By Andy Hammons
With the stated goals of “making out-of-state businesses pay their fair share of taxes” and “helping Tennessee-based businesses,” Tennessee Governor Bill Haslam recently signed into law the Revenue Modernization Act (RMA) (House Bill 0644). The RMA includes the following modifications to Tennessee law:
- Adopts economic nexus thresholds for the business tax and the franchise and excise tax
- Replaces the existing apportionment double-weighted sales factor with a triple-weighted sales factor for calculating the franchise and excise tax
- Adopts market-based sourcing for sales other than the sale of tangible personal property
- Adds an elective apportionment calculation for high-volume sellers with distribution centers in Tennessee
- Amends the excise tax deduction for intangible expenses paid to an affiliate
- Expands sales tax to include remotely accessed software
- Adds a presumption of “click-through” nexus for sales and use tax purposes for certain dealers
Effective for tax years beginning on or after January 1, 2016, the RMA broadens the definition of “substantial nexus in this state” for both business tax and franchise and excise tax purposes and implements a “bright-line presence” threshold. Under the RMA, a taxpayer has substantial nexus in the state if:
- The taxpayer is organized or commercially domiciled in Tennessee;
- The taxpayer owns or uses its capital in Tennessee;
- The taxpayer has systematic and continuous business activity in Tennessee that has produced gross receipts attributable to Tennessee customers;
- The taxpayer licenses intangible property for use by another party and derives income from that use in Tennessee; or
- The taxpayer has “bright-line presence” in Tennessee.
“Bright-line presence” in Tennessee occurs if any one of the following tests is satisfied:
- The taxpayer’s total receipts in the state during the tax year exceed the lesser of $500,000 or 25% of its total receipts everywhere;
- The average value of the taxpayer’s real and tangible personal property owned or rented and used in the state during the tax period exceeds the lesser of $50,000 or 25% of the average value of all the taxpayer’s total real and tangible personal property; or
- The total amount paid in the state during the tax period by the taxpayer for compensation exceeds the lesser of $50,000 or 25% of the total compensation paid by the taxpayer.
Triple-weighted Sales Factor Apportionment Formula
Effective for tax years beginning on or after July 1, 2016, the RMA changes the apportionment formula (property, payroll, and sales) for franchise and excise taxes from the current double-weighted sales factor to a triple-weighted sales factor.
Market-based Sourcing for Sales Other than the Sale of Tangible Personal Property
Effective for tax years beginning on or after July 1, 2016, the RMA changes the method for sourcing sales of services and sales of intangible property, for franchise and excise tax purposes, to market-based sourcing principles, replacing the current cost-of-performance method of sourcing. Market-based sourcing looks to where the consumer is located to determine whether a sale should be sourced to Tennessee. Under the market-based sourcing approach, receipts from sales, other than from the sale of tangible personal property, are in Tennessee if and to the extent the taxpayer’s market for the sale is in Tennessee. The taxpayer’s market for a sale is in the state:
- In the case of real property, to the extent the property is located in the state;
- In the case of tangible personal property, to the extent the tangible personal property is in the state;
- In the case of a service, to the extent the service is delivered to a location in the state; and
- In the case of intangible property, to the extent the intangible property is used in the state.
If the location of the sale cannot be determined, a reasonable approximation should be used; if the location cannot be reasonably approximated, the sale should be thrown out of the sales factor.
Elective Apportionment for High-volume Sellers Operating Distribution Centers in Tennessee
Effective for tax years beginning on or after January 1, 2016, the RMA creates an elective apportionment calculation, for franchise and excise tax purposes, for high-volume sellers who choose to use distribution centers located in Tennessee. To qualify, a taxpayer’s sales of tangible personal property in Tennessee must exceed $1 billion, and the taxpayer’s Tennessee receipts factor must exceed 10%. Qualifying taxpayers will be entitled to elect to exclude such sales from their receipts numerator and instead pay a graduated “gross receipts” tax on those excluded receipts with rates ranging from 0.125% to 0.5%, depending on the amount of certified distribution sales.
Change to the Excise Tax Deduction for Intangibles Expenses Paid to an Affiliate
Tennessee law currently provides an excise tax deduction for intangible expenses paid to an affiliate if a taxpayer meets one of three safe harbor exceptions or if the taxpayer submits an application to take the deduction and the application is approved by the Department of Revenue (“Department”) Commissioner. The RMA eliminates the application process and revises the safe harbor provision. Effective for tax years beginning on or after July 1, 2016, intangible expenses paid to an affiliate may be deducted if the expense is disclosed, and:
- The affiliate to whom the expense has been paid, accrued, or incurred is registered for and paying the excise tax; or
- The expense was paid, accrued, or incurred to an affiliate in a foreign nation that is a signatory to a comprehensive income tax treaty with the United States or to an affiliate that is otherwise not required to be registered for or to pay the excise tax.
Expansion of Sales and Use Tax to Include Remotely Accessed Software and Video Game Digital Products
Effective July 1, 2015, the RMA provides that for sales and use tax purposes, the use of computer software is defined to include access and use of software that remains in the possession of the dealer who provides the software or in the possession of a third party on behalf of such dealer. If the customer accesses the software from a location in this state as indicated by the residential street address or the primary business address of the customer, such access shall be deemed equivalent to the sale or licensing of the software and electronic delivery of the software for use in this state.
This provision applies to “cloud computing” and/or “software as a service.” The law change exempts dealers who purchase computer software only for reselling access and use of the software and also exempts software developed by an affiliate. Additionally, the RMA allows for multiple points of use sourcing based on the percentage of software users located inside and outside of Tennessee.
The Department is expected to promulgate regulations related to the taxation of software as a service, but these will not be final by the date the law becomes effective.
The sale of “video game digital products” is also subject to Tennessee sales and use tax. The Act defines a “video game digital product” as the right to access and use computer software that facilitates human interaction with a user interface to generate visual feedback for amusement purposes, when possession of the computer software is maintained by the seller or a third party, regardless of whether the charge for the service is on a per use, per user, per license, subscription, or some other basis.
A Presumption of Click-through Nexus for Sales and Use Tax Purposes
Effective July 1, 2015, the RMA creates a presumption of “click-through” nexus for sales and use tax purposes if:
- A dealer enters into an agreement with a person located in Tennessee under which such person refers potential customers to the dealer whether by an Internet link, website, or other means; and
- The dealer’s cumulative gross receipts from retail sales made by the dealer to customers in Tennessee who are referred to the dealer by all such persons who have entered into this type of an agreement with the dealer exceed $10,000 during the preceding 12 months.
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