State Tax Return. Josie Lowman Atlanta (404)

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1 October 2007 Volume 14 Number 10 State Tax Return Trick or Treat? The New Michigan Business Tax Rachel Wilson Dallas (214) Josie Lowman Atlanta (404) In July 2007, the Michigan Governor signed the Michigan Business Tax Act into law. 1 The new Michigan Business Tax ( MBT ) takes effect January 1, Generally, the legislation was drafted with the intent to make Michigan s business climate more competitive while simplifying the tax on corporations. The new MBT also broadens the tax base to bring in more revenue to satisfy Michigan s budget needs. While some taxpayers may see their corporate tax decrease, other taxpayers, mainly those that do not do substantial business or have substantial operations in Michigan, will experience a substantial tax increase. After passage of the MBT, the million-dollar question is whether the tax is an improvement over the much maligned Michigan Single Business Tax ( SBT ). The answer likely depends on a taxpayer s individual circumstances. Whatever you think of the new tax, it can hardly be called simple. For most taxpayers, the MBT is essentially two taxes: a Modified Gross Receipts Tax ( GRT ) and a Business Income Tax ( BIT ). 2 While we will leave an in-depth analysis of the MBT for a later edition once all the dust has settled, this article will hit some of the highlights and lowlights. Business Income Tax Except as otherwise provided, the BIT is levied on every person or unitary business group conducting business activity in Michigan, unless prohibited by P.L (a welcome change from the SBT). 3 Person includes any individual, corporation, partnership, limited liability company or other entity. 4 BIT is imposed on the business income tax base, after allocation and apportionment, at the rate of 4.95%. The tax base 1 S.B. 94 (referred to hereinafter as the MBT Act). The governor also signed H.B.s , which provide commercial and industrial personal property tax relief. This article will not discuss the personal property tax relief bills. 2 Insurance companies and financial institutions have industry-specific taxes, which are not discussed in this article. 3 MBT Act 201(1). The definition of a unitary business group is provided below. 4 MBT Act 113(3).

2 is business income (federal taxable income derived from business activity ) modified by various additions and subtractions. 5 For a unitary business group, business income is the sum of the business income of each person (other than foreign operating entities, financial institutions or insurance companies) included in the unitary business group less any items of income and related deductions arising from transactions including dividends between persons included in the unitary business group. 6 After allocation or apportionment, available business losses incurred after 2007 can be deducted. 7 A business loss can be carried forward for up to 10 years. Modified Gross Receipts Tax Except as otherwise provided, the GRT is levied on every person 8 or unitary business group with nexus in Michigan. 9 The GRT is levied and imposed upon the privilege of doing business and not upon income or property. 10 Because the GRT is not an income-based tax, P.L does not apply to the GRT. The GRT is imposed on the modified gross receipts tax base, after allocation or apportionment, at a rate of 0.80%. 11 The modified gross receipts tax base is a taxpayer s gross receipts less purchases from other firms before apportionment. 12 Gross receipts is defined as the entire amount received by the taxpayer from any activity whether in intrastate, interstate, or foreign commerce carried on for direct or indirect gain, benefit, or advantage to the taxpayer or to others except as specifically excluded. 13 Gross receipts exclusions under the SBT are carried over to the MBT with some industry-specific additions. Purchases from other firms includes acquired inventory, depreciable assets, and materials and supplies. 14 For 2008, 65% of unused SBT business losses incurred in 2006 and 2007 can be deducted against the GRT. 15 Business losses incurred before 2005 cannot be carried forward and used against the GRT. If the taxpayer is a unitary business group, the 5 MBT Act 105(2), 201(2). 6 MBT Act 201(3). 7 MBT Act 201(4). 8 Person includes any individual, corporation, partnership, limited liability company or other entity. See MBT Act 113(3). 9 MBT Act 203(1). The nexus provisions of the MBT Act are discussed below. 10 MBT Act 203(2). 11 MBT Act 203(1). 12 MBT Act 203(3). 13 MBT Act 111(1). 14 MBT Act 113(6). 15 MBT Act 203(4).

3 business loss carryforward may only be deducted against the MGR tax base of that person included in the unitary business group calculated as if the person was not included in the unitary business group. Nexus Standard The MBT Act provides that a taxpayer has substantial nexus in this state and is subject to the tax imposed under this act if the taxpayer has a physical presence in this state for a period of more than 1 day during the tax year or if the taxpayer actively solicits sales in this state and has gross receipts of $350, or more sourced to this state. 16 The MBT Act does not define the term actively solicits, but directs the Michigan Treasury Department to provide written guidance that will apply prospectively. 17 The term physical presence is defined as any activity conducted by the taxpayer or on behalf of the taxpayer by the taxpayer's employee, agent, or independent contractor acting in a representative capacity. Physical presence does not include the activities of professionals providing services in a professional capacity or other service providers if the activity is not significantly associated with the taxpayer's ability to establish and maintain a market in this state. 18 The same nexus threshold applies to both the GRT and BIT, except that the BIT is afforded the protections of P.L Unitary Business Group Definition A unitary business group is required to file a combined return. 19 A unitary business group is defined as: a group of United States persons, other than a foreign operating entity, 1 of which owns or controls, directly or indirectly, more than 50% of the ownership interest with voting rights or ownership interests that confer comparable rights to voting rights of the other United States persons, and that has business activities or operations which result in a flow of value between or among persons included in the unitary business group or has business activities or operations that are integrated with, are dependent upon, or contribute to each other. For purposes of this subsection, flow of value is determined by reviewing the totality of facts and circumstances of business activities and operations MBT Act 200(1). 17 MBT Act 200(2). 18 MBT Act 200(3). 19 MBT Act MBT Act 117(6).

4 Apportionment For taxpayers with business activities subject to tax both within and without the state, both the BIT and GRT apportion the Michigan tax base using a 100% sales factor. 21 This marks a departure from the three-factor method under the SBT. For unitary business groups, Michigan has adopted the Finnegan rule 22 sales include sales in Michigan of every person included in the unitary business group without regard to whether the person has nexus in Michigan. 23 Sales between persons included in a unitary business group must be eliminated in calculating the sales factor. Credits A substantial portion of the MBT Act is dedicated to numerous tax credit provisions. 24 Some tax credits are carried over from the SBT, while others are new. New credits include the compensation credit, investment tax credit, research and development credit, personal property tax credit, entrepreneurial credit, and credit for small business. Credit programs continued from the SBT include the MEGA credit, renaissance zone credit and small business credit among others. Any unused carryforward of credits under the SBT may be applied for the 2008 and 2009 tax years, but any unused carryforwards after 2009 are extinguished. 25 Fiscal Impact Winners and Losers While the MBT is expected to be revenue neutral, the distribution of Michigan tax liabilities will change. Taxpayers expected to pay less are manufacturing firms, small businesses, and Michigan-based multistate companies. 26 Taxpayers expected to pay more are those in the finance, insurance, and real estate industries, profitable companies, companies without much personal property, and companies that operate in Michigan but have little payroll or property in Michigan. 27 The senate fiscal report estimates that: Generally, manufacturing firms would experience liability reductions compared with the single business tax totaling approximately $403.6 million, while nonmanufacturing firms would experience increases totaling approximately $342.3 million. Similarly, while Michigan-only firms would generally experience 21 MBT Act See Appeal of Finnegan Corp., 1990 Cal. Tax LEXIS 4 (St. Bd. of Equal. of Cal. 1990). 23 MBT Act 303(2). 24 See MBT Act 400 et seq. 25 MBT Act See A Brief Overview of the New MBT (July 10, 2007) at Id.

5 liability increases totaling approximately $210.5 million and multistate firms based outside of Michigan would experience increases totaling approximately $125.0 million, Michigan-based multistate firms would generally experience liability reductions totaling approximately $434.3 million. 28 The MBT is not the only Michigan tax increase companies may experience. Even before the MBT takes effect and only a couple of months after its passage, Michigan was forced to pass additional tax legislation imposing a sales tax on services to raise the necessary revenue needed to fund the budget. 29 What s Next? Unfortunately, the short time between enactment and effective date leave taxpayers with little time to plan or to become familiar with the MBT. The legislature has already acted to correct the FAS 109 problem inherent in S.B. 94 by passage of H.B 5104, and may yet pass other technical corrections bills. The Michigan Department of Treasury is expected to issue guidance on the application of the MBT, but the extent of that guidance is not yet clear. As with most new taxes, litigation is likely to ensue over interpretation of various new provisions as taxpayers grapple with the MBT. Areas ripe for controversy include the application and denial of credits, the definition of unitary business, the application of the Finnegan rule, the inability to use SBT business losses and credits beyond the next two taxable years, and the definition and treatment of nonbusiness income. While there may be clear winners and losers under the MBT, the jury is still out on whether the MBT as a whole is a trick or a treat! This article is reprinted from the State Tax Return, a Jones Day monthly newsletter reporting on recent developments in state and local tax. Requests for a subscription to the State Tax Return or permission to reproduce this publication, in whole or in part, or comments and suggestions should be sent to Gail Whelan (214/ )1 in Jones Day s Dallas Office, 2727 N. Harwood, Dallas, Texas or StateTaxReturn@jonesday.com. Jones Day All Rights Reserved. No portion of the article may be reproduced or used without express permission. Because of its generality, the information contained herein should not be construed as legal advice on any specific facts and circumstances. The contents are intended for general information purposes only. 28 Bill Analysis, S.B. 94 & H.B , State Fiscal Agency (6/29/07). 29 See H.B