Connecticut - Combined reporting effective in 2016, personal income tax rate increases, and other income and sales tax changes

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1 Tax Insights from State and Local Tax Services Connecticut - Combined reporting effective in 2016, personal income tax rate increases, and other income and sales tax changes June 30, 2015 In brief On June 3, 2015, the Connecticut General Assembly passed H.B. 7061, which contained provisions for the state s biennial budget, including the adoption of mandatory combined reporting effective for tax years beginning on or after January 1, S.B. 1502, introduced on June 28, 2015, proposed numerous changes and technical corrections to H.B. 7061, including the delay of combined reporting until tax years beginning on or after January 1, On June 30, 2015, Connecticut Governor Dannel Malloy signed both H.B (P.A ) and S.B. 1502, which provide significant corporate income tax changes, effective for tax years beginning on or after January 1, 2016, including imposing mandatory unitary combined reporting, including entities incorporated in tax haven jurisdictions as members of a combined group, and extending the state s corporate income tax surcharge. Effective for tax years beginning on or after January 1, 2015, the legislation limits the use of net operating loss carryovers and tax credits. Effective January 1, 2015, the personal income tax is increased on high-wage earners per P.A P.A imposed increases to the sales tax rate on computer and data processing services. S.B repeals these changes. Additionally, P.A subjected to tax website development services effective July 1, S.B delays the applicable date to October 1, The imposition of mandatory combined reporting, makes Connecticut the last state in New England to adopt such a filing method. One immediate concern for employers and self-employed individuals is how to comply with the personal income tax rate increase. The retroactive nature of the increase means that employers and individuals will have to catch up payments. Guidance on how to comply with the increase for employers and individuals is expected later this summer.

2 Tax Insights In detail Corporate income tax Mandatory combined reporting General requirements (P.A , Sections , as amended by S.B. 1502) Combined groups engaged in a unitary business must file combined returns, on a water s-edge basis, unless an election to file on a world-wide or affiliated group basis is made, applicable to tax years beginning on or after January 1, Before P.A , Ct. Stat a allowed taxpayers an election to file a post-apportionment combined return together with other companies: (1) subject to Connecticut tax and (2) included in the same federal consolidated return. Additionally, Ct. Stat. Sec d allowed taxpayers in certain circumstances to elect to file a unitary return. Effective for tax years commencing on or after January 1, 2016, the prior combined return and unitary return filing elections are no longer available. Under the new law, corporations will continue to calculate their Connecticut tax liability on the basis of both their net income and capital base and pay the higher of the two amounts. For net income tax purposes, each taxable member must calculate its net income tax liability by multiplying its Connecticut apportioned net income or loss by 7.5%. An additional surcharge is applicable (see discussion below). As under prior law, insurance companies are not subject to Connecticut's corporate income tax as amended by P.A Combined group and unitary business (P.A , Section 138) A combined group means the group of all companies that have common ownership and that are engaged in a unitary business where at least one person is subject to the state's corporate tax. Common ownership means that more than 50% of the voting control of each group member is directly or indirectly owned by a common owner or owners (corporate or noncorporate). The owners do not themselves have to be members of the combined group. Unitary business is defined as a single economic enterprise that is made up of either separate parts of a single business entity or of a group of business entities under common ownership, which enterprise is sufficiently interdependent, integrated, or interrelated through its activities so as to provide mutual benefit and produce a significant sharing or exchange of value among such entities, or a significant flow of value among the separate parts. Pass-through entity treatment Any business conducted by a passthrough entity (defined as either a partnership or S corporation) is treated as being conducted by its members, whether directly held or indirectly held through a series of pass-through entities, to the extent of the member's distributive share of the pass-through entity's income, regardless of the percentage of the member's ownership interest or its distributive or any other share of passthrough entity income. Any business conducted directly or indirectly by one corporation is unitary with that portion of a business conducted by another corporation through its direct or indirect interest in a pass-through entity if (1) there is a mutual benefit and a significant sharing of exchange or flow of value between the two parts of the business and (2) the two corporations are members of the same group of business entities under common ownership. Net income (P.A , Section 139) A combined group's net income is the aggregate net income or loss of every taxable member and nontaxable member of the group derived from a unitary business. The income of a USincorporated member included in a federal consolidated group is its gross income, less certain subtractions allowed under Ct. Stat , as if the member were not consolidated for federal tax purposes. The legislation contains detailed provisions for determining the combined group's net income, including rules pertaining to US group members, members not included in a federal consolidated return, foreign members, income from pass-through entities, charitable expenses, gain or loss from the sale or exchange of capital assets and property subject to an involuntary conversion, and expenses attributable to constitutionally-exempt income. Dividends paid by one group member to another must be eliminated. Business income from intercompany transactions among members of the same combined group are deferred in a manner similar to the deferral under 26 CFR Capital gains and losses are generally: (1) combined for all members without netting among classes of gains and losses, (2) apportioned, (3) and applied to the income or loss of the Connecticut taxable members. If the deduction for a loss is limited and a loss carryover is required, the loss must be treated in a later year as being 2 pwc

3 incurred by the same member. Any resulting apportioned loss subject to IRC Sec limitations must be carried forward by that member and is treated as a short-term capital loss. Net income Foreign entity For a non-us incorporated entity, not included in a consolidated federal income tax return and not required to file its own federal corporate income tax return, income is determined from a profit and loss statement prepared for each foreign branch or corporation in the currency in which its books and records are regularly maintained, adjusted for GAAP, further adjusted to account for any book-tax differences required by federal or Connecticut law, then translated into the currency of the parent company. Income must be expressed in US dollars. In lieu of these procedures, subject to the determination of the Commissioner of Revenue Services, income may be determined on any reasonable basis consistently applied on a year-to-year or entity-by-entity basis. Apportionment Apportionment formula methodologies have not been changed by the legislation. Accordingly, companies will generally continue to use the same apportionment formula as they did before enactment of the legislation. For groups with members using different apportionment methodologies, each taxable member computes its statutory apportionment percentage. In computing its denominators for all factors, a taxable member uses the combined group s denominator for that factor. Each taxable member must add in a share of nontaxable members sales, property, and payroll factors as follows: Each taxable member must add to its sales factor numerator a share of the aggregate sales of the group s nontaxable members. This share is the ratio of the taxable member s Connecticut sales to the Connecticut sales of all the group s taxable members. Property and payroll factor denominators are the aggregate property and payrolls for the entire group, including taxable and nontaxable members, whether or not a member would otherwise apportion its income using such property and payroll factors. Transactions between group members are eliminated for apportionment purposes. To calculate each taxable member s apportioned net income or loss, each taxable member applies its apportionment percentage to the combined group s net income. Sales factor sourcing rules (e.g., sourcing sales of tangible personal property, services, intangible personal property, etc.) are not modified by the legislation. Accordingly, existing sourcing rules remain applicable following enactment of P.A and S.B Net operating loss carryovers A taxable member with an NOL carryover derived from the combined group in an income year beginning on or after January 1, 2016, may share it with other taxable group members if they were part of the same group when the loss was incurred. A taxable member can deduct an NOL carryover derived from either pre- January 1, 2016 losses or losses incurred before the taxable member joined the combined group and can share it with other members that were, in the year the loss was incurred, part of the same (1) pre elective combined group or (2) pre-2016 elective unitary group. See below for a discussion of NOL limitations. Tax credits Each taxable member separately computes its tax credits. A member may share tax credits and credit carryovers with other taxable members under certain conditions. If a taxable member has a credit carryover derived from an income year beginning on or after 2016, it may share the carryover credit with the group's taxable members as long they were taxable members in the income year in which the credit was earned. A taxable member with a credit carryover derived from an income year prior to 2016 or during which it was not a member of the combined group may (1) continue to use the carryover or (2) share it with other group members that were, in the year the credit was earned, part of the same (1) pre-2016 elective combined group or (2) pre-2016 elective unitary group. See below for a discussion of tax credit limitations. Water s-edge reporting (P.A , Section 140) Under the water's-edge approach, the combined group includes taxable and nontaxable members that: are incorporated in the US, or formed under the laws of the US (including states, territories, or possessions), unless 80% or more of the entity s property and payroll are located outside the US are incorporated or formed anywhere if 20% or more of their property and payroll are located within the US or its territories (including states, territories, or possessions) earn more than 20% of their gross income, directly or indirectly, from intangible property or service- 3 pwc

4 related activities, (the costs of which generally are deductible for federal income tax purposes, whether currently or over a period of time, against the income of other members of the group), but only to the extent of that income and the apportionment factors related thereto (added by S.B. 1502, Section 145) are incorporated in a deemed tax haven jurisdiction unless it is proven to the satisfaction of the commissioner that such member is incorporated in a tax haven for a legitimate business purpose. The legislation defines tax haven as a jurisdiction with certain characteristics (e.g., a tax regime that lacks transparency or a tax regime favorable for tax avoidance). The Commissioner must publish a list of tax haven jurisdictions by September 30, (Adjusted by S.B. 1502) If a reporting group makes a worldwide or affiliated group election, it must be made by the group's designated taxable member on an original timely-filed return and is binding for the income year in which the election is made and for the ten immediately succeeding income years. Affiliated group election (P.A , Section 140) A Connecticut affiliated group is generally any group treated as an affiliated group for federal tax purposes, except that it also includes members incorporated in a tax haven jurisdiction and includes domestic corporations that are commonly owned, directly or indirectly, by any member of the group, regardless of whether the group includes (1) corporations included in more than one federal consolidated return, (2) corporations engaged in one or more unitary business, or (3) corporations not engaged in a unitary business with any other affiliated group member. S.B. 1502, Section 145, provides that a corporation incorporated in a tax haven jurisdiction is a member of an affiliated group unless it is proven to the satisfaction of the commissioner that such member is incorporated in a tax haven for a legitimate business purpose. Deduction for deferred tax impact (P.A , Section 141, and S.B. 1502, Section 146) The legislation provides a deduction for unitary groups if the enactment of combined reporting results in (1) an aggregate increase to a member s net deferred tax liability, (2) an aggregate decrease in a member s net deferred tax asset, or (3) an aggregate change from a net deferred tax asset to a net deferred tax liability. (Adjusted by S.B. 1502) Specifically, for the seven-year period beginning with the group s first income year that begins in 2018, a deduction is allowed from unitary group net income equal to oneseventh of the amount necessary to offset the increase in the net deferred tax liability or decrease in the net deferred tax asset, or the aggregate change thereof from a net deferred tax asset to a net deferred tax liability as a result of the imposition of unitary reporting requirements but for the deduction provided above. Capital base calculation Combined groups determine their alternative capital bases by combining their separate bases, including those of the nontaxable members, but eliminating intercorporate or private company stockholdings in the combined group. Such eliminated stockholdings may not be deducted for purposes of the minimum tax; however, a deduction for stockholdings in companies that are not part of the unitary group are still permitted. A taxable member must apportion the combined group's capital base by a fraction, the numerator of which is such member s tangible and intangible property with a tax situs in Connecticut, and the denominator of which is the tangible and intangible property, wherever sitused, of the combined group. Taxable members that are financial services companies are not subject to the capital base tax computation, but instead are subject to a tax of $250. The maximum aggregate tax calculated under the capital base method is $1 million. To the extent the group s tax base exceeds $1 million, each taxable member will prorate its tax (in proportion to the group s tax calculated without the $1 million cap) such that the group s aggregate tax equals $1 million. Other corporate income tax changes Surcharge (P.A , Sections 83 and 84) The legislation extends the temporary 20% corporate income tax surcharge for two additional years, to the 2016 and 2017 income years. For the income year commencing on or after January 1, 2018, a 10% corporate income tax surcharge is imposed. S.B. 1502, Section 141, clarifies that the 10% surcharge applies to income years commencing on or after January 1, 2018, and prior to January 1, Consistent with pre-h.b law, an exception to the surcharges applies for companies that have less than $100 million in gross income for the income year. However, this exception does not apply to taxable members of a combined group filing a combined unitary tax return. Net operating loss limits (P.A , Section 87) Effective for income years beginning on or after January 1, 2015, the legislation limits 4 pwc

5 the amount of a net operating loss carryforward to the lesser of (1) 50% of apportioned net income or (2) the excess of such operating loss over the loss being carried forward from prior years. S.B. 1502, Section 492, provides an alternative limit for a combined group (as previously defined prior to P.A ) with over $6 billion in unused NOLs from tax years prior to Credit limitations (P.A , Section 88) Effective for income years beginning on or after January 1, 2015, the amount of allowable tax credits cannot exceed 50.01% (previously 70%) of a taxpayer s tax liability. (P.A , Section 85) The legislation extends, to the 2015 and 2016 tax years, the temporary cap on premium tax liability that an insurer may offset with tax credits. (P.A , Section 86) The legislation extends, to the state fiscal years ending June 30, 2016, and June 30, 2017, the temporary moratorium on issuing film and digital media production tax credits for certain motion pictures. Repeal of Preference Tax Under current law, the total tax due from corporations that file a combined return is the tax due on a combined basis plus the difference between the total that would have been due had the corporations filed separate returns, minus the total tax due on a combined basis. Currently, this preference tax is capped at $500,000. S.B. 1502, Section 152, repeals the preference tax, effective for tax years beginning on or after January 1, Personal Income Tax changes Margin rate increases (P.A , Section 66) Presently, the state has a six-bracket personal income tax system, with rates ranging from 3% to 6.7%. Effective for taxable years beginning on or after January 1, 2015, the 6.7% marginal tax rate is increased to 6.9% and a seventh, higher income, tax bracket is subject to a 6.99% marginal tax rate. Individuals earning more than $250,000 and married couples making more than $500,000 are taxed at 6.9% on the excess over these dollar limits. Individuals earning more than $500,000 and couples making more than $1 million are taxed at 6.99% on such excess amounts. The income tax rate for trusts and estates is increased from 6.7% to 6.99% for tax years beginning on or after January 1, Tax reductions delayed (P.A , Section 67 and 68). The legislation also delays for one year the scheduled personal income tax reductions for single filers by delaying increases in (1) adjusted gross income exempt from tax and (2) income thresholds for reducing the personal exemption and personal income tax credit based on adjusted gross income. Sales and Use Tax changes Rate increase repealed for computer and data processing services. P.A , Section 74, increased the tax rate on computer and data processing services to 3%. S.B. 1502, Section 133, repealed the increase. Taxation of website creation, development, maintenance delayed. P.A , Section 75, repealed the exclusion for services rendered in connection with web site creation, development, and maintenance effective July 1, S.B. 1502, Section 134, provides that the repeal is effective October 1, (P.A , Sections 72 and 73) The tax rate on luxury goods is increased to 7.75% from 7%, effective July 1, (P.A , Section 71) The annual sales tax holiday (at the end of August) will be limited to items of clothing or footwear that cost less than $100. State corporation business tax report (P.A , Section 219) By February 1, 2016, the Commissioner must: (1) review the impact of alternative apportionment and income sourcing methods for corporation business tax purposes on Connecticut businesses and (2) provide any recommendations to the Finance, Revenue, and Bonding committee. Commission on Economic Competitiveness (S.B. 1502, Section 601) The Commission on Economic Competitiveness is established to analyze the implications of state tax policy on state business and industry and to develop policies that promote economic growth. In addition, the commission shall: (1) Examine and report on the implications of the tax revisions set forth in public act , as amended by senate bill 1502 of the June 2015 special session, on state business and industry; (2) examine the needs of large and small state businesses and industries as relates to their ability to maintain economic competitiveness; and (3) offer legislative recommendations that promote the growth and prosperity of state business and industry, including, but not limited to, recommendations relating to state tax policy. The Commission s first report is due January 1, The takeaway Connecticut has had combined unitary proposals over the last few years. This year s legislation 5 pwc

6 resembles those in previous years with two notable additions: tax haven language, and the deferred tax deduction. The imposition of mandatory combined reporting makes Connecticut the last state in New England to adopt such a filing methodology. Let s talk Of immediate concern is how employers will comply regarding withholding for the personal income tax rate increases, which take effect immediately, applicable to income years commencing on or after January 1, The retroactive nature of the increase means that employers will have to catch up on the withholding If you have questions regarding Connecticut s law change, please contact: for affected individuals. Guidance on how employers will do this may not be issued until later this summer. By then, eight months of the 2015 tax year could have passed, meaning that any catch up withholding by employers who wait will be particularly impactful on affected employees. State and Local Tax Services Rob Ozmun Partner, Boston +1 (617) robert.c.ozmun@us.pwc.com Jennifer Whalley Manager, Hartford +1 (860) jennifer.whalley@us.pwc.com Tov Haueisen Principal, New York +1 (646) tov.haueisen@us.pwc.com Paul Sonoski Director, San Diego +1 (858) paul.b.sonoski.jr@us.pwc.com Anna Hoti Director, Stamford +1 (203) anna.hoti@us.pwc.com Click here to access our library of past state and local tax Insights. Stay current and connected. Our timely news insights, periodicals, thought leadership, and webcasts help you anticipate and adapt in today's evolving business environment. Subscribe or manage your subscriptions at: pwc.com/us/subscriptions 2015 PricewaterhouseCoopers LLP, a Delaware limited liability partnership. All rights reserved. PwC refers to the United States member firm, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see for further details. SOLICITATION This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors 6 pwc