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Jamie C. Yesnowitz
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On April 5, Arizona Gov. Doug Ducey signed legislation to conform to selected provisions of the Disaster Tax Relief and Airport and Airway Extension Act of 2017 (“Disaster Relief Act”), the Tax Cuts and Jobs Act (“TCJA”) and the Bipartisan Budget Act of 2018 (“Budget Act”) that are effective for the 2017 tax year.1
In separate legislation, enacted on March 29, Arizona broadened the applicability of the market-based sourcing apportionment election in determining the Arizona sales factor. The definition of a multistate service provider eligible to make this election has been expanded to include corporations deriving income from specific intangibles. 2
During the latter half of 2017 and the early part of 2018, Congress enacted several major pieces of legislation. On Sept. 29, 2017, Congress enacted the Disaster Relief Act to provide tax relief measures for zones and areas that were affected by Hurricanes Harvey, Irma, and Maria.3
The adoption of the TCJA on Dec. 22, 2017, provided a significant overhaul of the federal income tax system.4
The TCJA not only created entirely new sections of the IRC, but also made substantial changes to existing law. While most changes resulting from the TCJA are prospective in nature, certain provisions became applicable for the 2017 tax year. Finally, the Budget Act was enacted on Feb. 9, 2018, and reinstated numerous tax incentives that expired at the end of 2016. 5
The majority of these provisions were only extended for a single year, and, as a result, are retroactively available for 2017, but remain expired for 2018.
The impact of these Acts on Arizona taxpayers turns on the state’s conformity to the IRC. Arizona historically has conformed to the IRC on a fixed date basis, with the conformity date generally moved each year. While Arizona generally conforms to the IRC, it does decouple from certain provisions, including bonus depreciation.
Internal Revenue Code conformity
For tax years beginning in 2017 and thereafter, the IRC conformity date remains Jan. 1, 2017.6
However, for corporate and personal income tax purposes, Arizona has updated its IRC conformity to include the Disaster Relief Act and the Budget Act, to the extent such provisions are retroactively effective for the 2017 tax year, and the TCJA provisions that are retroactively effective for the 2016 and 2017 tax years.7
While Arizona conforms to the new federal taxable income starting point for the state taxable income calculation, Arizona’s decoupling statutes are unchanged, which will continue to require additions to and subtractions from federal taxable income in calculating Arizona state taxable income.8
It should be noted that for purposes of the Arizona transaction privilege tax and the complementary use tax, the term “Internal Revenue Code” is now defined as the code in effect as of Jan. 1, 2018. 9
For federal income tax purposes, pursuant to changes in IRC Sec. 168(k) under the TCJA, 100% bonus depreciation is available for assets placed in service from Sept. 27, 2017, to Dec. 31, 2022, with a phased reduction in the bonus depreciation percentage in the following four years. However, Arizona continues to require corporations to calculate depreciation expense without the provisions of IRC Sec. 168(k), as an addition to federal taxable income will be required for federal depreciation expense, with a corresponding subtraction for depreciation expense recalculated under the Arizona rules. 10
Conformity to IRC Section 965 deemed repatriation
For federal income tax purposes, a one-time tax is imposed on the deemed repatriation of earnings and profits of controlled foreign corporations pursuant to IRC Section 965. With respect to corporations recognizing this income, the deemed repatriation amount would appear to be includible in the Arizona tax base, as the corporation income tax starting point is federal taxable income, defined as “taxable income of a corporation computed pursuant to the Internal Revenue Code.”11
However, Arizona allows a subtraction for all dividends from foreign corporations. 12
While Arizona has not specifically addressed the one-time deemed repatriation, it is currently reasonable to conclude that a full subtraction serves to eliminate this income from the corporation income tax base.
Market-based sourcing election
Historically, Arizona has required sales of items other than tangible personal property to be sourced for Arizona sales factor purposes under cost of performance rules.13
For tax years beginning in 2014 and thereafter, Arizona has provided an exception to this rule for certain “multistate service providers,” generally defined as corporations deriving more than 85% of their revenue from services provided to purchasers receiving the benefit of the service outside Arizona.14
Multistate service providers may elect to calculate their Arizona sales factor using a market-based sourcing methodology. 15
Effective for tax years beginning in 2020 and thereafter, S.B. 1405 expands the definition of a multistate service provider eligible to elect market-based sourcing to include taxpayers with sales from the following types of intangibles:
- credit and charge card receivables, including fees;
- merchant discounts;
- interest; and
- related revenue.16
The current action taken by Arizona to update its IRC conformity for the impact of federal tax reform addresses only those changes effective for tax years beginning in 2017 or earlier. Given that Arizona generally updates its conformity to the IRC on an annual basis, there is still uncertainty as to how Arizona will eventually choose to incorporate or decouple from the host of federal tax changes that become effective for the 2018 tax year. Arizona’s treatment of the numerous federal tax provisions is similar to the approach taken by Virginia in its recent IRC conformity legislation. 17
The new rule on the applicability of the multistate service provider election marks the first additional guidance the state has released on this election. While the adoption of this rule was a major change for Arizona, there is little authority for taxpayers to rely upon when attempting to implement this provision. While it is available for “multistate service providers,” the statute does not specifically define the term “service.” Most states, when adopting a market-based sourcing rule, have broadly defined application of the rule to the sourcing of revenue from “other than tangible personal property.” Arizona chose to more narrowly define the rule as applying only to service providers, but has now begun to expand the election’s availability to taxpayers in other industries. As more corporations consider making the election, the state may continue to refine the rules and clarify their intended application.
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