On June 30, 2015, Ohio Governor John Kasich signed into law the biennial budget bill, Amended Substitute House Bill No. 64 (“HB 64”). The legislation underwent substantial changes during the legislative process such that the original budget proposed by the Governor was far different from the enrolled bill. Even at the end of the process, the Governor entered 44 line-item vetoes.
The Governor’s original proposal represented a tax shift favoring the conduct of business in pass-through entity form by decreasing the Ohio income tax, while increasing the tax burden for a business conducted as a C corporation. The Governor’s initial proposal also represented a shift from income taxes to consumption taxes (including the Ohio commercial activity tax [CAT], sales and use taxes, and certain excise taxes on specific commodities). The Ohio General Assembly largely rejected the Governor’s proposal to increase the CAT and the sales and use taxes, while approving a smaller reduction in the income tax. The enacted personal income tax reductions were not funded by CAT increases or sales and use tax increases. Instead, the tax reductions were “funded” by a 35-cent increase in the tax on a pack of cigarettes and the increased revenue recognized from existing taxes.
Changes in the Income Tax
Although the Governor did not achieve as much of a reduction in the income tax as he desired, the trend of reducing the income tax continued with this budget. Income tax rates were reduced by 6.3 percent across all brackets. The new top marginal rate is 4.997 percent. The new rates are retroactive to January 1, 2015.
Small business owners, including investors in pass-through entities, experience a decline in the tax burden through an increase in the benefit of the small business deduction. For 2015, the deduction is 75 percent of Ohio apportioned business income up to $250,000. The 2016 deduction is 100 percent of Ohio apportioned business income up to $250,000. Moreover, the excess Ohio business income is subject to only a 3.0 percent flat tax rate.
Limited Changes in the CAT
The Governor had proposed a 23 percent increase in the CAT rate, from .0026 to .0032. This increase was not enacted. Contrary to this proposed increase, the members of the Ohio General Assembly are hearing about how the CAT is unfair, especially for certain industries with small margins and unprofitable companies, such as start-ups.
The budget provides a new exclusion from the CAT, but the exclusion is limited to certain beauty and health products supply chain receipts for entities operating in New Albany, Ohio. The budget also made changes in the petroleum activity tax, including the sale of propane and LPG.
Limited Changes in the Sales and Use Taxes
The big news for sales and use taxes under the budget is that the General Assembly did not embrace the increases proposed by the Governor. An 8.7 percent increase in the state sales tax (from 5.75 percent to 6.25 percent) before addition of county and other local rates was rejected. The General Assembly also rejected the application of sales and use taxes to certain services, including research and public opinion polling, public relations, management consulting, debt collection, and repossession services. The public relations and management consulting services were of particular concern to the business community because the services were defined so imprecisely that they appeared to apply much more broadly than the services traditionally provided by public relations, lobbyist, and pure management consulting services firms.
Some specific exemptions were added or clarified, including (1) the rental of motor vehicles to customers while the customer’s car is in the shop when the cost of the rental is reimbursed and (2) sanitation services provided to meat processing operations that are necessary to comply with 21 U.S.C. 608. The sanitation exemption highlights the fact that the Tax Commissioner continues to assert that activities undertaken by food manufacturers that are necessary to prevent the adulteration of food product manufacturing operations are said to be taxable as janitorial services.
Nexus for Use Tax
While not much focus was placed on the revisions to the Ohio nexus standard for remote sellers for purposes of the use tax, it appears that the changes could be significant. The changes were perceived to be principally an implementation of the “Amazon” standards focused on “click-through nexus.” The budget bill does implement click-through nexus using the New York model (click-through activities by Ohio residents create a presumption of nexus), but the statutory amendment also makes other changes. Arguably, the other changes provide new safe harbors from a finding of Ohio nexus for activities conducted in Ohio. The changes to the nexus statute follow:
(H) "Nexus with this state" means that the seller engages in continuous and widespread solicitation of purchases from residents of this state or otherwise purposefully directs its business activities at residents of this state.
(I)(1) "Substantial nexus with this state" means that the seller has sufficient contact with this state, in accordance with Section 8 of Article I of the Constitution of the United States, to allow the state to require the seller to collect and remit use tax on sales of tangible personal property or services made to consumers in this state."
(2) "Substantial nexus with this state"
exists is presumed to exist when the seller does any of the following:
Maintains a (a) Uses an office, distribution facility, warehouse, storage facility, or similar place of business within this state, whether operated by employees or agents of the seller, by a member of an affiliated group, as defined in division (B)(3)(e) of section 5739.01 of the Revised Code, of which the seller is a member, or by a franchisee using a trade name of the seller; or any other person, other than a common carrier acting in its capacity as a common carrier. (2)(b) Regularly has uses employees, agents, representatives, solicitors, installers, repairmen, salesmen repairers, salespersons, or other individuals persons in this state for the purpose of conducting the business of the seller; or either to engage in a business with the same or a similar industry classification as the seller selling a similar product or line of products as the seller, or to use trademarks, service marks, or trade names in this state that are the same or substantially similar to those used by the seller. (3)(c) Uses a any person, other than a common carrier acting in its capacity as a common carrier, in this state for receiving following purposes: any of the purpose of
(i) Receiving or processing orders of the seller's goods or services;
(ii) Using that person's employees or facilities in this state to advertise, promote, or facilitate sales by the seller to customers;
(iii) Delivering, installing, assembling, or performing maintenance services for the seller's customers;
(iv) Facilitating the seller's delivery of tangible personal property to customers in this state by allowing the seller's customers to pick up property sold by the seller at an office, distribution facility, warehouse, storage facility, or similar place of business.
(4)(d) Makes regular deliveries of tangible personal property into this state by means other than common carrier;. (5)(e) Has membership in an affiliated group, as described in division (B)(3)(e) of section 5739.01 of the Revised Code, at least one other member of which person that has substantial nexus with this state;. (6)(f) Owns tangible personal property that is rented or leased to a consumer in this state, or offers tangible personal property, on approval, to consumers in this state; (7) Except as provided in section 5703.65 of the Revised Code, is registered with the secretary of state to do business in this state or is registered or licensed by any state agency, board, or commission to transact business in this state or to make sales to persons in this state;
(8) Has any other contact with this state that would allow this state to require the seller to collect and remit use tax under Section 8 of Article I of the Constitution of the United States.
(g) Enters into an agreement with one or more residents of this state under which the resident, for a commission or other consideration, directly or indirectly refers potential customers to the seller, whether by a link on a web site, an in-person oral presentation, telemarketing, or otherwise, provided the cumulative gross receipts from sales to consumers referred to the seller by all such residents exceeded ten thousand dollars during the preceding twelve months.
(3) A seller presumed to have substantial nexus with this state under divisions (I)(2)(a) to (f) of this section may rebut that presumption by demonstrating that activities described in any of those divisions that are conducted by a person in this state on the seller's behalf are not significantly associated with the seller's ability to establish or maintain a market in this state for the seller's sales.
(4) A seller presumed to have substantial nexus with this state under division (I)(2)(g) of this section may rebut that presumption by submitting proof that each resident engaged by the seller as described in that division did not engage in any activity within this state during the preceding twelve months that was significantly associated with the seller's ability to establish or maintain the seller's market in this state during the preceding twelve months. Such proof may consist of sworn written statements from all the residents with whom the seller has an agreement stating that the resident did not engage in any solicitation in this state on behalf of the seller during the preceding twelve months if such statements are provided and obtained in good faith.
(5) A seller that does not have substantial nexus with this state, and any affiliated person of the seller, before selling or leasing tangible personal property or services to a state agency, shall register with the tax commissioner in the same manner as a seller described in division (A)(1) of section 5741.17 of the Revised Code.
(6) As used in division (I) of this section:
(a) "Affiliated person" means any person that is a member of the same controlled group of corporations as the seller or any other person that, notwithstanding the form of organization, bears the same ownership relationship to the seller as a corporation that is a member of the same controlled group of corporations.
(b) "Controlled group of corporations" has the same meaning as in section 1563(a) of the Internal Revenue Code.
(c) "State agency" has the same meaning as in section 1.60 of the Revised Code.
The Ohio Tax Department was not the source of this language. We expect that at some point, the Tax Department will issue guidance about how the new statute will be implemented. Based on the initial review of the language, several observations are warranted.
- Merely registering to do business or being licensed in Ohio no longer creates nexus.
- Selling to a state agency requires registration in the same manner as a use tax seller.
- The catch-all language is eliminated that formerly provided that nexus is created by any contact with Ohio other than those contacts that the U.S. Constitution would prohibit using to create nexus. Thus, the Ohio tax commissioner must point to some statutory basis for asserting that a point of contact creates nexus.
- Certain activities conducted in Ohio by common carriers specifically do not provide nexus. See R.C. 5739.01(I)(2)(a), which seemingly permits a remote seller to store inventory in Ohio so long as the storage is done by a common carrier. The issue is whether a public warehouse (i.e., a warehouse that is not operated by the customer) would be a common carrier such that the storage of inventory in a public warehouse would not create nexus.
- The new statue in R.C. 5739.01(I)(3) provides that even if a presumption of nexus exists, the remote seller could overcome that presumption by proving that the seller “did not engage in any activities within [Ohio] during the preceding twelve months that weresignificantly associated with the seller’s ability to establish or maintain the seller’s market in this state …” See R.C. 5741.01(I)(4); emphasis added. This language would suggest that some kinds of non-marketing activities conducted in Ohio could be asserted to not create nexus.
We will continue to monitor developments in the application of the new nexus standards.
Tax Policy Issues
The consideration of the budget raised several policy questions that remain to be resolved, including:
- The proper severance tax rate;
- The appropriate manner of providing incentives for historical building projects;
- The adjustments needed for credits based on income taxes paid as the income tax rate declines – the jobs creation tax credit and the jobs retention tax credit are two examples of such incentives that must be adjusted; and
- Review of the overall tax structure.
That Commission is being established to evaluate every state tax reduction authorized by the Revised Code.