Tennessee’s recently passed Revenue Modernization Act contains five impactful provisions expected to boost tax revenue for the state.  Specifically, taxing revenue from out of state businesses by focusing on a tax concept called Nexus.  The legislation allows for a change to Market based sourcing of revenue (where the customer is located) instead of a Cost of Performance methodology (where the seller performs the activity) that may present state tax planning opportunities.

These first two changes, in particular, allow for many tax planning opportunities for both in-state and out-of-state businesses.  The bill is set to take effect for tax years beginning on or after July 1, 2016.  Thus, for calendar year taxpayers, the 2017 tax year will be the first year these changes will be in effect.  Barnes Dennig offers tax consulting services to help maximize your state tax savings.

Nexus is a concept that determines a business’ requirement to file a return and pay tax in a state outside of their home state.  In its infancy, one of the most important factors in determining whether a business had nexus in any particular state was having a physical presence in that state.  In other words, having a store or office location could make you a prime candidate for triggering tax in a state.  However, with the advent of the internet, business has changed and thus, the definition of nexus has changed with it.  In recent years, similar to Tennessee, many states have adopted these bright-line tests that pull into their web of nexus, businesses with sales in their states in excess of $500k (even without a physical presence).

Issue #1 – Bright-Line Presence Test –

The recently passed legislation expands the definition of nexus, for business tax as well as franchise and excise tax, to include a “bright-line” test.  An out-of-state business will be deemed to have nexus in Tennessee if –

  1. Their total receipts in the state exceed $500k or 25% of their total sales everywhere;
  2.  The average value of their real and tangible personal property owned or rented and used in the state exceed the lesser of $50k or 25% of the average value of all real and tangible personal property; or
  3. The amount of compensation paid in the state exceeds the lesser of $50k or 25% of the total compensation paid

Further, for purposes of franchise and excise taxes, if the business licenses intangible property for use by another party in TN and subsequently derives income from that use of the intangible property, they will also be deemed to have nexus in TN.

In addition to the expansion of nexus discussed above, the legislation also expanded the definition of activities that will subject a business to state business tax.  Prior to passing of the bill, only the delivery by an out-of-state business, in their own vehicle, of tangible personal property to an in-state buyer would subject a business to TN business tax.  The recently passed legislation expands the activity to any delivery of tangible property in TN, regardless of how it is delivered and whether it crossed state lines.

Issue #2 – Market Sourcing of Sales for Franchise and Excise Taxes –

Currently, businesses subject to tax TN pay both an excise tax, which is based on business’ net earnings and franchise tax, based on the greater of net worth or the book value of tangible property owned or used in the state.  Prior to the passing of the legislation TN required that sales were apportioned to where the seller was located.  Thus, if a business had sales both inside and outside the state, but were located within TN, they were required to apportion 100% of their sales to TN.

Instead, the recently passed legislation allows sales to be apportioned to where the “taxpayer’s market” is located.  The taxpayer’s market is basically wherever they taxpayer has sales/deliveries and/or has real or tangible personal property.   So if you sell, rent or lease real property, your market is where the real property is located.  If services are provided, the taxpayer’s market is TN, to the extent services are provided in TN.

Issue #3 – Apportionment Factors– Franchise and Excise Taxes

For taxpayers subject to TN business, franchise and excise taxes, a new apportionment method will be in effect for all taxpayers for tax years beginning on or after July 1, 2016.  The current double weighted sales amount will soon be a triple weighted factor.

Issue #4 – Sales and Use Tax

Recently passed legislation now subjects the sale of software and video games to sales and use tax regardless of how the software or video game is delivered.

In addition, the definition of “Dealer” has been expanded to include an out-of-state business, if that business pays a TN resident to refer potential customers to them whether by link on a website or any other means.  The dealer in this situation will be subject to sales tax if the sales referred by the TN resident exceed $10k in a 12 month period.

Issue #5 – Tax incentive for distributors using distribution centers located in TN –

The legislation creates an incentive for taxpayers who move large volumes of product through third- party distributors if the taxpayer chooses distributions centers located in TN.  Qualified taxpayers are defined as those having a gross receipts factor that exceeds 10% and $1 billion in gross sales of tangible personal property.

The incentive allows certified distribution sales to be excluded from the taxpayer’s receipts factor as when determining excise taxes.  Certified distribution sales are defined as sales of tangible property made in TN by the taxpayer who ultimately sells them for use outside TN.  However, the taxpayer will also be subject to an additional annual excise tax based on a sliding scale of certified distribution sales from $2 billion to in excess of $4 billion, tax rates will range from .5% – .125%, respectively.