Michigan recently adopted the Michigan Business Tax Act (“MBT”). The MBT, which becomes effective January 1, 2008, will replace the Michigan Single Business Tax (“SBT”) with two new taxes — a business income tax (“BIT”) and a modified gross receipts tax (“MGRT”).1
The MBT applies only to taxpayers with total Michigan gross receipts of at least $350,000.2 The taxpayer must compute its liability for each of the BIT and the MGRT separately (i.e., the taxes are cumulative), but must report the liability for both taxes on a single return.3 The return is due on the last day of the fourth month following the close of the taxpayer’s tax year.4
The BIT is imposed on every taxpayer with “business activity” within the state.5 Business activity is broadly defined to include all activities engaged in with the object of gain, benefit or advantage.6 The tax is equal to 4.95 percent of the taxpayer’s state taxable income.7 State taxable income is generally equal to that portion of federal taxable income derived from business activity, as modified by certain additions and subtractions, that is apportioned to Michigan.8 Accordingly, income that is not derived from business activity is apparently not subject to the BIT, although there is currently little guidance regarding what types of income would be included in this category. The state modifications provided for are similar to those found in most other state jurisdictions; however, it is important to note the disallowance of deductions for royalty and interest expenses paid to related parties if the related party is not within the unitary business group.
The MGRT applies only to taxpayers with either (1) gross receipts in excess of $350,00010 and involved in active solicitation of sales within Michigan or (2) a physical presence within Michigan for more than one day (including presence by an employee, agent or independent contractor acting on behalf of the taxpayer).11 The MGRT is equal to 0.80 percent of the taxpayer’s gross receipts less purchases from other firms that are apportioned to Michigan.12 Gross receipts are broadly defined to include all amounts received by a taxpayer for its own direct or indirect gain, benefit or advantage.13 Purchases from other firms include acquisitions of inventory, federally depreciable or amortizable assets (including the cost of fabrication and installation), materials, supplies, repair parts and fuel.14
Both the BIT and the MGRT apply the same general rules for apportioning income/gross receipts.15
Income/gross receipts are apportioned to Michigan based on a single sales factor.16 The sales factor is equal to the ratio of the taxpayer’s total sales that are sourced to Michigan to the taxpayer’s total sales everywhere. Sales include consideration from transfers of tangible (both real and personal) and intangible property; the performance of services that constitute business activities; the rental, lease, licensing or use of tangible and intangible property, including interest, as long as it is considered from business activities; or any combination of the above.17 For taxpayers not engaged in other types of business activities, sales include interest, dividends and other income from investment assets and activities from trading assets and activities.18
As in most states, sales of tangible personal property are sourced to the state to which the property is shipped (i.e., so-called “destination-based sourcing”). Sales of real property (as well as leases of real property or loans secured by real property) are sourced to the state in which the property is located.19 Sales of services are generally sourced based on either the location of the customer or the primary place of benefit or use (i.e., so-called “marketplace-based sourcing”). This is a departure from the sourcing rules adopted under the old SBT and also differs from the rules adopted in many states providing that the sourcing of sales of services is based on costs of performance. This difference may create significant advantages for taxpayers that are based in Michigan and that provide services to out-of-state customers — in particular, these taxpayers would often be able to exclude these sales from the numerators of their apportionment factors in both Michigan and the market state.
Michigan has adopted combined reporting for taxpayers under the MBT.20 Thus, in computing a taxpayer’s tax under either the BIT or the MGRT, the taxpayer must include all income, gross receipts and apportionment factors of all members of the taxpayer’s unitary business group. For this purpose, a unitary business group is defined to include all United States persons21 where (1) one entity within the group owns or controls, directly or indirectly, in excess of 50 percent by vote or comparable rights and (2) the group has operations that are integrated, dependent or contribute to one another or that result in a flow of value between its members.22 All of the facts and circumstances are considered in determining whether such a flow of value exists.23
All members included within the unitary business group are treated as a single taxpayer for purposes of the BIT and the MGRT. Accordingly, all intercompany transactions will be eliminated from the BIT base, the MGRT base and the sales factor utilized in calculation of both taxes.24
Qualified taxpayers may take advantage of an assortment of tax credits to reduce their combined BIT and MGRT liability.25 In addition to retaining a variety of credits currently available under the SBT, the MBT has increased the number and type of credits for the purpose of improving the state’s business climate and encouraging growth of small businesses. New credits include a compensation credit, investment credit, research and development credits and personal property tax credits. Eligibility is usually linked to a commitment to the state whether by creating jobs, setting up headquarters, purchasing certain types of equipment or making monetary investments within local communities.
Moreover, any credit carryforward yet to be utilized and generated under the SBT may be used to offset the MBT in either the 2008 or 2009 tax years.26
Insurance Companies and Financial Institutions
Insurance companies and financial institutions are not subject to either the BIT or the MGRT.27 Instead, an insurance company is subject to a tax equal to 1.25 percent of gross direct premiums written on property or risk located or residing within Michigan.28 A financial institution is subject to a tax equal to 0.235 percent of the entity’s net capital (computed on a five-year average) if the entity either (1) has gross receipts in excess of $350,000 and is involved in active solicitation of sales within Michigan or (2) has a physical presence within Michigan for more than one day (including presence by an employee, agent or independent contractor acting on behalf of the financial institution).29
Neither insurance companies nor financial institutions may be included in a combined BIT or MGRT report even if these entities belong to the unitary business group of a taxpayer filing such a report.30 Hence, any business income attributable to an insurer or financial institution must be eliminated from the BIT base; any gross receipts must be eliminated from the MGRT base; and any sales must be eliminated from the apportionment formulas used in computing the BIT and MGRT. Affiliated financial institutions will be required to file a combined report with only those members of a unitary business group similarly subject to the tax on financial institutions.31 There is no similar provision for affiliated insurance companies.