On Wednesday, April 26, 2017, Governor Haslam signed the "Improving Manufacturing Public Roads and Opportunities for a Vibrant Economy (IMPROVE) Act" (HB 534) into law. The Act permits manufacturers to elect single sales factor apportionment, accelerates the phase-out of the Hall income tax, authorizes select cities and counties to adopt local option tax surcharges to fund mass transit and reduces the state sales tax on grocery food.

Under the Act, a taxpayer whose principal business in Tennessee is manufacturing may elect single sales factor apportionment for purposes of Tennessee franchise and excise taxes. A taxpayer's principal business in Tennessee is manufacturing if more than 50% of the revenue — excluding passive income — derived from its activities in the state is from fabricating or processing tangible personal property for resale and consumption off the premises. Passive income includes items such as income from dividends, interest, the sale of securities, or intellectual property. The Act does not address how manufacturers that elect single sales factor apportionment and are members of a Tennessee consolidated net worth election affiliated group should calculate franchise tax; EY anticipates, however, that the Tennessee Department of Revenue will issue such guidance soon. The election is available for tax years starting on or after January 1, 2017, and is binding for five years.

The IMPROVE Act also accelerates the phase-out and repeal of the Hall income tax (i.e., the state tax on interest and dividends), by reducing the current 5% rate by one percentage point annually, beginning with a rate reduction to 4% effective January 1, 2017. As a result of the annual rate reduction, repeal of the Hall Income Tax will now be effective January 1, 2021, ahead of the previously established January 1, 2022 deadline.

The IMPROVE Act also permits certain local governments to impose, subject to referendum, "Local Option Transit Surcharges" dedicated to funding mass transit. Jurisdictions permitted to adopt such "surcharges" include counties with population over 112,000 (Blount, Hamilton, Knox, Rutherford, Shelby, Sullivan, Sumner, Washington, Williamson and Wilson) and cities with population over 165,000 (Chattanooga, Knoxville, Memphis, and Nashville). These jurisdictions may levy a surcharge on sales and use tax, business tax, motor vehicle tax, rental car tax, tourist accommodation tax or residential development tax. Such surcharges must be approved by a majority of the voters of the local government proposing the surcharge and the resulting revenue must be used for costs associated with a public transit system under a "transit improvement program." The sales and use tax surcharge may not exceed 2.75%. Combined with pre-existing local and state rates, this surcharge may result in an effective rate of up to 12.5%. In addition, the combination of sales tax and hotel occupancy taxes — including state taxes — may not exceed a combined 20% on hotels, motels or other tourist accommodations. The business tax, rental car tax, and residential development tax may not exceed 20% of the current maximum applicable rate. The combination of the motor vehicle tax and motor vehicle tax surcharge may not exceed $200. The Act authorizes the specified local governments to begin pursuing local option transit surcharges effective immediately.

Other tax changes in the Act include a $0.06 increase in the gasoline tax and a $0.10 increase in the diesel tax, each phased in over three years, as well as a reduction in sales tax on grocery food from 5% to 4% effective July 1, 2017, and an increase in property tax relief for veterans to $175,000.

Implications

Taxpayers that qualify as a manufacturer should consider whether making the singles sales factor apportionment election would be beneficial, keeping in mind that, once the election is made, it is binding for five years.

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