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By Jaye A. Calhoun, Jason R. Brown, and William J. Kolarik, II

On March 29, 2017, Louisiana Governor John Bel Edwards released the broad outlines of his Louisiana tax reform proposal (the “Tax Reform Proposal”), which he promoted as a comprehensive plan to stabilize Louisiana’s budget and avoid future mid-year budget cuts. The Governor’s plan includes individual income tax, sales and use tax, corporate tax, and tax expenditure proposals designed to, if enacted, replace the revenue generated by the “fifth-penny” of sales and use tax (that expires in 2018) and generate revenue to sustain Louisiana’s current budget structure. Governor Edwards announced the proposal alongside Kimberly Robinson, Secretary of the Louisiana Department of Revenue, during a press conference at the Louisiana State Capitol. And, while he did not provide a draft of legislation proposed to implement the tax plan or discuss many specific details, he did provide an overview of the Tax Proposal.

The Governor made an effort to tie the Tax Reform Proposal to the Final Report issued January 27, 2017, by the Task Force on Structural Changes in Budget and Tax Policy (the “Task Force”), but many who have studied the report were unconvinced. Indeed, while some of the sales tax changes were discussed in the Final Report, the commercial activity tax, the most significant and controversial aspect of the Governor’s tax reform proposal did not appear in the Task Force’s Final Report. An overview of the Governor’s Tax Reform Proposal follows.

Corporate Tax Proposals

The Governor’s plan would implement a number of changes impacting corporate taxpayers, including: (1) phasing out the corporation franchise tax; (2) repealing the corporation income tax deduction for federal income taxes; (3) reducing the corporation income tax rate; and (4) enacting a commercial activity tax (i.e., a gross receipts tax). Essentially, the Governor proposes to eliminate the franchise tax, over time, and retain the corporation income tax, but also impose a gross receipts tax to serve as a type of alternative minimum tax. Until the franchise tax is phased out, a corporate taxpayer would compute its liability under all three taxes, but would only owe franchise taxes and the greater of the corporation income or the commercial activity tax.

Phase-Out of the Corporation Franchise Tax

Under the Tax Reform Proposal, the corporation franchise tax would be phased out over a ten-year period. The Governor did not provide specifics on the phase-out but, presumably, it would occur in equally incremental annual reductions over a ten-year period. The Governor Edwards was unsure of the cost of phasing-out the franchise tax. The effective date of this reform was not specifically mentioned, but, because it was discussed in conjunction with the proposed commercial activity tax (discussed below), the Edwards Administration is likely considering beginning the phase-out in the 2019 franchise tax year (2018 filing period).

Repealing the Federal Income Tax Deduction

Currently, corporate income tax filers may deduct their federal income taxes paid when computing their Louisiana taxable income. Because the federal income tax deduction is constitutionally protected, repealing the deduction requires passage of a constitutional amendment supported by (a simple majority of) voters. Governor Edwards indicated at his press conference that the reduced corporate income tax rates, discussed below, would be contingent upon passage of such a constitutional amendment.

In 2016, the Governor proposed to collapse the tiered corporation income tax brackets into a flat six-and-one-half-percent (6.5%) corporate income tax rate to help resolve the 2016 budget shortfall. That proposal was similarly contingent upon the repeal of the federal income tax deduction through a constitutional amendment, which Louisiana voters rejected by a fifty-six to forty-four percent (56-44%) margin. Governor Edwards did not indicate at his press conference when the proposed constitutional amendment would be put to voters, but the most likely date would be November, 2017.

Reducing the Corporation Income Tax Rate

The Tax Reform Proposal would reduce the number of corporate income tax brackets from five (5) to three (3) and would reduce the corporation income tax rate upon repeal (via constitutional amendment) of the federal income tax deduction. Currently, Louisiana has five corporate income tax brackets – four percent (4%), five percent (5%), six percent (6%), seven percent (7%), and eight percent (8%). The Tax Reform Proposal would reduce the number of corporation income tax brackets to three (3) brackets at three percent (3%), five percent (5%), and seven percent (7%).

The Commercial Activity Tax

The Governor suggested that enacting a commercial activity tax would offset the costs of allowing the fifth-penny (of sales and use tax, discussed below) to expire on schedule, reducing the corporate and individual income tax rates, and phasing-out the franchise tax. The Governor did not provide many details of the proposed commercial activity tax, but did indicate that the tax was modeled upon similar taxes in use by other states. Based on the details released by the Governor and information provided by Secretary Robinson in meetings with trade groups around the state, it appears that the commercial activity tax would be similar to the commercial activity tax levied by the state of Ohio.

The commercial activity tax would be assessed upon any legal entity doing business in Louisiana. The tax base would be the entity’s gross receipts after deductions for (1) cash discounts allowed and taken; and (2) returns and allowances that are attributable to Louisiana. The proposed tax rate is thirty-five hundredths of one percent (0.35%).

The proposed commercial activity tax would apply as follows:

Entities subject to tax Entities exempt from tax
Partnerships Non-profit organizations
Limited liability companies Governmental entities
Limited liability partnerships Certain public utilities
Corporations Certain financial institutions
Subchapter S corporations Certain insurance companies
Joint ventures Businesses with $1.5 million or less of taxable gross receipts
Disregarded entities

While not specifically stated, it appears that sole proprietorships would also be subject to the commercial activity tax.

The proposed tax would apply at the full rate to businesses with $1.5 million or more in gross receipts.[1] All other businesses would be subject to a minimum commercial activity tax. The proposed minimum tax rates and commercial activity tax computation follow:

Taxable Gross Receipts Minimum Commercial Activity Tax Commercial Activity Tax
Less than $500K $250 No additional tax due
$500K – $1M $500 No additional tax due
$1M-$1.5M $750 No additional tax due
$1.5M to $3M N/A (0.35% x Taxable Gross Receipts) – [5,250 x ($3M – Taxable Gross Receipts)/$1.5M]
Greater than $3M N/A 0.35% x Taxable Gross Receipts

As noted above, the proposed commercial activity tax would only apply to gross receipts attributable to Louisiana. According to the proposal, the determination of gross receipts attributable to Louisiana would be identical to the determination of the numerator of the Louisiana sales apportionment ratio (for purposes of calculating the corporation income tax). The Tax Reform Proposal notes that gross receipts attributable to Louisiana would include:

  1. Gross rents attributed to real property located in Louisiana;
  2. Gross royalties from real property located in Louisiana;
  3. Gross receipts from the sales of tangible personal property received by the purchaser in Louisiana;
  4. Gross receipts from the sales of all other services if the purchaser or recipient of the service receives the benefit in Louisiana.

Because the determination of gross receipts attributable to Louisiana would be identical to the determination of the numerator of the Louisiana sales apportionment ratio, it appears the guidance related to sourcing sales for Louisiana corporation income tax purposes would also apply to the commercial activity tax.

For a corporation or a limited liability company that has elected to be taxed as a corporation, the commercial activity tax would function similar to an alternative minimum tax. For those taxpayers, the amount of tax liability would be the greater of: (1) the minimum commercial activity tax; (2) the commercial activity tax; or (3) the net corporation income tax due after the application of all credit carryforwards, nonrefundable credits, and (available) refundable credits. For a pass-through entity that is not subject to the corporation income tax with more than $1.5M in taxable gross receipts, the amount of tax liability would be the greater of: (1) the top-tier minimum commercial activity tax (i.e.,$750); or (2) the commercial activity tax.

Governor Edwards also noted that the administration intends to present an additional plan that would mitigate the impact of the commercial activity tax on low-margin businesses. The Governor did not provide specific details on the low-margin business plan, but he indicated that it would create a separate calculation designed to ensure that a business does not pay more than its “fair share.” The Governor did not indicate when he would provide details on his low-margin business plan.

The commercial activity tax proposal is projected to raise approximately $800-900M in revenue, which taken together with the other tax reforms would replace the revenue from the expiring fifth penny. Because the commercial activity tax is intended to replace the revenue from the expiring fifth penny, the proposed effective date is July 1, 2018.

Tax Expenditure Proposals

The Tax Reform Proposal would make permanent the temporary reductions to certain credits and incentives enacted in 2015 and currently set to expire in 2018. The proposal would also allow certain credits and incentives to sunset or expire as scheduled. The reductions to credits and incentives are expected to raise $192.5M in revenue based on fiscal notes from other legislative sessions.

While the tax reform proposal does not discuss specific credits and incentives, legislation enacted in 2015 reduced several corporate income and franchise tax credits for tax returns filed on or after July 1, 2015, and before June 30, 2018. The reduced tax credits included the jobs credit, the corporation income tax credit and credits paid by economic development corporations, regardless of the taxable year to which the return relates.

During the press conference, there was no substantive discussion of the tax expenditure proposals, but the Governor did note that he anticipated changes to the motion picture tax credit in the future. Specifically, Governor Edwards indicated a desire to replace the $180 million/year cap on motion picture tax credit payments with a $180 million/year cap on motion picture tax credits granted. The intention of this proposal is to align the granting and payment of motion picture tax credits so that credits are paid in the same year they are issued. The Governor indicated these changes to the motion picture tax credit would likely be phased-in over time. In informal meetings, Secretary Robinson has suggested that some of the 2015 and 2016 cuts would likely be made permanent.

Sales and Use Tax Proposals

The Governor’s Tax Reform Proposal contains three substantial sales and use tax proposals: (1) removing the “fifth-penny” enacted in 2016; (2) “cleaning” the two remaining “dirty pennies”; and (3) broadening the sales and use tax base to include certain services.

For those unfamiliar with Louisiana’s current state sales and use tax regime, currently, the cumulative state sales and use tax rate is five-percent(5%) and consists of the following components:

  1. The “basic rate” (two percent (2%));[2]
  2. Additional tax (one percent (1%));[3]
  3. Additional tax (ninety-seven hundredths of one percent (0.97%));[4]
  4. Louisiana Tourism Promotion District Tax (three-hundredths of one percent 0.03%);[5] and
  5. Effective for the period April 1, 2016 through June 30, 2018, a one percent (1%) additional tax, referred to as the “fifth-penny”.[6]

At present, Louisiana only levies the sales and use tax on the sale of eight specific services, including, notably, repair and maintenance services and the furnishing of hotel rooms. In addition, the current Louisiana sales and use tax regime contains approximately two hundred (200) sales and use tax exclusions and exemptions. But many of those exemptions and exclusions only apply to the two-percent (2%) basic rate. Those portions of the overall state sales and use tax rate to which all exemptions and exclusions apply do not apply are often referred to as “clean pennies,” although that term is misleading since many exemptions and exclusions still apply.

Removing the Fifth-Penny

To resolve the most recent Louisiana budget shortfall, in 2016, the Louisiana Legislature enacted “La. R.S. Sec. 47:321.1, which increased the cumulative state sales and use tax rate from four percent (4%) to five percent (5%). The so-called fifth-penny is currently set to expire on June 30, 2018. The tax reform proposal would allow the fifth-penny expire, as scheduled, at a cost of approximately $880 million.

“Cleaning” the Two Pennies That Comprise the Basic Rate

As noted above, the two pennies that compose the basic rate are subject to approximately 200 exclusions and exemptions. Governor Edwards’ Tax Reform Proposal would “clean” those two pennies, such that the exemptions and exclusions that apply to those pennies would be identical to those that apply to the other two pennies (that comprise the remainder of the full four percent (4%) sales and use tax rate, after the fifth-penny expires).

As a result of this proposal, certain Louisiana businesses may see an increase in the sales tax they pay on utilities and other business inputs. However, Governor Edwards hinted that certain business inputs, such as utilities used to power manufacturing equipment and related facilities, may remain exempt from the two percent (2%) basic rate. He also indicated that sales and use tax would be imposed upon certain manufacturing machinery and equipment, but that a new rebate may be available for taxes paid on those purchases. Finally, the Governor noted that existing agricultural exemptions and exclusions would be retained.

Cleaning the two “dirty pennies” is projected to raise approximately $180 million in revenue. The permanent repeal of certain sales and use tax exclusions and exemptions to the two pennies would be effective October 1, 2017.

Broadening the Sales and Use Tax Base to Include Additional Services

The Tax Reform Proposal would expand the sales and use tax base by subjecting additional services to tax. According to Governor Edwards, this aspect of the proposal would expand the sales and use tax to services currently taxed in Texas (with the exception of internet access fees). Services currently taxed in Texas that are not subject to tax in Louisiana include cable and satellite television services; credit reporting services; data processing services; information services; insurance services; non-residential real property repair, restoration, or remodeling services; real property services; and security services.

Similar to cleaning the two pennies that compose the basic rate, this expansion of the sales tax base has the potential to levy sales and use tax on certain business inputs, particularly real property and non-residential real property repair services, data processing services, and information services. According to Governor Edwards, expanding the sales tax base to include additional services is expected to generate approximately $200 million in revenue and would be effective October 1, 2017.

 Individual Income Tax Proposals

The Tax Reform Proposal would reduce Louisiana’s individual income tax rates for each of the three tax brackets from two percent (2%), four percent (4%), and six percent (6%) to one percent (1%), three percent (3%), and five percent (5%). However, like the corporation income tax proposal (described above), the reduction in individual income tax rates would be contingent upon Louisiana voters passing a constitutional amendment that would repeal the deduction for federal income taxes paid by the individual. According to Governor Edwards, this part of the proposal would cost the state approximately $42 million in revenue and would reduce the individual income tax liability for ninety-percent (90%) of filers. Nevertheless, Governor Edwards also noted that the inability to deduct federal income taxes would likely increase the Louisiana tax liability for individuals with incomes greater than $140,000.

It is not certain whether voters will approve a constitutional amendment to repeal the federal income tax deduction. As discussed above, in 2016, the last time such a change was put to the voters, the proposed constitutional amendment was handily rejected. Governor Edwards did not indicate when the proposed constitutional amendment would be put to voters but the likely date is November, 2017.

Going Forward

As with any legislative proposal, the “devil is in the details.” While the Governor announced at his press conference the broad outlines of his Tax Reform Proposal, detailed legislation has yet to be filed. Though non-fiscal bills must be pre-filed by March 31, 2017, the deadline for filing fiscal-related bills is April 18, 2017. Though it is likely one or more members of the Louisiana House of Representatives will author and introduce the Governor’s Tax Reform Proposal as a bill prior to the April 11, 2017 convening of the 2017 Regular Session, it is unclear at this time when that bill will be filed.

Implications

As noted above, the Edwards Administration did not provide copies of draft legislation or extensive details on the proposed tax reform package. Therefore, the implications of the proposal are not entirely clear. Nevertheless, it is possible to speculate on some of the most significant potential impacts of the tax reform proposal.

Implications of the Corporate Tax Proposals

The Edwards Administration, citing the Louisiana Department of Revenue, stated that, in 2015, there were 149,000 corporate tax filers in the state and that 129,000 of those filers paid no taxes to the state of Louisiana.[7] According the Governor Edwards, the commercial activity tax is designed to ensure that those 129,000 taxpayers with no corporate income tax liability pay their fair share. What the Edwards Administration did not discuss is the reason why certain taxpayers had no corporate income tax liability.

Due to the slump in the oil and gas industry and other factors, many corporate income tax filers are likely in net operating loss positions. Under the proposed tax reform package, those taxpayers would now pay the greater of: (1) the minimum commercial activity tax; (2) the commercial activity tax; or (3) the net corporation income tax due. It appears this proposal would allow the net operating losses of certain taxpayers, which are reflected as deferred tax assets on their financial statements, to expire unused. The expiration of net operating losses (or the proposed decrease in the tax rate) could reduce the value of deferred tax assets and immediately reduce a taxpayer’s earnings for financial statement purposes. A taxpayer with significant deferred tax assets should model the potential financial statement consequences of the proposed corporate tax reforms and determine the extent to which those consequences may impact its operations.

In addition, there is significant uncertainty in Louisiana about how the Department of Revenue will apply recent changes to the recently-enacted market-based corporate income tax sourcing rules for services. In October 2016, the Department issued proposed regulations related to the new market-based sourcing rules but, as of this writing, it has yet to issue final regulations. Therefore, it is not clear how gross receipts from services will be sourced for purposes of the proposed commercial activity tax.

The proposed commercial activity tax appears to rely on Louisiana’s ultimate destination rule for sourcing sales of services. Strict application of this rule would appear to benefit a corporate income taxpayer that manufactures goods in Louisiana for out-of-state export. In contrast, goods imported into the state for consumption, may be subject to multiple levels of the commercial activity tax. As a result, the proposed tax reforms appear to reallocate the tax burden among industry sectors. When modeling the proposed corporate tax reforms, a taxpayer should carefully consider its supply chain and whether its business inputs may bear one or more levels of commercial activity tax.

Finally, Ohio, upon which the proposed commercial activity tax appears to be modeled, attempts to mitigate commercial activity tax pyramiding by permitting certain related parties to eliminate intercompany transactions. The Tax Reform Proposal gives no indication that Louisiana intends to provide similar relief. Therefore, a taxpayer should assume that any intercompany transactions it engages in may be subject to commercial activity tax. This may result in a significant impact on certain supply chain structures, such as centralized procurement companies, leasing companies, and the reliance on other related parties.[8]

Implications of the Sales and Use Tax Proposals

As noted above, the proposed sales and use tax reforms have the potential to result in the taxation of a substantial amount of business inputs. The taxation of business inputs has the potential to result in tax pyramiding and may adversely impact certain business that cannot pass the cost of the tax through to consumers. Louisiana taxpayers should review the sales and use tax exemptions and exclusions that they rely upon and determine whether the tax reform proposal with repeal those exemptions and exclusions. In addition, a service industry taxpayer should determine whether the services it provides would be subject to tax under Texas sales and use tax law and, if so, how the proposed taxation of services, to be based on the Texas model, would affect their Louisiana business. Affected taxpayers may also want to consider whether they should be proactive and become involved in the legislative process at this time.

It should also be noted that the Governor did not propose streamlining the sales and use tax laws, or taking other action to make the laws more uniform, such as centralized collection for the state and its localities. Therefore, it does not appear that the proposals will remedy some of the most onerous features of the current Louisiana sales and use tax regime.

Implications of Considering Both the Corporate and Sales and Use Tax Proposals Together

At a minimum, the Governor’s proposals create significant additional compliance burdens for some taxpayers. Further, commercial activity taxes are sometimes referred to as “turnover taxes” because the tax burden is imposed on revenues generated by all transactions preceding the ultimate sale to the consumer. Turnover taxes tend to increase the costs of goods and services for businesses which, in turn, increases the cost of goods and services to consumers, and presumably sales and use tax collections on the final sales. As a result, the Governor’s commercial activity tax has the potential to make it more expensive to do business in Louisiana with whatever correlative impact that may have on economic development. Nevertheless, much is still unknown about the Governor’s plan. The Kean Miller State and Local Tax Team will provide additional information when more is known.

For questions or additional information, please contact: Christopher J. Dicharry at (225) 382-3492, Jaye Calhoun at (504) 293-5936, Phyllis Sims at (225) 389-3717, Jason Brown at (225) 389-3733, Angela Adolph at (225) 382-3437, or Willie Kolarik at (225) 382-3441.

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[1] According to Governor Edwards, there are approximately 414,000 businesses in the state. Of those businesses, 389,000 “make less than $1.5 million annually” and “would be assessed a flat $250 tax, rather than the calculation for gross receipts.” Gov. Edwards Unveils Reforms to Stabilize Louisiana’s Budget.

[2] La. R.S. § 47:302.

[3] La. R.S. § 47:321.

[4] La. R.S. § 47:331.

[5] La. R.S. § 51:1286.

[6] La. R.S. § 47:321.1.

[7] Gov. Edwards Unveils Reforms to Stabilize Louisiana’s Budget.

[8] When modeling the impact of intercompany transactions, a taxpayer should also consider whether the purchaser is located in a foreign trade zone because, under current corporation income tax sourcing rules, a taxpayer selling corporeal movable property to a customer who receives the property in a foreign trade zone may exclude the sales from the numerator of its sales factor.