categorize their income as business income, investment income or subsidiary income, as the state treats each category differently for Corporate Franchise Tax purposes. The new law redefines “business income” as entire net income minus investment income and other exempt income. The new law also narrows the definition of investment capital to only stock held in a non-unitary entity held no more than six months but not held for sale to customers, and excludes bonds and other securities. The new law presumes that ownership of stock representing less than 20 percent of the voting power of the corporation is non-unitary. Furthermore, the new law defines “other exempt income” as exempt unitary corporation dividends and exempt controlled foreign corporation income. A unitary corporation dividend is considered to be a dividend from a corporation engaged in a unitary business with the taxpayer that is not included in the unitary combined return. Exempt foreign corporation income means income which federal law requires to be included, under IRC §951(a), from a unitary entity that is not included in the unitary combined report.

Changes to net operating losses

Under current New York law, net operating losses are carried pre-apportionment and are subject to a series of complex carryback and carryforward rules. Under the new law, net operating losses are computed on a post-apportionment basis, can be carried back for up to three years before the preceding loss year or carried forward 20 years. The net operating losses cannot be carried back to any tax year before the 2015 tax year. The new law provides that the New York net operating loss deduction is no longer limited to that allowed under the federal net operating loss deduction. However, the maximum net operating loss which can be claimed in a given year can be no higher than the higher of the tax on the capital base or the fixed dollar minimum. The new law also provides specific rules regarding the treatment of any net operating losses created prior to the laws’ new unitary combined reporting rules.

Apportionments redefined

The new law significantly changes New York’s rules regarding how business income is apportioned. Under the new law, most corporate taxpayers will generally be required to utilize a customer-based approach to sourcing receipts. Under current law, service receipts are sourced to where the taxpayer actually performs the service and most other types of receipts are sourced on a destination basis. Therefore, recharacterization of receipts from services receipts to any other category can make a significant difference in the calculation of the apportionment factor. The new law eliminates the discrepancy in the sourcing rules for service receipts and other types of receipts by providing destination or market sourcing rules for all types of receipts.

The new law provides several categories and examples of receipts and how such receipts should be treated for sourcing and apportionment purposes and creates several new categories for categorizing receipts, including a new category for digital products. The new law also provides specific rules for sourcing of advertising based on the type of media used. In general, the new law provides that print advertising will be sourced to where the print media is delivered and television, radio and Internet advertising will be sourced to the location where the program or website is viewed.

Changes in tax rates

The new law reduces the tax rate for the business income base and eliminates the capital base by gradually reducing the rate over seven years. The business income tax rate is being reduced from 7.1 percent to 6.5 percent for tax periods after Jan.1, 2016. Furthermore, the maximum limit on the capital tax base will be reduced from $10 million to $5 million. Once the capital base has been completely phased out, starting after Jan.1, 2021, the Corporate Franchise Tax will be calculated by the greater of the business income base or the fixed dollar minimum. The new law retains the current fixed dollar minimum tax for New York state-sourced receipts. However, the tax is incrementally increased up to $200,000 for those taxpayers with more than $1 billion in New York receipts, which is significantly more than the previous $5,000 cap.

Alterations to combined reporting standards

New York’s new law also completely repeal’s the former combined reporting rules. Under the new law, a combined report is required if the taxpayer owns or controls either: (1) directly or indirectly more than 50 percent of the voting power of capital stock of one or more corporations; or (2) more than 50 percent of the voting power of the capital stock of which is owned or controlled either directly or indirectly by one or more other corporations; or (3) more than 50 percent of the voting power of capital stock of which, and the capital stock of one or more other corporations, is owned and controlled, directly or indirectly by the same interests. If one of the preceding applies, combined reporting is required if the taxpayer is also engaged in a unitary business with those corporations. The new law generally requires a few other corporations to be included in a combined report: (1) “combinable” captive insurance companies; (2) alien corporations with effectively connected income; and (3) captive real estate investment trusts (REITs) and regulated investment companies (RICs).

The budget also allows a taxpayer to elect to be treated as a combined group if all corporations in its combined group meet the greater than 50 percent ownership requirement, even if each member of the group is not conducting a single, unitary business. Once the election to file a combined report is made, it is irrevocable for that tax year and the subsequent six tax years. Such combined report election will renew automatically if not revoked on the applicable return.

Conclusion

Companies who currently pay New York franchise taxes should carefully review these changes with their advisors to consider the advantages and disadvantages created by the enactment of the new law. Furthermore, corporations which are not currently liable for New York franchise taxes should also review the changes with their advisors to ensure that they remain exempt and do not have nexus under the expanded nexus definition.

For additional information regarding these subjects or any other multistate tax issues, please contact:

David M. Kall
216.348.5812
dkall@mcdonaldhopkins.com

Susan Millradt McGlone
216.430.2022
smcglone@mcdonaldhopkins.com

Jeremy J. Schirra
216.348.5444
jschirra@mcdonaldhopkins.com 

Businesses must be vigilant and careful in managing their state and local tax liabilities and exposures. We understand this can be a daunting task. McDonald Hopkins Multistate Tax Services provides a broad range of state and local tax services including tax controversy, tax evaluation, tax planning, and tax policy. With professionals who have worked both inside and outside government agencies, our multistate tax team leverages its knowledge and experience to help clients control their complex multistate taxes.

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