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Kentucky continues corporate income tax reforms

Changes implement market-based sourcing, clarify net operating loss computation

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The Kentucky Department of Revenue recently amended corporate income tax regulations to address the sourcing of receipts for apportionment purposes1 and the computation of net operating losses (NOLs).2 In response to the major tax reform legislation that Kentucky enacted last year, the sales factor apportionment regulation is amended and greatly expanded to reflect the adoption of market-based sourcing for sales of items other than tangible personal property.3 Because the new regulation provides special rules for certain industries, many apportionment regulations concerning specific industries are repealed.4 The tax reform legislation enacted last year also requires combined reporting for members of a unitary business group that do not elect to file a consolidated return. The NOL regulation is amended to clarify the computation of NOLs for taxpayers that file combined returns, nexus consolidated returns or elective consolidated returns. The amendments to both regulations apply to tax years beginning on or after Jan. 1, 2018.

Sourcing of receipts for apportionment For taxable years beginning on or after Jan. 1, 2018, Kentucky is requiring most taxpayers to use a single sales factor apportionment formula.5 Also, sales other than sales of tangible personal property are sourced to Kentucky if the taxpayer’s market for the sales is in the state.6 Most of the amendments to the apportionment regulation are consistent with the Model General Allocation and Apportionment Regulations adopted by the Multistate Tax Commission (MTC). The major provisions of the amended Kentucky regulation and notable differences from the MTC’s model regulations are discussed below.

Definitions and additional principles The amended Kentucky regulation adopts the following definitions from the MTC model regulation: billing address, business customer, individual customer, intangible property, place of order, population, and state where a contract of sale is principally managed by the customer.7 Also, the Kentucky regulation includes additional principles from the model regulation such as year-to-year and state-to-state consistency (which if not followed, may require taxpayer disclosures to that effect), and items included in the denominator and numerator of the sales factor.8 However, the Kentucky regulation also defines additional terms that are primarily related to specific industries, including: advertising services, barrel mile, broadcaster, financial institution, platform distribution company, public service company and qualified air freight forwarder.9

Sales of tangible personal property Similar to the model regulation, the Kentucky regulation contains provisions on sales of tangible personal property in the state.10 In general, gross receipts from sales of tangible personal property are in Kentucky if the property is delivered or shipped to a purchaser within the state regardless of the freight on board (FOB) point or other conditions of sale. Kentucky largely adopts the model regulations for sourcing sales of tangible personal property, including the model examples, but Kentucky does not throw back sales shipped from Kentucky if the taxpayer is not taxable in the state of the purchaser. Also, Kentucky adopts the MTC model regulations for generally sourcing sales of tangible personal property to the U.S. government via location of origin rather than destination.11

Sales other than sales of tangible personal property The Kentucky regulation addresses sales other than sales of tangible personal property at great length, generally requiring sourcing to the taxpayer’s market for the sales.12 The regulation establishes uniform rules for: (i) determining whether and to what extent the market for the sale is in the state; (ii) reasonably approximating the state or states of assignment if the state or states cannot be determined; (iii) excluding certain receipts from the sale of intangible property from the numerator and denominator of the sales factor; and (iv) excluding receipts from the denominator if the state of assignment cannot be determined or reasonably approximated, or if the taxpayer is not taxable in the state to which the receipts are assigned.13 Furthermore, the Kentucky regulation adopts the model regulations concerning: (i) contemporaneous records; (ii) reasonable approximation; (iii) the exclusion of receipts from the receipts factor; (iv) the sale, rental, lease or license of real property; and (v) the rental, lease or license of tangible personal property.14

Sourcing sales of a service. The Kentucky regulation largely follows the model regulations for sourcing sales of a service.15 In general, the receipts from the sale of a service are in Kentucky if and to the extent the service is delivered to a location in the state. Similar to the model regulations, the Kentucky regulation discusses the sourcing of receipts from in-person services.16 If the service provided by a taxpayer is an in-person service, the service is delivered to the location where the service is received. If the state or states where a service is actually received cannot be determined, the taxpayer should reasonably approximate the state or states. The Kentucky regulation includes the same examples as provided in the model regulations.

Similar to the model regulations, the Kentucky regulation includes a detailed discussion regarding the treatment receipts for services delivered to the customer, or on behalf of the customer, or delivered electronically through the customer.17 If the service is not an in-person or professional service, and the service is delivered to or on behalf of the customer, or delivered electronically through the customer, the receipts from a sale are in Kentucky if and to the extent the service is delivered in the state.18 The assignment of receipts to a state or states from this type of service depends upon the method of delivery of the service and the nature of the customer.19 Separate rules of assignment apply to services delivered by physical means and services delivered by electronic transmission. The Kentucky regulation follows the model regulations and covers: (i) delivery to or on behalf of a customer by physical means whether to an individual or business customer; (ii) the rule of determination; and (iii) the rule of reasonable approximation. Also, the Kentucky regulation adopts the model regulations’ examples. The Kentucky regulation also adopts the model regulations’ detailed discussion of delivery to a customer by electronic transmission.20 Similar to the model regulations, the Kentucky regulation covers: (i) services delivered by electronic transmission to an individual customer; (ii) services delivered by electronic transmission to a business customer; and (iii) services delivered electronically through or “on behalf of” an individual or business customer.

Sourcing sales of a service. In adopting most of the model regulations’ provisions, the Kentucky regulation also includes a very detailed section on sourcing receipts from professional services.21 Because the location of delivery of a professional service is not susceptible to a general rule, the location of delivery must be reasonably approximated. Comparable to the model regulations, the Kentucky regulation covers: (i) overlap with other categories of services; (ii) professional services delivered to individual customers; (iii) professional services delivered to business customers; and (iv) a safe harbor for a large volume of transactions. Also, the regulation follows the model regulations by discussing: (i) architectural and engineering services with respect to real or tangible personal property; (ii) services provided by financial organizations and institutions; and (iii) related member transactions.22 The Kentucky regulation adopts the numerous examples provided by the model regulations.

License or lease of intangible property. The Kentucky regulation generally adopts the license or lease of intangible property provisions from the model regulations.23 Receipts from the licensing of intangible property are in Kentucky if and to the extent the intangible property is used in the state. The Kentucky regulations address licenses of: (i) marketing intangibles; (ii) production intangibles; (iii) mixed intangibles; and (iv) intangibles if the substance of the transaction resembles a sale of goods or services.24 The Kentucky regulation generally adopts the numerous examples in the model regulations.

Sourcing sales of intangible property. Finally, the Kentucky regulation adopts the model regulations’ provisions for sourcing sales of intangible property.25 The assignment of receipts from the sale or exchange of intangible property depends upon the nature of the intangible sold. The Kentucky regulation follows the model regulations by covering the sourcing of receipts in the following types of transactions: (i) a contract right or government license that authorizes business activity in a specific geographic area; (ii) a sale that resembles a license; and (iii) a sale that resembles a sale of goods and services. The regulation also addresses excluded receipts and provides the numerous examples from the model regulations. Similar to the model regulations, the Kentucky regulation also provides special rules for software transactions and sales or licenses of digital goods or services.

Special rules In a departure from the model regulations, the Kentucky regulations also provide special sourcing rules for: (i) bank holding companies; (ii) barge lines; (iii) bus lines; (iv) passenger airlines; (v) pipelines; (vi) public service companies; (vii) qualified air freight forwarders; (viii) railroads; (ix) regulated investment companies; (x) securities brokerage services; and (xi) truck lines.26

Net operating losses For tax years beginning on or after Jan. 1, 2019, Kentucky is implementing mandatory combined reporting for members of a unitary business group, except for groups which elect to file a consolidated return with all members of the affiliated group.27 Each member of the group is responsible for tax based on its taxable income or loss apportioned or allocated to the state, which includes its NOL carryover.28 Kentucky recently enacted legislation allowing a member to share its NOL carryover with other members of the group in certain situations, which is not reflected in this regulation.29

Kentucky has amended its NOL regulation to provide guidance for combined group filers, elective consolidated filers, nexus consolidated filers30 and separate filers.31 The Kentucky regulation first provides a general rule for combined group filers, elective consolidated filers and separate filers, confirming that the NOL is first apportioned, and such apportioned NOL is available for carryforward to future years.32 With respect to transitional provisions, an elective consolidated filer having an NOL carryforward on the last elective consolidated return may carry that loss forward to combined group returns or separate returns.33 If a nexus consolidated filer ceases to exist or a member leaves the group and a consolidated NOL carryforward exists, the NOL carryforward may be carried forward to the combined group return, elective consolidated return or separate returns.34 The regulation includes detailed examples that illustrate the computation of NOLs when: (i) a member leaves the nexus consolidated group; (ii) the remaining nexus consolidated group dissolves; (iii) a member leaves the elective consolidated group; and (iv) the remaining elective consolidated group dissolves.35

As amended, the regulation provides an NOL limitation.36 Losses generated in tax years beginning on or after Jan. 1, 2018, are limited to 80% of the taxable net income as allowed by IRC Sec. 172.37

The regulation also addresses NOLs by corporations included in a combined group return.38 As provided in the regulation, NOLs generated by corporations included in a combined group may not be used to offset income of other corporations included in the combined group (though presumably, this provision will need to be amended to reflect the recent legislation allowing group members to share NOLs). NOLs may only be used if the corporation that generated the loss has taxable net income in subsequent years. All NOL carryforwards must be used on a first-in-first-out basis. Finally, no prior year NOL carryforward is available to separate entities that were not doing business in Kentucky prior to becoming part of a combined group return.

Commentary Kentucky substantially amended the sales factor apportionment regulation to reflect the change to market-based sourcing that was enacted last year. The regulation is very extensive and generally adopts the MTC model apportionment regulations. Due to the frequently complex nature of sourcing receipts from services or intangibles, this regulation should assist taxpayers in determining reasonable positions in how to source these types of receipts. Also, the regulation includes many examples that are useful in determining the application of the various sourcing provisions.

The NOL regulation also was amended to reflect the major tax reform legislation that Kentucky enacted last year. As amended, the regulation reflects the state’s change to unitary combined reporting. The NOL regulation provides guidance on computing NOLs for combined filers, elective consolidated filers, nexus consolidated filers and separate filers. As discussed above, however, some of these provisions may be further amended to reflect recent legislation.

 



1 103 KY. ADMIN. REGS. 16:270. The amendments are effective May 3, 2019
2 103 KY. ADMIN. REGS. 16:250. The amendments are effective April 5, 2019.
3 Ch. 207 (H.B. 487), Laws 2018. For further information, see GT SALT Alert: Kentucky Enacts Tax Reform Including Mandatory Unitary Combined Reporting, Single Sales Factor Apportionment and Remote Seller Nexus.
4 Specifically, the following apportionment regulations are repealed: 103 KY. ADMIN. REGS. 16:100 (telephone and telegraph companies); 16:110 (pipeline companies); 16:120 (truck lines, bus lines and airlines); 16:130 (railroads); 16:145 (barge lines); and 16:150 (financial organizations and loan companies).
5 KY. REV. STAT. ANN. § 141.120(9). Previously, business income was apportioned to Kentucky using a three-factor formula consisting of a property, payroll and double-weighted sales factor. Former KY. REV. STAT. ANN. § 141.120(8). For a discussion of other apportionment regulations that were amended earlier this year, see GT SALT Alert: Kentucky Amends Regulations to Clarify Apportionable Income Determination, Alternative Apportionment Procedures.
6 KY. REV. STAT. ANN. § 141.120(11)(a). Under prior law, receipts from sales other than sales of tangible personal property were sourced based on costs of performance. Former KY. REV. STAT. ANN. § 141.120(8)(c).3.
7 103 KY. ADMIN. REGS. 16:270.1.
8 103 KY. ADMIN. REGS. 16:270.2.
9 103 KY. ADMIN. REGS. 16:270.1
10 103 KY. ADMIN. REGS. 16:270.3.
11 103 KY. ADMIN. REGS. 16:270.4.
12 103 KY. ADMIN. REGS. 16:270.5.
13 103 KY. ADMIN. REGS. 16:270.5(1).
14 103 KY. ADMIN. REGS. 16:270.5(2)-(6).
15 103 KY. ADMIN. REGS. 16:270.5(7).
16 103 KY. ADMIN. REGS. 16:270.5(7)(b). In-person services are services that are physically provided in person by the taxpayer, if the customer or the customer’s real or tangible personal property upon which the services are performed is in the same location as the service provider when the services are performed. The regulation includes a list of examples of personal services. In-person services include services that are performed: (i) at a location that is owned or operated by the service provider; or (ii) a location of the customer, including the location of the customer’s real or tangible personal property. Various professional services, including services such as accounting, financial and consulting services, are not treated as in-person services.
17 103 KY. ADMIN. REGS. 16:270.5(8).
18 103 KY. ADMIN. REGS. 16:270.5(8)(a).
19 103 KY. ADMIN. REGS. 16:270.5(8)(b).
20 103 KY. ADMIN. REGS. 16:270.5(9).
21 103 KY. ADMIN. REGS. 16:270.5(10). Professional services are services that require specialized knowledge, and in some cases, require a professional certification, license or degree. These services include the performance of technical services that require the application of personalized knowledge. The regulation provides a list of professional services.
22 Unlike the model regulations, the Kentucky regulation addresses broadcast advertising services.
23 103 KY. ADMIN. REGS. 16:270.5(11).
24 The Kentucky regulation also covers the license of a broadcasting intangible.
25 103 KY. ADMIN. REGS. 16:270.5(12).
26 103 KY. ADMIN. REGS. 16:270.6.
27 KY. REV. STAT. ANN. § 141.201.
28 KY. REV. STAT. ANN. § 141.202(5)(a).
29 Ch. 196 (H.B. 458), Laws 2019, amending KY. REV. STAT. ANN. § 141.202(5)(c). For a discussion of this legislation, see GT SALT Alert: Kentucky Enacts Legislation Repealing Bank Franchise Tax, Amending Combined Reporting and Expanding Sales Tax Nexus to Marketplace Providers.
30 A “nexus consolidated filer” is a corporation that is a member of an affiliated group that is required to file a consolidated return under KY. REV. STAT. ANN. § 141.200(8)-(11). 103 KY. ADMIN. REGS. 16:250.1(9). Note that these statutory nexus consolidated filer provisions are limited to tax years beginning prior to January 1, 2019.
31 103 KY. ADMIN. REGS. 16:250.
32 103 KY. ADMIN. REGS. 16:250.2(1).
33 103 KY. ADMIN. REGS. 16:250.2(2). The filer must: (i) determine the post-apportionment elective consolidated group NOL carryforward; (ii) determine the years that are in the post-apportioned elective consolidated group NOL carryforward; and (iii) determine each loss corporation’s share of the NOL by: (a) allocating the post-apportioned elective consolidated group NOL carryforward by year to each loss corporation in each year; (b) adding together each loss corporation’s allocated share of the losses for each year it was a member of an elective consolidated group; and (c) carrying the separate entity NOL carryforward computed above to the first combined return or separate return due after the elective consolidated return. No prior year NOL carryforward is available to separate entities that were not doing business in Kentucky prior to becoming part of an elective consolidated return.
34 103 KY. ADMIN. REGS. 16:250.2(3). The filer must: (i) determine the pre-apportioned nexus consolidated group NOL carryforward; (ii) determine the years that are in the pre-apportioned nexus consolidated group NOL carryforward; and (iii) determine each loss corporation’s share of the NOL for each year by: (a) allocating the pre-apportioned nexus consolidated group NOL carryforward by year to each loss corporation in each year; (b) multiplying the pre-apportioned NOL carryforward amounts as assigned to the members by the nexus consolidated group’s apportionment factor for each year an NOL exists to determine the post-apportioned NOL carryforward that member may carry forward in the future; (c) adding together the post-apportioned losses generated for each loss corporation during the time in which it was included in a nexus consolidated return; and (d) carrying the separate entity NOL carryforward computed above to the first combined group return, elective consolidated return or separate return due after the nexus consolidated group ceases to exist. No prior year NOL carryforward is available to separate entities that were not doing business in Kentucky prior to becoming a part of a nexus consolidated return.
35 103 KY. ADMIN. REGS. 16:250.6.
36 103 KY. ADMIN. REGS. 16:250.3.
37 Id. This 80% limitation is based on conformity to amended IRC Sec. 172. Nexus consolidated returns are subject to the 50% limitation under KY. REV. STAT. ANN. § 141.200(11)(c).
38 103 KY. ADMIN. REGS. 16:250.4.




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