The Tennessee General Assembly recently passed the Revenue Modernization Act (the “Act”), which imposes broad, sweeping changes by adopting revised nexus standards for Tennessee business tax, franchise and excise tax, and sales and use tax purposes; revising Tennessee apportionment for business tax and franchise and excise tax purposes; and imposing sales tax upon remotely accessed video games as well as online software access. The Act stems from comments by Tennessee Governor Bill Haslam in his State of the State address delivered on February 9, 2015, wherein he noted the sharp decline in tax collections from business that the state experienced in 2014. Gov. Haslam stated that the drop in revenue collections was partly due to a disparity between the taxes paid by “companies outside of Tennessee that do business in Tennessee,” and those “that our in state and homegrown companies” are required to pay. The resulting Revenue Modernization Act was proposed to remedy this disparity and “level the playing field in terms of sales tax and business taxes.” The Act currently awaits signature by the House Speaker and Governor.
Broad Nexus Standards
With regard to nexus, the Act affirms the Legislature’s intent to broadly impose taxing nexus over out-of-state businesses to the full extent permissible under the United States Constitution for business tax, franchise and excise tax, and sales and use tax purposes. The Act also creates a bright-line nexus test for business tax and franchise and excise tax purposes whereby taxpayers would be deemed to have sufficient physical presence in Tennessee when, during a tax period:
- total receipts exceed $500,000 or 25% of total receipts everywhere, or
- the average value of tangible personal property owned or rented in Tennessee exceeds the lesser of $50,000 or 25% of the average value of real and tangible personal property everywhere, or
- compensation paid in Tennessee exceeds $50,000 or 25% of total compensation paid.
The Act additionally imposes nexus for franchise and excise tax purposes on taxpayers licensing intangibles for use within Tennessee—following a trend already adopted in numerous other states. Finally, for sales and use tax purposes, the Act creates a presumption of nexus where a seller enters into an agreement with one or more Tennessee persons where, in exchange for some consideration, said person refers potential customers to the dealer and the dealer’s gross sales from such referrals exceed $10,000 over a twelve-month period. This provision is similar to what has been dubbed “Amazon legislation” adopted in several other states, and the presumption of substantial nexus would only be rebuttable where a taxpayer could show by clear and convincing proof that no contracted party conducted any activities in Tennessee that would substantially contribute to the seller’s ability to establish and maintain a market in the State.
Business Tax Changes
With regard to business tax, the Act broadens the tax base by applying the tax to parties:
- selling tangible personal property shipped into Tennessee,
- selling services delivered to a Tennessee location,
- leasing tangible personal property located in Tennessee, and
- natural gas marketers selling to in-state customers while holding property (including pipeline capacity) or conducting any other activities within the state via employees, agents, independent contractors, or similar parties.
The Act also limits the exclusion from business taxation for out-of-state services to include only those delivered to out-of-state locations, as opposed to the current rule which excludes services substantially performed in another state.
Franchise and Excise Tax Changes
With regard to franchise and excise tax, the Act changes Tennessee’s apportionment formula to adopt a triple-weighted receipts factor beginning July 1, 2016. The Act also replaces Tennessee’s cost-of-performance methodology for sourcing sales of other than tangible personal property for apportionment purposes with a market-sourcing approach. Under the cost-of-performance test, such sales are sourced to Tennessee only where the greater proportion of earnings-producing activity that can be attributed to the sales is performed in Tennessee based upon costs of performance. The new market approach under the Act sources sales based upon the deemed delivery location, or use location, of the sale or service. To the extent that a sale cannot be sourced—either precisely or approximately—under this proposed methodology, the Act adopts a throw-out rule which excludes the sale from both the numerator and denominator of the sales factor for apportionment purposes. However, to the extent that market sourcing results in a lower apportionment factor, a taxpayer may elect to continue using costs-of-performance sourcing for intangibles so long as such election results in a higher apportionment factor. We understand that this election is intended to address taxpayer concerns regarding financial reporting and tax credit carry-forward valuations. The General Assembly’s replacement of the cost-of-performance method with a market-based sourcing method and its adoption of a triple-weighted sales factor in Tennessee’s apportionment formula places greater emphasis upon a taxpayer’s sales market, as opposed to where a taxpayer chooses to primarily operate, in carving up income among states for taxation purposes.
The Act also adopts special rules for sourcing receipts for certain telecommunication service providers, mobile telecommunication service providers, Internet providers, video programming service providers, direct-to-home satellite television service providers, or parties providing a combination of these services which constitute qualified members of a qualified group making total qualified expenditures or taxable Tennessee sales in excess of $150 million. The Act additionally provides a new franchise and excise tax apportionment carve-out incentive election for taxpayers operating in Tennessee and both making sales of tangible personal property in excess of $1 billion and having a receipts factor exceeding 10% for apportionment purposes. Qualifying taxpayers making this election would be entitled to exclude “certified distribution sales” from the numerator of the sales factor for apportionment purposes. “Certified distribution sales” are defined to include sales of tangible personal property made in Tennessee to distributors when such goods are certified as having been sold for resale and ultimate use outside Tennessee. Electing taxpayers will be subject to an excise tax on certified distribution sales at a graduated rate starting at 0.5% for up to $2 billion in certified distribution sales, 0.375% for certified distribution sales between $2 billion and $3 billion, 0.25% for certified distribution sales between $3 billion and $4 billion, and 0.125% for certified distribution sales exceeding $4 billion.
Finally, the Act restricts deductions for intangible expenses paid to affiliates to instances where the intangible expense is disclosed to the Department and either (i) the affiliate is registered and paying Tennessee franchise tax, or (ii) the affiliate is in a foreign nation that is a signatory to a comprehensive income tax treaty with the United States or is otherwise not required to register and pay Tennessee franchise and excise tax. The Act imposes a negligence penalty upon taxpayers who fail to disclose intangible expenses paid to affiliates or to include such expenses in net earnings or losses.
Sales and Use Tax Changes
With regard to sales and use tax, the Act imposes sales and use tax upon purchases of “video game digital products,” which are defined to include video games, access to which are provided remotely over the Internet on a per use, per user, per license, subscription, or other basis. The Act also imposes Tennessee sales and use tax upon the sale of online computer software access provided pursuant to application service provider (ASP) or software as a service (SAAS) platforms to customers with residential street addresses or primary business addresses in Tennessee. Where the purchase price of such ASP or SAAS access relates to users both inside and outside of Tennessee, the Act provides that the seller may allocate the sales price based upon the percentage of in-state and out-of-state users. The Act further provides that services not currently subject to tax, such as payment processing services, Internet services, or the mere provision of online data storage, will remain exempt. ASP/SAAS providers will be permitted to purchase software using resale certificates; however, software purchased by qualified data centers for use by affiliated entities will still be subject to sales and use tax. The Act also enacts revised exemption provisions for self-created and/or affiliate-created software.