On the heals of the passage of the Revenue Modernization Act in 2015 and a quiet regulation project that the Department embarked upon in 2016 to implement the broadened tax authority implemented by the RMA (market sourcing, taxation of remotely accessed software and business tax revisions), the question in the Tennessee tax community in 2017 was whether the Legislature could come up with any new tax changes that would be of any significance. That thinking changed when the Governor decided to pursue a full-court press during the 2017 Tennessee legislative session to increases to the gas tax. At that point, all bets were off, and taxpayers began coming out of the woodwork seeking numerous tax law changes that had been considered dead on arrival in previous years, turning the 2017 legislative session into a rather eventful year for the Tennessee tax community.
The primary legislation was the IMPROVE Act, which was a continuing trend of the Haslam Administration to bake rhetoric into Tennessee tax legislation, so that legislators could use these "clever" titles while on the campaign trail - "Revenue Modernization" ... "IMPROVE" ... get it, we're doing some good work for you guys ... despite having to raise taxes. It appears that IMPROVE wasn't good enough for some legislators, so the bill was amended during the session to add the alternative title of the "2017 Tax Cut Act" ... we guess so that there would be no doubt about what a great job the Tennessee government is doing on behalf the voters ... except for the small fact that the Act included offsetting revenue increases that, according to the bills fiscal note, exceeded the tax cuts. (Interestingly, the fiscal notes have been removed from the legislature's website. How convenient...)
In addition to the IMPROVE Act, there were also separate bills that had significance, including changes for sales tax economic nexus, annualized estimated payments for F&E taxes, adoption of the Revised Uniform Unclaimed Property Act, and modifications to the sales taxation of telecom companies. Below is a summary of the most significant changes.
Single Sales Factor for Manufacturers
A measure that had been pushed by the Tennessee Chamber of Commerce for years, single sales factor apportionment for manufacturers, finally made it into a bill that could pass. In years past, the Department of Revenue was unwilling to get on board with the change due to the fiscal note assigned to single sales factor apportionment, but to gain the support of the Chamber and Tennessee manufacturers for a bill that was highly controversial for its increase in the gas tax, the Administration pulled out all the stops, and Tennessee manufacturers were the benefactors of this confluence of events with an amendment that allows manufacturers to elect to apportion franchise and excise tax using a single sales factor.
The key term in this revision is that the taxpayer has to be a "Tennessee manufacturer," which is defined as a taxpayer with revenue from its Tennessee activities of 50% or more from fabricating or processing tangible personal property for resale and consumption off the premises.
Practice Point: This definition is a familiar one for Tennessee manufacturers as it is used for the sales tax, industrial machinery exemption but with the key difference being that the determination of whether a taxpayer is a manufacturer for purposes of F&E apportionment is based on a statewide calculation and not on a location-by-location basis, which is the case with the sales tax. The location-specific determination under the sales tax code oftentimes leaves certain facilities in Tennessee out, and they do not qualify as manufacturing facilities for purposes of the sales tax exemption. Based on this distinction, manufacturers should carefully evaluate whether they meet the 50% test under this change.
Another important part of the definition is that passive income is excluded from the test to determine whether a taxpayer is a manufacturer, which again makes it more plausible for some entities to qualify as manufacturers despite being close to the line when they run the numbers.
Single sales factor apportionment is elective, but once a taxpayer elects in, it is bound by the election for five years. Another point to focus on for taxpayers is the proper application of single sales factor to combined franchise tax filers, as the election only applies to group members that qualify as manufacturers.
Annualized Estimated Excise Tax Payments
Dating back several years, the Tennessee Chamber of Commerce, along with numerous Tennessee taxpayers, had been focusing the Department of Revenue on the antiquated estimated payment regime that did not provide alternative estimated payment mechanisms for taxpayers whose income stream is not consistent throughout the year. Federal tax law allows such taxpayers to make "annualized" estimated payments based on a rolling determination of net income, and the Chamber has been a consistent proponent of incorporating such a provision into the Tennessee F&E tax code.
Under the former law, there was an incentive for tax directors to overpay estimated payments to avoid penalties in Tennessee, which resulted in unrealistic revenue expectations for the state when budgeting. Some even believe that this small issue accounted, in part, for the revenue shortfalls from the 2014 time period when the Haslam Administration's tax collections came up well short of projected revenues.
Despite the Chamber's efforts, this change had been rebuffed in previous years due to a fiscal note and concerns that the one-time shift of revenue from the timing of estimated payments was too costly. However, just as single-factor apportionment became doable so the Governor could get his gas tax increase passed, the annualized estimated payment proposal became palatable for the Administration to avoid any opposition to other tax increases being proposed by the state in the IMPROVE Act.
Based on the change, Tennessee taxpayers now have the option to make estimated payments on an annualized basis. This change only applies to the excise tax and not to the Tennessee franchise tax.
Practice Pointer: The annualized estimated payment methodology was modeled in part on the federal law, so taxpayers should carefully review the provisions of this change to determine whether the annualized estimated payment methodology is beneficial and should be used.
Sales Tax, Economic Nexus Regulation Cannot be Enforced
Another significant and highly controversial act of the Legislature in 2017 was the passage of limitations on the Department of Revenue's ability to enforce the recently-promulgated regulation adopting sales tax, economic nexus in Tennessee. Based on the amendment passed to the Omnibus Rules Bill, the Department cannot require out-of-state retailers with no physical presence in Tennessee to collect and remit Tennessee sales tax until the pending lawsuit challenging Rule 129 (American Catalog Marketers Association v. Gerregano) is fully resolved AND the rule is approved by the General Assembly.
Practice Point: Based on the pending lawsuit and the legislation, taxpayers should carefully review what, if any, action is warranted considering the uncertainty surrounding the economic nexus rule. Taxpayers whose only contact with Tennessee is through economic nexus need not begin collecting and remitting tax until future action by the Legislature. The Department has, however, issued Notice 17-12 indicating that taxpayers may voluntarily begin collecting and remitting sales tax under the economic nexus rule, and if they do so, they will receive amnesty for prior periods. Amnesty is not available unless a taxpayer voluntarily registers and begins collecting sales tax. This may present an opportunity for out-of-state companies to receive a de facto amnesty, by coming into compliance - a lucrative proposition that should be considered.
Tennessee - Early Adopter of Revised Uniform Unclaimed Property Act
The Legislature became the second state to adopt the Revised Uniform Unclaimed Property Act - which is a model law drafted by the Uniform Law Commission. Tennessee's own Charlie Trost was the Reporter on the revised model law. Tennessee pretty much adopted the entire revised model act, except Tennessee maintained its existing law related to ongoing business relationships and the treatment of gift cards - two of the most controversial provisions during the drafting process.
Practice Point: Unlike some states, that provide an unlimited business to business exemption for unclaimed property, Tennessee's unclaimed property B2B exemption is limited to situations in which there is an ongoing business relationship, which creates some uncertainty for holders of property.
There are revised procedures for administrative challenges under the new law, which take effect immediately. For entities under audit, these provisions will likely mean a more familiar appeal process as the changes are similar to the tax appeals process in Tennessee with preliminary appeal rights at the administrative level before having to proceed with a challenge in Chancery Court.
Because the revised uniform law is new, there is little guidance or law for entities to consider as they deal with audits or appeals. We will continue to monitor this issue in the coming months and years to determine how broadly the revised uniform law is adopted by other states.
Further Reductions in the Sales Tax on Food
Tennessee has reduced the tax on groceries in recent years, and the IMPROVE Act continued that trend, reducing the state rate from 5% to 4% beginning July 1, 2017.
Hall Income Tax Phase-Out Continues
There is nothing more hated in Tennessee than the income tax, which is why we do not have one, and the Hall Income Tax, even though it only applies to interest and dividends, is still despised. Tennessee began phasing the Hall Income Tax out over the last few years, and the IMPROVE Act codified a complete phase out by 2021. The rate for 2017 is 4%, with 1% reductions through 2020 and the full phase out is effective January 1, 2021.
All those celebrity stalkers and kings and queens of pop culture should expect more entertainers and sports personalities to continue to flock to Tennessee to take advantage of Tennessee's no income tax reputation, ala Jack White, Justin Timberlake, Kirk Herbstreit, Tim and Elisabeth Hasselbeck, and Eric Decker (TITANUP!) just to name a few.
Practice Point: Note to the University of Tennessee - Heck, why wouldn't Nick Saban want to coach the Tennessee Vols and not have to pay that Alabama income tax. Just a thought!
One aspect of the IMPROVE Act that locals should pay close attention to is the authorization for local governments to propose referenda to raise various local taxes in Tennessee to pay for additional transportation improvements. This could be increases in local sales tax, business tax, and property tax, among others.
Based on this change, we are already hearing rumblings that Davidson County (Nashville) and Wilson County (Lebanon), among others, are considering proposing transit surcharges. These have to be approved by the voters, so it remains to be seen whether local officials will be able to garner enough support to raise local taxes for transit...
Streamlined Sales Tax Delayed ... Again
For those still tracking Tennessee's participation in the Streamlined Sales Tax Project, please note that Tennessee has again delayed the effective date. The new effective date was moved out two years and is now July 1, 2019. Tennessee remains an associate member of the streamlined sales tax project but is not a fully compliant member having only adopted a portion of the streamlined provisions. The provisions that remain on hold are those equalizing certain tax rates as well as the controversial sourcing rules.
Changes in the Telecom World!
There has been a constant struggle for years in the telecom world regarding the property tax treatment of telecom providers and the perceived inequities between providers depending on the technology used to deliver telecom service. For traditional telecom companies, the property tax assessment rate has been 55% while the general commercial rates for commercial and industrial companies ranged from 30% to 40%. This difference caused the codification of an ad valorem tax reduction fund, which was intended to mitigate some of the differences that existed in this arena between public utilities and commercial/industrial businesses.
In 2017, the Legislature finally took the step to eliminate the difference that existed among telecom providers, and under the amended law, most telecom providers are taxed at the standard commercial and industrial rates and no longer at the 55% public utility rate. As part of this change, the ad valorem tax reduction fund was repealed except that the tax revenue generated by the sales tax that was formerly used to cut checks to telecom companies will now be used to hold localities harmless based on these modifications to telecom taxation.
In addition, there was an amendment that adopted a new broadband internet access equipment credit applicable in the franchise and excise tax.
Practice Pointer: Telecom providers should review these new property tax and franchise and excise tax provisions to determine how these amendments may apply to their business operations in Tennessee.
Oh and the Gas Tax Increase
If Tennessee can raise the gas tax, you should expect every state in the Union to jump in line and begin proposing increases. The Governor had to fight tooth and nail for this increase, and as set forth above, he had to give away a lot of other revenue to offset the increase in the gas tax increases. In the end, he got it done.