United States: Minnesota Enacts Omnibus Tax Legislation Including Major Tax Increases, Click-Through Nexus

On May 23, Governor Mark Dayton signed omnibus tax legislation intended to raise $2.1 billion in taxes by adding a higher individual income tax rate, making significant changes to both the corporate income tax and to the sales and use tax, and reinstituting a gift tax.1 Notably, Minnesota will no longer be a member of the Multistate Tax Compact.

The revenue expected to be raised pursuant to the legislation will be used to offset a projected $627 million deficit for the next two-year budget period and provide revenue to fund additional spending on education and for property tax relief.

Corporate Income Tax

Treatment of Foreign Income Items

The legislation changes three provisions involving the treatment of foreign income effective for tax years beginning after December 31, 2012:

  1. The 80 percent subtraction of foreign source royalties received from unitary foreign affiliates is repealed.2
  2. The 80 percent subtraction of deemed dividends received from a foreign operating company which was a U.S. entity that earned more than 80 percent of its income from foreign sources is repealed.3
  3. The income and apportionment factors of a foreign partnership or a foreign entity which is disregarded for U.S. purposes will now be included in the Minnesota combined group as long as the income from that partnership or entity is included in the federal return.4 Historically, the income and apportionment factors from such entities have been excluded from the Minnesota combined group.5

Finnigan Rule Adopted

For taxable years beginning after December 31, 2012, all Minnesota sales made by any member of the unitary group are includible in the Minnesota sales factor numerator.6 Commonly known as the Finnigan rule, the legislation requires that sales made to a customer in Minnesota by a unitary member that does not have nexus with the state are included in the sales factor numerator.7

Multistate Tax Compact Repealed

The legislation contains an affirmative repeal of Minnesota's adoption of the Multistate Tax Compact effective August 1, 2013.8 Minnesota enacted the entire Compact in 1983, but in 1987 the Minnesota Legislature repealed the adoption of Articles III and IV of the Compact. Article IV of the Compact contains the Uniform Division of Income for Tax Purposes Act (UDITPA) which provides for the use of an equally-weighted three-factor apportionment formula and for the use of the cost of performance method in determining the sales factor for services. Article III provides taxpayers with the opportunity to elect to use the equally-weighted three-factor apportionment formula in lieu of state-specific apportionment.

The legislation adopts a request from the Minnesota Department of Revenue to affirmatively repeal the Compact. In a statement to the Legislature, the Department said:

The Department strongly believes that the legislature's repeal of Articles III and IV of the compact 26 years ago properly eliminated the option to use the Uniform Law to apportion income. However, the Department believes it is prudent for the legislature now to repeal Minn. Stat. § 290.171 in its entirety to avoid even the possibility going forward of the State having to pay refunds on some previously filed returns or lose future tax revenue as is the case in California if the California court decision is upheld.9

The Commissioner of Revenue is authorized to continue to use the audit services provided by the Multistate Tax Commission.10

Research Credit No Longer Refundable

Historically, the research credit was non-refundable in nature. In 2010, as a means to encourage activities that would qualify for the credit, the research credit was converted into a refundable credit.11 This change resulted in a significant expansion in the number of companies that claimed the credit. As a response, the legislation restores the research credit to a non-refundable credit effective for tax years beginning after December 31, 2012. Unused credit amounts can be carried forward for 15 years. The law was changed to allow unused credit amounts to be used to offset the tax liability of any member of the unitary group.12

Minimum Fee Increased

Since 1990, Minnesota has imposed a minimum fee on C corporations, S corporations and partnerships based on the sum of the entity's Minnesota property, payroll and sales.13 For taxable years beginning after December 31, 2012, the fee amounts and the bracket amounts are adjusted to reflect what these amounts would have been if they had been adjusted each year for inflation. The maximum fee amount has been increased from $5,000 per entity to $9,340 per entity. In the future, these amounts will be adjusted for inflation on an annual basis.14

REIT Dividends Received Deduction Eliminated

For taxable years beginning after December 31, 2012, a corporation will no longer be able to claim the 80 percent dividends received deduction on a dividend that is received from a real estate investment trust (REIT).15

Sales and Use Tax

Business Services Taxed

Earlier this year, Governor Dayton had proposed to impose the sales tax on most services that are purchased by individuals and businesses. He later withdrew that plan in the face of criticism that he received about how costly these tax changes would be to businesses that are headquartered in Minnesota.

In a surprising turn, the legislation expands the sales and use tax to include services purchased by businesses after June 30, 2013 to repair and maintain the following items:

  • Commercial and industrial machinery and equipment;
  • Electronic and precision equipment;
  • Computer hardware;
  • Office equipment;
  • Scientific instruments; and
  • Medical equipment.16

Businesses that purchase warehousing or storage services for tangible personal property will be required to pay sales or use tax on these services after March 31, 2014.17 Exemptions are provided for warehousing or storage services purchased to store agricultural products, refrigerated storage, and services purchased to store electronic data. As a result, fees paid to store petroleum products will be subject to sales and use tax along with fees paid to store agricultural inputs such as fertilizer and chemicals.

Telecommunications Equipment Exemption Repealed

In 2002, Minnesota enacted a sales tax exemption for the purchase of telecommunication equipment including ancillary machinery and equipment along with repair and replacement parts.18 This special exemption has now been repealed effective for purchases made after June 30, 2013.19

Digital Goods Taxed

For purchases made after June 30, 2013, sales and use tax will be imposed on the purchase of digital books, digital movies, digital music and audio works, digital greeting cards, online video or electronic games that are transferred electronically to a customer.20 The purchase of a digital code providing the purchaser with the right to obtain a digital product will also be subject to tax. These digital products are subject to tax if the purchaser has the right to use the product on a temporary or permanent basis, and even if the purchaser is required to make continued payments for the right to use the product.21

Upfront Capital Equipment Exemption Procedure Adopted

Since 1989, Minnesota has allowed a sales and use tax exemption to businesses for the purchase of capital equipment and machinery used to manufacture tangible personal property to be sold ultimately at retail.22 However, businesses have been required to first pay the sales or use tax and then apply for a refund. Businesses have long advocated for an upfront exemption from tax on these purchases. In response to these requests, the legislation provides that sales or use tax will no longer be payable on capital equipment purchases made after August 31, 2014.

Data Center Exemption Revised

In 2011, Minnesota enacted a sales tax exemption for the purchase of enterprise information technology equipment and computer software for use in a qualified data center.23 To encourage more activity in this area, the enacted legislation reduces the requirements to qualify as a data center from consisting of 30,000 square feet to 25,000 square feet and from being required to make a $50 million investment over a 24-month period to a $30 million investment over a 48-month period. The law has also been expanded to include a qualified refurbished data center under the exemption. These changes become effective for purchases made after June 30, 2013.

Multiple Points of Use Exemption Revised

For purchases made after June 30, 2013, a business that purchases computer software delivered electronically or a digital good or service that will be concurrently available for use in more than one taxing jurisdiction will be allowed to provide a multiple points of use exemption certificate to the seller.24 The purchaser must use a reasonable but consistent and uniform method to apportion the tax liability. The law requires that the multiple points of use exemption certificate be given to the seller at the time of purchase but also provides that it will be treated similarly to other exemption certificates.

Exemption for Businesses Adding Jobs in Greater Minnesota Created

Businesses that are adding jobs in Greater Minnesota (defined as being outside the Twin City metropolitan area) may receive a refund of sales and use taxes paid on the purchase of tangible personal property or services if the property or services are primarily used in Greater Minnesota.25 This provision also applies to the purchase of construction materials and supplies. In order to receive these benefits, the business must apply for certification from the Commissioner of the Department of Employment and Economic Development. The business must have been in operation in a Greater Minnesota city for at least one year and it must agree to add jobs in a Greater Minnesota city. A retail business does not qualify. In order to certify a business as qualifying for this exemption, the Commissioner must determine that the business would not expand its operations in Greater Minnesota without these tax incentives. The certification is effective for a 12-year period. This sales and use tax exemption becomes effective for purchases made after June 30, 2014. The total amount that may be refunded to all businesses in a fiscal year is limited to $7 million.

Click Through and Remote Seller Nexus Adopted

For sales made after June 30, 2013, a retailer will be presumed to have a solicitor in Minnesota if it enters into an agreement with a Minnesota resident where the resident will receive a commission or other similar consideration for referring potential customers to the retailer by a link on a Web site or otherwise.26 A retailer is not subject to this provision if total gross receipts from Minnesota customers were less than $10,000 during the prior year. The retailer may rebut the presumption with proof that the resident is not soliciting on its behalf. In addition, the legislation revises Minnesota's sales tax nexus law to clearly provide that remote sellers will be required to collect and remit sales tax on sales made to customers who are located in Minnesota when a federal remote seller law is enacted.27

Individual Income Tax

Governor Dayton's major tax policy initiative had been to secure an increased income tax rate on high-income individuals. Current Minnesota law provides for three income tax rates with the top tax rate being 7.85 percent.28 The legislation adopted the Governor's proposal and added a fourth income tax rate of 9.85 percent applicable to Minnesota taxable income in excess of $250,000 for joint filers (in excess of $150,000 for single filers).29 In addition, the alternative minimum tax rate is increased from 6.4 percent to 6.75 percent.30

This new tax rate is effective retroactively to tax years beginning after December 31, 2012. No underpayment of estimated tax penalty can be imposed on payments made for periods prior to September 15, 2013 to the extent the underpayment resulted from the increase in the tax rates.31

Gift and Estate Tax

Gift Tax

The legislation reinstitutes a 10 percent gift tax on taxable gifts made after June 30, 2013.32 The law provides a donor with a lifetime credit of $100,000 which would exempt $1 million of taxable gifts. Minnesota will follow the federal definition of a taxable gift.33 As a result, Minnesota will adopt the federal annual exclusion amount of $14,000 per donor per recipient. Gift tax returns will be due by April 15 of the following calendar year.34

To be subject to the gift tax, real or tangible personal property that is gifted must be located in Minnesota.35 Gifts of intangible personal property are taxable if made by a donor who is a Minnesota resident. Taxable gifts made within three years of the donor's death are included in the taxable estate with a credit provided for Minnesota gift tax that was paid on these gifts.36

Estate Tax

The estate tax will now apply to real or tangible personal property located in Minnesota which was owned by a nonresident decedent with an ownership interest in a pass-through entity.37 The law provides that the situs of the property will be determined as if the pass-through entity did not exist and the property was personally owned by the decedent. A pass-through entity includes an S corporation, partnership, single member limited liability company or a trust. This provision is effective for decedents dying after December 31, 2012.38

Commentary

This bill imposes a major tax increase on high-income individuals and business. Proponents of the bill asserted that business benefits the most from a well-educated workforce and that much of the revenue is dedicated to improving education services. They also argued that high-income individuals were paying a smaller percentage of their income in taxes than middle-income individuals. Opponents of the bill asserted that many high-income individuals are business owners and that these people will leave the state because of the higher income tax rate.

The most volatile revenue source, the corporate income tax, has been significantly increased. Proponents will assert that tax preferences for foreign income have been repealed and that corporate income tax loopholes have been closed. Opponents assert that these provisions were placed into the law to encourage companies to conduct their research operations in Minnesota and to then offer these products for sale worldwide, and without such provisions there will be a desire to move research operations to a more taxpayer-friendly jurisdiction.

What began as a tax reform effort to broaden the sales and use tax base to include clothing and services ended with sales and use tax being imposed on the purchase of specified digital goods and purchases made by business to repair or maintain machinery or equipment or to store or warehouse goods. Ironically, while parts used to repair manufacturing or agricultural machinery or equipment will be exempt, the labor that was purchased to repair that machinery or equipment will now be taxable. While the upfront exemption of capital equipment does help businesses that have been required to outlay sales tax in order to receive a refund, it is essentially a timing difference that does not offset the impact on business of the other sales and use tax and income tax changes.

It is not surprising to see Minnesota repeal its membership in the Multistate Tax Compact out of concern about the potential requirement to allow corporations the ability to elect the equally-weighted three-factor apportionment formula given the litigation in other states, even though it had been thought that Minnesota had acted to eliminate the election many years ago. This move follows several other states that have acted to repeal or substantially alter the Compact in the past year.

Footnotes

1 Ch. 143 (H.F. 677), enacted on May 23, 2013. Note that the revenue estimates throughout this alert are from the Minnesota House and Senate Fiscal Analysis of H.F. 677 that was issued on May 19, 2013.

2 Former MINN. STAT. § 290.01(19d)(10). The repeal of this provision is projected to raise $189 million during the next two-year budget period.

3 Former MINN. STAT. §§ 290.01(6b); 290.17(4)(g). The repeal of this provision is projected to raise $44 million during the next two-year budget period.

4 This provision is projected to raise $12 million during the next two-year budget period.

5 MINN. STAT. § 290.17(4).

6 MINN. STAT. § 290.17(4)(h). This provision is projected to raise $46 million during the next twoyear budget period.

7 Under the approach followed in Appeal of Finnigan Corp., No. 88-SBE-022-A, Cal. State Bd. of Equalization, Jan. 24, 1990, a member of a unitary group has nexus with a state if any of the members of the group have nexus with the state. The alternative approach was taken in Appeal of Joyce, Inc., Cal. State Bd. of Equalization, Dkt. No. 66-SBE-070, Nov. 23, 1966.

8 MINN. STAT. § 290.171.

9 Repeal of Minn. Stat. § 291.171, 290.173, and 290.174, Minnesota Department of Revenue, April 11, 2013.

10 MINN. STAT. § 270C.03(1).

11 MINN. STAT. § 290.068(6a).

12 This change is projected to raise $90 million during the next two-year budget period.

13 MINN. STAT. § 290.0922(1).

14 This change is projected to raise more than $18 million during the next two-year budget period.

15 MINN. STAT. § 290.21(4)(c).

16 MINN. STAT. § 297A.61(3)(m)(1), (2). This was the largest single sales and use tax revenue increase as taxing these services is projected to raise $152 million during the next two-year budget period.

17 MINN. STAT. § 297A.61(3)(m)(3). Taxing these services is projected to raise $95 million over the next two-year budget period.

18 MINN. STAT. § 297A.68(35).

19 The repeal of this exemption is projected to raise $66 million over the next two-year budget period.

20 MINN. STAT. § 297A.61(3)(l), (10), (50)-(56).

21 These provisions are projected to raise more than $8 million during the next two-year budget period.

22 MINN. STAT. § 297A.68(5).

23 MINN. STAT. § 297A.68(42).

24 MINN. STAT. § 297A.668(6a). Note that this provision is generally similar to the multiple points of use exemption provision that was repealed in 2008.

25 MINN. STAT. § 297A.68(49).

26 MINN. STAT. § 297A.66(4a).

27 MINN. STAT. § 297A.66(3).

28 MINN. STAT. § 290.06(2c).

29 This rate increase is the largest single tax increase item in this bill as it is projected to raise $1,118,000,000 over the next two-year budget period.

30 MINN. STAT. § 290.091 (1).

31 H.F. 677, Art. 6, § 33.

32 MINN. STAT. § 292.17. Note that Minnesota's prior gift tax was repealed in 1979. This new gift tax is projected to raise $41 million over the next two-year budget period.

33 MINN. STAT. § 292.16(d).

34 MINN. STAT. § 292.19.

35 MINN. STAT. § 292.17(3).

36 MINN. STAT. §§ 291.005(1)(4); 291.03(1).

37 MINN. STAT. § 291.005(1)(9), (10).

38 This provision is projected to raise more than $12 million during the next two-year budget period.

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