North Carolina Governor Pat McCrory signed into law several key pieces of tax legislation following the 2015-2016 legislative session. These bills include HB 1030, HB 533, and SB 481 (collectively, "the Bills"). Provisions of the Bills affect corporate and personal income taxes and sales and use tax. This Alert highlights the significant legislative modifications in these Bills.

Corporate income tax

Market-based sourcing

HB 1030, signed into law on July 14, 2016, contains "proposed" market-based sourcing statutory provisions for sales of non-tangible personal property and services for general corporations and banks. HB 1030 requires the North Carolina Department of Revenue (Department) to adopt and submit to the Rules Review Commission proposed administrative rules regarding the implementation and administration of the proposed market-based sourcing principles by January 20, 2017. The Department will accept comments on the proposed market-based sourcing rules for at least 90 days after publication. The proposed rules will not become effective unless and until the General Assembly passes further legislation enacting market-based sourcing rules.

Further, as provided in an information notice, any person who wants to receive notice of the text of the proposed market-based sourcing rules must contact the Department and request to be added to a notification list. The email address for this request is MBSRulesNotification@ncdor.gov.

Written determination publication

SB 481, signed into law on July 22, 2016, requires the Department to publish redacted versions of all written determinations on its website within 90 days of issuance to the taxpayer. Additionally, the Department must, within 120 days of enactment of SB 481, publish redacted versions of all written determinations issued since January 1, 2010 and before enactment. Written determinations include alternative apportionment rulings, private letter rulings, and redetermination private letter rulings.

Personal income tax

Standard deduction increase

HB 1030 increases the standard deduction for 2016 and 2017 tax years. The deduction increases by $1,000 each year for surviving spouses and taxpayers filing jointly, $800 each year for head of household taxpayers, and $500 each year for single taxpayers and married taxpayers filing separate returns.

Sales and use tax

Repair, maintenance and installation services

North Carolina recently changed its sales tax treatment of repair, maintenance and installation services (collectively, "law changes"). HB 1030 provides temporary relief for the under-collection of sales or use tax for retailers due to the law changes if the retailer makes a good faith effort to comply with the law and collect the proper amount of tax. This temporary relief applies to the period beginning March 1, 2016 and ending December 31, 2016. In addition, the ability of the Secretary of the Department (Secretary) to compromise a taxpayer's liability for a tax that is collectible under North Carolina law has been expanded accordingly to include the assessment for sales or use tax as a result of the change in the definition of retailer or sales tax base expansion to (1) service contracts; (2) repair, maintenance and installation services; or (3) sales transactions for a person in retail trade. The Secretary will make the determination as to whether the taxpayer made a good-faith effort to comply with the laws. This provision applies to assessments for any reporting period beginning March 1, 2016 and ending December 31, 2022.

For real property contractors, any invoice for tax separately stated on an invoice given to a consumer is treated as an erroneous collection and must be remitted to the Secretary. However, HB 1030 provides that the contractor may apply the erroneous tax remittance to offset its use tax liability.

In addition, effective January 1, 2017, HB 1030 amends the definition of "repair, maintenance, and installation services" to include repair, maintenance, and installation activities (RMI activities) performed on real property. Taxable RMI activities, however, do not include real property contracts and certain RMI services performed with respect to real property contracts. For example, services performed to resolve an issue that was part of a capital improvement if the services are performed within six months of the completion of the improvement or within 12 months of a new structure being occupied for the first time are outside of the scope of the taxable definition.

A "real property contract" is defined as "a contract between a real property contractor and another person to perform construction, reconstruction, or remodeling with respect to a capital improvement to real property." A "capital improvement" is defined as "an addition or alteration to real property that is new construction, reconstruction, or remodeling of a building, structure, or fixture on land that becomes part of the real property or is permanently installed or applied to the real property so that removal would cause material damage to the property or article itself." "Reconstruction" means to "rebuild or construct again a prior existing permanent building, structure, or fixture on land and may include a change in the square footage from the prior existing building, structure, or fixture on land." "Remodeling" is "the process of improving or updating a permanent building, structure, or fixture on land or major portions thereof. The term includes renovation." A capital improvement does not include the replacement of a fixture in or on a building or structure unless the replacement is part of a remodeling. The term does not include a single repair, maintenance, or installation service. Thus, when determining whether a service qualifies as an exempt capital improvement, the following should be considered (although this is not necessarily an exhaustive list):

— The method of attachment for the property installed

— The degree of customization of the property installed

— The value added by or the useful life of the property installed

Further, the following services have been specifically exempted from sales tax:

— Inspection services required by law

— Services performed for related persons

— Services performed to resolve an issue that was part of a real property contract (e.g., punch-list items)

— Real property cleaning services (other than cleaning services related to the taxable rental of an accommodation or to pools, fish tanks, and similar aquatic features)

— Services on roads, driveways, parking lots, and sidewalks

— Removal services for waste, trash, debris, grease, and snow (other than removal of waste from portable toilets)

— Home inspection services related to the sale of real property

— Landscaping services

— Alteration and repair services with respect to clothing (other than alteration and repair to belts, shoes, and rental clothing)

— Pest control services

— Moving services

— Self-service car washes

Lastly, HB 1030 includes special mixed transaction contract rules for determining the taxability of real property contracts that include repair, maintenance, and installation services. Specifically, a mixed transaction contract where the price of repair, maintenance, and installation services is less than 10% of the contract price will not be subject to tax because the entire contract will be treated as a real property contract. In contrast, if the price for repair, maintenance, and installation services is equal to or greater than 10%, then sales and use tax applies to only the taxable repair, maintenance, and installation services portion of the contract.

Mill machinery tax

HB 1030 expands the definition of property subject to the mill machinery tax to include:

— Machinery and equipment, including related parts and accessories, used to unload and process bulk cargo at a port's facility

— Capitalized equipment used by certain metal recyclers, metal fabricators, and precious metal extractors

— Fuel, piped natural gas, and electricity sold to a secondary metals recycler for use in a recycling facility

These changes are effective retroactively to purchases made on or after July 1, 2013. The tax rate remains 1% with a maximum of $80 per article.

Other changes

Corporate income tax rate reduction

The Department issued an important notice on August 4, 2016, informing taxpayers of the corporate income tax rate reduction resulting from the general fund exceeding the threshold for its tax collections for fiscal year 2015-2016. The rate will be reduced from 4% to 3% for tax years beginning on or after January 1, 2017.

Refund claim denial procedures

On June 30, 2016, Governor Pat McCrory signed HB 533 into law. HB 533 provides taxpayers with the option to contest denied refund claims that have been barred based on the statute of limitations. Taxpayers may contest the statute of limitations determination by filing a petition for a contested case hearing at the Office of Administrative Hearings (OAH). The remedy is available to taxpayers immediately upon enactment of HB 533. Statute of limitations refund denials issued prior to June 30, 2016 may be contested with the OAH until August 29, 2016.¹ Under prior law, a taxpayer was not permitted to contest such determinations with the OAH.

Implications

The drafting of market-based sourcing rules for taxpayers in varying industries has proven to be difficult. The requirement of the Department to propose interpretative rules requires the General Assembly, as well as taxpayers, to fully consider the complexity and application of rules across such industries and any need for modification.

Further, HB 1030 attempts to address inequity in the definition of "retail trade." However, as a result of the changes brought about by HB 1030, additional ambiguity has been created related to repairs, maintenance and installation services with regard to tangible personal and real property, as well as certain repairs, services and installation services being taxable unless expressly enumerated as exempt.

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ENDNOTES

¹ See "Important Notice: A Taxpayer May Contest the Department's Determination That an Amended Return or Claim for Refund Was Not Filed Within the Statute of Limitations", North Carolina Department of Revenue (July 13, 2016) for detailed procedures.