Major Arkansas Tax Reform Bill Introduced: Remote Seller Collection, Apportionment, and NOLs

A bill was filed today to implement several major recommendations of the Tax Reform and Relief Legislative Task Force to make the Arkansas tax system fairer and more competitive.  Senate Bill 576 (SB 576) includes: (1) sales tax collection by remote sellers and marketplace facilitators; (2) single sales factor apportionment and repeal of the throwback rule; (3) extension of the net operating loss (NOL) carryforward limit from 5 years to 20 years; and (4) substitution of a car wash water fee for the current sales tax on car washes.  These reforms are a culmination of the two-year Tax Reform and Relief Legislative Task Force process and would create more favorable tax climate for many Arkansas businesses, and particularly retailers, manufacturers, wholesalers, and banks.

Remote Seller and Marketplace Provider Sales Tax Collection

Unlike most states, Arkansas has not yet taken advantage of last year's overturning of the physical presence rule for sales tax collection obligations.  SB 576 (section 19) would adopt the typical thresholds of $100,000 or 200 transactions for obligations to require collection of tax.  The thresholds apply to both remote sellers and to marketplace facilitators.  Marketplace transactions are attributed to the marketplace facilitator, not the remote seller, for purposes of the thresholds, such that marketplace sales would not "count" for nexus for the seller itself.  SB 576 (section 18) would also repeal the pre-Wayfair affiliate and click-through nexus provisions that are no longer needed. 

The remote seller requirements would come into effect July 1, 2019.  The fiscal impact is estimated at approximately $35 million for state revenue ($24 million general revenue) and $12 million for local revenue.  It is also anticipated to help local community bricks-and-mortar retailers by eliminating the competitive advantage that some remote sellers have in not collecting sales tax.

Single Sales Factor Apportionment and Repeal of the Throwback Rule

Amendments to Arkansas's income tax apportionment statutes would substantially benefit in-state businesses, particularly manufacturing, retail, wholesale, and banking, offset in part by shifting burdens to out-of-state businesses.

Like other states, the Arkansas income tax is apportioned, meaning that a formula is applied to a business's income to determine Arkansas's share of income to tax.  States can choose their formulas.  Arkansas's is currently 25% property, 25% payroll, and 50% sales.  This means that a business with operations in the state currently pays more tax than an equivalent out-of-state company with equal sales into Arkansas.  The national trend is for states to abandon the property and payroll factors and adopt single sales factor apportionment because it does not penalize in-state investment and job creation.

SB 576 (section 6) changes Arkansas's apportionment formula to single sales factor apportionment, effective for tax years beginning on or after January 1, 2021.  It also repeals the property and payroll factors (section 7).  Matching changes to the separate codification of the Multistate Tax Compact are also implemented (section 3).  Single sales factor on its own is expected to be roughly revenue-neutral for Arkansas.

Going to single sales factor makes the sales factor all the more important.  The benefits from single sales factor apportionment will be felt primarily by in-state businesses engaged in the sale of tangible personal property (manufacturers, wholesalers, retailers), because Arkansas generally still sources income from services and intangibles using a costs of performance approach rather than market-based sourcing.

The repeal of the sales factor throwback rule by SB 576 (section 8) is important to Arkansas retailers, wholesalers, and especially manufacturers.  Current law "throws back" sales actually going to other states to instead count them as Arkansas sales if the seller is not taxable in the destination state.  This can turn the sales factor into effectively an additional property/payroll factor; for some manufacturers upwards of 75% of their Arkansas sales factor results from the throwback rule.  More tax-competitive states, such as Tennessee, do not have a throwback rule because it penalizes in-state businesses.

Repeal of the throwback rule would be phased in over two years.  It would be halved for tax years beginning January 1, 2021, and then eliminated for tax years beginning January 1, 2022.  In the Tax Reform Task Force, repeal of the throwback rule was scored at a $57 million revenue cost assuming adoption of single sales factor.

In addition to reforming the general apportionment formula, SB 576 (sections 10-16) also reforms the special apportionment formula for financial institutions along the same principles.  Currently it is an equal-weighted (33% each) combination of the receipts factor, property factor, and payroll factor.  It would go to receipts factor only (equivalent to single sales factor) for tax years beginning January 1, 2021.  Repeal of the throwback rule would be similarly phased-in as above.  The benefit to Arkansas-headquartered banks that do business in multiple states may be considerable.

Net Operating Loss Carryforward Extension to 20 Years

SB 576 also provides a substantial improvement in Arkansas's restrictive net operating loss (NOL) rules that should reduce the risk of double taxation for cyclical businesses.

A business that is not profitable in a year generates a NOL that then can offset income in a later year.  The idea is to net out the subsequent income against the prior loss, to better reflect the overall economic performance of the business.  Failing to do so results in double taxation of affected businesses.

Arkansas is currently tied with Rhode Island for a worst-in-the-nation NOL carryforward period of 5 years, after which the NOLs expire and cannot be used.  SB 576 (section 4) extends this to 20 years over a 5-year phase-in period: NOLs generated in the tax year beginning January 1, 2020 would last 8 years, January 1, 2021 would last 11 years, and so on until completely phased in with a NOL carryfoward period of 20 years for tax years beginning on or after January 1, 2024.  20 years has been widely adopted by other states.

At the Task Force, the NOL extension cost was estimated at $97 million once fully phased in.  The impact is deferred since it would really begin to have an effect in the mid-2020's and would near its full effect in the following decade.

Car Wash Exemptions and Water Fee

These broad, general tax reforms are coupled with a specific one: Car washes.  Currently Arkansas imposes sales tax on car washes, excepting coin-operated car washes that are specifically exempt.  SB 576 (sections 20-23) would make three changes:

  1. Eliminate the coin-operated car wash exclusion from the definition of taxable service;
  2. Add a sales tax exemption for property and services used by all car washes; and
  3. Impose a water fee on all car washes in lieu of a sales and use tax on car washes.

The net effect appears to be prejudicial to coin-operated car washes and possibly beneficial to personal service car washes or detailing services.  (Note: This discussion was corrected on March 18: The exemption is for car wash equipment, not car wash services.)

Outlook Going Forward

SB 576 has been filed late in the legislative session, amidst a flurry of tax bills and other significant legislation.  Its lead sponsor is Senator Hester and it has a number of Senate sponsors as well as a sole House sponsor, Representative Douglas.  Business tax reforms with a net revenue loss can be a tough sell to a legislature that recently passed tax increases for highway funding.  With little time left in the session, SB 576 is likely to move quickly and enactment is not assured; interested parties should get involved sooner than later.

The work of the Tax Reform Task Force has created a unique opportunity to reform the Arkansas tax system.  With a final push, Arkansas could emerge from the process with one of the more competitive tax systems in the region.

 

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