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August 3, 2012
Multistate Tax Commission (MTC): Proposed Pass-Through Entity Statute Advances with REIT-Specific Language Deleted, But State Taxation of Partnerships at Least Half-Owned by Entities not Subject to State Income Tax (like REITs Potentially) Still in Play
Background
For a number of years, the Multistate Tax Commission (MTC), an organization of state governments that drafts uniform state statutes that states may consider adopting, has been developing a proposed statute to address what they view as an inequity with respect to insurance companies that own businesses through partnerships or pass-through entities. Specifically, the MTC is concerned that, because insurance companies pay a state premium tax, rather than a state income tax, they can compete with businesses owned by C corporations that pay a state income tax by conducting businesses through partnerships and other pass-through entities that do not pay an entity-level income tax.
MTC's Model Captive REIT Statutes Adopted
As the MTC has considered the best approach to impose an income tax on the business income earned by pass-through entities owned by insurance companies, they also considered expanding the scope of their project to include REITs owned by insurance companies and REITs owned by other entities "not subject to state income tax." The MTC considered doing so notwithstanding that several years ago they had adopted a model captive REIT statute that would deny the DPD for a "captive REIT," generally speaking, a non-listed REIT more than 50% owned by a taxable C corporation. Last July, the MTC also adopted a model statute that would require a party related to a "captive REIT" to add back expenses like interest and rental deductions. For more details, see NAREIT's August 3, 2011 SALT Report.
MTC's June 2011 Proposed Pass-Through Entity Statute Would Go Beyond Captive REIT Statutes to Deny a REIT's DPD in Certain Additional Cases
In June 2011, the MTC staff proposed a revised statute, which would have:
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imposed corporate level tax on a partnership or disregarded entity owned 50% or more on any entity "not subject to income tax" ? presumably, this means another partnership, REIT (potentially); pension fund; section 501(c)(3) charity, and possibly even a taxpayer with sufficient NOLs to offset any tax liability, etc.; and,
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disallowed a REIT's DPD if a REIT were owned 50% or more by any entity "not subject to income tax" (same list as above).
This proposed statute modified an earlier proposed statute with respect to which NAREIT submitted two sets of comments on May 12, 2011 and May 26, 2011, and Dara Bernstein of NAREIT and Kathleen Courtis of General Growth Properties both spoke against at a public hearing in May 2011. On the positive side, this proposal also would confirm that a REIT is not a pass-through entity. MTC's Executive Committee Sends Back June 2011 Proposed Pass-Through Entity Statute for Further Analysis
In July 2011, this proposed statute was considered by the MTC's Executive Committee and sent back to the MTC staff for further analysis of how existing law could address their concerns of tax inequity. NAREIT submitted additional comments opposing this proposal, and Dara Bernstein of NAREIT attended the Executive Committee hearing. In July 2012, MTC Re-Proposes June 2011 Pass-Through Entity Statute
Since last summer, MTC staff apparently has focused on the most recent proposal's effect on the insurance industry, but not on NAREIT's comments or the proposal's effect on REITs or interaction with the MTC's existing captive REIT statutes. On July 20, 2012, MTC staff re-proposed the same pass-through entity statute as it had proposed in June 2011, along with a report that contained additional analysis regarding insurance companies. However, the report did not contain any analysis of NAREIT's comments or its submissions (proposed statute is on page 27). MTC Uniformity Subcommittee Deletes REIT DPD Disallowance Provision
On July 29, 2012, the MTC's Uniformity Subcommittee considered this proposed statute, and decided to: 1) delete the provision that would deny a REIT's DPD if owned by an entity not subject to state income tax (but possibly defer it to a project that might be considered at a later date); and, 2) also include a mutual fund as a type of entity that is not a pass-through entity. The Uniformity Subcommittee then voted to send the proposal to the Uniformity Committee. MTC Uniformity Committee Votes to Send Revised Proposal to MTC's Executive Committee
On July 30, 2012, the MTC's Uniformity Committee met to discuss, among other things, the July 2012 revised statute. Dara Bernstein of NAREIT attended the July 30th meeting and summarized NAREIT's comments. While NAREIT appreciates that the MTC would be deleting, at least for the present, the provision that would disallow a REIT's DPD, the remaining portion of the statute raised some troubling issues. Specifically, and, as noted above, the proposed statute theoretically could impose corporate-level tax on a partnership owned by REITs (such as an Operating Partnership in an UPREIT structure), mutual funds, or tax-exempt entities notwithstanding that these entities would not face corporate-level tax if they invested directly in the partnership's assets.
The Uniformity Subcommittee voted to send the revised statute to the Executive Committee for review. There was some discussion among members suggesting that the Executive Committee might once again return the statute for further analysis. NAREIT was informed that the Executive Committee would not be analyzing the statute in detail at its next meeting on August 1st, but instead, at its next scheduled meeting. NAREIT will continue to monitor this project for developments.
Arkansas Allows REIT to Offset Allocated Partnership Income with DPD
NAREIT recently was informed by one of its members (REIT A), a publicly traded UPREIT, about the following favorable resolution to a tax audit. The facts are set forth below.
REIT A's operating partnership owns property in Arkansas and other states. Arkansas law expressly adopts Subchapter M for non-captive REITs. Additionally, Arkansas requires that partnership income be specifically allocated rather than apportioned. The Arkansas multistate corporate tax form (AR1100CT) does not address how to treat the REIT's direct expenses and dividends paid deduction (DPD).
REIT A filed its 2010 Form AR1100CT showing its allocated Arkansas partnership income and claiming an offsetting DPD as it distributed 100% of its taxable income (after state-level adjustments). The state initially denied the entire DPD on the grounds that "partnership income is not apportionable," and there was no place on the form to claim the DPD. Following submission of a memorandum, which challenged the state's position on constitutional, statutory and case law grounds, the state agreed to accept REIT A's return as filed, allowing the DPD to offset the allocated partnership income in full.
While this was a favorable outcome for REIT A, requiring taxpayers to allocate rather than apportion either real estate income or partnership income raises a troubling issue for companies with tiered structures and multistate operations. Essentially, the upper-level taxpayer may be denied a non-resident state deduction for any of its own expenses that were not pushed down to the lower-tier partnership(s).
Michigan Eases Pass-Through Entity Withholding Rules
NAREIT thanks Michele Randall of Deloitte Tax LLP (Deloitte) for informing us of this development.
Background: Pass-Through Entity Withholding Enacted
In 2011, Michigan enacted a law requiring flow-through entities to withhold 6% tax from their corporate partner's or member's share of apportioned business income. The law became effective January 1, 2012. Unfortunately, this withholding obligation applied regardless of whether the partner or member might actually have Michigan tax liability.
Relief Provisions Enacted
On June 28, 2012, S.B. 1104, passed by the Michigan legislature, and signed by Michigan Governor Rick Snyder (R), became effective as Act No. 217.
S.B. 1104 provides that withholding is not required if a flow-through entity receives an exemption certificate from a corporation, and the corporation agrees to: a) file all required returns; b) pay the applicable tax on its distributive share of business income received from any flow-through; and, c) submit to the taxing jurisdiction of the state. The exemption certificate must be developed by Michigan's Department of Treasury. NAREIT understands that the Department of Treasury has not yet developed the exemption certificate.
For a copy of Deloitte's alert on this issue, please contact Michele Randall at micrandall@deloitte.com.
San Francisco: Gross Receipts Tax Proposal on November Ballot
The following summary was provided to NAREIT by the California Taxpayers Association (Cal-Tax), of which NAREIT is a member, and is being forwarded with Cal-Tax's consent.
To: All Members, California Taxpayers Association
From: Rob Gutierrez, Research Analyst
Subject: San Francisco Puts Business Gross Receipts Tax Measure on Ballot
After months of infighting among officials over proposals to modify San Francisco's payroll tax, a final proposal emerged July 31 that would slowly transition the city from a payroll tax to a gross receipts tax. The Board of Supervisors voted unanimously to place Mayor Ed Lee's measure, which is estimated to cost business taxpayers an additional $28.5 million per year, on the November ballot.
Before a mid-July agreement, Mayor Lee and Supervisors David Chiu and John Avalos disagreed on the approach that should be taken. The more liberal supervisors sought to increase taxes more than the mayor proposed.
The change to the payroll tax is backed by a broad coalition that includes the San Francisco Chamber of Commerce and labor unions.
In a July 31 statement to the press, Mayor Ed Lee said: "After years of debate and failed attempts, today we took a historic step towards reforming our business tax system so we no longer punish companies for creating jobs in our City. With strong support from the Board of Supervisors, business, organized labor and community organizations, San Francisco has sent a powerful message that it's time to end our City's direct tax on jobs and unleash the full potential of our innovators, small businesses and entrepreneurs."
The measure, if approved by voters, will phase in a gross receipts tax in place of the payroll tax over a five-year period, beginning in 2014. In calculating gross receipts, businesses would exclude federal, state and local taxes. Gross receipts are defined by the measure as the total amounts received or accrued from sales, services, dealings in property, interest, rent, royalties, dividends, fees, commissions and other amounts received.
Revenue from the tax would be placed in San Francisco's general fund, meaning the proposal requires a simple majority vote of the public. The rate of the gross receipts tax depends on a business' North American Industry Classification System (NAICS) code and the size of the business' receipts. If it is determined that a business operates in multiple industry areas, it will be directed to use a formula to determine gross receipts if 80 percent or more of its activities are derived from one source of activity ? otherwise, each component of the business' activities must be accounted for separately.
The proposal includes a number of exemptions for activities that San Francisco is prohibited from taxing due to state law or the California Constitution, such as banking and financial services (Article XIII of the California Constitution), for-hire motor carriers (Revenue and Taxation Code Section 7233), transportation of household goods (Public Utilities Code Section 5327), charter-carriers operating a limousine (Public Utilities Code Section 5371.4). Property owners of rent-controlled buildings also are provided an exclusion under the proposal.
Last year, San Francisco approved a payroll tax exclusion for businesses operating in the Central Market Street region of the city. The tax incentive was used to draw Twitter to the city's Tenderloin area. The gross receipts tax proposal maintains this incentive and allows companies in the region to continue getting this exclusion.
For the full text of the measure that will appear on the November ballot, or full text of ballot, visit the San Francisco Board of Supervisor's website.
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NAREIT notes that, because the gross receipts tax is replacing the payroll tax, REITs may face greater liability in San Francisco if the proposal passes.
Guest Article: "Choice of Entity in Pennsylvania"
NAREIT thanks Wendi Kotzen for sending us a link to the article she wrote regarding choice of entity in Pennsylvania.
Contact
For further information, please contact Dara Bernstein, NAREIT's Senior Tax Counsel, at dbernstein@nareit.com.
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