This Week in State Tax

Read recent state tax developments including a California sales and use tax update, Illinois and Maine adjusting sales tax of leased personal property, Nebraska rejecting repatriation tax deduction, Massachusetts allowing financial institutions tax credits, and Virginia exempting tax on manufacturing equipment.

State and local developments for the week of September 9, 2024

California: Legislature Sends Bills to Reduce Taxation of Machinery and Equipment and Require Disclosure of Local Tax Agreements to Governor

Last week, the California Legislature approved and sent to Governor Newsom two bills involving the state’s Bradley-Burns Uniform Local Sales and Use Tax Law, which allows counties, cities, and districts to impose local sales and use tax in their respective jurisdictions.

Assembly Bill 52, creates an income tax credit for taxpayers that paid local sales or use tax on property qualifying for the manufacturing or research and development exemptions. The current exemption for such equipment extends only to the 3.9375 percent state tax that is allocated wholly to the state. The current exemption (and credit if approved) applies to qualified tangible personal property purchased by a qualified person for use primarily in manufacturing, processing, refining, fabricating, or recycling of tangible personal property, or for use primarily in research and development.

Under AB 52, if approved, a taxpayer is allowed a credit against its net income tax in an amount equal to the total of local sales and use tax paid during the taxable year on tangible personal property that qualifies for the state-level exemption. The authorized credits would only take effect for taxable years for which the Legislature appropriates funding specifically to administer the credits. They would be available beginning January 1, 2025, and before January 1, 2030. If a credit exceeds the net tax due, it may be carried over to the following taxable year, and the succeeding eight years or until the credit is exhausted.

The Legislature also passed Assembly Bill 2854 concerning agreements between certain local jurisdictions and retailers for rebates of a portion of the local sales and use tax. In the past, local jurisdictions have used such agreements to incentivize retailers to locate within that jurisdiction by sharing with the retailer a portion of the local sales and use tax emanating from its sales, a feature attributable largely to the origin-based sourcing rules applied by California.

Under AB 2854, if approved, local jurisdictions will be required to report to the Department of Tax and Fee Administration by April 30 of each year certain information about agreements involving the rebate of sales and use tax revenues. The required information includes the names of parties, the amount of rebated revenues received by each party for the current and preceding fiscal year, the date the agreement was executed, and the percentage of a retailer’s sales and use taxes used to determine the rebated revenues received. The same information must be posted on the local government’s website on or before April 30 of each year. The bill authorizes the imposition of daily monetary penalties for failure to provide or publish the information. On or before June 1, 2025, the Department of Tax and Fee Administration shall also publish on its website the information submitted by local jurisdictions. Governor Newsom has until September 30 to sign or veto these bills. For questions about the legislation, please contact Jim Kuhl.

Massachusetts: Appellate Board Says Financial Institutions Eligible for Tax Credits

The Massachusetts Appellate Tax Board (Board) recently determined that a financial institution is eligible to claim the state’s research credit. For tax years 2016 - 2018, the taxpayer filed a combined return as a “Financial” group, which included a principal banking subsidiary and investment software company. On its returns for the relevant tax years, the taxpayer claimed the Massachusetts research credit. The Commissioner of Revenue (Commissioner) audited the relevant years and denied the credit. The taxpayer appealed to the Board.

Before the Board, the Commissioner contended that eligibility for the research credit was limited to general corporations subject to the corporation excise tax. This disqualified financial institutions that are subject to a separate tax. The Board ultimately held in favor of the taxpayer, holding that under the plain and ordinary meaning of the statutory language of the research credit, there was nothing to limit it to corporations subject to the corporation excise tax. The statute says that “business corporations” are eligible to claim the research credit. Massachusetts law defines “business corporation” as “any corporation,” which would include a financial institution. The Board rejected the Commissioner’s argument that the statute was limited to business corporations subject to the general corporation tax, holding that no such limitation exists and creating one would be beyond the plain reading of the statute. Further, there was nothing “absurd” or “illogical” about a financial institution claiming a research credit for which it otherwise qualified. The Board ultimately granted the taxpayer a full abatement of the assessment. Please contact Nikhil Sequeira for more information on State Street Co. v. Massachusetts Commissioner of Revenue (August 15, 2024).

Nebraska: Supreme Court Holds TCJA Repatriation Income Not Deductible Dividend

The Nebraska Supreme Court recently upheld a district court ruling holding that repatriation income under IRC section 965 did not qualify for the state’s “deemed dividends received” deduction. Recall, the Tax Cuts and Jobs Act of 2017 (TCJA) required the shareholders of certain controlled foreign corporations (CFCs) to include the accumulated earnings and profits of the CFCs from 1986 through 2017 on their 2017 federal tax return (i.e., section 965 or repatriation income) and imposed a 10 percent federal tax on that amount. The taxpayer reported the repatriation income on its 2017 federal tax return but did not include it on its Nebraska corporation income tax return. In December 2021, the taxpayer amended its 2017 Nebraska return to include the section 965 income. In March 2022, the taxpayer filed a request with the Department of Revenue seeking a declaratory order to amend its 2017 Nebraska return to claim the dividends received deduction for the section 965 income. The Tax Commissioner denied the order. In the Commissioner’s view, the deduction did not apply to section 965 inclusion income. The taxpayer appealed to the district court, which affirmed the Commissioner’s position. The taxpayer then appealed to the Nebraska Supreme Court.

The court first noted that it was undisputed that the IRC section 965 income was properly included in federal taxable income: the starting point for Nebraska taxable income. At issue was whether the section 965 income was considered “dividends ... deemed to be received” and thus eligible for deduction under Nebraska law. The Tax Commissioner contended that nothing in the language of IRC section 965 deems the income inclusion to be a dividend. The taxpayer, on the other hand, argued that section 965 deemed the income inclusion as having been received as a distribution from the retained earnings of its CFCs, and such distribution should have been treated as a dividend for purposes of the deduction.

The court ultimately held that the section 965 income was not a dividend deemed received by the taxpayer. The court relied heavily on the U.S. Supreme Court’s recent Moore decision when characterizing the income. In that case, the Justices characterized section 965 inclusions as “pass-through income,” which attributed earnings of the CFCs to the shareholders without regard to whether those earning are distributed to the shareholders. Thus, the pass-through income did not operate as a deemed distribution (i.e., a deemed dividend received) and as such was not deductible. Notably, the court’s opinion did not consider whether the taxpayer was entitled to any apportionment factor representation related to the IRC section 965 income, as is generally the case for other types of “pass-through income” (e.g., a partner’s distributive share of a partnership’s income).

Please contact Kara Hernandez for more information on Precision Castparts Co. v. Nebraska Department of Revenue (August 30, 2024).

Virginia: Commissioner Determines Testing Equipment Qualifies for Manufacturing Exemption

The Tax Commissioner recently ruled that a manufacturer of electronic components used primarily in telecommunications was entitled to an exemption on purchases of property used directly in its manufacturing process. Initially, the department denied the taxpayer’s refund request, stating the property was used for testing finished products and not in the manufacturing process. The Commonwealth exempts the purchase of machinery, tools, repair parts, or supplies from sales and uses tax if used directly in manufacturing or processing. The state defines “used directly” as being used in activities integral to the production of a product, including handling and storage of raw materials, control up to the last step of production, and production line testing and quality control. Virginia law further classifies equipment used for production line testing or quality control as exempt from tax.

Before the Commissioner, the taxpayer provided supplemental information demonstrating that the equipment was used for testing or quality control during the manufacturing process, before the product was placed into its housing and labeled. This indicated that the testing occurred before the final stage of assembly. The Commissioner determined that the taxpayer’s property was used directly in its manufacturing process for quality control and testing during production. Therefore, the taxpayer was entitled to a refund. For information on Ruling 24-69 (July 9, 2024), contact Jeremy Jester.

Multistate: Illinois and Maine Change Sales Taxation of Leased Personal Property

Illinois and Maine adopted legislation earlier this year to change the collection and remittance of sales and use tax on leased property. In June, Illinois Governor Pritzker signed House Bill 4951 which will require lessors to begin collecting tax on payments for the lease of tangible personal property. Under prior law, lessors would pay Illinois retailers’ occupation tax or use tax on the cost price of tangible personal property to be leased and were not required to collect tax from lessees on periodic lease payments. The bill states that the imposition of tax applies to leases in effect, entered into, or renewed on or after January 1, 2025. The new rules do not apply to leases of motor vehicles, watercraft, aircraft, and semitrailers that are required to be registered with the state. There is also an exemption for leased property that is subject to a tax imposed by a home rule unit of local government, such as Chicago, if the ordinance imposing the tax was adopted prior to January 1, 2023.

As to Maine, the Department of Revenue Services (MRS) recently released a bulletin summarizing changes to the taxation of leases of tangible personal property under legislation signed by Governor Mills earlier this year. Beginning on January 1, 2025, sales tax on leased tangible personal property will be imposed on each periodic lease payment charged by the lessor to the lessee. Previously, the lessor was required to pay sales tax upfront based on the purchase price of the property. Under the new regime, lessors will provide a resale certificate when purchasing tangible personal property for lease or rent. Lessors will then collect sales tax from lessees on each subsequent lease payment due on or after January 1, 2025, including leases that commenced prior to that date.

New rules also apply for sourcing periodic lease or rental payments as of January 1, 2025. For tangible personal property other than motor vehicles, trailers, and transportation equipment, the first payment will be sourced according to existing rules. Subsequent payments will be sourced to the “primary property location,” defined as an address for the property provided by the lessee that is available to the lessor from its records and maintained in the ordinary course of business, when use of the address does not constitute bad faith.

Finally, MRS advises qualified lessors who paid Maine sales or use tax upfront on the purchase of qualifying lease or rental property on or after January 1, 2023 and before January 1, 2025, and who subsequently collect and remit Maine sales or use tax on the lease of that property on or after January 1, 2025, may request a refund of the tax paid. The refund claim must be submitted on or after January 1, 2027 and before March 31, 2027, and the refund is limited to the tax collected and remitted by the lessor on the property on or after January 1, 2025 and before January 1, 2027.

For questions about Illinois leasing rules, please contact Drew Olson. For questions about Maine leasing rules, please contact Ryanne Tannenbaum.

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