North Carolina Enacts Related Party Interest Addback, Phases in Single Sales Factor Apportionment, and Imposes Sales Tax on Repair, Maintenance, and Installation Services.
On September 18, 2015, North Carolina Governor Pat McCrory signed into law H.B. 97, 2015-2016 Session (“H.B. 97”), which, for Corporation Income Tax purposes, includes a related party interest addback provision, implements the phase-in of single factor apportionment, imposes a market-based sourcing informational reporting requirement, and reduces the Corporation Income Tax rate to 4 percent. In addition, H.B. 97 modifies the Franchise Tax base and increases the minimum Franchise Tax to $200 and the maximum Franchise Tax on holding companies to $200,000. Lastly, H.B. 97 imposes sales and use tax on repair, maintenance, and installation services, and it makes changes to the Individual Income Tax standard deductions, itemized deductions, and tax rate.
Corporation Income Tax
Related Party Interest Addback. Effective for taxable years beginning on or after January 1, 2016, North Carolina requires an addback to the federal taxable income starting point for net interest expense to a “related member” to the extent it exceeds 30 percent of the taxpayer’s adjusted taxable income. However, North Carolina allows a deduction for 100 percent of net interest expense to a related member if the related member:
- Is subject to North Carolina Corporation Income Tax;
- Pays a net income or gross receipts tax to another state with respect to the interest income;
- Is organized under the laws of a foreign country that has an income tax treaty with the U.S. and the country taxes interest income at a rate that at least equals the Corporation Income Tax rate; or
- Is a bank.
For these purposes, North Carolina adopts the definition of “related member” used for purposes of the current royalty expense addback provision.
Single Sales Factor Phase-In. For taxable years beginning in 2016, the sales factor of the current three factor property, payroll, and sales apportionment fraction is triple-weighted. Currently, the sales factor is double-weighted. For taxable years beginning in 2017, the sales factor is quadruple-weighted. Starting with taxable years beginning in 2018, North Carolina adopts single sales factor apportionment. This provision also applies to Franchise Tax.
Market-Based Sourcing Informational Reporting. While the new law does not modify the current sales sourcing provisions, a taxpayer that has more than $10 million in apportionable income must file an information return showing the calculation of the 2014 apportionment factor using market-based sourcing. See the following table for sales sourcing under this provision:
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This article originally appeared in BDO USA, LLP’s “State and Local Tax Alert” newsletter (October 2015). Copyright © 2015 BDO USA, LLP. All rights reserved. www.bdo.com.