Arizona adopts economic nexus for transaction privilege tax


Metisse Lutz
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Louise Gregory
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Jamie C. Yesnowitz
Washington, DC
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Chuck Jones
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Lori Stolly
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On May 31, 2019, Arizona Gov. Doug Ducey signed legislation updating the state’s conformity to the Internal Revenue Code (IRC), modifying its conformity to various provisions of the Tax Cuts and Jobs Act of 2017 (TCJA),1 and adopting an economic nexus standard for the transaction privilege tax.2 Separate legislation expands the definition of a multistate service provider eligible to make a market-based sourcing election for corporate income tax apportionment purposes.3

Corporate income tax The legislation modifies several components of the corporate income tax, including adjustments that will affect the tax base and apportionment provisions.

Tax base For tax years beginning on or after Dec. 31, 2017, through Dec. 31, 2018, Arizona adopts the IRC in effect as of Jan. 1, 2018.4 Provisions which took effect during 2017 are retroactively adopted for Arizona purposes. For tax years beginning on or after Dec. 31, 2018, the IRC in effect on Jan. 1, 2019, applies, with retroactive adoption of all provisions taking effect in 2018.5

Notably, Arizona has selectively decoupled from several provisions of the TCJA. For example, the state continues to decouple from federal bonus depreciation.6 However, no adjustment is adopted for the IRC Sec. 163(j) interest expense limitation, leaving Arizona in conformity with this provision. Further, Arizona has not adopted any new limitations with respect to the state net operating loss deduction. The federal net operating loss is added back, with a subtraction available for any Arizona net operating loss, which is defined without reference to IRC Sec. 172(a).7

The new law also clarifies the applicability of the previously available dividends received deduction to certain types of income. While the statute provided a subtraction from Arizona income for dividend income received from foreign corporations, questions lingered regarding which types of income qualified.8 The recent legislation clarifies that gross-up income described in IRC Sec. 78, global intangible low-taxed income (GILTI) defined in IRC Sec. 951A, and Subpart F income defined in IRC Sec. 952 are all considered foreign dividends that qualify for this subtraction.9 The related dividend deductions allowed on the federal income tax return pursuant to IRC Secs. 243, 245, 245A and 250(a)(1)(B) are added back on the Arizona return. The net effect of these adjustments results in the gross-up, Subpart F and GILTI being excluded from taxation in Arizona.10 Further, in a news release posted to its Web site, the Arizona Department of Revenue confirmed that net income recognized under IRC Sec. 965(a) is also eligible for the foreign dividends subtraction, to the extent included in Arizona taxable income.11 Because the income is not taxed, the related federal deduction under IRC Sec. 965(c) must be added back.

Apportionment A market-based sourcing election for apportionment purposes is currently available to qualified multistate service providers.12 To qualify, a taxpayer must receive more than 85% of its revenue from services provided to customers outside Arizona. Certain educational institutions also qualify. Effective for tax years beginning in 2019 and thereafter, the definition of qualified “multistate service provider” is expanded to include a taxpayer (including its Arizona combined or consolidated group members) with more than 2,000 employees within Arizona which receives more than 85% of its revenue from certain educational support services.13 For qualifying taxpayers, revenue from these support services is sourced to the billing address of the student to whom its services relate.14

Individual income tax For tax years beginning on or after Dec. 31, 2018, the number of individual income tax brackets has been reduced from five to four, with a slight reduction in rates for each bracket. The top rate, which applies to income over $159,000 for taxpayers filing as single or married filing separately, and income over $318,000 for heads of household and married filing jointly, has been slightly reduced from 4.54 percent to 4.5 percent.15 The Arizona standard deduction amounts also have been substantially increased, in tandem with the federal changes adopted with the TCJA.16

Arizona decouples from the IRC Sec. 199A deduction for pass-through entity income, based on the state’s use of federal adjusted gross income as the starting point to calculate Arizona taxable income.17

Economic nexus for transaction privilege tax Effective Oct. 1, 2019, Arizona adopts an economic nexus threshold for transaction privilege tax purposes, applicable to retailers without physical presence in the state or other reason for holding a transaction privilege tax license. Specifically, a remote retailer is subject to the transaction privilege tax if gross proceeds from sales or gross income derived from Arizona customers (not facilitated by a marketplace facilitator) exceed $200,000 in the 2019 calendar year, $150,000 in 2020 or $100,000 in 2021 and subsequent years.18 For marketplace facilitators, the annual threshold is $100,000 of sales to Arizona customers on its own behalf or on behalf of at least one marketplace seller.19 Sales of affiliated parties, defined as sharing more than 5% common ownership, are aggregated to determine whether the threshold is met.20 Remote sellers are offered a limited amount of protection from penalties for failure to pay the correct amount of transaction privilege tax if such failure was due to an error other than an error in sourcing the sale.21

For purposes of meeting the threshold, the term “marketplace facilitator” includes a person that facilitates a retail sale by advertising or listing tangible personal property for sale, regardless of whether such person was compensated for that service.22 Payment processors (including credit card payment services) are excluded. Marketplace facilitators with more than $100,000 in annual sales are generally required to remit tax for sales made through their marketplace. Similar to the remote seller statute, the marketplace facilitator statute provides a limited amount of protection from penalties for facilitators who remit incorrect amounts of tax based on erroneous information provided by unaffiliated sellers, or the failure was due to an error other than an error in sourcing sales by unaffiliated sellers.23

If the annual threshold is met at any point during a calendar year, the retailer must apply for a transaction privilege tax license and begin remitting tax on the first day of the month beginning at least 30 days after the threshold is met. The statute also contains a provision allowing a seller to cancel its transaction privilege tax license if the sales threshold is not met in a subsequent year.24 If a person is required to hold a transaction privilege tax license, but does not have physical presence in the state, no municipal level license fees apply.25 Further, a city or town may not require a person to obtain a business license simply as a result of meeting the specified thresholds.26

Commentary This legislation ends a lengthy period of uncertainty surrounding Arizona’s conformity to the IRC. The Department released its 2018 tax year forms in early 2019, assuming that the conformity date would be advanced to incorporate most of the TCJA changes. Previous conformity bills failed to pass, however, creating the possibility that taxpayers would have to use incorrectly designed forms. While the forms and statute are now in harmony, taxpayers who filed returns or distributed Form K-1s prior to April 15 may need to amend their filings to reflect the recent changes.

The state has signaled its intent that all income and expenses generated under the TCJA’s GILTI provisions should be removed from the taxable income base, through operation of the dividends received deduction. The statute, however, is silent on the treatment of foreign-derived intangible income (FDII). On its face, the statute allows taxpayers to deduct the amount of GILTI included in the state taxable income base, and adds back the amount of the 50% GILTI deduction under IRC Sec. 250(a)(1)(B). In using this specific citation, the Arizona addback statute does not reference IRC Sec. 250(a)(1)(A), effectively allowing the FDII deduction to remain in the calculation of Arizona taxable income. Other states which have similarly failed to address FDII have later made technical corrections to their statutes to address this disparity. Taxpayers with FDII deductions should consider waiting for additional guidance from the Department before filing Arizona income tax returns this year.

While Arizona now conforms to the IRC Sec. 163(j) interest expense limitation through its new IRC conformity date, no further guidance has been adopted to address how the state will apply the limitation in a consolidated or combined filing group. Arizona’s rules provide for an elective consolidated return to match the federal filing group, and a mandatory combined unitary group return. The membership of a federal affiliated group and state unitary group may differ, with Arizona’s additional criteria for unity occasionally resulting in a unique filing group.27 Taxpayers filing an Arizona combined return may face difficulties in applying the interest expense limitation without further guidance.

Arizona previously signaled its intent to adopt economic nexus provisions should South Dakota v. Wayfair, Inc.28 be favorably decided. The state has adopted an economic nexus threshold based on sales volume that declines over a short period of time, but has not included a provision based on the number of transactions within the state. The state is relatively unique in providing a mechanism for sellers to cancel their transaction privilege tax license if sales volume falls below the economic nexus threshold in a subsequent year. Smaller businesses with a one-time large taxable sale into Arizona will not be permanently burdened with this filing requirement.

1 Pub. Law No. 115-97. For a discussion of this Act, see GT Alert: Tax Reform Law Transforming Business and Tax Planning.
2 Ch. 273 (H.B. 2757), Laws 2019.
3 Ch. 272 (H.B. 2756), Laws 2019.
4 ARIZ. REV. STAT. § 43-105.A. Previously, Arizona adopted the IRC in effect as of Jan. 1, 2017.
5 ARIZ. REV. STAT. § 43-105.B.
6 ARIZ. REV. STAT. §§ 43-1121.16; 43-1122.22.
7 ARIZ. REV. STAT. §§ 43-1121.11; 43-1122.12; 43-1123.
8 ARIZ. REV. STAT. § 43-1122.11.
9 Id.
10 ARIZ. REV. STAT. § 43-1121.7.
11 Income Tax Notice for Corporate Taxpayers, Arizona Department of Revenue, June 4, 2019.
12 ARIZ. REV. STAT. § 43-1147.
13 ARIZ. REV. STAT. § 43-1147.E.3(c). The services must be provided to a regionally accredited institution for higher education.
14 ARIZ. REV. STAT. §§ 43-1147.D; 43-1147.E.4.
15 ARIZ. REV. STAT. § 43-1011.6. Prior to this legislation, the top tax rate of 4.54% was applicable to income over $150,000 for taxpayers filing as single or married filing separately, and income over $300,000 for heads of household and married filing jointly. The rate brackets will be adjusted for inflation for years beginning on or after Dec. 31, 2019.
16 ARIZ. REV. STAT. § 43-1041.A.
17 ARIZ. REV. STAT. § 43-1001.2. For federal purposes, the IRC § 199A deduction is not included in the calculation of adjusted gross income.
18 ARIZ. REV. STAT. § 42-5043.A.1.
19 ARIZ. REV. STAT. § 42-5043.A.2.
20 ARIZ. REV. STAT. §§ 42-5043.B; 42-5043.F.
21 ARIZ. REV. STAT. § 42-5042.C.
22 ARIZ. REV. STAT. § 42-5001.9. Related definitions are also provided for marketplace, marketplace seller and remote seller.
23 ARIZ. REV. STAT. § 42-5042.
24 ARIZ. REV. STAT. § 42-5043.C.
25 ARIZ. REV. STAT. § 42-5005.B, C.
26 ARIZ. REV. STAT. § 9-491.02.
27 An Arizona regulation provides three “threshold characteristics” necessary for components of an entity, an entity or a group of entities to be considered a unitary business: (i) the entities are owned or controlled, directly or indirectly, by the same interests that collectively own more than 50 percent of the voting stock; (ii) the entities or components share common management; and (iii) the entities or components have reconciled accounting systems. ARIZ. ADMIN. CODE R 15-2D-401.D. In addition, there must be evidence of substantial operational integration. The regulation includes a list of 15 factors that indicate operational integration. ARIZ. ADMIN. CODE R 15-2D-401.E.
28 138 S. Ct. 2080 (2018). For a discussion of this case, see GT SALT Alert: Wayfair Ruling Overturns Quill Physical Presence Requirement.

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