United States: North Carolina Enacts Legislation Providing Extensive Tax Changes

On May 29, North Carolina Governor Pat McCrory signed legislation addressing a wide range of state and local taxes, including the repeal of authority for localities to institute privilege license taxes, alterations to the state's corporate net loss attribute, the imposition of excise taxes on tobacco vapor products, and changes to the sales and use tax.1 The legislation follows on the heels of the Tax Simplification and Reduction Act of 2013, a tax reform bill that resulted in a significant reform to the state's tax structure and a reduction in individual and corporate tax rates.2 Unless otherwise indicated, the changes discussed below take effect July 1, 2014.

Privilege License Tax

Perhaps the most contentious change included in the legislation was the revocation of the authority for localities to institute privilege license taxes. Prior to the enactment of this legislation, North Carolina provided cities3 and counties4 with the authority to levy privilege license taxes against all trades, occupations, professions, businesses, and franchises carried on within that city or county. In addition to the authority for cities and counties to levy privilege license taxes, other North Carolina statutes authorized localities to levy privilege license taxes against certain other types of entities, including loan agencies;5 waste management facilities;6 and hazardous or low-level radioactive waste facilities.7

Effective for taxable years beginning on or after July 1, 2014, the new legislation amends the authority provided to North Carolina cities to levy privilege license taxes by changing the nexus standard under which a city has the authority to levy such a tax on a trade, occupation, profession, business, or franchise. In order to be subject to a privilege license tax, the new legislation provides that such an entity must be "physically located" within the city.8 The "physically located" requirement marks a shift from the previous requirement under which a city was authorized to levy privilege license taxes against a trade, occupation, profession, business, or franchise that was "carried on" within the city.

The legislation provides that for fiscal year 2014-2015, a city is required to apply the privilege license tax ordinance that was in effect for that city in fiscal year 2013-2014, subject to the modifications required by the legislation, namely the change from a "carried on" standard to a "physically located" standard necessary to be subject to tax. Cities that did not have a privilege license tax ordinance in effect for fiscal year 2013-2014 are prohibited from enacting such a tax ordinance for fiscal year 2014-2015.

Effective for taxable years beginning on or after July 1, 2015, the legislation repeals the authority for cities, counties, and localities to levy privilege license taxes. The legislation provides that this repeal does not affect the rights or liabilities or a city, county, or taxpayer, including the right to seek any refund or credit of a tax that would otherwise have been available under the statutes prior to repeal.

Corporate Income Tax – Net Loss Deductions

The legislation also amended North Carolina's treatment of deductions for taxpayers that sustain losses. Historically, North Carolina has allowed a net economic loss (NEL) as a deduction from federal taxable income. The North Carolina NEL tax attribute differed substantially from the federal net operating loss (NOL), with significant restrictions placed on utilization.9 Effective for taxable years beginning on or after January 1, 2015, the legislation repeals North Carolina's NEL statute10 and replaces it with a new statute creating a "State net loss" (SNL).11

The legislative fiscal note explains that the new statute is meant to more closely align North Carolina's loss tax attribute to the federal NOL. The SNL is defined as "the amount by which allowable deductions for the year, other than prior year losses, exceed gross income under the Code for the year adjusted," as provided in the North Carolina income modification statute.12 For corporations that have income from business activity both within and outside North Carolina, the SNL must be allocated and apportioned to North Carolina in the year of the loss.13 Further, the SNL may be carried forward 15 years, but any SNL carried forward is applied to the next succeeding taxable year before any portion of the SNL is carried forward and applied to a subsequent taxable year.14

The legislation also provides that North Carolina applies the standards contained in Internal Revenue Code Sections 381 and 382 to determine whether a SNL survives a merger or acquisition.15 The previous statute did not include this required conformity for mergers and acquisitions.

Finally, similar to the prior statute, the new statute provides that North Carolina or the taxpayer may redetermine a SNL originating in a taxable year that is closed under the applicable statute of limitations, for the purpose of determining the amount of loss that can be carried forward to a taxable year that remains open under the statute of limitations.16

The legislature provides that for taxable years beginning before January 1, 2015, a taxpayer is allowed a NEL as calculated under the rules of the previous statute.17 However, any unused portion of a NEL carried forward to taxable years beginning on or after January 1, 2015 is administered in accordance with the new statute.18 As a result, the new statute removes the previous statutory limit that a NEL that is more than five years old may not offset more than 15 percent of any taxable income for a taxable year before the remaining portion may be carried forward to a succeeding year.

Excise Tax – Tobacco Vapor Products

Another key change included in the legislation is the institution of an excise tax on nicotine vapor products for use in electronic cigarettes effective June 1, 2015 at a rate of five cents per fluid milliliter of consumable product.19 In doing so, the legislation amends the definition of tobacco product to include vapor products.20 The term "vapor product" is defined to include any non-lighted, non-combustible product that employs a mechanical heating element that can be used to produce vapor from nicotine in a solution that is intended to be used with or in an electronic cigarette or similar product.21 This tax does not apply to tobacco products sold outside the state, to the federal government, or consists of a sample tobacco product distributed without charge.22 An exemption is provided to the wholesale dealer who sells a tobacco product to a person who has notified the wholesale dealer in writing that the person intends to resell the item.23

Sales and Use Tax

In addition, the legislation amends certain aspects of the North Carolina sales and use tax. For example, the legislation amends the definition of certain terms, including that of "qualifying farmer" for purposes of being able to claim an agricultural exemption from the sales and use tax for items used in farming operations.24 Effective October 1, 2014, the legislation also amended the definition of "service contract" to a "contract where the obligor under the contract agrees to maintain or repair tangible personal property or a motor vehicle," 25 and instituted a sales tax on those service contracts,26 while also providing for a refund of tax paid on rescinded sales or a cancellation of service.27 Further, effective January 1, 2015, the legislation distinguishes between a "real property contractor," which includes a general contractor, a subcontractor or a builder,28 and "retailer-contractor," which includes a person acting as a retailer when it sells tangible personal property and as a real property contractor when it performs real property contracts.29 The legislation provides that sales tax applies to the sales price of tangible personal property sold to a real property contractor.30

The legislation also provides that prepaid meal plans at institutions of higher learning are subject to sales tax.31 The gross receipts derived from those prepaid meal plans are sourced to the location where the food is available to be consumed.32 The legislation also provides reporting options for those prepaid meal plans.33

Effective June 1, 2014, the legislation amends the sales tax on accommodation rentals by defining and instituting a sales tax on facilitator transactions, subject to certain exemptions.34 The legislation also institutes a privilege tax based on the gross receipts, defined as the sales price, of admissions to certain entertainment activities, effective for admissions charges sold at retail on or after January 1, 2015.35

Commentary

While not as expansive as the legislation enacted last year, the current legislation is notable for its impact on taxation for both the provisions included and excluded in the final version. As for the aspects that were included in the final version, it was previously uncertain whether the bill would survive the legislature and receive Gov. McCrory's signature due to its repeal of the authority for localities to institute privilege license taxes. Along with property taxes, privilege license taxes constitute a large percentage of funding for localities.

In addition to providing a full repeal of privilege license taxes effective for taxable years beginning on or after July 1, 2015, the legislation is notable for its change to the nexus requirement, which is in effect for taxable years beginning on or after July 1, 2014. The change from "carried on" to "physically located" may result in many entities who were previously subject to privilege license taxes, to no longer be subject to those taxes. As this change in nexus will take effect soon, taxpayers should consider whether they may no longer be subject to privilege license taxes in the third quarter of 2014, as opposed to having to wait until the third quarter of 2015 when the privilege license tax authority is repealed in full.

Of additional importance to corporate income taxpayers is the legislative amendment to the prospective treatment of the NEL tax attribute. In many cases, the NEL was substantially restricted. By creating the SNL, the legislation provides another step towards conforming the North Carolina treatment of losses to the federal treatment of a NOL. For taxpayers considering mergers and acquisitions, the adoption of IRC Sections 381 and 382 to the SNL and carryforward NELs, effective for taxable years beginning on after January 1, 2015 may provide benefit to taxpayers impacted by these provisions for federal income tax purposes.

Further, the removal of the prior NEL statute's limitation that a NEL that is more than five years old may not offset more than 15 percent of any taxable income for a taxable year before the remaining portion may be carried forward to a succeeding year may allow certain taxpayers to utilize more of their NEL earlier than previously expected.

The legislation is also notable for the items that were not included in the final version. Specifically, there was discussion that the legislation would change the formula under which North Carolina apportions income for its corporate income taxpayers who have income from business activity both within and outside the state. In particular, discussion involved changing the North Carolina apportionment formula from a double-weighted sales factor formula to a quadruple-weighted sales factor formula. While the final version of the legislation contained no change to North Carolina's apportionment formula, the current legislative session remains open and changes to the apportionment formula could be introduced under a separate, standalone bill.

Footnotes

1 Ch. 3 (H.B. 1050), Laws 2014.

2 For further commentary regarding the Tax Simplification and Reduction Act of 2013, see GT SALT Alert: North Carolina Enacts Legislation Reducing Income Tax Rates, Expanding Sales Tax to Service Contracts [August 1, 2013 Alert].

3 N. C. GEN. STAT. § 160A-211 (2013).

4 N. C. GEN. STAT. § 153A-152.

5 N. C. GEN. STAT. § 105-88(e).

6 N. C. GEN. STAT. § 130A-294(r).

7 N. C. GEN. STAT. §§ 160A-211.1; 153A-152.

8 N. C. GEN. STAT. § 160A-211.

9 For further commentary regarding North Carolina's previous treatment of NELs, see GT SALT Alert: North Carolina Department of Revenue Issues Notice Regarding Computation of Net Economic Loss [January 21, 2013 Alert].

10 N. C. GEN. STAT. § 105-130.8.

11 N. C. GEN. STAT. § 105-130.8A.

12 The North Carolina modification statute is contained in N. C. GEN. STAT. § 105-130.5.

13 N. C. GEN. STAT. § 105-130.8A(a).

14 N. C. GEN. STAT. § 105-130.8A(b).

15 N. C. GEN. STAT. § 105-130.8A(c).

16 N. C. GEN. STAT. § 105-130.8A(d).

17 N. C. GEN. STAT. § 105-130.8A(e).

18 Id.

19 N. C. GEN. STAT. § 105-113.35(a1).

20 N. C. GEN. STAT. § 105-113.4(11a).

21 N. C. GEN. STAT. § 105-113.4(13a).

22 N. C. GEN. STAT. § 105-113.35(a2).

23 N. C. GEN. STAT. § 105-113.35(b).

24 N. C. GEN. STAT. § 105-164.13E.

25 N. C. GEN. STAT. § 105-164.3(38b).

26 N. C. GEN. STAT. § 105-164.4I.

27 N. C. GEN. STAT. § 105-164.11A.

28 N. C. GEN. STAT. § 105-164.3(33a).

29 N. C. GEN. STAT. § 105-164.3(35a).

30 N. C. GEN. STAT. §§ 105-164.4(a)(13), 105-164.4H.

31 N. C. GEN. STAT. § 105-164.4(a)(12).

32 N. C. GEN. STAT. § 105-164.4B(g).

33 N. C. GEN. STAT. § 105-164.16A.

34 N. C. GEN. STAT. § 105-164.4F.

35 N. C. GEN. STAT. §§ 105-164.4(a)(10), 105-164.4G.

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