TWIST - This Week in State Tax

Welcome to TWIST for the week of May 1, 2023, featuring Sarah McGahan from the KPMG Washington National Tax state and local tax practice.

First up today, a significant tax package has been sent to Governor Bill Lee of Tennessee for signature. The bill makes numerous corporate excise and franchise tax changes, including adopting IRC section 168 as it exists and applies under the Tax Cuts and Jobs Act, and phasing in single receipts factor apportionment over a three-year period. Although there is no excise rate reduction in the bill, the legislation exempts a company’s first $50,000 in net earnings from excise tax and exempts up to $500,000 of property in computing franchise tax liability.  On the sales tax side, the bill provides for a sales tax holiday for food and food ingredients from August 1, 2023 through October 31, 2023 and also makes certain changes to the state’s sales tax sourcing rules and business tax laws.

In Michigan, the Department of Treasury has issued a Notice in response to legislation effective April 26, 2023 providing that delivery and installation charges are not included in the “sales price” under certain conditions. Notably, such charges must be separately stated on the invoice or bill of sale provided to the purchaser, and the seller must maintain records to show separately the transactions used to determine the sales or use tax. Delivery and installation charges that fail to satisfy these conditions or that involve, or are related to, the sale of electricity, natural gas, or artificial gas by a utility remain subject to sales tax and use tax unless otherwise exempt.

In other news, the Arizona Tax Court recently held that a laundry business was not entitled to state and city sales tax exemptions for purchases of equipment and chemicals used to transform unusable, soiled linens into disinfected linens suitable for use in healthcare facilities. The court concluded that although the taxpayer’s business included some processing of the linens as they were cleaned and disinfected, it was required to look to the taxpayer’s business as a whole to determine whether it was commonly understood to be a processing operation. In the court’s view, a linen rental business that used equipment to clean and disinfect linens for healthcare facilities was not commonly understood to be a processing operation, but a laundry.

Arizona: Laundry Business Not Entitled to Processing Exemption

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The Arizona Tax Court recently held that a laundry business was not entitled to state and city sales tax exemptions for purchases of equipment and chemicals used to transform unusable, soiled linens into clean, disinfected linens suitable for use in healthcare facilities. Under Arizona law, a Transaction Privilege Tax (sales tax) exemption applies to purchases of “machinery, or equipment, used directly in manufacturing, processing, fabricating, job printing, refining or metallurgical operations.”  The issue before the court was whether the taxpayer’s laundry business was a “processing” operation entitled to the exemption. The term "processing," is defined to include operations commonly understood to be within the ordinary meaning of the term. The Department of Revenue asserted that the taxpayer did not qualify for the exemption because it was not preparing raw materials for conversion into marketable form, as the Department asserted was necessary to qualify for the exemption.  The tax court did not find the issue of whether the taxpayer prepared raw materials to be determinative. Rather, the court concluded that although the taxpayer’s business included some processing of the linens as they were cleaned and disinfected, it was required to look to the taxpayer’s business as a whole to determine whether it was commonly understood to be a processing operation. In the court’s view, a linen rental business that used equipment to clean and disinfect linens for healthcare facilities was not commonly understood to be a processing operation, but a laundry. In reaching this conclusion, the court cited to an earlier case addressing whether a pizzeria was entitled to the processing exemption for equipment used to prepare dough and make pizza. The appeals court in that instance similarly found that as a matter of law, a restaurant that uses machinery or equipment to make pizza dough from scratch is not commonly understood to be a processing operation. In a bit of rhetorical flourish, the tax court ended by citing an earlier state supreme court decision indicating that when the legislature creates a tax exemption, “it does so notoriously enough to attract investors, not surreptitiously enough to evade detection.”  Although the fact that laundries had not attempted to avail themselves of the processing exemption for over 30 years was not dispositive, in the court’s view, it did buttress the Department’s argument. Please contact Stacey Matthew with questions on 9W Halo Opco LP v. Dep’t of Rev.

Michigan: Notice Addresses Recent Change in Taxability of Delivery and Installation Charges

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The Department of Treasury recently issued guidance on a recent law change around the taxability of delivery and installation charges. Public Act 20 made several changes to the taxability of delivery and installation charges previously included in the “sales price” for sales tax purposes or “purchase price” for use tax purposes. Effective April 26, 2023, delivery and installation charges are no longer included in the “sales price” or “purchase price” if the seller (1) separately states the charges on the invoice, bill of sale, or similar document provided to the purchaser and (2) maintains appropriate books and records detailing the transactions used to determine the applicable tax. Delivery and installation charges related to the sale of electricity, natural gas, or artificial gas by a utility remain taxable for sales and use tax purposes unless otherwise exempt. 

In addition to the taxability changes, Public Act 20 requires Treasury to cancel all outstanding (unpaid) balances in existence before the effective date related to the delivery and installation charges on Notices of Intent to Assess and Final Assessments issued by Treasury no later than ninety (90) days after the effective date. The Act further prohibits Treasury from issuing new assessments for tax periods before the effective date. The Act does not establish a right to a refund for sales or use tax on delivery or installation charges remitted before the effective date. While there is no statutory requirement for retailers to refund customers for taxes collected in error, customers may seek a refund from retailers who continue to charge taxes on delivery or installation charges after the effective date, and the retailer may then seek a refund from Treasury for tax remitted upon proof of refunding to the customer. Treasury is working to locate and cancel existing assessments, but taxpayers with outstanding balances for delivery or installation charges are strongly encouraged to contact Treasury. Please contact Ryan Hohenthaner for questions on Public Act 20 of 2023 and Treasury Release on “Changes in the Taxability of Delivery and Installation Charges for Sales and Use Taxes, dated April 26, 2023.

Tennessee: Significant Tax Changes Pending Enactment

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A significant tax bill (Senate Bill 275 and House Bill 323) was recently presented to Governor Bill Lee for signature; the governor has indicated his intent to sign the bill. If enacted, the bill would make several changes to Tennessee’s tax laws. On the excise (corporate income) tax side, for assets purchased on or after January 1, 2023, Tennessee would adopt IRC section 168 as it exists and applies under the Tax Cuts and Jobs Act. A provision requiring taxpayers to add back federal bonus depreciation would be revised to make clear it applies only to assets purchased before January 1, 2023. A new subtraction equal to the lesser of net earnings or $50,000 would apply in computing net earnings under the excise tax law. However, this amount could not create a net loss. For franchise tax purposes, for tax years ending on or after December 31, 2024, a new exemption applies in computing the franchise tax base. Specifically, the measure of the tax would apply only to the actual value of the taxpayer's aggregate real or tangible property in excess of $500,000.   On the franchise and excise tax side, the bill phases in single sales factor apportionment. Currently, for both excise and franchise tax purposes, taxpayers are required to use a three-factor formula with the receipts factor weighed three times. Under the bill, for tax years ending on or after December 31, 2023, but before December 31, 2024, the receipts factor would be weighted five times. That weighting for the receipts factor would increase to eleven for tax years ending on or after December 31, 2024, but before December 31, 2025.  For tax years ending on or after December 31, 2025, net earnings would be apportioned using the receipts factor only. If applying the revised law resulted in a lower apportionment ratio than the current method under which the receipts factor is weighted three times, a taxpayer with net earnings (not a net loss) would be allowed to annually elect to apply the old method.

On the sales and use tax side, the bill would impose use tax (at the same rate as sales of tangible personal property at retail) on the repairing of tangible personal property or computer software, the laundering or dry cleaning of tangible personal property, the installing of tangible personal property that remains tangible personal property after installation, and the installing of computer software, when such repair, cleaning, or installation occurs at a place of business outside this state and the serviced tangible personal property or computer software is delivered by the seller to the purchaser or the purchaser's designee within the physical limits of Tennessee. Exemptions for certain magazines and books and cooperative direct mail advertising would be eliminated. A sales tax holiday for food and food ingredients would be held from August 1, 2023 through October 31, 2023.  The bill also makes certain changes to the state’s sourcing rules and business tax laws. Please stay tuned to TWIST for future legislative updates.