DC Council overrides mayor’s veto of FY 2015 Budget Support Emergency Act
Implements single sales factor apportionment and market sourcing
TAX ALERT |
On July 14, 2014, the District of Columbia Council (Council) overwhelmingly approved the FY 2015 Budget Support Emergency Act (Emergency Act), overriding Mayor Vincent Gray’s July 11, veto and immediately implementing significant changes to the business franchise tax, individual income tax, estate tax, and sales tax, without the requirement for Congressional review.
Business franchise tax
The Emergency Act adopted four major changes to the District’s business franchise tax: rate reduction, single sales factor apportionment, market sourcing for sales other than sales of tangible personal property with a throw-out provision, and an exemption for investment funds.
Under current law, the District’s business franchise tax rate is 9.975 percent. Pursuant to the Emergency Act, for tax years beginning after Dec. 31, 2014, the District will reduce the franchise tax rate from 9.975 percent to 9.4 percent. Subject to availability of funding and in accordance with priorities provided in DCC sections 47-181, the District’s business franchise tax rate will decline to 9.0 percent, 8.75 percent, 8.5 percent and 8.25 percent (one rate decrease per year, assuming the District meets its fiscal goals). Taxpayers should monitor updates to see if the District meets its fiscal goals, and in fact reduces its franchise tax rate to 8.25 percent.
Under current law, the District apportions income using a three-factor formula (property, payroll and sales) with a double-weighted sales factor. Pursuant to the Emergency Act, for tax years beginning after Dec. 31, 2014, taxpayers will be required to apportion income utilizing a single sales factor formula.
Under current law, the District sources sales other than sales of tangible personal property (e.g., sales of intangibles and services) based on an all-or-nothing income-producing activity test. Under this test, receipts from sales of intangibles and services are sourced to the District if (1) the income-producing activity or service is performed in the District, or (2) the income-producing activity or service is performed both in and outside of the District and a greater proportion is performed in the District than in any other state, based on costs of performance. Pursuant to the Emergency Act, for tax years beginning after Dec. 31, 2014, taxpayers will be required to source receipts from sales of intangibles and services using a market-based sourcing test. Under this test, receipts from sales of services will generally be sourced to the District if the service is delivered to a location in the District, and receipts from sales of intangibles will generally be sourced to the District to the extent the intangibles are used in the District. If such receipts cannot be sourced to a state or are sourced to a state where the taxpayer is not taxable, the receipts must be thrown out of the sales factor.
Under current law, the District provides an exemption from unincorporated business franchise tax for businesses that derive 80 percent or more of gross income from personal services. An investment fund’s trading activities do not qualify as personal services for the purposes of this exemption, and therefore, a fund’s dividends, interest and capital gains are subject to the tax. Although the Emergency Act does not extend the application of this exemption to investment funds, it does create a new exemption applicable to businesses that solely “purchase, hold, sell or enter, maintain or terminate positions in, stocks, securities, or other commodities for the taxpayer’s own account.” This new exemption does not apply to (1) a taxpayer that holds property, or maintains positions, as stock in trade, as inventory, or for sale to customers in the ordinary course of the taxpayer’s business, (2) a taxpayer that acquires debt instruments in the ordinary course of the taxpayer's business for funds loaned or services rendered, or (3) a taxpayer that holds stock in a real estate investment trust or a partnership interest that is not traded on an established securities market.
Individual income tax
The Emergency Act makes several changes to the District’s individual income tax, including adding a new income tax bracket, increasing the standard deduction, and increasing the personal exemption. Some taxpayers will also benefit from rate reduction. As with the business franchise tax changes, some of the individual tax provisions of the Emergency Act are tied to fiscal triggers and will only become effective if the requisite funds are available in future years.
If certain fiscal triggers are met, the Emergency Act will incrementally increase the District’s estate tax threshold from $1 million to $2 million and, subsequently, to the federal level.
The Emergency Act broadens the applicability of the sales tax to a number of services, including bottled water service, storage of household goods, carpet cleaning, health club services, tanning, car washes, bowling alleys, and billiard parlors. The imposition of tax on these services is effective immediately.
The provisions of the Emergency Act are temporary and can remain in effect for no longer than 90 days. However, the provisions of the Emergency Act mirror the provisions of Bill 20-750 (Permanent Act), which has already passed the Council and is subject to review by the Mayor. If the Mayor either signs the Permanent Act or his veto is overridden by the Council, which appears likely based on the support for the Emergency Act, it will be sent to Congress for its 30-day review prior to becoming law. Taxpayers should consider the implications of the Emergency Act for their businesses, and should continue to monitor the Permanent Act to see if it becomes law.