Competitive Posture Drives Emegency D.C. Business Tax Law

The District of Columbia Council (the 'Council') voted recently, 12 to 1, to approve a motion to override Mayor Gray's veto of the FY 2015 Budget Support Emergency Act (the 'Emergency Act'), which makes signeificant changes to the business franchise tax, designed to make the District of Columbia more business friendly to neighboring statets Maryland and Virginia. The Emergency Act does not need Congressional approval, and is effective immediately; it remains in effect for no longer than 90 days. The Emergency Act is comprised of the same language of the FY 2015 Bucget Support CAct (the 'Permanent Act'). The Emergency Act is in effect to cover the period until the Permanent Act is approved by Congress.

Highlights

In 2011, the District of Columbia Tax Revision Commission (the “Commission”) was established, consisting of 11 members appointed by the Mayor and the Chairman of the Council. From the fall of 2012 through the end of 2013, the Commission explored different options to improve the District’s tax system and help residents and businesses prosper. The Commission delivered its final recommendations in February 2014.

Tax reform procedure and priority

The Council accepted most of the Commission’s recommendations and adopted a plan that phased-in the tax revisions over a five year period. In May 2014, the Council discussed and voted on the first draft of the Permanent Act. Under DC law, the Permanent Act required two votes by the Council before sending to the Mayor for his consideration.  The implementation of the tax reform measures is driven by achieving certain budget triggers rather than established dates. Consequently, the phased-in implementation of some of these changes may occur only if revenue targets in the next few years are met.  The Council approved the Emergency Act on one required vote and the Permanent Act on their second of two required votes on June 24, 2014, before submitting the Emergency Act to the Mayor for his signature or veto.

Business franchise tax

The Emergency Act phases in a reduction of the franchise tax rate on corporations and unincorporated businesses, whether domestic or foreign, from 9.975% to 8.25%. For the taxable year beginning after December 31, 2014, the rate will be 9.4% for all corporations, and, subject to availability of funding in subsequent years, the rate will be further reduced to 9.0%, 8.75%, 8.5%, and 8.25%.

The Council also accepted two significant changes to the apportionment method for the business franchise tax:

1. the adoption of a single weighted sales factor formula, which is effective for tax years beginning after December 31, 2014; and
2.  a market-based sourcing method for sales of other than tangible personal property.

The Emergency Act substantially adopts the approach to market sourcing proposed by the Multistate Tax Commission, and requires that sales of other than tangible personal property be sourced to the District if the taxpayer’s market for the sales is in the District. A taxpayer’s market is located in the District to the extent the service is delivered to a location in the District. For intangible property, sales are sourced to the District to the extent such property is used in the District. The Emergency Act requires that, if the sales are sourced to a state in which the taxpayer is not subject to tax, they must be excluded from the sales factor.

The Emergency Act also adopts the Commission’s recommendation to exempt certain investment funds’ income from the Unincorporated Business Franchise Tax (‘UBFT’) by creating a ‘trading safe harbor.’ The Emergency Act does not provide an express effective date for this change. Currently, the District exempts business firms that derive 80% gross income from personal services, such as accounting, law and engineering firms, from the UBFT. However, an investment fund’s ‘trading’ business does not qualify for this exemption and, therefore, capital gains, dividends, and interest income relating to the ‘trading’ business are subject to the current UBFT 9.975% tax rate. The Emergency Act provides that unincorporated entities that ‘purchase, hold, sell or enter, maintain or terminate positions in, stocks, securities, or other commodities for the taxpayer’s own account’ are not subject to the UBFT. However, the Emergency Act excludes from this exemption taxpayers that: 

i)          hold property, or maintain positions, as stock in trade, inventory, or for sale to customers in the ordinary course of the taxpayer’s trade or business,

ii)          acquire debt instruments in the ordinary course of the trade or business for funds loaned or services rendered, or

iii)         hold any of the following that is not traded on an established market; stock in a real estate investment trust, or a partnership interest.

Conclusion

Business taxpayers in the District of Columbia should monitor closely the subsequent developments concerning the enactment of the tax reform provisions and also the achievement of the budget targets which will trigger the subsequent changes to take effect.

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