Winning a contract in a new state can present many challenges, not least of which is ensuring that your company is compliant with the state’s tax code. The worst approach to state tax compliance is assuming that the taxes your company may be subject to and the tax treatment of your company’s activity will be the same as in other states. This is especially the case when it comes to Hawaii. It’s not surprising that many government contractors venturing into Hawaii overlook the General Excise Tax (GET), as it’s often assumed that the GET is essentially the same as most other states’ sales and use taxes. However, the unique nature of the GET can catch many businesses off guard, and the Department of Taxation’s penalties can be quite unforgiving.
The first thing every government contractor needs to know about the Hawaii GET is that it is NOT a sales tax. Certainly, the GET has some similarities to a typical sales and use tax. However, the GET has three critical distinctions from a typical sales tax, all of which affect government contractors. Those distinctions are:
Contractors hanging their hat on the “I am a government contractor, so I am exempt from tax” stance are in for a rude awakening when they receive a notice from Hawaii requesting GET returns for the past decade. Most government contractors providing services to the government are subject to the GET at a rate of either 4.0% or 4.5% of their gross receipts, so it does not take a particularly large contract to result in a material tax liability.
At its core, the GET is rather simple. The tax base for a service provider is generally gross revenue from services performed from within Hawaii. Given that the GET is a gross receipts tax, there are very few exemptions or deductions. However, the few that government contractors should be aware of are:
Government contractors need to be proactive in recognizing that their receipts will likely be subject to the GET, so the additional costs should be factored into their bids. Contractors that are assessed years after a contract has ended will likely be unable to recoup those liabilities from their customers. Finally, the penalties assessed by Hawaii can be up to 60% of the tax liability, but there is a fair chance of getting those penalties waived, especially if you come into compliance before Hawaii issues you a notice.
If you have concerns about your company’s compliance with the Hawaii GET, please contact Aronson or Michael L. Colavito, Jr. at 301.231.6200.
Three more jurisdictions have added their names to the growing list of states that are implementing market-based sourcing into their income tax rules. Effective for tax years beginning on or after January 1, 2016, Connecticut, Louisiana, and Tennessee will change their method of calculating the sales factor for sales of other than tangible personal property to a market-based rule from a cost-of-performance rule. Service providers will likely bear the brunt of this change.
Of course, when it comes to implementing market-based sourcing provisions, one size does not fit all. There are many variations of how states define a service providers market and a number of hierarchical step-down rules that are used when the general rule cannot be applied. For example, a state may define a taxpayer’s market as where the service is delivered, where the benefit of the service is received, or where the customer is located. These may be distinctions without a difference depending on a taxpayer’s particular facts. Tax practitioners could engage in lengthy debates regarding if and when these slight differences in the state market-based sourcing rules result in different outcomes for service providers.
However, it’s the differences clear as day, which should cause the most concern for taxpayers. For instance, many states have enacted market-based sourcing for one business entity type, but not for all. This is reflected in the most recent group of states: Connecticut, Louisiana, and Tennessee, who are moving to market-based sourcing. Louisiana’s legislation (H.B. 20) is specific to the corporate income and franchise tax. Thus, pass-through entities will still apply a rule that requires taxpayers to source revenue from services based on where they’re performed. Tennessee and Connecticut, on the other hand, made the change applicable to both its corporate and individual income and excise tax rules. Nonetheless Connecticut’s shift to market-based sourcing will take effect for tax year 2016 for corporate taxpayers, while the individual income law will not change until 2017.
Thus, taxpayers have to deal with states having different sourcing rules such as cost-of-performance v. market-based, as well as the variations from state-to-state within those different rules. Currently, a handful of states now have different sourcing rules for different types of taxpayers; New York, Pennsylvania, and Rhode Island have contradicting sourcing rules across different entity types. These states are also relative newcomers to market-based sourcing. There may be valid reasons for states limiting the application of market-based sourcing, and those reasons may vary from state-to-state. Regardless, as we move toward market-based sourcing as the majority rule in states with an income tax, taxpayers and practitioners alike should be mindful that the lack of uniformity in revenue sourcing arises on varying fronts.
If you have questions about your company’s revenue sourcing methodology, please contact Michael L. Colavito, Jr., JD, at 301.231.6200.
The D.C. Council has proposed legislation that would provide most D.C. workers 16 weeks of paid leave after the birth or adoption of a child, to recover from an illness, to recuperate from a military deployment, or to tend to an ill family member. The benefits would be funded by a new tax on employers, similar to a state unemployment tax. The legislation, if it passes, would make the District the most generous jurisdiction in the nation when it comes to paid family leave benefits.
According to the legislation (the Universal Paid Leave Act of 2015), employees working at least 50% of the time for a District employer would be eligible for 16 weeks of paid leave. Employees making up to $52,000 a year would receive 100% of their pay. Employees who earn more than that would be eligible for $1,000 a week plus 50 percent of their additional income, up to a maximum of $3,000 per week. Residents of the District employed by the federal government can opt into the system for a small fee.
D.C. employers would fund the family leave coverage through a payroll tax. Although the tax is structured somewhat similar to an unemployment tax, there are two key differences that many employers could find controversial. First, instead of a flat rate applying to all wages paid by an employer, the tax rate increases for highly paid employees. Secondly, there is no taxable wage-base for the proposed tax. The tax brackets are as follows:
It seems likely that some form of the legislation will pass, as the initial version of the proposal is supported by half of the Councilmembers. The proposal is arguably somewhat in contrast to recent legislation in the District that reduced income tax rates for businesses in the District. Still, some proponents of the bill claim that the legislation, if enacted, will make the District even more competitive.
If you have any questions about the proposal or any other D.C. tax issues, please contact your Aronson tax advisor or Michael L. Colavito, Jr. at 301.231.6298.
A new sales tax regulation in Alabama directly contradicts the bright-line physical presence nexus standard created by the U.S. Supreme Court in Quill Corp. v. North Dakota. While Congress has debated (and been unable to enact) multiple versions of federal legislation that would limit the application of the physical presence nexus standard for certain retailers, the Alabama Department of Revenue has ignored these impediments by promulgating its own “economic nexus” rule.
The new regulation, which takes effect on January 1, 2016, establishes a bright-line sales threshold for nexus that is similar to Alabama’s recently enacted statute defining when a corporation is doing business for income tax purposes. However, Alabama is the first state to apply such a bright-line rule for sales tax.
The regulation provides that “out-of-state sellers who … are making retail sales of tangible personal property into the state have a substantial economic presence in Alabama for sales and use tax purposes and are required to . . . collect and remit tax . . . if the seller’s retail sales of tangible personal property sold into the state exceed $250,000” in a calendar year. The regulation also requires some form of activity that reflects purposeful availment to the Alabama market by a retailer. However, most of the activities listed in the regulation that will trigger the collection of tax do not require a physical presence in the state. These activities include solicitation of sales through television or print advertising, such as the distribution of catalogs. These are the exact types of activities that have been deemed not to create a “physical presence” under the current sales tax nexus rules established by the U.S. Supreme Court.
The Department’s expectation with respect to this new regulation is unclear. Most retailers meeting the requisite $250,000 sale threshold that do not have a physical presence in Alabama will likely not follow the new rule given its apparent inconsistency with federal law. It will be interesting to see if the Department of Revenue seeks to enforce the rule against non-compliant retailers, especially given the U.S. Supreme Court’s recent hinting at its willingness to reconsider the rule established in Quill.
If you have questions about your company’s sales and use tax obligations, please contact your Aronson tax advisor or Michael L. Colavito, Jr. at 301.231.6298.
Alabama has revoked a twenty-year-old sales tax ruling, and in doing so has ruled that electronically transmitted information is taxable tangible personal property for sales tax purposes. The notice issued by the Alabama Department of Revenue on September 3, 2015 cites advances in technology and analogous expansions of the definition of “tangible personal property” to canned (i.e., prewritten) software and electricity as support for it decision. Alabama’s decision seems troubling when considering the otherwise limited application of it sales tax and the means by which it has expanded its sales tax in the past.
The application of a state’s sales tax to what most states consider a service (i.e., an information service) is typically accomplished by the enactment of a statute that specifically enumerates the service as being subject to sales tax. Alabama’s informal memorandum (which seems to be the best characterization of the document issued by the Department) is a prime example of a significant change in tax policy being established by an administrative agency. Other states have issued similar informal guidance, for example, by ruling that sales tax applies to software-as-a-service (SaaS). However, states that have administratively concluded that SaaS is taxable have largely already had an enacted statute stating that canned software is taxable regardless of the method of delivery. In such case, the taxing authority is arguably making a reasonable interpretation of existing law. Here, Alabama does not otherwise tax information services.
The expansion of Alabama’s tax base to canned software was accomplished through an Alabama Supreme Court case in 1996, which held that canned software is “tangible personal property.” The Department of Revenue subsequently promulgated a regulation addressing the taxation of computer software in more detail. Thus, in the case of software, the Department had a decision of the state’s highest court that it was interpreting. The Department’s reliance on that very case, which addressed the narrow issue of whether canned software is subject to sales tax, to support its conclusion that electronically transmitted information is also tangible personal property is quite a stretch.
This is especially the case given the fact that Alabama does not otherwise tax information services. How expansive are taxpayers to interpret this pronouncement? Is all electronically transmitted information now taxable? Can sales tax be avoided if the information is delivered in hard copy because the application of the “true object” test, which Alabama applies, results in the principal purpose of the sale being a nontaxable transfer intangible property?
Essentially, Alabama’s notice leaves taxpayers, both those providing information services online and in a tangible form, with a significant amount of uncertainty. Still, this is not terribly surprising, given the slow nature of state legislatures to react to new methods by which products and services are delivered. Tax administrators across the country are routinely faced with similar questions requiring them to fit a square peg into a round hole. Unfortunately, the conclusions are anything but uniform; leaving taxpayers, especially those offering products and services online to customers in multiple states, with a certain level of risk.
If you are interested in learning more about how states are taxing technology companies, please join us for our upcoming webinar series: Taxing Tech. If you have questions about the application of sales tax on your products or services, please contact your Aronson tax advisor or Michael L. Colavito, Jr. at 301.231.6200.