The Washington State Legislature recently passed 2ESSB 6143 that includes the following components. This description is at a very high level, and there is much detail that is not mentioned below. This post addresses only the 2ESSB 6143. There were also other tax bills that passed this session and they are not covered in this discussion.
1. Minimum Nexus. The legislation enacts “economic” nexus standards to apply to out-of-state businesses for B&O tax purposes. This affects businesses that do not sell tangible personal property; in other words, the affects businesses that sell services and other business activities (rate 1.5%, 1.8% beginning May, 1, 2010 and 1.5% beginning July 1, 2013) like financial services or the management and receipt of royalties. Except for financial institutions, the provision would use a single sales factor formula (the state is abandoning the Rule 194 apportionment method; the Department must establish apportionment for financial institutions by rule), which means that out-of-state businesses would pay B&O tax on 100% of the sales into Washington. The corollary is that instate businesses selling services out of state would also use the single sales factor, allowing Washington services business to pay no B&O on their out-of-state sales. This is good news for the instate businesses and bad news for the out-of-state businesses. Apportionment formula for service income is Washington sales divided by worldwide sales. Sales are sourced to Washington if the benefit can be attributed to Washington. Otherwise, there is a series of attribution rules that must be followed. This will be tricky because the formula is based on the current tax year, which is technically impossible to determine until the tax year has been completed. The law permits the use of the prior year’s formula but the taxpayer must make adjustments by October 31 following the close of the tax year. Any taxes due bear interest from the date the tax was due.
Economic nexus is established with the state if the taxpayer has more than $250,000 of receipts from Washington customers. Nexus is also established if Washington payroll is more than $50,000 and the Washington property is more than $50,000. Nexus is also established if more than 25% of the total property, total payroll and total sales are in Washington. There are allocation rules to determine whether the payroll, property or sales are treated as part of Washington’s domain. These standards, presumptively, reach taxpayers who might try to dissociate physical nexus from a revenue stream that lacks physical presence. Once economic nexus is present, it lasts for the current and one subsequent tax year.
An obvious question is whether it is constitutional on either the nexus principle or the single sales factor division of income. The bill recognizes the risk stating that this section of the bill is null and void if a court invalidates the law. It is not clear why this language is in bill unless the state will interpret null and void to mean that the law never existed, opening the door to tax retroactively the businesses that benefitted from the single sales factor formula. (Effective June 1, 2010.)
2. Tax Avoidance Transactions. This section of the bill allows the Department of Revenue to disregard certain transactions that it believes lack economic substance and are used to avoid Washington excise taxes. The power to disregard applies to three identified transactions if they lack economic substance that include:
- joint ventures organized so as to substitute payments for goods and services with the return of capital;
- setting up separate entities outside of Washington in order to move taxable income to another jurisdiction; and
- the “drop kick” subsidiary that was used to eliminate sales or use tax on tangible personal property transfers between non-related parties.
The Department is permitted to consider the following to determine if the transactions have economic substance:
- Whether an arrangement or transaction changes in a meaningful way, apart from its tax effects, the economic positions of the participants in the arrangement when considered as a whole;
- Whether substantial nontax reasons exist for entering into an arrangement or transaction;
- Whether an arrangement or transaction is a reasonable means of accomplishing a substantial nontax purpose;
- An entities' relative contributions to the work that generates income;
- The location where work is performed; and
- Other relevant factors.
The bill also requires the Department to apply a 35% penalty when it determines that transaction or arrangement should be disregarded. Transactions or arrangements have immunity if the taxpayer reported its tax liability based on specific reporting instructions given by the Department, a determination published under RCW 82.32.410, or other instructions that the Department gave to the general public. (Effective date of the preceding provisions is retroactive to January 1, 2006.)
The bill creates a temporary joint legislative review committee to monitor the Department’s implementation of this section of the bill and to study use of substance over form. Further, to the extent resources allow, the Department may study the taxing of intercompany transactions when tax applied is merely because of the form of the transaction and the economic substance is lacking. (Both expire on July 1, 2011.)
The bill also addresses gaps in the real estate excise tax by eliminating the use of options to avoid the real estate excise tax. Parties used binding options, requiring buyers to acquire not more than 50% of the real estate interest over three consecutive years to a transfer a taxable “controlling interest.” This can no longer be done to avoid the real estate excise tax. (Effective May 1, 2010.)
The bill also eliminates the ability of the seller and buyer to avoid the real estate excise tax by use of entity created for the purpose of holding and then selling the real estate in cases it that entity was eventually dissolved without paying the tax before dissolution. (Effective May 1, 2010.)
The bill also clarifies that a foreclosure does not trigger the tax on the transfer to the secured creditor but it does apply to the eventual sale to a third party. (Effective May 1, 2010.)
3. The First Mortgage Interest Deduction. This section clarifies the deduction that mortgage lenders take on the interest that they receive. It clarifies that interest, points and loan origination fees recognized over the life of the loan qualify for the deduction. A sample of what is excluded are receipts for documentation preparation, finder fees, brokerage fees, title examination fees, gains from the sale of servicing rights, and gains from the sale of loans. However, the originator of the loan may deduct service fees if the originator sold the loans under certain circumstances or the taxpayer acquired the loan originator through a merger or acquisition. (Effective June 1, 2010.)
4. The Direct Seller Representative Exemption. This section eliminates a substantial part of the exemption for out-of-state sellers who sold goods exclusively through a statutorily defined agent. This section retroactively narrows the exemption to sales only done in home parties and door-to-door sales by limiting the exemption to (1) out-of-state taxpayers that sell only consumer products (taxpayer cannot sell both consumer and nonconsumer products) and (2) out-of-state taxpayer that use direct seller representatives who make retail sales in the home. (Effective retroactively for periods prior to April 1, 2010; the exemption is repealed for the period after March 31, 2010.)
5. B&O Tax Preferences for Manufacturers of Products Derived from Certain Agricultural Products. Under the original statutory language, certain processing of meat products derived from animals extended beyond slaughterhouses and butchers. The legislature now prevents the processing of meat into food products (like chili con carne) from qualifying the lower B&O tax rate (.0138%). The provision also clarifies the special processing rate does not apply to fish. (Effective June 1, 2010.)
Similarly, the bill clarifies that the special rate (.0138%) applies to fruit and vegetable processing as long as the final product is exclusively fruits, vegetables or any combination of the two. (Effective June 10, 2010.)
6. Suspending Sales and Use Tax Exemption for Livestock Nutrients etc. This section suspends the sales and use tax exemption for certain livestock nutrient management equipment and related labor and services. (Effective July 1, 2010 until June 30, 2013.)
7. B&O Tax Treatment on for Director Fees Received. There is no statutory exemption and this bill makes it clear that such director fees paid to a director must be reported as gross receipts for B&O tax purposes under the service rate (1.8% including the temporary service tax increase described below). Recognizing that some taxpayers have already paid this tax, the bill denies refunds to those who previously paid the tax on the basis that the tax was always due and to grant refunds would be a gift of public funds in violation of Article VIII, Section 5 of the state constitution. Consequently, there is a temporary, unwritten exemption --- for those directors who received director fees but have not paid the tax --- until the July 1, 2010 effective date of this section. (Effective July 1, 2010 and retroactively.)
8. Tax Debts. Under current law, if a taxpayer collects sales tax from its customers but does not pay it over to the state, then the “responsible party” who “willfully” failed to pay the state could be held personally liable for the collected but unremitted sales tax. This section will create strict and personal liability for the CEO and CFO of the collected but unremitted sales tax. Lack of knowledge (which means, apparently, even theft by an employee) is no defense. In order to trigger this personal liability, the Department of Revenue must (1) issue a warrant to the taxpayer and (2) the taxpayer must be insolvent, or the taxpayer must have been terminated, dissolved or abandoned. Noteworthy is that the personal liability attaches even though the CEO or CFO may not be employed at the time the warrant is issued and the taxpayer is insolvent, or has been terminated, dissolved or abandoned. The critical question is whether the CEO or CFO was employed in that capacity at the time the liability accrued. (Effective May 1, 2010.)
9. Repeal of the Sales and Use Tax Exemption for Bottled Water and Candy. Under this section, sales tax will now apply to bottled water and candy until July 1, 2013. “Candy” is defined as a product prepared with sugar, honey, or other natural or artificial sweeteners in combination with chocolate, fruits, nuts, or other ingredients or flavorings in the form of bars, drops, or pieces. It does not include preparations made with flour and does not require refrigeration. “Bottled water” is water that is bottled in a sealed container or package for human consumption. It is calorie free and does not contain sweeteners or other additives though it may contain antimicrobial agents, fluoride, carbonation, vitamins, minerals, electrolytes, oxygen, preservatives and flavors, extracts or essences derived from a spice or fruit. There are some exceptions that apply to prescriptions; bottled water is the only source of water and others. For candy manufacturers, there is a B&O credit for employees employed in Washington State. The Department of Revenue must compile a list of products that fall within and without the products on which the sales and use tax applies. (Effective June 1, 2010.)
10. PUD Privilege Tax Clarification. This section clarifies that any recurring charge billed to customers as a condition to receiving electric power is subject to the tax imposed under Chapter 54.28 RCW. (Effective prospectively.)
11. Temporary Increase of B&O Tax on Service; Increase of Small Business Credit. This section temporarily increases the B&O tax rate from 1.5% to 1.75% beginning on May 1, 2010 until June 30, 2013. This increase does not apply to hospitals or companies performing research and development. The small business credit for the businesses affected by this temporary tax doubled from $35 to $70 per month. (Effective May 1, 2010.)
12. Property Management Salaries. Under current law, property management companies that assigned employees to live on-site property for property owners (owners of apartment houses) were allowed to deduct the wages paid to the assigned employees. This section will eliminate the deduction for profit property management companies. The exemption remains for (1) wages of employees employed by nonprofit management companies and (2) amounts paid by a housing authority to a property management company for on-site personnel. (Effective June 1, 2010.)
13. Temporarily Increasing Beer Taxes. Until June 30, 2013, this section imposes an additional tax of $15.50 on a thirty-one gallon barrel of beer. This section exempts the first 60,000 barrels of beer per year if the brewery is entitled to a reduce tax rate under 26 U.S.C. Sec. 5051 of the federal internal revenue code. (Effective June 1, 2010.)
14. Temporarily Imposing Tax on Carbonated Beverages. This section imposes a selling tax on the privilege of selling at wholesale or retail carbonated beverages at the rate of two cents per twelve ounces of carbonated beverages. There is an exemption for carbonated beverages if they were previously taxed under this section. There is also an exemption for the first ten million dollars of carbonated beverages sold in Washington. (Effective July 1, 2010 through June 30, 2013.)
15. Limiting Bad Debt Deduction. This section limits the bad debt deduction for sales that has been collected and paid to the state to the seller who collected, paid but did not fully recover the sales tax from the customer. This eliminates the ability to assign the right to the refund to a purchaser of the loan, preventing the assignee from taking the bad debt deduction. (Effective May 1, 2010.)
16. Data Centers. This section permits a sales and use tax exemption for eligible server equipment installed in an eligible computer data center. The scope includes equipment, labor and services to install the same as well as eligible power infrastructures. The applicant must apply in advance for a certificate to buy the goods and services without paying the sales or use tax. The benefit is tied to creating a certain number and type of jobs. As with other tax benefit programs, an annual report must be filed with the Department. (Effective May 1, 2010.)