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District of Columbia reduces QHTC benefits

Budget law also amends sales, property and individual income tax provisions

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On Sept. 4, 2019, the District of Columbia enacted an emergency budget law modifying a variety of the District’s tax provisions. These provisions are effective Oct. 1, 2019, unless otherwise provided, and are expected to become permanent.1 One of the more noteworthy items addressed in the bill involves significant limitations and reductions to the tax benefits available for qualified high technology companies (QHTCs). Other amendments include various changes to property taxes, deed recordation and transfer taxes, a sales tax rate increase for soft drinks, and statutory sales tax exemptions for diapers and feminine hygiene products.

QHTC benefits greatly reduced The QHTC program, which has provided technology companies with an incentive to locate and develop in the District for nearly 20 years, currently provides the following tax benefits:

  • A five-year corporate franchise tax exemption with a reduced 6% tax rate thereafter for corporate franchise taxpayers;2
  • An indefinite franchise tax exemption for an unincorporated business that would otherwise be subject to the District’s unincorporated business franchise tax;3
  • Various franchise tax wage credits for corporate franchise taxpayers;4
  • Sales and use tax exemptions;5
  • A 10-year personal property tax exemption for qualifying property;6 and
  • A reduced 3% tax rate on capital gains from the sale of an investment in a QHTC.7

Under the bill, QHTCs will no longer enjoy the reduced corporate franchise tax rate of 6 percent following the five-year exemption period.8 For tax years beginning after Dec. 31, 2019, a QHTC will be subject to the general corporate franchise tax rate of 8.25%.9 However, the District will still provide newly QHTC-certified companies with the five-year franchise tax exemption.10 The reduced rate is being replaced with a tax credit that may be claimed each tax year for five years in an amount equal to the lesser of $250,000 or the difference between the taxes imposed under the regular rate and the reduced 6 percent tax rate.11 Those QHTC taxpayers for which the five-year exemption has already expired will also receive the opportunity to claim this credit, with the first year beginning on or after Jan. 1, 2020.12

The bill also decreased the corporate franchise tax credits for wages paid to qualified employees.13 Previously, corporate QHTCs were able to claim a franchise tax credit for the lesser of $5,000 or 10 percent of the wages paid to a qualified employee during the first 24 months of employment. Additionally, any unused credit could be carried forward for 10 years. For tax years beginning after Dec. 31, 2019, this credit decreases from 10% to 5% of the wages paid, with the maximum credit reduced to $3,000.14 Further, the opportunity to carry forward the credit will no longer be allowed for any employee hired on or after Oct. 1, 2019.15 It should be noted that the bill did not alter a corporate QHTC’s ability to claim other employment-based franchise tax credits, such as the credit for qualified disadvantaged employee retaining costs, the credit for wages paid to qualified disadvantaged employees, and the credit for certain relocation costs.16

Lastly, the bill completely removed the sales and use tax exemptions provided to a QHTC.17 Taxable retail sales of products or services performed within the District involving intangible property, such as digital products, licences or subscriptions to software as a service, Internet-related sales and services, and data processing services, are no longer exempt from sales tax. Additionally, the complementary use tax exemptions on purchases of computer software or hardware for use in connection with a QHTC’s operations have been repealed.18 Accordingly, effective Oct. 1, 2019, QHTCs are now subject to the general collection and remittance requirements on such previously exempt transactions.

Property tax The bill made various changes to the District’s property tax code. As a result of the anticipated revenue growth from remote seller legislation adopted following the U.S. Supreme Court’s decision in South Dakota v. Wayfair,19 the Council enacted legislation at the end of 2018 that used the expected revenue to support a reduction in the commercial property tax rate from $1.89 per $100 of assessed value to $1.85 per $100 of assessed value on properties valued at more than $10 million.20 However, less than a year later, the Council rescinded this reduction and reinstated the original tax rate of $1.89 per $100 of assessed value.21

Based on the newly adopted legislation, the Council reverted back to its original plan of reinvesting the sales tax revenue from its Wayfair legislation into programs addressing homelessness and stable housing in the District. By the same token, the District enacted exemptions from the real property tax, deed recordation tax and deed transfer tax available for rental housing owners who meet the following qualifications: (i) are non-profit entities; (ii) lease their units at certain income thresholds; and (iii) comply with additional requirements, including continued monitoring of compliance with the qualifications.22 In order to maintain the exemptions, the housing must satisfy the following criteria: (i) at least 50 percent of the units must be leased to tenants with income at or below 80 percent of the adjusted median income for the Washington Metropolitan Statistical Area as published by the U.S. Department of Housing and Urban Development; and (ii) the remaining units must be leased to households with incomes not exceeding 120 percent of the adjusted median income.23 There are also additional limitations on the amount of rent chargeable to tenants.24

Deed recordation and transfer taxes The District enacted an additional 1.05% tax on direct transfers and 30-year-or-more leases of commercial real property and on transfers of economic interests in real property if the consideration exchanged in either transfer is more than $2 million.25 The 1.05% additional tax is also applicable to certain deed recordations.26 As such, this brings the effective tax rate for deed recordations and deed transfers to 5% for certain transactions, consisting of a 2.5% tax rate for deed recordations and a 2.5% tax rate for deed transfers.

As it applies to transfers of economic interests in real property, the maximum 5% rate is applicable to real property with any commercial component if the consideration attributable to that commercial component is $2 million or more.27 Additionally, for the purposes of this analysis, the deed is considered to be a transfer of an economic interest only if, prior the execution of the deed, the commercial component of the property and the majority ownership of the economic interest to be transferred was under common ownership.28

The 1.05% additional deed recordation tax rate is also applicable to debt security instruments securing a debt of $2 million (or more) upon any real property with a commercial property component, bringing the total tax rate to 2.5%.29 There are specific debt aggregation rules in evaluating whether or not the $2 million threshold is met. Once the threshold is met or exceeded, the tax applies to each individual debt security instrument.30

The increases are effective Oct. 1, 2019, and are scheduled to expire on Sept. 30, 2023.

Sales Tax Following a recent trend set by Maryland and other states, the Council instituted a sales tax exemption for diapers and feminine hygiene products.31 Originally, the Council approved this exemption in late 2016.32 However, the effective date was delayed until the District was able to subsidize the cost attributable to the loss in revenue related to the exemption.

As a means to balance this new exemption from a revenue perspective, the Council raised the 6% sales and use tax on soft drinks to 8%.33 To ensure that the higher tax rates do not inadvertently affect healthy drinks, it revised the current definition to statutorily exclude: (i) beverages that are 100% fruit or vegetable juice; and (ii) beverages that are at least 50% milk or milk substitutes (such as rice milk, soy milk, etc.).34 However, this alteration effectively expands the definition of a soft drink, so that any beverage that does not meet these specific ingredient tests will be subject to the tax. Targeting sin taxes has become a familiar method for the District to raise additional revenue. For example, last year, the District raised tax rates applicable to sales of spirituous alcoholic beverages sold for off-premise consumption and cigarettes (including e-cigarettes).35

Individual income tax The bill provisioned $2.5 million for the purposes of making early child care more affordable for all District residents. Previously called the Early Learning Tax Credit, the now-permanent Keep Child Care Affordable Tax Credit provides a $1,000 tax credit for each family with an eligible child enrolled in a licensed District child care facility for the 2018 and 2019 tax years.36 For the 2020 tax year and thereafter, the tax credit is subject to a cost-of-living adjustment.37

Additionally, for the 2019 tax year and thereafter, the income eligibility limit to claim the tax credit is reduced from $750,000 to $150,000 for those taxpayers filing as single, head of household, or married filing jointly. The income eligibility limit was reduced from $375,000 to $75,000 for taxpayers married and filing separately.38 These thresholds are indexed for inflation. Originally, the tax credit was to sunset after Dec. 31, 2018, but the enactment of this Act has eliminated the sunset provision and extended the tax credit indefinitely.39

Commentary The most notable adjustment made to the District’s tax code relates to the QHTC incentive program. The considerable reduction of tax benefits may make it more difficult for the District to attract and retain technology businesses. Notably, these changes occurred soon after the District began to require taxpayers claiming the QHTC designation to provide additional information, such as historical benefits claimed and employment data pertaining to District residents, in order to maintain their status.40 Based on the dialogue surrounding these changes, it appears that the Council may consider termination of the exemption if the program does not continue to drive growth in the District in future years.

A report from November 2018, which was issued as part of a mandatory five-year review by the Chief Financial Officer covering the District’s tax expenditures, illustrated that from 2001 to 2015, the District lost $184 million in corporate franchise tax revenue due to the QHTC program.41 Additionally, there was evidence indicating that some large companies were benefitting disproportionately without contributing a corresponding economic benefit to the District. Since the District was not in the practice of tracking QHTC sales and purchases from 2010 to 2015, it was unable to compute a thorough analysis of the indirect tax impact on District coffers.

Regardless, the review noted significant problems with the QHTC program, prompting D.C. Councilmember Brianne Nadeau (D-Ward 1) to propose reducing the incentives for QHTCs and focusing funds toward social services.42 Accordingly, during a public oversight roundtable on this related matter hosted by the Committee on Finance and Revenue in May 2019, approximately 33 witnesses from special interest groups supporting causes such as child and educational welfare, homelessness, and mental health and awareness, testified that the revenue should be redirected due to the ineffectiveness of the QHTC incentives program. Ultimately, these witnesses successfully persuaded the Council to reduce the tax benefits offered by the QHTC program, reflecting a desire by the Council to provide more support for the District’s social welfare rather than simply focusing on corporate growth.
 


1 Act 23-0112 (D.C.B. 23-0367), Laws 2019. The District adopts emergency, temporary and permanent legislation. Emergency legislation eventually must be replaced by temporary or permanent legislation. The District originally enacted emergency legislation, Act 23-0091 (D.C.B. 23-0352), Laws 2019, covering the same tax matters to support the Fiscal Year 2020 budget on July 22, 2019. This Act was effective for up to 90 days and was set to expire on Oct. 20, 2019. However, Act 23-0112 extends the expiration date to Dec. 2, 2019. For the Act to become permanent, the District will need to enact temporary legislation, and eventually permanent legislation, which requires the U.S. Congress to review the Act. To do so, the District must send Congress the temporary or permanent legislation. Congress then has 30 days (when it is in session) to approve the bill, which it often does without affirmative approval.
2 D.C. CODE ANN. § 47-1817.06.
3 D.C. CODE ANN. § 47-1808.01(5).
4 D.C. CODE ANN. §§ 47-1817.02 -- 47-1817.05.
5 D.C. CODE ANN. § 47-2001(n)(2)(G).
6 D.C. CODE ANN. § 47-1508(a)(10).
7 D.C. CODE ANN. § 47-1817.07a.
8 D.C. CODE ANN. § 47-1817.06.
9 D.C. CODE ANN. § 47-1817.06(a)(1)(B).
10 D.C. CODE ANN. § 47-1817.06(a)(2).
11 D.C. CODE ANN. § 47-1817.06(a)(3).
12 Id.
13 D.C. CODE ANN. § 47-1817.03.
14 D.C. CODE ANN. § 47-1817.03(a-1), (b)(1).
15 D.C. CODE ANN. § 47-1817.03(c).
16 D.C. CODE ANN. §§ 47-1817.02; 47-1817.04; 47-1817.05.
17 D.C. CODE ANN. § 47-2001(n)(2)(G).
18 D.C. CODE ANN. § 47-2005(31).
19 138 S. Ct. 2080 (2018). For a discussion of this case, see GT SALT Alert: Wayfair Ruling Overturns Quill Physical Presence Requirement.
20 Act 22-556 (D.C.B. 22-1070), Laws 2018. For further information, see GT SALT Alert: D.C. Enacts Remote Seller Sales Tax Provisions.
21 D.C. CODE ANN § 47-812(b-9)(2).
22 D.C. CODE ANN. § 47-1005.03.
23 D.C. CODE ANN. § 47-1005.03(b).
24 Id.
25 D.C. CODE ANN. § 47-903(a-6).
26 D.C. CODE ANN. § 42-1103(a-5).
27 D.C. CODE ANN. §§ 42-1103(a-5)(1); 47-903(a-6)(1).
28 D.C. CODE ANN. §§ 42-1103(a-5)(2); 47-903(a-6)(2).
29 D.C. CODE ANN. § 42-1103((a-5)(1)(B).
30 Id.
31 D.C. CODE ANN. § 47-2005(39).
32 Act 21-0557 (D.C.B. 21-0696), Laws 2016.
33 D.C. CODE ANN. §§ 47-2002(a)(8); 47-2202(a)(5).
34 D.C. CODE ANN. § 47-2001(r-1)(1).
35 Act 22-0442 (D.C.B. 22-0753), Laws 2018.
36 D.C. CODE ANN. § 47-1806.15.
37 D.C. CODE ANN. § 47-1806.15(b)(2)(B)(ii).
38 D.C. CODE ANN. § 47-1806.15(d)(5).
39 The bill repealed D.C. CODE ANN. § 47-1806.15(f).
40 D.C. MUN. REGS. tit. 9, § 1101. This regulation was amended effective January 4, 2019.
41 Jeffrey S. De Witt, Chief Financial Officer, Review of Economic Development Tax Expenditures, District of Columbia Office of Revenue Analysis, Nov. 2018.
42 Ally Schweitzer, Tax Incentives for D.C. Tech Companies Expected to Be Slashed, WAMU 88.5, AMERICAN UNIVERSITY RADIO, May 27, 2019.



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