LEGISLATIVE
POSITIONS ADOPTED BY THE
NCCBI TAXATION AND FISCAL POLICY COMMITTEE
DEFINING “DOING BUSINESS” IN NORTH
CAROLINA
POSITION: NCCBI
opposes efforts by the North Carolina Department of Revenue to expand, by
rule-making, the meaning of the term “doing business” for purposes of corporate
income tax liability. Such proposed rule-makings effect a tax increase by
administrative fiat, and without permission of the North Carolina General
Assembly. The taxing power is the sole prerogative of the General Assembly and
should not be usurped by administrative agencies.
NCCBI supports the
legislative enactment of a statutory physical presence standard for what
constitutes “doing business” in North Carolina for tax purposes. Such a
standard is consistent with existing state and federal law limiting the tax
powers of states, and will avoid costly and protracted litigation concerning
North Carolina’s taxing power. A more expansive definition of the term “doing
business” would frustrate the economic growth of North Carolina by impairing
the ability of existing North Carolina companies to obtain capital and
undermining North Carolina’s existing reputation as a state dedicated to the
maintenance of a favorable business climate.
EXPLANATION: Traditionally,
North Carolina has attempted to impose corporate income tax only on companies
that have a physical presence in this State. In 1992, the North Carolina
Department of Revenue, by administrative rule-making, expanded the class of
companies subject to taxation in North Carolina to include companies that had
licensed the use of intangible assets in North Carolina, including trademarks,
tradenames, computer programs, and copyrights. The 1992 rule foreshadowed still
more aggressive efforts by the Department in 1996, and again in 1998, to tax
companies with interests in North Carolina as ethereal as loans to North
Carolina residents and security interests in property located in North
Carolina. The Department’s steady march from taxation based on physical
presence to its new, legally untested, “economic presence” standard was halted
in both 1996 and 1998 by a broad coalition of companies alarmed by these
bureaucratic efforts. At the request of concerned parties, the North Carolina
General Assembly in 1998 directed its specially constituted Revenue Laws Study
Commission to review the issue of when a company is “doing business” in North
Carolina and to recommend appropriate action.
The Department of
Revenue’s efforts to tax companies based on their “economic interests” in this
State are flawed in three important ways. As an initial matter, by expanding
the scope of state taxing authority through administrative fiat, the Department
attempts to usurp the legislative power of the General Assembly and implement a
tax increase without a vote of the people’s popularly elected representatives.
A study by the North Carolina Office of State Budget and Management shows that
the rule-making proposed by the Department in 1998 alone would increase taxes
and related compliance costs by some $62 million per year. Such a tax increase
should plainly be beyond the prerogative of administrative agencies, and if
implemented at all, should be based on solemn deliberation by the legislature.
Rules proposed
previously by the Department of Revenue pose a significant threat to North
Carolina’s stature as a national center for economic development that is well
known for its favorable business climate. By extending revenue agents’ reach,
the Department’s proposed “economic presence” taxing standard would discourage
national lenders and other types of investors from loaning money to North
Carolina businesses or collateralizing other transactions with property in
North Carolina. Under the proposed rules, such lenders who would otherwise have
no taxable connection to North Carolina could become liable for millions in
taxes and incur substantial compliance costs simply because of their
willingness to provide financial support to growing tar heel firms. Just as
important, the “economic presence” taxing standard previously proposed by the
Department of Revenue would place North Carolina among a clear minority of
states that aggressively assert the right to tax companies with no physical
presence within their borders. Such “tax aggressor” states are plainly not the
jurisdictions where new and expanding businesses will want to invest.
Finally the “economic
presence” taxing rules sought previously by the Department of Revenue press the
limits of the constitutional authority to tax established under both state and
federal law. Any attempt to impose a new “economic presence” taxing standard
would place North Carolina at the precipice of constitutional boundaries on
taxation and would undoubtedly provoke protracted and expensive litigation
testing the power of the State to reach business interests only remotely
connected to North Carolina. In this regard, the aggressive taxing policy
promoted by “economic presence” advocates could easily subject North Carolina
to the same types of multimillion dollar tax refund judgements won by
intangibles taxpayers and state and federal retirees in recent years.
NCCBI therefore
supports legislative enactment of a statutory physical presence standard that
maintains North Carolina’s traditional rule for determining when businesses are
“doing business” in this state. A statutory physical presence standard will:
PROPERTY TAX EXEMPTIONS FOR
CONSTRUCTION IN PROGRESS
AND PRODUCT SAMPLES
POSITION: North
Carolina counties should not subject construction in progress to the business
personal property tax. Further, product samples should be considered as
inventory and should be exempt from the property tax.
EXPLANATION: North
Carolina counties are taxing construction in progress at 100% of its cost
throughout the construction phase. This approach, while of questionable validity
under North Carolina’s law, creates a disincentive for businesses for building
or expanding in North Carolina. In addition, it is creating administrative
difficulties for counties and taxpayers. Finally, the inconsistent approaches
used to tax this property among North Carolina’s 100 counties and even within a
county are creating a sense of unfairness and lack of uniformity in our taxing
system.
“Construction in
progress” is the accounting category for property while it is being built and
prior to its being used. Depending on the size of the project, construction in
progress can be accounted for on the books of a company for several years.
Several counties are taking the position that construction in progress should
be taxed at 100% of its cost until the asset is placed in service. Once it is
placed in service, then it can be depreciated, but prior to that, it is a
continually increasing aggregation of costs.
The approach of 100%
of cost is not supported by our statutes which require that applying property
be taxed at its true value in money or money’s worth. This definition is
difficult for counties and taxpayers alike, as they struggle to determine the
true value of a partially completed facility. Thus, if this property is to be
taxed at all, a simple, fair method of assessing the true value for
construction in progress is needed.
But more
fundamentally, this property should not be taxed at all, prior to its producing
income. To do so is discouraging businesses from constructing additional
facilities in North Carolina. Such practice is not used by our surrounding
states. Therefore, a reduction or elimination in the taxation of construction
in progress would be advantageous for future economic development in our State.
As for product
samples, these are the same ingredients as inventory products but packaged in
smaller containers. Since the samples are not sold, they are not considered
inventory. Hence the inventory exemption for the State’s personal property tax
does not apply. However, since the product samples are similar to inventory, it
makes sense to extend the property tax exemptions to them as well.
CONTINGENT FEE
AUDITS
POSITION: State and local
auditors and audit advisors should not be paid on a contingency fee basis in
any form.
EXPLANATION: NCCBI supports tax
and other audits by governmental entities. Approximately 27 North Carolina
counties have performed property tax audits of their taxpayers using outside
auditing firms being paid as much as 35% of the additional taxes assessed as a
result of their audits. Specifically, these auditors are paid fees based on the
amount of additional taxes generated by their audits.
On
December 3, 1993, the North Carolina Supreme Court held that contingent fee
property tax audits are permissible in North Carolina. The rationale of the
Court was that the Court could not make the public policy concerning these
audits. Instead, the Court said that the Legislature of North Carolina should
determine whether permitting a property tax audit with the auditor's being paid
a percentage of the additional taxes generated by the audit is acceptable under
the public policy of North Carolina.
Permitting
audits of taxpayers with another private citizen being paid a percentage of the
additional taxes or amount generated by the audit services is contrary to the
public good. Such audits create a hostile taxing environment and a sense of
unfairness among taxpayers.
North
Carolina's Supreme Court decision allowing contingent fee audits has received
national attention and has sent a message to businesses that the State's taxing
system is hostile to business. Outlawing contingent fee audits will still
permit audits of taxpayers, but will indicate North Carolina's desire to treat
all taxpayers fairly.
POSITION: The
North Carolina General Assembly should reform the state franchise tax by
removing inventories/work-in progress from Schedule D.
EXPLANATION: This
reform of the franchise tax on inventories will assist companies which engage
in high, value-added manufacturing and encourage the types of jobs that we as a
state most want to retain and attract. North Carolina is one of only three
states that taxes inventories as a part of the franchise tax. This puts our
state at a great disadvantage when we are trying to recruit and retain
high-wage employers with expensive or large inventories. It also makes it more
difficult for new businesses to make a profit, when they must pay a franchise
tax based on their inventory.
The manufacturing industry
in our state has always been a source of economic stability. We need to nurture
and encourage this high-value part of our economy.
KEEP DOUBLE WEIGHTED SALES FACTOR
POSITION: North
Carolina should retain the double-weighted sales factor for use in computing
corporate income tax liability of multistate corporations.
EXPLANATION: From
the 1950’s, North Carolina has used the three-factor formula for levying income
taxes on multistate corporations doing business in the state. The three factors
are (1) the proportion of a company’s sales in the state, (2) the proportion of
its total payroll paid in North Carolina, and (3) the value of its property in
the state as a percentage of its total property. Prior to 1989, each of the
three factors carried equal weight.
In the 1988 session,
the General Assembly passed House Bill 2372 which changed the corporate tax law
to include a “double-weighted” sales formula for use in computing state income
tax liability. Under the double-weighting concept, the sales proportion is
counted twice in the formula for computing a company’s North Carolina income
tax liability, while property and payroll are only counted once.
NCCBI believes that
the General Assembly was correct in making this change, based on its
recognition of the steps being taken by other states that compete with North
Carolina for new industry. Passage of this measure helped to offset the effect
of corporate tax rate differentials. The double-weighted sales formula benefits
companies that have a significant portion of their plants and payroll in North
Carolina but sell into the nationwide market. It encourages multistate
manufacturers and distributors to invest in our state, and it is an incentive
for such companies that are already here to expand their present investments.
POSITION: North Carolina should not increase the rate or remove the
$80 cap on the tax on sales of machinery. Additionally, the sales tax on
utilities used in manufacturing and farming needs to be reduced from 2.83
percent rate to one percent to be consistent with the tax on machinery and
equipment.
EXPLANATION: There are no
states contiguous to North Carolina that impose a sales tax on machinery and
equipment used in manufacturing. This tax has not been opposed by business
because of an $80 cap which the General Assembly wisely placed on this tax. The
moderation with which this tax has long been applied has helped North
Carolina’s attractiveness to industry.
When
a company is considering North Carolina as a place to locate or expand, it
looks at many factors: transportation, availability of skilled labor, wage
rates, quality of life, utilities, educational and cultural opportunities, land
and building costs, and overall tax climate. When it is building a plant, it
must equip that facility with the tools that will enable that company to
produce the goods and services profitably. A tax on the purchase of machinery,
without the $80 cap could be significant enough to cause a company not to build
a facility in the state-resulting in a loss of jobs and tax revenues.
Likewise,
utilities (electricity) are a major cost to manufacturers and farmers. All the
southeastern states, except North Carolina, exempt electricity and natural gas
used in manufacturing from the sales tax. For North Carolina to be competitive,
this tax rate should be reduced to one percent.
Larger
companies and some company divisions often operate under a system called
“contention manufacturing.” Under this system, divisions of the same company
compete against other divisions and plants within the company for the right to
manufacture a given product. Decisions are based on cost, quality, and other
criteria. Competition is often very close. If the cost for purchasing equipment
to manufacture the product or the cost of utilities are higher for a plant in
North Carolina because of these taxes, this fact may tip the scale against the
product’s being manufactured in our state.
Furthermore,
a tax on machinery to manufacture goods that ultimately will be sold at retail
contradicts the notion of a tax aimed only at retail sales themselves.
From
an economic standpoint, taxing the tools or utilities of production will only
serve to decrease the level of economic activity and growth in North Carolina,
and will decrease the level of revenues to the State in the long run.
CHANGE THE NET ECONOMIC LOSS (NEL)
CARRYOVER
TO A NET OPERATING LOSS (NOL) CARRYOVER
POSITION: The North Carolina General Assembly should conform the
state’s current net economic loss (NEL) calculation to the federal net
operating loss (NOL) calculation. Although conformity to the former federal
15-year carryover period passed previously by the General Assembly was a good
first step, North Carolina will not be truly competitive with its neighboring
states until the NEL calculation is replaced with the NOL calculation currently
in use by the federal government and most state departments of revenue.
EXPLANATION: To more accurately
reflect normal business cycles and long-range planning done by business
enterprises, the federal tax code and most state tax codes allow companies to
deduct current losses from future (and past) earnings. These net operating loss (NOL) carryover
provisions recognize that the annual tax reporting period is artificial. They are designed to prevent unfairly
penalizing companies with year-to-year fluctuations in earnings and capital
investment.
North
Carolina is the only state in the nation that requires businesses to use a net
economic loss (NEL) calculation rather than a net operating loss (NOL)
calculation for purposes of deducting business losses in future years. In most other states, a business with a net
operating loss may deduct those losses against income in future (and in some
cases past) years. In North Carolina that business with the same net operating
loss must add back nontaxable income (for example, dividends from subsidiaries)
to calculate its NEL. Only if its deductions exceed both taxable and nontaxable
income can the North Carolina business offset the loss against income in future
years.
The
unique North Carolina rule places the State at a distinct competitive
disadvantage against other states, particularly neighboring states (e.g.,
Alabama, South Carolina, Virginia, Delaware, Kentucky, Florida and Tennessee),
all of which use an NOL computation. Specifically, the NEL rule:
·
Penalizes the use of subsidiaries in
corporate structure – Because the North Carolina rule forces companies to add
back dividends from subsidiaries in the NEL calculation, it adds significant
costs to a company’s ability to create an optimal corporate structure.
·
Discourages establishment of corporate
headquarters in North Carolina - The tax penalty for using corporate
subsidiaries creates a disincentive to locate the headquarters operations of a
corporate group (and its high-salary jobs) in North Carolina.
·
Creates additional
administrative and compliance burdens – Taxpayers in North Carolina are forced
to track and calculate the NEL carryforward separately from federal and other
state NOLs, thereby creating an additional and unnecessary compliance burden
for North Carolina taxpayers.
In
short, by limiting carryforward losses to net economic losses, North Carolina’s
unique NEL rule places it at a competitive disadvantage with most other states,
particularly its neighbors.
CONTINUE N.C.
BUDGET REFORM
POSITION: The General Assembly should continue reforming the State's
budget process begun in 1991. Fiscal expenditures should not be based on
revenue projections, but rather should be based on some other measure such as
the amount of prior calendar year revenues, plus growth and inflation, as an
example. The rainy day fund should be continued for unanticipated needs.
Moreover, the budget should be approved to meet statutory deadlines for local
governments and local school systems.
EXPLANATION: Revenues for the State of North Carolina have increased
each year, even in times of recession. The increases, however, have not always
been uniform. Budget estimates based on the anticipated percentage growth in
State revenues have fluctuated greatly. With the present size of the State
budget, even a 1% error in the revenue estimates can be a big problem.
The
natural tendency in the political process is to keep taxes as low as possible, and
to provide the most services possible. Once a program has been established,
there is great reluctance to ever dismantle it, especially after staff is
hired, and the program develops an even wider constituency. In the minds of
those who administer and who benefit from the program, it becomes almost
impossible to remember the time when the program did not exist. The State has
made some efforts to review programs on a regular basis and cut out unnecessary
programs and positions. However, State
government continues to grow and efforts to streamline government must continue
to be improved.
RESEARCH AND DEVELOPMENT TAX CREDIT
POSITION: NCCBI
recommends that the General Assembly pass legislation to create a globally
competitive research and development tax credit. NCCBI believes that taxpayers
should have the option of electing a fixed percentage of 5% of their actual,
yearly research and development expenditures performed in North Carolina as a
credit against North Carolina income and franchise taxes, rather than the 5% of
the apportioned qualified research expenses determined under IRC 41 or the
alternative incremental method. In addition, NCCBI recommends that companies
conducting their Research & Development at a North Carolina research
university should receive a flat 25% credit against North Carolina income and
franchise taxes.
EXPLANATION: Currently,
NC General Statute 105-129.10 allows taxpayers a tax credit in the amount of 5%
of the qualified research expense as determined under IRC sec. 41. The calculations
prescribed in sec. 41 utilize base year expenditures and a percentage of annual
gross receipts as thresholds in determining the amount of R&D credit to
which a company is entitled. This calculation of credit “penalizes” start-up
and certain large companies which do not grow research expenditures relative to
sales growth. North Carolina recently passed legislation adopting the federal
alternative method provisions, a federal change recognizing the arbitrary
nature of the then existing federal credit provisions.
Current law fails to
reward relative increases in research conducted in North Carolina. For example,
if a company were to move $100 million in research expenses from another state
into North Carolina, but still not exceed the federal limitations in total
annual research expenditures, such company would receive no credit in North
Carolina.
Taxpayers should be
allowed to receive a flat percentage of their yearly R&D expenditures,
occurring in North Carolina, as a tax credit. Such credit should be allowed to
carry forward for a period of at least 15 years. The proposed change in this
tax credit provision would remove the uncertainty for taxpayers doing business
in the State, because all qualified expenses incurred in this State during the
taxable year would be eligible for the research tax credit. Companies incurring
research expenditures cross all industry lines; therefore, this change in the
R&D credit would benefit taxpayers without being discriminatory or
targeting specific industries. Consequently, companies would realize more value
from their R&D activities and would have more incentive to increase such
activities in this State. Since companies bear an inherent risk of being
unsuccessful when developing new products, less constrained R&D budget
could result in pursuit of previously unfeasible ideas. The public at large
could benefit from safer, more advance products being brought to market faster,
and North Carolina will benefit from increased high wage employment – the
largest component of qualifying research expenditures.
Allowing an
aggressive flat percentage against a company’s North Carolina R&D
activities would allow North Carolina to have a competitive state tax credit
compared with other states. This change could potentially attract new
businesses and prompt out-of-state companies to relocate to North Carolina.
MODEL UNCLAIMED PROPERTY ACT AMENDMENTS
POSITION: The North Carolina Escheats and Abandoned
Property Act should be amended to remove as unclaimed property all business to
business transactions including unclaimed checks and remove the ability to hire
contingent fee auditors to perform unclaimed property audits.
EXPLANATION: In 1999, the North Carolina Escheats and
Abandoned Property Act was amended to include significant portions of the Model
Unclaimed Property Act of 1995 (the “Model Act”). Although the Legislature made several important changes to the
Model Act, the Model Act that passed contained two provisions which should be changed
in order to conform to modern business practices and to be consistent with the
trend of many states in the administration of unclaimed property.
The 1999 amendment
removed credit balances from the definition of unclaimed property, but failed
to eliminate other transactions between businesses such as uncashed
checks. The administrative cost of
determining whether property has been abandoned on business-to-business
transactions, in most cases, is well in excess of the amount that should be
remitted to the Treasurer as unclaimed property. Businesses maintain sophisticated record keeping systems and know
when they are due a payment. Most
uncashed checks result from businesses failing to place a stop payment on a
check or the account was settled in another form, such as a credit on another transaction.
The Model Act gives
the State’s Treasurer the discretion to administer unclaimed property laws,
particularly with respect to the hiring of auditors and attorneys on a
contingent fee basis. Consistant with
NCCBI’s position regarding contingent audits, the Treasurer should not be
allowed to hire auditors or attorneys on a contingent basis.
SALES TAX DISCOUNT
POSITION: The
sales tax discount to sales tax collectors and remitters should be reinstated
in an amount that is fair and equitable within the revenue available.
EXPLANATION: Prior
to changes enacted in 1987, retail merchants were allowed to retain a small
portion of the sales tax they collected to defray the costs they incurred in
helping the State administer the sales tax. This discount was repealed in 1987
when the inventory tax was repealed but most merchants did not gain any net
benefit because at the same time the maximum corporate income tax rate was
increased by 1%. The corporate income tax rate was increased again in 1991 then
decreased in 1996, 1997 and 1998. However, it has not been reduced to below the
1991 level.
STREAMLINED SALES TAX LEGISLATION
POSITION: The Streamlined Sales Tax project is an
important endeavor, which will result in legislation that will need to be monitored
and analyzed to protect current sales and use tax exemptions.
EXPLANATION: In the 2000 legislative session, the General
Assembly enacted legislation to participate in the Streamlined Sales Tax
Project. While the initial legislation
called for participation in the project, it will result in additional
legislation to bring uniformity between the participating states. For all types of commerce, this project is
intended to simplify and modernize sales and use tax administration for both
Main Street and remote sellers.
One of the key
elements of this project will be to develop a multistate uniform definition
within a tax base. Each state will
still be able to enact legislation defining if a tax base is taxable or exempt;
however, a multistate uniform definition may result in items within a tax base
that are currently exempt in North Carolina, becoming taxable under the
multistate definition.
NCCBI supports
simplifying and modernizing sales and use tax administration, but wants to
insure that current exemptions are not lost as a result of a multistate uniform
definition of a tax base.