United States: Connecticut Enacts Legislation Amending Mandatory Combined Reporting, Adopting Singles Sales Factor Apportionment

On December 29, 2015, Connecticut Governor Dan Malloy signed a budget bill passed by the legislature during a recent special session that makes many tax law changes, including amendments to the mandatory unitary combined reporting statutes and adoption of a single sales factor apportionment formula.1 The legislation also amends the corporate income tax general credit limitations and the net operating loss (NOL) provisions. In addition, the legislation enacts personal income tax sourcing provisions for nonresidents who perform services. This is the latest round of major tax reform legislation enacted by Connecticut. On June 30, 2015, Connecticut enacted budget legislation that contained sweeping tax reform featuring unitary mandatory combined reporting.2

Mandatory Unitary Combined Reporting

In June 2015, budget legislation was enacted that adopted mandatory unitary combined reporting for tax years beginning on or after January 1, 2016. The recent legislation amends several of the unitary combined reporting provisions, generally effective for tax years beginning on or after January 1, 2016, including placing a cap on the incremental amount of tax owed as a result of the mandatory unitary combined reporting.

Incremental Tax Cap

As amended, the tax calculated for a combined group on a combined unitary basis, prior to the surtax and application of credits, may not exceed the "nexus combined base tax" by more than $2.5 million.3 The nexus combined base tax equals the tax measured on the sum of the net income or loss of each taxable member, or the minimum tax base of each taxable member, as if the members were not required to file a combined unitary tax return.4 However, this is limited to the extent that the income, loss or minimum tax base of any taxable member is separately apportioned to the state pursuant to Connecticut statute except for the specific intercompany eliminations discussed below. Intercompany dividends are eliminated in computing the separate net income or loss. Intangible expenses and costs and interest expense are also eliminated, as is the income attributable to such items, provided those expenses are subject to Connecticut's addback provisions and provided that the related members are both taxable members of the combined group.5 Additionally, intercorporate stockholdings are eliminated in computing the combined additional tax base.6

Items Included in Combined Group's Net Income

The recent legislation amends the provisions listing the items that must be included in a combined group's net income. Under existing law, if the unitary business has income from an entity that is treated as a pass-through entity, the combined group's net income must include its member's direct and indirect share of the pass-through entity's unitary business income.7 As amended, the distributive share of income received by a limited partner from an investment partnership will not be considered to be derived from a unitary business unless the general partner of the investment partnership and the limited partner have common ownership.8 If the limited partner is otherwise carrying on or doing business in the state, it must apportion its distributive share of income from an investment partnership using special apportionment provisions.9 If the limited partner is not otherwise carrying on or doing business in the state, its distributive share of income from an investment partnership is not taxable.10

Application of Federal Consolidated Return Regulations

The June 2015 legislation provided that intercompany gains among members of the same combined group are treated in a manner consistent with Treas. Reg. Section 1.1502-13 and generally deferred.11 The recent legislation replaces this provision to clarify that the principles set forth in the Treasury Regulations promulgated under Internal Revenue Code (IRC) Section 1502, including the principles relating to deferrals, eliminations and exclusions, apply to the extent consistent with the Connecticut combined group membership and reporting principles.12

Entities Included in Group

The recent legislation amends the provision concerning the entities that are included in the combined group. Under existing law, a combined unitary group generally files a return on a water's edge basis, but it may elect to file on a worldwide unitary or federal affiliated group basis.13 Combined unitary groups filing on a water's edge combined basis generally include U.S. companies, any companies with at least 20 percent of their payroll and property in the U.S., and companies located in designated tax havens.14 The recent legislation repeals the inclusion of companies earning at least 20 percent of their gross income from intangible property or service-related activities.15 Also, while retaining a qualitative list of factors contained in the definition of the term "tax haven," the recent legislation explicitly provides that "tax haven" does not include a jurisdiction that has entered into a comprehensive income tax treaty with the U.S.16 Furthermore, the Tax Commissioner is no longer directed to publish a list of tax havens.

Apportionment

Existing law provides that each taxable member of a combined group must use Connecticut apportionment law, including sourcing rules, to compute its applicable apportionment factor.17 If any member of the group is taxable outside Connecticut, all members have the right to apportion income in accordance with the rules provided in determining a combined group apportionment factor.18 This provision is amended to allow financial service companies that are members of the combined group the same right to apportion income in accordance with the rules provided in determining a combined group apportionment factor.19

Capital Base Tax

Each combined unitary group also is subject to a capital base tax.20 In determining the combined group's additional capital base tax, the recent legislation provides that assets and liabilities attributable to transactions with another member of the combined group, including, but not limited to, a financial service company, are eliminated.21

Foreign Corporations

Under existing law, any company that derives income from sources within Connecticut and that has a substantial economic presence within the state, without regard to physical presence, and to the extent permitted by the U.S. Constitution, is subject to the state's corporate income tax.22 However, these provisions do not apply to a company that is treated as a foreign corporation under federal law and has no income effectively connected with a U.S. trade or business.23

To the extent that a company that is treated as a foreign corporation under federal law has income effectively connected with a U.S. trade or business, the company's gross income, notwithstanding any of the combined reporting provisions, is its income effectively connected with its U.S. trade or business.24 For apportionment purposes, only items effectively connected with the company's U.S. trade or business are considered in calculating the company's apportionment fraction. As amended, the provisions in this paragraph do not apply to a foreign corporation that is included in a combined group.25

Single Sales Factor Apportionment

For tax years beginning on or after January 1, 2016, the legislation adopts a single sales apportionment factor that will apply to most taxpayers.26 Taxpayers previously used different apportionment formulas in Connecticut depending on their type of business. In general, net income derived from business other than the manufacture, sale or use of tangible personal or real property was apportioned using a single sales factor.27 Net income derived from the manufacture, sale or use of tangible personal or real property was apportioned using a three-factor formula with a double-weighted sales factor.28 However, there were some exceptions to these general rules. For example, the income of a taxpayer that was primarily engaged in manufacturing activities was apportioned using a single sales factor.29

As amended, most taxpayers will apportion income to Connecticut using a single sales factor. However, the statute continues to provide that a taxpayer that receives at least 75 percent of its income from the sale of tangible personal property to the U.S. government may elect to use a three-factor formula with a double-weighted sales factor.30

The change to the single sales factor method of apportionment applies only to the income tax base and does not apply to the capital base (which will continue to require apportionment based on the value of intangible assets and tangible property).31

General Credit Limitations

For tax years beginning on or after January 1, 2015, the June 2015 budget legislation limits the application of credits to 50.01 percent of tax due.32 For tax years beginning on or after January 1, 2016, the recent legislation allows taxpayers to claim certain credits in excess of the general 50.01 percent limitation.33 The increased credit limitation applies to the "excess credits" available under the research and experimental expenditures tax credit,34 research and development expenses tax credit,35 and urban and industrial site reinvestment tax credit.36 Taxpayers may claim these excess credits that remain after application of the general 50.01 percent limitation.37 However, the aggregate amount of tax credits and excess credits may not exceed the following amounts:

  • For tax years beginning in 2016, 55 percent;
  • For tax years beginning in 2017, 60 percent;
  • For tax years beginning in 2018, 65 percent; and
  • For tax years beginning after 2018, 70 percent.38

NOL Election

The recent legislation amends the NOL election provisions that were enacted earlier in 2015. Under the June 2015 legislation, for tax years beginning on or after January 1, 2015, the amount of NOLs that may be applied against income is limited to an amount equal to 50 percent of net income.39 However, combined groups with over $6 billion of unused NOLs for tax years beginning before January 1, 2013 may make an election to forfeit 50 percent of their unused NOL balance and use the reduced balance to exceed the 50 percent limitation in tax years beginning on or after January 1, 2017. The recent legislation allows combined groups to make this election for tax years beginning on or after January 1, 2015. Also, the recent legislation amends the statute to provide that combined groups making the election cannot use the remaining NOLs to reduce the group's tax to less than $2.5 million, prior to the surtax and application of credits.40

Personal Income Tax Sourcing

For tax years beginning on or January 1, 2016, personal income tax sourcing rules are added for nonresident employees who perform personal services in Connecticut.41 Specifically, compensation for personal services rendered in Connecticut by a nonresident employee who is present in the state for up to 15 days during a taxable year is not sourced to Connecticut.42 However, if a nonresident employee is present in Connecticut for more than 15 days during a taxable year, all compensation that the employee receives for the rendering of all personal services in the state is sourced to Connecticut. This provision only applies to compensation for personal services rendered by a non-resident employee and excludes the income of an athlete, entertainer or performing artist.43

The statute also was amended to provide that income from a business, trade, profession or occupation carried on in Connecticut includes, but is not limited to, compensation paid to a nonresident natural person for rendering personal services as an employee in the state.44

Commentary

The implementation of mandatory unitary combined reporting in Connecticut has been a lengthy and complex process. The initial budget bill, H.B. 7061, was passed by the legislature on June 3, 2015, at the conclusion of the regular legislative session by a slim margin,45 despite significant efforts from large Connecticut-based corporations to prevent its passage. Before the initial budget bill was signed into law by Governor Malloy, several prominent Connecticut-based companies voiced significant concern regarding its tax implications and threatened to move their operations outside the state.

As a result, the legislature was called into special session to enact S.B. 1502 implementing the budget and altering some of the more controversial provisions included in the original law. Specifically, the new legislation delayed implementation of the unitary combined reporting requirement and discarded a proposed increase to the sales and use tax rate applicable to sales of computer and data processing services.

Despite the changes made by S.B. 1502, there continued to be controversy surrounding the combined reporting provisions. As a result, the legislature was called into special session during December 2015 to further amend the combined reporting statutes as well as other provisions. Several of the recent changes were specifically tailored to benefit the Connecticut-based companies that had challenged the enactment of the legislation earlier in 2015. For example, the incremental tax cap is set at a very high amount, so that the effect of the cap in limiting any additional tax burden resulting from mandatory unitary combined reporting will only be felt by a select few taxpayers. On the other hand, the exclusion of companies earning at least 20 percent of their gross income from intangible property or service-related activities from the combined group may have broader effect.

The legislation contains significant amendments beyond the scope of combined reporting.46 The move to a single sales factor for most taxpayers is an important development. Apportionment of income to Connecticut traditionally has been a complex procedure because the apportionment formula varied depending on the source of a taxpayer's income. Taxpayers were required to make a determination of whether they should use a three-factor formula with a double-weighted sales factor or a single sales factor formula. The adoption of a single sales factor method for most taxpayers should simplify this procedure. Also, the increase in the general credit limitations for certain "excess credits" should encourage companies to invest in their Connecticut operations.

In addition, the personal income tax amendments should assist nonresident individuals who perform personal services in the state for up to 15 days during a taxable year. For these taxpayers, the income from personal services is no longer sourced to Connecticut. Congress has considered this issue on a national basis by proposing the Mobile Workforce State Income Tax Simplification Act,47 which would prevent a state from taxing the income of a nonresident employee who is present and performing work in the state for 30 days or less during the calendar year. Similar legislation has been considered in prior sessions of Congress. Given the current status of the proposed federal legislation, Connecticut may have decided to provide some income tax relief to nonresident employees who spend a short amount of time in the state. It will be interesting to see if other states decide not to wait for Congressional intervention on this issue and provide their own specific form of relief to nonresident employees, and whether such activity may encourage Congress to move on this issue in the coming year.

Finally, since the income tax law changes discussed above were enacted on December 29, 2015, such changes should be accounted for as a fourth quarter event by calendar year taxpayers for ASC 740 purposes.

Footnotes

1 Public Act No. 15-1 (S.B. 1601), Dec. Spec. Sess., Laws 2015; Special Notice 2015(11), Connecticut Department of Revenue Services, Dec. 22, 2015.

2 Public Act 15-244 (H.B. 7061), Laws 2015; Public Act 15-5 (S.B. 1502), June Spec. Sess., Laws 2015. For a detailed discussion of the budget legislation that was enacted in June 2015, see GT SALT Alert: Connecticut Enacts Sweeping Tax Reform Including Mandatory Unitary Combined Reporting Requirement.

3 Public Act No. 15-1 (S.B. 1601), Dec. Spec. Sess., Laws 2015, § 36, adding Public Act 15-244 (H.B. 7061), Laws 2015, § 139(k)(1).

4 Public Act No. 15-1 (S.B. 1601), Dec. Spec. Sess., Laws 2015, § 36, adding Public Act 15-244 (H.B. 7061), Laws 2015, § 139(k)(2)(A).

5 Public Act No. 15-1 (S.B. 1601), Dec. Spec. Sess., Laws 2015, § 36, adding Public Act 15-244 (H.B. 7061), Laws 2015, § 139(k)(2)(B).

6 Public Act No. 15-1 (S.B. 1601), Dec. Spec. Sess., Laws 2015, § 36, adding Public Act 15-244 (H.B. 7061), Laws 2015, § 139(k)(2)(A).

7 Public Act 15-244 (H.B. 7061), Laws 2015, § 139(a)(4).

8 Public Act No. 15-1 (S.B. 1601), Dec. Spec. Sess., Laws 2015, § 36, adding Public Act 15-244 (H.B. 7061), Laws 2015, § 139(a)(4)(B).

9 See CONN. GEN STAT. § 12-218(g)(2).

10 Public Act No. 15-1 (S.B. 1601), Dec. Spec. Sess., Laws 2015, § 36, adding Public Act 15-244 (H.B. 7061), Laws 2015, § 139(a)(4)(B).

11 Public Act 15-244 (H.B. 7061), Laws 2015, § 139(a)(6).

12 Public Act No. 15-1 (S.B. 1601), Dec. Spec. Sess., Laws 2015, § 36, amending Public Act 15-244 (H.B. 7061), Laws 2015, § 139(a)(6).

13 Public Act 15-244 (H.B. 7061), Laws 2015, § 140(a), (b).

14 Id.

15 Public Act No. 15-1 (S.B. 1601), Dec. Spec. Sess., Laws 2015, § 37, repealing Public Act 15-244 (H.B. 7061), Laws 2015, § 140(b)(3).

16 Public Act No. 15-1 (S.B. 1601), Dec. Spec. Sess., Laws 2015, § 37, amending Public Act 15-244 (H.B. 7061), Laws 2015, § 140(b)(4).

17 Public Act 15-244 (H.B. 7061), Laws 2015, § 139(b)(1).

18 Public Act 15-244 (H.B. 7061), Laws 2015, § 139(b)(5).

19 Public Act No. 15-1 (S.B. 1601), Dec. Spec. Sess., Laws 2015, § 36, amending Public Act 15-244 (H.B. 7061), Laws 2015, § 139(b)(5).

20 Public Act 15-244 (H.B. 7061), Laws 2015, § 139(f).

21 Public Act No. 15-1 (S.B. 1601), Dec. Spec. Sess., Laws 2015, § 36, amending Public Act 15-244 (H.B. 7061), Laws 2015, § 139(f)(1). Note that financial service companies are excluded from the calculation of the capital base for combined unitary groups and are instead subject to the capital base tax at the minimum $250 amount. Public Act 15-244 (H.B. 7061), Laws 2015, § 139(f)(2), (h)(2).

22 CONN. GEN STAT. § 12-216a(a).

23 CONN. GEN STAT. § 12-216a(b)(1).

24 CONN. GEN STAT. § 12-216a(b)(2).

25 Id.

26 CONN. GEN STAT. § 12-218(b).

27 Former CONN. GEN STAT. § 12-218(b).

28 Former CONN. GEN STAT. § 12-218(c).

29 Former CONN. GEN STAT. § 12-218(k). 30 CONN. GEN STAT. § 12-218(j).

31 CONN. GEN STAT. § 12-219a(a).

32 CONN. GEN STAT. § 12-217zz(a)(2). Previously, credits had been allowed to reduce taxable income by up to 70 percent.

33 CONN. GEN STAT. § 12-217zz(a)(3).

34 CONN. GEN STAT. § 12-217j.

35 CONN. GEN STAT. § 12-217n.

36 CONN. GEN STAT. § 32-9t.

37 CONN. GEN STAT. § 12-217zz(a)(3).

38 Id.

39 CONN. GEN STAT. § 12-217(a)(4).

40 Id.

41 CONN. GEN STAT. § 12-711(b)(2).

42 CONN. GEN STAT. § 12-711(b)(2)(A).

43 CONN. GEN STAT. § 12-711(b)(2)(C).

44 CONN. GEN STAT. § 12-711(b)(2)(A). Note that this provision applies "[b]efore, on and after the effective date of this section."

45 The legislation was approved by the Senate by a 19-17 vote just before the scheduled expiration of the legislative session on June 3. House members had approved the bill by a vote of 73-70 earlier the same day.

46 In addition to the income tax provisions, this legislation repeals the sales and use tax exemption for residential weatherization products and compact fluorescent light bulbs for sales occurring on or after January 1, 2016. CONN. GEN STAT. § 12-412k. The Connecticut Department of Revenue Services is providing transitional rules for eliminating the exemption for sales of residential weatherization products. Special Notice 2015(11), Connecticut Department of Revenue Services, Dec. 22, 2015.

47 H.R. 2315.

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