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Tennessee's Revenue Modernization Act: What it Means for Businesses

09/18/2017  |  By: Mason Barrick, CPA, Senior Manager, State and Local Tax, Brian McCuller, JD, CPA, Shareholder, Practice Leader Tax

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Governor Bill Haslam's Revenue Modernization Act, which he signed into law on May 20, 2015, was designed largely as an effort to make sure that out-of-state companies doing business in Tennessee pay their fair share of business taxes.

The legislation contains several significant tax law changes to business taxes in Tennessee, which appear to be designed both to level the playing field between out-of-state companies and their Tennessee counterparts and to increase and stabilize tax revenue collections.

Summary of the Revenue Modernization Act

Economic Nexus Standard for Tennessee Business Tax

The Tennessee Department of Revenue requires out-of-state businesses to collect and remit sales tax even when the business lacks a “physical presence” in the state. Tennessee's Economic Nexus Standard for state business tax requires out-of-state businesses that exceed $500,000 in Tennessee receipts to file a franchise and excise tax return. 

Under Tennessee law, a taxpayer is generally deemed to have substantial nexus with Tennessee if:

  1. The taxpayer is organized or commercially domiciled in Tennessee,
  2. The taxpayer owns or uses its capital in Tennessee,
  3. The taxpayer has systematic and continuous business activity in Tennessee that has produced gross receipts attributable to customers in Tennessee, or
  4. The taxpayer has bright-line presence in Tennessee.

A bright-line presence test establishes nexus for business tax and franchise, excise tax, very similar to the economic nexus standards for the Ohio Commercial Activity Tax (CAT) and the Washington B&O tax:

  • $500,000 in Tennessee receipts;
  • $50,000 in Tennessee property or payroll; or
  • Tennessee receipts, property or payroll greater than 25% of the total everywhere. 

Will Federal Tax Reform Make State Tax Nexus Even More Important? (March 22, 2017)

Remotely Accessed Computer Software Subject to Tennessee’s Sales and Use Tax

Remotely accessed computer software used by customers but remains in the possession of the seller or its agent subject to sales tax. Before the change, you paid sales taxes on software you bought at the store or downloaded on the Internet, but you did not pay taxes if you purchased the software and used it remotely without ever downloading it.

Many people play video games with a subscription to cloud-based software. Another common example is TurboTax Online, where you buy the software, but you only access by using the internet through the TurboTax system. Regardless of how you get the product, the state wants sales tax collected on it.

The significant gray area is whether something is a product or a service; this distinction impacts an entire market segment know as Software-as-a-Service, or SaaS. The state’s sales and use tax is generally imposed on the sale of products, not services. Defined as software, SaaS products would be taxed. Defined as a service, not so.

A good example of something that might be in a gray area for business is a cloud model that couples SaaS with business-process outsourcing, such as call center and telemarketing outsourcing. In this model, the service provider hosts the application and provides service desk personnel as well. Companies have the ability to access the product remotely to manage customer outreach efforts and get information through the program. Is it a service or a product?

Click-Through Nexus 

Out-of-state retailers must collect sales and use tax if they pay an in-state party a fee or commission to route customers to their online website (commonly referred to as “Click-Through Nexus”). Tennessee joins 14 other states who already do this.

An example would be If the seller enters into an agreement or contract with a Tennessee resident to refer customers to the online retailer's website for a commission, such as via a link on the resident's website.

Substantial Business Purpose for Intangible Expenses

Added a requirement for any transaction to have a "substantial business purpose" to deduct intangible expenses paid to an affiliate for excise tax purposes. This was designed to keep businesses from shifting income outside of Tennessee by paying intangible expenses to an affiliate.  This requirement places the burden of proof on the taxpayer in a dispute with the Commissioner over the deductibility of such expenses using a clear and convincing evidence standard.

Market-Based Sourcing Standard

Changes the sourcing method for sales of service revenue other than sales of tangible personal property, which includes services and the sale of intangible property, for franchise, excise tax apportionment purposes.  In past, Tennessee used a cost of performance analysis for the receipts factor. 

This change to a market-based sourcing of receipts, will more than likely be a benefit to Tennessee-based service companies. It requires out-of-state service providers to apportion their service revenue to Tennessee if they have customers located in Tennessee. This benefits state service companies by allowing them to apportion their service receipts outside of Tennessee.

A seller must allocate revenues to Tennessee for franchise and excise taxes if services are delivered to customers in Tennessee, regardless of the seller’s location. This is called “market based sourcing” standard that has been adopted by 20 other states including neighbors Alabama and Georgia.

Tangible Personal Property

A new election for qualified excise taxpayers to remove their “certified distribution sales” from the numerator of the receipts apportionment factor and pay a new tax annually on such sales at a graduated rate in addition to the franchise and excise taxes. To qualify, a taxpayer must have either sales of tangible personal property in Tennessee of greater than $1 billion or a receipts apportionment factor of greater than 10%.

LBMC's Perspective on the Revenue Modernization Act

The Revenue Modernization Act represents significant changes to Tennessee business taxes in an effort to level the playing field for Tennessee businesses with their out-of-state competition.

The switch to market-based sourcing of receipts for franchise, excise tax will end the confusion among taxpayers and practitioners created by court decisions involving alternative apportionment methods.  This change should benefit our clients in the service industry as Tennessee will join the growing number of states to adopt market-based sourcing. 

The economic and “click-through” nexus provisions are designed so that out-of-state businesses will pay the same taxes as Tennessee-based companies.  It will help ensure that state and local taxes do not give those out-of-state companies doing business in Tennessee a competitive edge.

Moving of some distribution centers out of Tennessee may have triggered the new election for qualified taxpayers to use an alternative apportionment method for franchise, excise tax purposes.  While it may incentivize existing facilities to stay in the state, it will also be a tool for Tennessee to use to entice businesses looking to build new distribution centers to locate here.

The one negative impact on Tennessee businesses is the change in the sales taxability of remotely accessed software.  Tennessee businesses using providers of such software will feel an increased sales tax burden while many technology companies may find themselves with a new sales tax collection responsibility.

There are often changes to bills during the legislative process so Tennessee companies should stay alert to developments. Please contact us if you have any questions and/or we can assist you in any way.

Keep up-to-date on Tennessee taxes by visiting our Center for Tennessee Tax.

Posted in: Tax
Tagged with: State and Local Tax