State Tax Return CAT SITUSING RULES FOR CERTAIN SERVICES FINAL RULE EFFECTIVE DECEMBER 28, 2006

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1 January 2007 Volume 14 Number 1 State Tax Return Update On Ohio Commercial Activity Tax: Final Rules And Revised Information Releases Charles M. Steines Phyllis J. Shambaugh Cleveland Columbus (216) (614) The Ohio Department of Taxation ( Department ) continues to finalize rules and revise information releases regarding the Ohio Commercial Activity Tax ( CAT ). Since our May 2006 article covering CAT releases and rules, the Department has issued ten final rules. Most of the releases are discussed in this issue. Information Release Topic CAT Situsing Rules for Certain Services, final rule effective December 28, CAT Nonprofit Organizations, final rule effective June 15, CAT Agency Defined, final rule effective October 5, CAT Cash Discounts, Defined, final rule effective August 11, CAT Highway Transportation Services: Bright Line Presence and Situsing, final rule effective August 11, CAT CAT Credit for Unused Franchise Tax Net Operating Losses, Issued April, CAT Qualified Distribution Centers, final rule effective September 1, CAT Situsing Receipts from Periodic Payments for Mobile Property, final rule effective December 21, CAT Record Retention Requirements, final rule , effective December 28, 2006 CAT Changes in Ownership, final rule , effective December 28, 2006 CAT SITUSING RULES FOR CERTAIN SERVICES FINAL RULE EFFECTIVE DECEMBER 28, 2006 The Department has finalized its rule for the situsing of services for purposes of CAT. Ohio Admin. Code In general, gross receipts from services are sitused to

2 Ohio in the proportion that the purchaser s benefit from the service in Ohio bears to the purchaser s benefit everywhere. Ohio Admin. Code (A). The physical location where the purchaser ultimately uses or receives the benefit of the service purchased is paramount in determining the proportion of the benefit received in Ohio. Id. The Tax Commissioner does not require taxpayers to upgrade their systems in order to comply with this rule, as long as the taxpayer makes a good faith effort to situs receipts from services in a reasonable, consistent, and uniform method supported by the taxpayer s business records. Id. If the Tax Commissioner disagrees with the taxpayer s reasonable, consistent and uniform method of situsing its gross receipts, the Tax Commissioner will not impose a penalty if the situsing is found to be in good faith. This final rule includes situsing methods that may be used for various services, including accounting services, advertising services, agency services, appraisal services, barbershop and beauty salon services, cable or satellite services, call center services, collection agency services, computer programming services, engineering services, and many others. CAT NONPROFIT ORGANIZATIONS FINAL RULE EFFECTIVE JUNE 15, 2006 Pursuant to R.C (A) a nonprofit organization is not a person for purposes of CAT. Since only persons with taxable gross receipts are subject to CAT under R.C (A), a nonprofit organization is not required to pay CAT. The Department issued this rule to define nonprofit organization. For purposes of CAT, a nonprofit organization means an entity that: (1) Is organized other than for the pecuniary gain or profit of, and the entity s net earnings or any part of them are not distributed to, the entity s members, directors, officers, or other private persons; and (2) The entity is operating consistent with its organization. Ohio Admin. Code (B)(1) and (2). This definition includes nonprofit organizations organized under the nonprofit provisions in chapter 1702, 1707, 1711, 1713, 1715, 1716, 1717, 1719, 1721, 1724, 1725, 1727, 1729 or 1733 of the Revised Code. CAT AGENCY DEFINED - FINAL RULE EFFECTIVE OCTOBER 5, 2006 This final rule defines an agency relationship for purposes of CAT. R.C (P) defines an agent as a person authorized by another to act on its behalf to undertake a transaction for the other. Further, under R.C (F)(2)(I), an agent is required to pay CAT only on the portion of gross receipts it retains as a commission or fee.

3 In determining who is an agent for purposes of CAT, the Department looks to Ohio Supreme Court cases regarding agency relationships. The holdings of these cases are summarized in Ohio Admin. Code (B) and include tests such as whether the: Agent has the power to bind the principal by his or her actions; Principal has the right to control the activities of agent; and Agent has legal authority to act on behalf of the principal. The party asserting the existence of an agency relationship bears the burden of proof. Id. In determining whether an agency relationship exists, the Department will apply the statutory rules of construction regarding exemptions from taxation, i.e., in determining whether an agency relationship exists, the facts must be determined under a strict, narrow reading of the definition. Id. Unless the agency relationship is specifically stated in a contract available for the Department s inspection, an agent is subject to CAT on his or her total taxable gross receipts, including those amounts collected on behalf of and paid to the principal. Ohio Admin. Code (C)(2). Subsection C of the rule includes a list of agents under this rule. These include: A person receiving a fee to sell financial instruments; Persons issuing licenses and permits under R.C ; Lottery agents; Liquor control agents. CAT CASH DISCOUNTS DEFINED - FINAL RULE EFFECTIVE AUGUST 11, 2006 Cash discounts are deducted from a taxpayer s gross receipts pursuant to R.C (F)(4)(a) provided that they are based on making timely payments or volume purchases. The following discounts or rebates are deducted from gross receipts: Cash discounts provided by a seller for prompt payment by the purchaser; and Incentive based rebates received by purchaser such as a promotional rebate awarded by a manufacturer to a purchaser based on the purchaser s sales volume. Note that these discounts must be received and/or taken by the purchaser, not the purchaser s customer. Ohio Admin. Code (A).

4 Conversely, the following must be included in the calculation of gross receipts: Amounts received from a manufacturer for the redemption of manufacturer s coupons; Monthly shelving allowances provided by a manufacturer; and Fees received by a franchisee from a franchisor for providing local advertising. Ohio Admin. Code (3)(a) and (4). CAT HIGHWAY TRANSPORTATION SERVICES BRIGHT LINE PRESENCE AND SITUSING, FINAL RULE EFFECTIVE AUGUST 11, 2006 R.C (I) sets forth five tests that determine if a person has nexus for purposes of CAT. One of those tests is if the person has property in Ohio with an aggregate value of at least $50,000 at any time during the calendar year. Ohio Admin. Code (A). A person providing highway transportation services will be presumed to have at least $50,000 of property in Ohio during the calendar year if the person has $50,000 worth of property in Ohio for more than 13 days, which need not be consecutive. Ohio Admin. Code (B). Gross receipts from highway transportation services are sitused pursuant to R.C (G). That provision requires that gross receipts from highway transportation services be sitused in proportion to the miles traveled by the carrier in Ohio compared to the miles everywhere. Ohio Admin. Code (D)(1). CAT CREDIT FOR UNUSED FRANCHISE TAX NET OPERATING LOSSES, ISSUED APRIL Information Release CAT describes taxpayers that are eligible for the CAT credit for franchise tax net operating losses ( NOL ). It also provides formulas for calculating the credit and details the procedural steps necessary to claim the credit. The CAT credit is available only if: (1) The taxpayer filed its 2005 franchise tax return as a separate company and the taxpayer s accumulated NOL carryover exceeds $50 million; or (2) The taxpayer filed its 2005 franchise tax return as a member of a combined return and the combined group s accumulated NOL carryover exceeds $50 million. 1 This is reprinted from the May, 2006 issue of the State Tax Return.

5 Further, a taxpayer cannot claim this credit unless the taxpayer files a report with the Tax Commissioner setting forth the taxpayer s amortizable amount of the NOL. This report must be filed by July 1, Once the taxpayer elects to claim the CAT credit, the taxpayer can claim the amortizable amount as a credit against one-half of the taxpayer s CAT liability in years 2010 through CAT SITUSING RECEIPTS FROM PERIODIC PAYMENT OF MOBILE PROPERTY - FINAL RULE EFFECTIVE DECEMBER 21, 2006 The Department has promulgated Ohio Admin. Code to establish guidelines for situsing receipts from the lease or rental payments of mobile property. As a general rule, the lease payments are sitused as follows: In the case of airplanes or other aircraft, the receipts are sitused to the location where the aircraft is primarily hangered; Motor vehicles used in business for the transportation of passengers or property in interstate commerce are sitused in accordance with R.C (G); The receipts from the lease from all other vehicles are sitused based on the primary property location for the period in which the charges areincurred; and The receipts from the initial lease payments for all other property are sitused to the location where the lessee takes possession of the property. Subsequent lease payment receipts are sitused to the primary property location for the period in which the lease charges are incurred. Ohio Admin. Code (B). If a taxpayer believes that a strict application of the standards in this rule do not fairly represent the taxpayer s operation, the taxpayer may situs receipts to Ohio using any reasonable, consistent, and uniform method of apportionment supported by its records as they existed at the time the lease payments were made. If the Tax Commissioner disagrees with the taxpayer s apportionment, the Tax Commissioner will not impose a penalty if the situsing was found to be made in good faith. Ohio Admin. Code (C)(1). A taxpayer may file a written request with the Tax Commissioner to request permission to use an alternate means of situsing such gross receipts. CAT RECORD RETENTIONS REQUIREMENTS FINAL RULE EFFECTIVE DECEMBER 28, 2006 The Department promulgated this rule to assist taxpayers in determining their record retention responsibilities for CAT. All persons subject to CAT must keep and maintain primary and supporting records including, but not limited to, the following: sales

6 journals, financial statements, charts of accounts, cash journals, annual reports, general ledgers, income statements, tax returns and invoices. Ohio Admin. Code (B). Companies with net operating loss credits under R.C must retain records relating to the credit until June 30, Ohio Admin. Code (C). Purchase records and all records and documents relating to the situsing of receipts from the sale of tangible personal property or the sale of services must be maintained for at least four years from the later of the filing or the due date of the return covering the period. Ohio Admin. Code (D). CAT CHANGES IN OWNERSHIP - FINAL RULE EFFECTIVE DECEMBER 28, 2006 This final rule clarifies the consequences of a change in ownership value and/or structure during the tax period. A group of two or more persons may elect under R.C to be in a consolidated elected taxpayer group that includes all persons at least 50% owned and controlled or at least 80% owned and controlled by common owners. The percentage chosen, either 50% or 80%, applies to all persons meeting the common ownership requirements. In other words, if Company A elects to consolidate at 80% with its wholly-owned sub, Company B, only those entities which are 80% or more owned by Company B are also included in the consolidated elected taxpayer group. Ohio Admin. Code (A). If at any time the ownership structure changes such that a common owner no longer owns or controls the group, that person must be removed from the group. The taxpayer must notify the Tax Commissioner of ownership changes at the time it files its next return or in writing prior to the return due date. Ohio Admin. Code (B)(1). Likewise, if a consolidated elected taxpayer acquires a member and the ownership requirements are met, that acquired company must be added to the group. Ohio Admin. Code (C). This article is reprinted from the State Tax Return, a Jones Day monthly newsletter reporting on recent developments in state and local tax. Requests for a subscription to the State Tax Return or permission to reproduce this publication, in whole or in part, or comments and suggestions should be sent to Susan Ervien (214/ or shervien@jonesday.com) in Jones Day s Dallas Office, 2727 N. Harwood, Dallas, Texas Jones Day All Rights Reserved. No portion of the article may be reproduced or used without express permission. Because of its generality, the information contained herein should not be construed as legal advice on any specific facts and circumstances. The contents are intended for general information purposes only.