Tennessee Expands Tax Bases

 
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Authored by: Ron Tambasco, Tracey Sellers, Patrick Philpott and Kristina Wurth

On May 20, 2015, Tennessee enacted the Revenue Modernization Act (the “Act”). The Act brings sweeping changes  to several aspects in which Tennessee taxes business activity, including expanding the definition of nexus, sourcing sales for apportionment, changing the requirements for intangible expense deductions, and broadening the sales tax base.

Nexus

Franchise and Excise Tax
Effective January 1, 2016, the Act expands Tennessee’s nexus standards used in determining the state’s ability to subject a business to its tax collection responsibility. Under the new nexus provisions, a business will create substantial nexus and be subject to Tennessee franchise and excise tax through any direct or indirect connection to Tennessee such that the taxpayer could be required to pay tax up to the highest level available under the United States Constitution. The Act includes a non-exclusive list of business activities that satisfy this standard:

  • Being organized or domiciled in Tennessee;
  • Owning or using capital in Tennessee;
  • Having systematic and continuous business activity in Tennessee that produces gross receipts attributable to Tennessee; or
  • Licensing intangible property to a party in Tennessee that derives income from the intangible property in Tennessee.

The Act also institutes a “bright-line” nexus test where a business will be found to have substantial nexus with Tennessee to the extent:

  • The taxpayer's receipts in Tennessee exceed either $500,000 or 25% of the taxpayer's total receipts anywhere;
  • The average value of the taxpayer's real and tangible property owned or rented and used in Tennessee during the tax period exceeds $50,000 or 25% of the taxpayer's total real and tangible property; or
  • The taxpayer paid compensation in Tennessee that exceeded $50,000 or 25% of the total compensation paid by that taxpayer.

Business Tax
Nexus standards for Tennessee’s business tax were changed to a standard substantially similar to the excise and franchise tax. However, the licensing of intangible property to a party in Tennessee that derives income from the intangible property in Tennessee is omitted from the business tax examples. In addition, only for business tax purposes, the

Act provides that “engaged in Tennessee” will include out-of-state sellers whose only connection to the state is delivering goods to customers within Tennessee, regardless of method of delivery. These changes are effective January 1, 2016.

Apportionment—Sales Factor

For tax years beginning on or after July 1, 2016, for purposes of computing a taxpayer’s Tennessee apportionment ratio, Tennessee will switch its method of sourcing sales “other than tangible personal property” from a cost-of-performance method to a market-based sourcing method. The Act further designates Tennessee as the source of a sale where:
  • The sale, rental, lease, or license of real or tangible property is located in Tennessee;
  • The sale of services are delivered to a location in Tennessee;
  • The rental, lease, or license of intangible property is used in Tennessee; intangible property that is used in marketing a good or service is sourced to Tennessee if the good or service is purchased by a customer in Tennessee;
  • A contract right, government license, or similar intangible property that authorizes the holder to conduct a business activity in a specific geographic area will be considered “used in Tennessee” if the geographic area includes all or part of Tennessee and the property is used in Tennessee; or
  • The gain derived from the sale of securities by a dealer in securities is sourced to Tennessee if the dealer’s customer is located in Tennessee.
A taxpayer who has net earnings can make a cost of performance sales sourcing election, which will result in a greater sales factor.
 
Also, effective July 1, 2016, the Act adopts a reasonable approximation standard for sales where the state of assignment cannot be determined. Where the state of assignment cannot be determined, it should be reasonably approximated. If the state of assignment cannot reasonably be approximated, a throw-out standard applies and any such receipts should be excluded from the sales factor. Further, the Act contains special sales sourcing provisions for the sales of telecommunications service firms engaged in providing telecommunication and video programming services. These provisions apply if the taxpayer is a qualified member of a qualified group that has greater than $150 million of both qualified expenditures and taxable sales in Tennessee. Qualified members of a telecommunications company are required by the Act to calculate their sales factor as an average of the sales factors as calculated using market and cost of performance sourcing. The sales sourcing provisions for sales from telecommunications firms also become effective on July 1, 2016.
 
A triple-weighted sales factor will also replace the current double-weighted sales factor when determining the taxpayer’s overall apportionment ratio for tax years beginning on or after July 1, 2016.
 
The Act also includes an incentive for taxpayers who have greater than $1 billion of sales to distributors in Tennessee who resell the goods for consumption by customers outside of Tennessee. The taxpayer will be allowed to exclude these sales from their sales factor so long as they pay a gross receipts tax on the sales.

Intangible Expense Deduction— Excise Tax

The Act modifies the requirements for deducting intangible expenses related to a transaction with an affiliated party. The Act changes the current law by removing the burdensome application requirement and by removing the ‘conduit exception’ that is present in current law. Effective July 1, 2016, intangible expenses related to a transaction with an affiliated party may be deducted if they are disclosed, and the affiliate to who the intangible expense relates to is:
  1. Registered for and paying Tennessee excise tax;
  2. In a foreign nation that is a signatory to a comprehensive income tax treaty with the U.S.; or
  3. Is otherwise not required to register for, or pay Tennessee excise tax.
Similar to the current intangible expense deduction, to the extent the Department of Revenue considers the deduction to be abusive, it may disallow the deduction. The Act also subjects taxpayers to a negligence penalty if they fail to disclose or add back a related party intangible expense.

Sales Tax

Click-Through Nexus
The Act creates a rebuttable presumption that an out-ofstate seller is subject to the Tennessee sales tax if the taxpayer utilizes a person in Tennessee to refer potential customers, whether through an internet link or otherwise. For the presumption to apply, the out-of-state seller must make in excess of $10,000 of sales into Tennessee from referrals of this type. The seller may only rebut the presumption where it can be demonstrated that it did not conduct any activities that would “substantially contribute to the dealer’s ability to establish and maintain a market” in Tennessee through clear and convincing evidence.

Computer Software
Tennessee imposes sales tax on the ‘use of computer software’ within Tennessee. With the enactment of the Act, the ‘use of computer software’ will be considered to include software accessed over the internet that will remain in the possession of the seller, often referred to as Software as a Service or “SaaS.” The use of computer software will be subject to Tennessee sales tax as the sale or licensing of electronically delivered software where the customer accesses the software from a location within Tennessee. Where the sale relates to customers accessing software from both within and outside Tennessee, the seller would be required to allocate to Tennessee the portion of sales related to users accessing software from within the Tennessee.

Exemptions from Tennessee sales tax may apply for the use and access of software that remains in the possession of a seller that provides software used solely to fabricate other software or that is developed by an affiliated company. It is also important to consider that software may be purchased exempt as a sale for resale under limited circumstances. The Act also expands the types of digital products that are subject to Tennessee sales tax to include video games, when the seller or other third party, retains possession. This provision applies regardless of how access to the video game is charged.
 
All sales tax changes in the Act are effective July 1, 2015.
 
 
We are here to help
The state tax specialists at True Partners Consulting closely monitor state tax law changes. We are available to advise on the impact that the Tennessee law changes may have on your company, including the incorporation of the law changes into quarterly and annual provisions and compliance. Please contact a member of our State Tax Team to learn more about how we can help.
 

Kristin Mauer
Director
408.625.5069
Kristin.Mauer@TPCtax.com
 

 

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