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Indiana adopts market-based sourcing, updates IRC conformity

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Indiana Gov. Eric Holcomb recently signed into effect two revenue bills with significant impact to Indiana corporate taxpayers. The first, retroactively effective to Jan. 1, 2019, codifies market-based sourcing for sales other than tangible personal property not specifically allocated to Indiana for most industries.1 Further, the bill clarifies that income derived from Indiana is taxable regardless of whether the taxpayer has a physical presence in Indiana. The legislation also establishes the redevelopment tax credit and amends certain existing credits. The second bill, which is also retroactively effective to Jan. 1, 2019, updates Indiana’s conformity to the Internal Revenue Code (IRC), and modifies the statutory language for several Indiana modifications.2

Market-based sourcing Previously, Indiana defined “sales” as all non-allocated gross receipts of the taxpayer.3 Sales other than tangible personal property constituting business receipts to the taxpayer were sourced to Indiana on a cost-of-performance basis.4 With its adoption of S.B. 563, Indiana changes its method of sourcing such receipts to a market basis, and attributes the receipts to Indiana if the taxpayer’s market for the sales is in Indiana.5

In determining the location of the market, several specific rules apply. The sale of real property, or the rental, lease, or license of real or tangible personal property is sourced to the location of such property. The sale of a service is sourced to the location where the benefit of the services is received. The rental, lease or license of intangible property is sourced to the location of use, which for marketing intangibles is measured by the location where the consumer purchased the marketed item. A sale of intangible property is also sourced to the location of use, provided that: (i) a contract right, government license, or similar intangible property that authorizes the holder to conduct a business activity in a specific geographic area is sourced in line with the geographic use of such item; (ii) intangible property sales that are contingent on the productivity, use, or disposition of the intangible property are treated as receipts from the rental, lease, or licensing of such intangible property; and (iii) other sales of intangible property are excluded from the receipts factor. If these sourcing rules are not determinative, the receipts are sourced to the location of delivery, or if such location is not determinable, the receipts are excluded from the receipts factor.6

Broadcasting and telecommunication services will continue to be sourced on a cost-of-performance basis. Broadcasting services are generally defined as video broadcasts and related ancillary activities by a television broadcast network, a cable program network, or a television distribution company. The term also includes any advertising or promotional activity furnished in conjunction with the broadcast services.7 Telecommunication services include the transmission of signals with certain exceptions.8

S.B. 563 further allows the Indiana Department of Revenue to adopt rules, also applied retroactively to Jan. 1, 2019, to specify where sales, receipts, income, transactions, or costs are attributable so long as such rules are consistent with the Multistate Tax Commission (MTC) model regulations for income tax apportionment in effect as of that date, including specialized industry provisions unless expressly different under the corporate income tax chapter of the Indiana statute.9

Codification of economic nexus Indiana also statutorily expands the definition of adjusted gross income derived from sources within Indiana to explicitly state that all such income is taxable in Indiana regardless of physical presence,10 effectively codifying economic nexus for income tax purposes. No modifications were made to the historic list of included elements (i.e., income from in-state property, income from doing business or from a trade or business conducted, compensation for in-state labor or services rendered, and income from certain intangible property apportioned or allocated to the state). Instead, the new language clarifies that income derived from Indiana is taxable to the fullest extent permitted by the U.S. Constitution and federal law. It refrains from including specific thresholds considered indicative of economic nexus.

IRC conformity and modifications With its adoption of S.B. 565, Indiana updated its IRC conformity date to Jan. 1, 2019,11 and updated certain statutory modifications required for corporations to determine adjusted gross income:

  • The IRC Sec. 179 adjustment is now the sum of the Sec. 179 amount deducted in excess of $25,000 related to non-Sec.-1031-eligible assets, plus the Sec. 179 amount deducted on property if: (i) the property was acquired in an exchange qualifying for non-recognition of gain/loss under IRC Sec. 1031 in effect on Jan. 1, 2017; (ii) the property does not qualify for non-recognition of gain/loss under the current IRC; and (iii) the taxpayer made an election to take deductions under IRC Sec. 179 with regard to the acquired property in the year that the property was placed into service.12
  • For purposes of determining intangible interest expense, the definition of directly related interest expense was expanded to include applicable business interest under IRC Sec. 163(j), but this interest is considered to have reduced the taxpayer’s federal taxable income only in the first taxable year in which the deduction would have been allowable if IRC Sec. 163(j) did not exist.13
  • The IRC Sec. 965(c) adjustment was updated to include an addition for IRC Sec. 965(c) amounts deducted on the taxpayer’s federal income tax return.14
  • The IRC Sec. 118(b)(2) adjustment was updated to include a subtraction for IRC Sec. 118(b)(2) amounts that would have been excluded from gross income but for the enactment of IRC Sec. 118(b)(2).15
  • For purposes of determining the IRC Sec. 168(k) adjustment, the definition of bonus depreciation was updated to exclude any additional first-year special depreciation allowance under IRC Sec. 168(k) in the amount of adjusted gross income realized on the exchange of property that otherwise would have been deferred under IRC Sec. 1031 in effect on Jan. 1, 2017, if the exchange would have been eligible for non-recognition of gain/loss under IRC Sec. 1031 in effect on Jan. 1, 2017, but: (i) the exchange is no longer eligible for non-recognition of gain/loss under current IRC Sec. 1031; and the taxpayer claimed a deduction for the additional first-year special depreciation allowance under IRC Sec. 168(k) on that acquired property.16
  • The Indiana net operating loss (NOL) (effective retroactively to Jan. 1, 2018) now includes the portion of the loss for a taxable year disallowed because of IRC Sec. 461(l) and incurred from Indiana sources.17

Redevelopment tax credit Effective Jan. 1, 2020, S.B. 563 establishes the redevelopment tax credit to incentivize the redevelopment of certain qualified redevelopment sites.18 The amount of credit a taxpayer may claim is the amount of qualified investment made by the taxpayer and agreed to by the Indiana Economic Development Corporation (IEDC) multiplied by a credit percentage,19 and can be used against a taxpayer’s Indiana adjusted gross income tax, insurance premiums tax and financial institutions tax, in that order.20 The maximum credit percentage, which is determined by the IEDC, can range from 10% to 25%. This percentage is dependent upon when the qualified redevelopment site was placed in service, and whether or not such site is part of a development plan of a regional development authority established under Ind. Code Secs. 36-7.5-2-1 or 36-7.6-2-3.21 The IEDC may increase the credit amount by up to 5% if the qualified redevelopment site is located in a federally designated qualified opportunity zone or the project qualifies for federal new markets tax credits under IRC Sec. 45D.22

Excess credits may be carried over for up to nine additional taxable years, beginning with the taxable year after the year in which the corporation certifies the taxpayer's expenditures as a qualified investment.23 To be awarded this credit, a taxpayer must file an application with the IEDC and enter into an agreement with the corporation as set forth under Ind. Code Sec. 6-3.1-34.24

Other credits and incentives In addition to changes to the redevelopment tax credit, S.B. 563 made numerous changes to other tax credits and incentives, effective July 1, 2019:

  • The IEDC and similar border state agencies or bodies may enter into mutual economic development and payment agreements to incentivize cross-border employee arrangements.25
  • A taxpayer is permitted to receive an industrial recovery tax credit for qualified investment made between 2020 and 2029 for qualified investment made in Indiana, under an application approved by the IEDC before the beginning of 2020; or as an award under an agreement entered into by the taxpayer and the IEDC before Jan. 1, 2021.26
  • The sunset date of the community revitalization enhancement district tax credit provisions is extended, to the extent that the taxpayer’s application for the credit is approved by the IEDC prior to the expiration of the district, and the taxpayer and the IEDC enter into an agreement with the IEDC not later than one year after the expiration of the district.27
  • The Hoosier business investment tax credit is expanded to include the purchase of retooled or refurbished machinery; new pollution control and abatement, energy conservation, or renewable energy generation equipment; and new onsite digital manufacturing equipment as qualified investments.28 In addition, a higher credit amount of 15 percent of the qualified investment made by a taxpayer in onsite digital manufacturing equipment may be granted for tax years beginning after Dec. 31, 2018, and before Jan. 1, 2030 (effective Jan. 1, 2019).29
  • The headquarters relocation credit is expanded to include certain businesses receiving venture capital funds. Specifically, businesses who have received or closed on at least $4 million of venture capital in the six months before submitting an application for the tax credit (if venture capital is to be received) or six months after submitting an application for the tax credit (if venture capital is to be closed) are eligible businesses. In addition, the definition of taxpayer will include an individual or entity that submits incremental tax withholdings30 if it is considered to be an eligible business. The Indiana-employee requirement is lowered to 10 employees for eligible businesses under the venture capital provisions. The credit may lower the taxpayer’s Indiana tax liability below that of the year immediately preceding the year in which the taxpayer incurred relocation costs if the eligible business definition under the venture capital provisions is met. Finally, a refund of excess credit to eligible businesses under the venture capital provisions may be allowed, at the discretion of the IEDC.31
  • The economic development for a growing economy (EDGE) credit is expanded by updating the definition of incremental income tax withholdings to include withholdings for Indiana non-resident employees covered by a mutual economic assistance and payment agreement.32

Commentary With the passage of these two bills, Indiana joins the growing number of states that have moved to economic nexus and market-based sourcing of receipts from intangibles. Taxpayers should be prepared to see more states move in this direction as state legislatures are emboldened by the Wayfair decision, despite its direct application to sales and use taxes.33 In fact, in a specific nod to Wayfair, Indiana amends its definition of gross income to specify that income derived from Indiana is taxable to the fullest extent permitted by the U.S. Constitution and federal law, regardless of whether the taxpayer has a physical presence in Indiana.34 It should be noted, however, that the Indiana statute does not provide a specific bright-line sales or transactional threshold for purposes of determining whether a company could be subject to the corporation income tax.

In the area of credits and incentives, the legislation provides significant latitude to the IEDC to collaborate with like organizations in bordering states to incentivize cross-border employment by providing such states with payments of forgone withholding taxes on Indiana residents working in bordering states, while requiring reciprocal agreements from counterpart states. If well-administered, this could be a boon to Indiana employers in need of specialized labor. In combination with the expansion of the headquarters relocation credit and the creation of a new credit for revitalization of Indiana properties, the changes to Indiana’s incentive system seem to offer a compelling tax environment for businesses, particularly those seeking to relocate.


 
1 P.L. 158 (S.B. 563), Laws 2019 (May 1, 2019).
2 P.L. 234 (S.B. 565), Laws 2019 (May 5, 2019).
3 IND. CODE § 6-3-1-24 (prior to adoption of S.B. 563).
4 IND. CODE § 6-3-2-2(f) (prior to adoption of S.B. 563).
5 IND. CODE § 6-3-2-2(f)(3).
6 IND. CODE § 6-3-2-2(f)(3)-(5).
7 IND. CODE § 6-3-1-38.
8 IND. CODE §§ 6-3-1-37; 6-2.5-1-27.5(a)-(c).
9 IND. CODE § 6-3-2-2(u)(1)-(3).
10 IND. CODE § 6-3-2-2(a)(5).
11 IND. CODE § 6-3-1-11(a)-(c).
12 IND. CODE § 6-3-1-3.5(b)(7).
13 IND. CODE § 6-3-1-3.5(b)(8)(B).
14 IND. CODE § 6-3-1-3.5(b)(13)(A)(ii).
15 IND. CODE § 6-3-1-3.5(b)(16).
16 IND. CODE § 6-3-1-33. For this purpose, if the taxpayer elected to claim a Sec. 179 deduction on the acquired property, the adjusted gross income realized on the exchange must be reduced (but not below zero) by the amount of the deduction under Sec. 179 elected to be claimed on the acquired property.
17 IND. CODE § 6-3-2-2.6(c)(2).
18 IND. CODE §§ 6-3.1-34; 5-28-28-10(9).
19 IND. CODE § 6-3.1-34-11(b)(1).
20 IND. CODE § 6-3.1-34-9.
21 IND. CODE § 6-3.1-34-17(b). The credit percentage maximums are higher for older qualified redevelopment sites that are part of an Indiana regional development authority development plan.
22 IND. CODE § 6-3.1-34-17(c).
23 IND. CODE § 6-3.1-34-13.
24 IND. CODE § 6-3.1-34-15.
25 IND. CODE § 6-3-5-4.
26 IND. CODE § 6-3.1-11-25(a)-(d).
27 IND. CODE § 6-3.1-19-2(b).
28 IND. CODE § 6-3.1-26-8(a)(6), (10), (11).
29 IND. CODE § 6-3.1-26-14(3).
30 As defined by IND. CODE § 6-3-4-8.
31 IND. CODE § 6-3.1-30-2.
32 IND. CODE § 6-3.1-13-5(a)(2)(B).
33 South Dakota v. Wayfair, Inc., 138 S. Ct. 2080 (2018). For a discussion of this case, see GT SALT Alert: Wayfair Ruling Overturns Quill Physical Presence Requirement.
34 IND. CODE § 6-3-2-2(a)(5).



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