North Carolina enacts budget bill
Significant tax changes included
TAX ALERT |
On Sept. 18, 2015, North Carolina Gov. Pat McCrory signed into law HB97, which makes several significant changes to the state’s tax code. Some changes are immediately effective for tax years beginning on or after Jan. 1, 2015, with additional changes phasing in throughout tax years 2016 through 2020.
Corporate income tax
The legislation updated North Carolina’s statutes to reflect the reduction of the corporate income tax rate from 5 to 4 percent for taxable years beginning on or after Jan. 1, 2016. This rate reduction was already in effect due to legislation passed during the 2013 legislative session, which automatically lowered the corporate income tax rate when certain state revenue goals were met. The change enacted by HB97 codifies the implementation of the 4 percent tax rate. The new law provides for a potential additional reduction of the corporation income tax rate to 3 percent on Jan. 1 of the year following any fiscal year when state tax collections exceed $20.975 billion.
Also included in the bill are provisions requiring interest expense paid to a related member to be added to federal taxable income in computing North Carolina net income. A taxpayer may then deduct this interest expense up to a limit equal to 30 percent of the taxpayer’s adjusted taxable income. This limitation does not apply if tax is imposed on the related member with respect to the interest in North Carolina or another state, or the related member is organized under the laws of a foreign country that has a comprehensive tax treaty with the United States and the country taxes the interest at a tax rate that equals or exceeds the North Carolina corporate income tax rate. There is no conduit exception in the new add-back statute; however, the add-back provisions do not apply if the related member is a bank.
The legislation phases in single sales factor apportionment over three years, beginning with a triple-weighted sales factor for tax years beginning on or after Jan. 1, 2016, and fully phased-in single sales factor apportionment for tax years beginning on or after Jan. 1, 2018.
The bill also requires the Revenue Laws Study Committee to perform a study of market-based sourcing, and includes a requirement for corporate taxpayers with apportionable income greater than $10 million and an apportionment percentage less than 100 percent to file an informational report showing the results of market-based sourcing for the 2014 taxable year when filing their 2015 returns (using the model market-sourcing regulations drafted by the Multi-State Tax Commission and any additional DOR guidelines consistent with the MTC regulations). A taxpayer may not request an extension of time to file the informational report, and will be assessed a civil penalty of $5,000 for failure to timely file an informational report.
Corporate franchise tax
The corporate franchise minimum tax is raised to $200 for all entities that are subject to the franchise tax, and the maximum tax is increased to $150,000 for holding companies. The bill eliminates the capital stock franchise tax base and replaces it with a net worth tax base. The net worth of a corporation is its total assets, reduced by a deduction for accumulated depreciation, depletion and amortization as determined in accordance with the method used for federal tax purposes, less its total liabilities. Other adjustments, such as an addition for affiliated indebtedness, are also required in calculating the net worth base. These changes are effective Jan. 1, 2017, for the taxes due on or after that date.
Historic preservation tax credit
This bill amended Chapter 105 of the General Statutes to add Article 3L, Historic Rehabilitation Tax Credits Incentive Program, and updated certain limitations. This article expires for qualified rehabilitation expenditure and rehabilitation expenses incurred on or after Jan. 1, 2020.
Individual income tax
Changes to the individual income tax include an increased standard deduction, medical and dental expenses provision, changes to withholding tables and a lower tax rate. Changes related to the standard deduction are effective for tax years beginning on or after Jan. 1, 2016. The reduction of the individual income tax rate from 5.75 percent to 5.499 percent is effective for tax years beginning on or after Jan. 1, 2017.
Sales and use tax
The legislation provides that the sales tax will expand to certain previously exempt services.
Pursuant to the bill, sales tax now applies to “repair, maintenance and installation services” that includes the activities listed below:
- Keeping or attempting to keep tangible personal property or a motor vehicle in working order to avoid breakdown and prevent repairs.
- Calibrating, restoring or attempting to calibrate or restore tangible personal property or a motor vehicle to proper working order or good condition. This activity may include replacing or putting together what is torn or broken.
- Troubleshooting, identifying or attempting to identify the source of a problem for the purpose of determining what is needed to restore tangible personal property or a motor vehicle to proper working order or good condition.
- Installing or applying tangible personal property except tangible personal property installed or applied by a real property contractor pursuant to a real property contract.
However, the bill does provide limited exemptions from the tax on repair, maintenance and installation service charges, including:
- Parts, repairs, installation and maintenance services which are purchased for resale.
- Services performed on certain equipment owned by a utility company regulated by the public service commission.
- Services performed on qualifying equipment purchases made by North Carolina based professional motorsports racing teams.
- Services performed on qualifying manufacturing (mill) machinery and equipment.
- Parts and materials used to maintain or repair tangible personal property or a motor vehicle covered by a service contract, when the purchaser is not charged for the parts and materials under the terms of the service contract.
Additionally, separately stated service charges will no longer be tax-exempt after March 1, 2016.
The bill also provides that, effective March 1, 2016, the definition of a taxable service contract includes an agreement to repair or maintain tangible personal property, regardless of whether the property becomes a part of or affixed to real property with the exception of real property security or similar monitoring service contracts. Prior to this change, retail sales of service contracts were subject to state and local sales tax with the exception of service contracts providing coverage for real property. Note that construction contractors are not affected by this law provided that their primary business is the maintenance or improvements to real property and not the retail sale of parts or materials from inventory.
HB97 implements significant changes to North Carolina’s tax system. These changes involve a wide variety of taxes and there is substantial variation in effective dates. Accordingly, taxpayers should exercise due care in determining the impact of the legislation on their business and individual liabilities, tax systems and procedures, and financial reporting.