Summary of Ohio's Commercial Activity Tax and
Other Ohio Tax Reform

Mark Engel
Bricker & Eckler LLP
Updated June 30, 2005

On June 30, 2005, Governor Taft signed Amended Substitute House Bill 66, the biennial budget bill. This bill contains the governor’s plan to reform Ohio’s taxes to improve Ohio’s economic climate for business. While the governor exercised his line-item veto authority over a few relatively minor provisions, the bulk of the bill as agreed by the House and Senate conference committee remains intact. This memorandum summarizes the plan as approved by both chambers.

Plan Overview

The plan phases out the tax on tangible personal property over four years, and the corporation franchise tax over five years. It also reduces all personal income tax rates by 21% over five years. Various excise taxes are increased and the 10% rollback on real estate taxes for most commercial and industrial property is eliminated. However, the centerpiece of the plan is a commercial activity tax (“CAT”). The CAT is essentially a tax on gross receipts from commercial activities. It is imposed at a rate of 2.6 mills (.0026) on the taxable gross receipts of virtually all commercial activity in Ohio.

Provisions governing the CAT will be discussed first. A summary of the remaining provisions follows that discussion.

Gross Receipts

“Gross receipts” is broadly defined and means the total amount realized, without any deduction, in a transaction or transactions that contribute to the production of gross income, including the fair market value of any property and any services received, and any debt transferred or forgiven as consideration.

There is a short list of receipts that are included in the definition, while there is a lengthy list of excluded receipts. Notable exclusions include interest, except interest received as part of a credit sale, dividends and distributions received, capital gains, capital contributions to retirement plans and charitable institutions, and compensation, including deferred amounts, paid to employees.

Other excluded receipts include federal and state excise taxes paid on alcohol and tobacco, the “handle” from race track betting, amounts from the sale of lottery tickets, hunting fees for agents of the department of natural resources, and receipts from automobiles transferred between dealers for resale. In addition, the commission paid to a real estate broker is excluded to the extent it is shared with another broker.

The exclusion for gross receipts from the sale of tangible personal property that is delivered into or shipped from a “qualified foreign trade zone area that includes a qualified intermodal facility” is contained in an uncodified section of the bill. A “qualified foreign trade zone area” means a warehouse that is located within one mile of the boundary of an international airport and is located in a foreign trade zone. A “qualified intermodal facility” is a transshipment station that is capable of receiving and shipping freight by rail, highway, and air transportation.

Receipts from the sale of motor fuel are excluded from the CAT until July 1, 2007. At that time, the tax commissioner is to provide information to the general assembly regarding the constitutionality of taxing such receipts.

Gross receipts are calculated on the same basis that the taxpayer uses for federal income tax purposes. Allowances are made for cash discounts taken, returns, bad debts, and amounts received from the sale of a receivable to the extent the receipts from the underlying transaction were included in the taxpayer’s gross receipts.

“Taxable gross receipts” means those gross receipts allocated to Ohio. Receipts from the sale of tangible personal property delivered to customers in Ohio, and receipts from the sale of services in proportion to the extent that the benefit of the service is received in Ohio, are all allocated to Ohio.

Receipts from property that is brought into Ohio, and then removed from Ohio to another location, are not considered Ohio receipts. Receipts from the right to use intellectual property, such as copyrights, patents, and trademarks, are allocated to Ohio to the extent the receipts are based on the extent of the use of the property in Ohio, or to the extent the receipts are based on the right to use the property in Ohio. Receipts from services are in Ohio to the extent the benefit of the service is received in Ohio. The place where the purchaser ultimately uses or receives the service shall be “paramount” in determining the portion of the benefit received in Ohio. The use of an alternate method is permitted if these rules do not accurately reflect commercial activity in Ohio. The tax commissioner is also given express authority to promulgate rules regarding the allocation of receipts for specific industries.

If a person receives property outside Ohio for its own use and brings it into Ohio within one year, it must include the value of the property in its taxable gross receipts. Similarly, the value of property brought into Ohio by one member of a consolidated elected or combined taxpayer and used by it or by another member of the group must also be included in the taxable gross receipts of the group.

There is a provision for determining whether receipts relating to interest, dividends, capital gains, and similar sources are in Ohio. Although a provision attempting to subject such receipts to the CAT was left out of the bill, this provision was inexplicably left in.

Taxpayers

“Taxpayers” are all persons who are required to file returns or pay the tax. Financial institutions, public utilities, insurance companies, and dealers in intangibles that are subject to special taxes for the entire tax measurement period are considered “excluded persons.” Most affiliates of financial institutions and insurance companies are excluded persons, as are persons with no more than $150,000 in gross receipts unless they are part of a “consolidated elect taxpayer” or “combined taxpayer”. “Person” is broadly defined and means essentially all individuals, joint ventures, and entities, including disregarded entities. The state, its agencies and political subdivisions are expressly excluded, as are persons organized on a non-profit basis.

There is mandatory combined reporting for two or more entities having at least 50% of the value of their ownership interests owned or controlled, directly or constructively through related interests, by common owners. A group of two or more persons may elect to be treated as a “consolidated elected taxpayer”. In that case, all persons meeting the ownership requirements must be included, whether they have nexus with Ohio or not. The consolidated elected taxpayer may elect whether to include or exclude foreign corporations that meet the ownership requirements, but the election applies to all such corporations. In addition, the group can elect to include all entities meeting either the 50% or more, or the 80% or more, ownership threshold. Receipts from all transactions made among members of the group shall be eliminated, including members that are not subject to the CAT. The entity is treated as a single taxpayer and members have joint and several liability for the tax; the election applies for eight quarters and there is automatic renewal unless the persons opt-out.

All groups of taxpayers that meet these ownership requirements, but that do not elect to be consolidated elected taxpayers, must file as “combined taxpayers.” There are three main differences with consolidated elected taxpayers. First, persons without nexus in Ohio need not be included. Second, there is no elimination of receipts from transactions between members of the group. Third, the combination is not limited to eight quarters.

In both cases, the group is treated as a single taxpayer and files a single return. Since the group is treated as a single taxpayer, there is a single $1 million exclusion for the entire group. There is also a $200 registration fee, or $20 per member. As new persons or taxpayers meet the ownership requirement, they must be added; as existing persons or members fall below the threshold, they are eliminated and must file on an independent basis.

A provision calling for “bright line presence” is contained in the bill. A taxpayer has “bright line presence” in Ohio if it (i) has property in Ohio with an aggregate value of at least $50,000; (ii) has payroll in Ohio of at least $50,000; (iii) has taxable gross receipts of at least $500,000; (iv) has at least 25% of its total property, payroll or sales in Ohio; or (v) is domiciled in Ohio. Challenges to the validity of this provision may be taken directly to the state supreme court.

A provision that would have required customers to report the identity of vendors from whom annual purchases exceeded $2 million in the event the “bright-line presence” section was struck down was removed from the bill.

Reporting and Paying the Tax

The tax is an annual tax imposed upon the privilege of doing business in Ohio and is not a tax on income. This provision is intended to strengthen the bill against possible attack on constitutional grounds. The tax is effective beginning July 1, 2005. While the tax may not be passed through to customers as an itemized charge, its cost may be passed on in the form of an increase in price. The tax is included as part of the sales tax base.

Persons with annual receipts of $1 million or less may elect to be calendar year taxpayers. Such persons must file a single annual return by the 40th day after the end of the prior calendar year and pay the $150 minimum tax. Persons with annual receipts in excess of $1 million must be calendar quarter taxpayers. Returns are due and the tax must be paid by the 40th day after the end of each calendar quarter, and the return for the fourth quarter is considered a reconciliation return. An exclusion of $250,000 may be taken with each quarterly return; any unused excess may be carried forward to subsequent quarters for that year.

The minimum tax on the first $1 million in taxable receipts per calendar year is $150. If a taxpayer has receipts in excess of $1 million, the tax is the sum of $150 and the product of the tax rate and the receipts in excess of $1 million. For the six month period beginning July 1, 2005, the tax for 2005 is $75 plus the product of .06% (the phased tax rate) and receipts in excess of $500,000. Initial returns and payment are due February 10, 2006. Beginning April 1, 2006, the tax is phased in by increasing increments of 20% for the subsequent 12 months, until it is fully in place by April 1, 2009.

The minimum tax is reduced $75 if the taxpayer first engaged in business in Ohio after May 1 and before December 1 of a given year, and the first $500,000 in gross receipts is excluded from the tax.

All persons must register by the later of November 15, 2005, or within 30 days after having receipts in excess of $150,000 in a calendar year. The fee is $15 if registration is done electronically; otherwise the fee is $20. The fee is credited against a taxpayer’s first CAT payment. No fee is imposed if the person registers after November 30 of a year, or if its taxable gross receipts do not exceed $150,000 by December 1. There is a late fee of $100 per month, up to $1000, for failing to register.

No person may engage in business in Ohio without registering. If a taxpayer fails to pay the CAT, the attorney general may seek proceedings in quo warranto to suspend the taxpayer’s right to engage in business, similar to existing franchise tax law procedures.

Credits

Limited credits are available against the tax. These include the jobs creation tax credit, the jobs retention tax credit, a qualified research and development credit under R.C. 5751.51, equal to 7% of the excess of qualifying expenditures during the year over the average for the prior three years; and the borrowers qualified research and development loan payment credit, which is capped at $150,000 annually. The credits that were earned prior to 2008 and that carry forward to 2008 and beyond can be applied against the CAT for periods beginning July 1, 2008; no further action is required in order to convert the credits from the franchise tax to the CAT.

In addition, a non-refundable credit for net operating loss carry-forwards is added for NOLs and other deferred tax assets in excess of $50 million. The credit is based on amounts reflected on the taxpayer’s books and records as of the end of its taxable year ending in 2004. Up to 10% of the credit may be claimed against up to one-half of the CAT liability for tax years between 2010 and 2019; from 2020 through 2029, up to 100% of the credit may be claimed against the first one-half of the CAT liability. If any credit remains in 2030, the credit is refundable, but only if the taxpayer is subject to the CAT for the entire tax year. A taxpayer wishing to claim this credit against the CAT may not claim the similar credit against its franchise tax for tax years 2005 and after.

Rate Adjustment

Three possible rate adjustments may be made under the tax. Targeted revenue amounts are established for the period beginning with the commencement of the tax through June 30, 2007; July 1, 2008 through June 30, 2009; and July 1, 2010 through June 30, 2011. If revenues exceed the targeted amount by more than 10%, one-half of the excess will be applied to the budget stabilization fund, while the other half will be deposited in the CAT refund fund. The rate will be adjusted downward for the following year and a tax credit based on the portion of the excess in the CAT refund fund will be provided to CAT taxpayers. If revenues fall short of the projections, the rate will be adjusted in order to generate the intended amount of revenue.

The rate adjustments are calculated by the tax commissioner.

Penalties

Numerous penalties that may be abated by the tax commissioner are imposed:

• Failure to timely pay or file returns: Greater of $50 or 10% of the tax.

• For deficiencies: Up to 15% of the deficiency.

• Failure to register within 60 days of notification: Up to 35% of tax due.

In addition, there is a penalty if the taxpayer fails to pay the tax electronically. The penalty is 5% of tax due during the first two quarters after notification, and 10% thereafter.

Audit & Refunds

There is a four-year statute of limitations. Refunds may be set-off by other liabilities owed to the state, and may be applied against future liability in lieu of a cash refund.

Audits may be conducted using samples; the consent of the taxpayer is not required. However, sampling procedures must be established by administrative rule. Pre-assessment interest is imposed on all deficiencies, and additional interest accrues if payment is not made within 60 days of the assessment. Protest proceedings are identical to those for other taxes. The tax commissioner may prescribe the documents and records that must be maintained in order to assure compliance with the tax. While information is generally confidential, the tax commissioner may publish electronically a list of the names, business names, addresses, and account numbers for all taxpayers.

Successor Liability

If a person sells at least 75% of its business, or quits business, any tax is due within 15 days. The person purchasing the business must withhold an amount from the purchase price unless the purchaser obtains a receipt from the tax commissioner that all taxes are paid. If the purchaser fails to withhold from the price, the purchaser is personally liable for the tax. There is no provision for personal liability for officers, owners, or parties responsible for filing returns or paying the tax.

Other Tax Changes

Personal Property Tax

Manufacturing machinery and equipment not used in business prior to January 1, 2005, is not subject to taxation. The personal property tax on all other property is phased out over four years. [The phase-out period for the franchise tax and the 21% reduction in personal income tax rates remains five years.] The listing percentage for manufacturing machinery remains at 25% for 2005, and then falls to 18.75% in 2006, 12.5% in 2007, 6.25% in 2008, and 0% in 2009 and thereafter. Inventory is listed at 23% for 2005, then follows the same schedule as other property beginning in tax year 2006. It appears that furniture not held for sale and business fixtures may also be taxed at 23% for 2005.

The exemption for patterns, jigs, dies and drawings remains. The definition of manufacturing equipment that is not taxed if acquired after January 1, 2005, includes patterns, jigs, dies and drawings. However, this provision does not change the definition of personal property that is subject to tax found in R.C. 5701.03.

For public utilities, the exclusion for patterns, jigs, dies and drawings is deleted and the listing percentage is reduced beginning with tax year 2006. And, persons who generate electricity for sale incidentally to their primary business activity will be treated as a public utility to the extent the property is used for that purpose. That is, the value of the property is multiplied by the proportion of the electricity that is sold; that is the base on which that property will be taxed.

The property tax on property owned by telephone companies, telegraph companies, and interexchange carriers will also be phased out over 5 years beginning with tax year 2007.

Kilowatt hour Tax

The proposed increase in the kWh tax is eliminated.

Corporation Franchise Tax

The franchise tax is phased out by 20% annually between 2006 and 2010. Certain corporations excluded from the CAT because they are related to financial institutions or insurance company remain subject to the franchise tax.

The manufacturing machinery and equipment credit in R.C. 5733.33 no longer applies to qualifying equipment purchased after June 30, 2005 and installed before June 30, 2006. The governor vetoed a provision that would have converted existing credits to grants in response to federal litigation challenging the validity of the credit.

Real Property Tax

The 10% roll back in real property taxes for most commercial and industrial property is removed. Property that is (i) owned or leased and used for farming; (ii) improved with one-, two-, or three-family dwellings; or (iii) vacant land determined by the county auditor to be held for one of these specified purposes, remains eligible for the roll-back. This change is effective with the 2005 tax year and will be reflected on bills paid in 2006.

Personal Income Tax

The trust tax is made permanent. In addition, beginning in tax year 2006, personal income tax rates are reduced 4.2% per year for five years, until the top marginal bracket is reduced to 5.95% in 2010.

Tax Amnesty

A tax amnesty for sales, use, corporation franchise, personal and school district income, and personal property taxes unpaid as of May 15, 2005, is established. The amnesty period will run from January 1, 2006 through February 15, 2006. During that period, taxpayers may pay any tax and one-half the interest that is otherwise due in satisfaction of unpaid or unreported tax liability. Amnesty is limited to those taxpayers who have not previously been contacted by the department about the liability or an audit.