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On June 12, 2018, the North Carolina Republican-controlled legislature overrode Gov. Roy Cooper's (D) veto of Senate Bill 99 (the Bill), which includes provisions affecting various taxes. Provisions are effective beginning June 12, 2018, unless otherwise noted.

IRC conformity update

The Legislation updates the conformity date reference in N.C.G.S. Section 105-228.90(b)(1b) to the Internal Revenue Code of 1986, as amended (the Code or IRC) from January 1, 2017 to February 9, 2018. This change means that North Carolina's tax laws conform to the changes made to the Code by the Tax Cuts and Jobs Act (P.L. 115-97) (TCJA) and the Bipartisan Budget Act of 2018 (P.L. 115-123) (BBA) to the extent the state follows federal tax provisions.

Under the Bill, North Carolina's tax laws will specifically decouple from the following TCJA provisions:

— Transition tax: N.C.G.S. Section 105-130.5 is amended to include a subtraction modification for any amount included in federal taxable income under IRC Section 965 and an addition modification for the amount deducted under IRC Section 965(c).¹

— Global intangible low-taxed income (GILTI): N.C.G.S. Section 105-130.5 is amended to include a subtraction modification for any amount included in federal taxable income under IRC Section 951A.² This provision applies to tax years beginning on or after January 1, 2018.

— Foreign derived intangible income (FDII): N.C.G.S. Section 105-130.5 is amended to include an addition modification for the amount deducted under IRC Section 250.³ This provision applies to tax years beginning on or after January 1, 2018.

— Opportunity zones: N.C.G.S. Section 105-130.5 is amended to decouple from the federal provisions that defer and exclude gains from the sale of assets invested in Opportunity Funds.⁴ This provision applies to tax years beginning on or after January 1, 2018.

The Bill also repeals the addback for the domestic production activities deduction under IRC Section 199, which was repealed by the TCJA, and decouples North Carolina's individual income tax filing requirement from the federal filing requirement.⁵ The provision repealing the addback for the IRC Section 199 domestic production activities deduction applies to tax years beginning on or after January 1, 2018.

Corporate income / franchise tax

Currently, partnerships that elect to be taxed as corporations are not subject to the North Carolina franchise tax. The Bill amends N.C.G.S. Section 105-114(b)(2) so that the definition of "corporation" includes partnerships electing to be taxed as corporations for federal income tax purposes. As a result, such electing partnerships will be subject to the North Carolina franchise tax as if they were corporations.⁶ This change is effective January 1, 2019, and applies to the calculation of franchise tax reported on the 2018 C Corporation tax returns.

Additionally, the Bill amends N.C.G.S. Section 105-122(b), removing vague language to clarify that the net worth base of a corporation that does not maintain its books in accordance with Generally Accepted Accounting Principles (GAAP) is computed in accordance with the method it uses for federal income tax purposes.⁷ For franchise tax purposes, these taxpayers will be required to calculate asset valuation, depreciation, depletion, and amortization using the same method used for federal income tax purposes.⁸ The Bill also prevents a double deduction of treasury stock that is already included in the current franchise tax calculation by striking N.C.G.S. Section 105-122(b)(3) from the statute.⁹ This change is effective January 1, 2019 and applies to the calculation of franchise tax reported on the 2018 C Corporation tax returns.

For corporate income and franchise tax purposes, the Bill provides guidance to the North Carolina Department of Revenue (the Department) regarding the sourcing of service income through the addition of a statutory definition of the term "income-producing activity." Under amended N.C.G.S. Section 105-130(l)(3)(c), an "income-producing activity" is an activity "directly performed by the taxpayer or its agents for the ultimate purposes of generating the sale of the service. Receipts from income-producing activities performed within and [outside] [North Carolina] are attributed to [North Carolina] in proportion to the income-producing activities performed in [North Carolina] to total income-producing activities performed everywhere that generate the sale of service."¹⁰ Additionally, the Bill clarifies that income from incidental services is sourced to North Carolina if the services are performed in connection with the sale of tangible property located in North Carolina.¹¹

The Bill also amends N.C.G.S. Section 105-130(l)(3)(b), to clarify that receipts from intangible income are sourced to the state where the intangible property is used.¹²

Sales and use tax

The Bill amends the definition of "qualifying datacenter" in N.C.G.S. Section 105-164.3(33c) to require a non-operating datacenter to certify, when applying for a written determination, that it "will satisfy" the wage standard, "will provide" health insurance for all of its full-time employees as long as the datacenter operates, and "will pay" at least 50% of health care as required by statute.¹³

The Bill expands N.C.G.S. Section 105-164.4B to provide that bad faith does not include sourcing gross receipts derived from the renewal of a service contract for prewritten software to the address where the purchaser received the underlying prewritten software, provided the seller has not received information from the purchaser indicating a change in the location of the underlying software. Additionally, language was added to the general sourcing provisions providing that the sourcing provisions are to assist a seller in determining where to source the sale of product and do not alter the application of use tax imposed on a purchaser under N.C.G.S. Section 105-164.6.¹⁴

The Bill expands and further clarifies the list of activities in N.C.G.S. Section 105-164.4G(e) where gross receipts derived from such activities are not admission charges subject to sales and use tax.¹⁵ These added activities were previously considered exempt from sales and use tax, but not listed as such in the statute.

The Bill adds N.C.G.S. Section 105-164.11B, which allows a retailer that pays sales and use tax on property or services and subsequently resells the property or services at retail before using them to recover the sales or use tax originally paid to a seller. The section also allows a retailer entitled to recover tax under this section to reduce taxable receipts by the taxable amount of the purchase price of the property or services resold for the period in which the retail sale occurs. Any amount recovered over the tax due for the reporting period is not refundable, but may be used to offset taxable receipts in subsequent periods. This section is effective June 12, 2018.¹⁶

The Bill amends N.C.G.S. Section 105-164.13(13) to clarify the exemption language for over-the-counter drugs and provides that pet food is subject to sales and use tax, even if the manufacturer of that food may require the food to be sold on prescription. The amendment also clarifies that over-the-counter drugs purchased by hospitals and other medical facilities for use and treatment of patients are subject to sales and use tax.¹⁷

The Bill expands the provisions of N.C.G.S. Section 105-164.13(61a) to provide a sales and use tax exemption for property management contracts related to real property used for business, commercial, educational or income-producing purposes. N.C.G.S. Section 105-164.3 adds a definition of property management contract for purposes of the exemption.¹⁸ These changes are effective January 1, 2020.

The Bill amends N.C.G.S. Section 105-164.13(15) to codify for purposes of the exemption the definition of "worthless account." A "worthless account" is a "bad debt" as allowed under Section 166 of the IRC. The amount calculated under IRC Section 166 must be adjusted to exclude financing charges or interest, sales or use taxes charged on the sales price, uncollectible amounts on property that remain in the seller's possession until the full purchase price is paid, repossessed property, and collection expenses.¹⁹ Before this amendment, the definition was included and remains in the Sales and Use Tax Bulletins published by the Department of Revenue.

The Bill amends N.C.G.S. Section 105-164.4G(f) to provide that receipts received from a charitable contribution described under IRC Section 170(l)(2) do not qualify as taxable admission charges to an entertainment activity for sales and use tax purposes. As a result of the TCJA, charitable contributions to educational institutions of higher learning are no longer deductible for federal income tax purposes if the taxpayer receives the right to purchase tickets to the institution's athletic events. This amendment prevents the potential for the sales tax base for admission charges from changing with the expanded income tax base.²⁰

The Bill amends N.C.G.S. Section 105-164.13E to extend the exemption from sales and use tax to purchases of remedies, medications, vaccines and other certain items by a person for use in providing a service on plants and animals held for commercial purposes by qualifying farmers. A person that purchases a qualifying item for use to fulfill a service for a person holding a qualifying farmer exemption number must provide an exemption certificate to the retailer that includes the name of the purchaser and an exemption number issued to the purchaser by the Department of Revenue, under N.C.G.S. Section 105-164.28A.²¹ This provision is effective retroactively to July 1, 2014 and a person that paid sales and use tax on qualifying items for a sales and use tax return period ending before June 1, 2018, may apply for a refund directly from the Department of Revenue without the normal statute of limitations to request a refund in N.C.G.S. 105-241.6 applying.

The Bill amends N.C.G.S. Section 105-164.4(a) to merge the imposition of sales and use tax of repair, maintenance, and installation services (RMI) with the taxation of the items themselves. As a result, taxpayers will no longer need to make the determination of whether the imposition is on the sale of the item plus installation or on the RMI service.²²

The Bill amends N.C.G.S. Section 105-164.19 to remove the 30-day limitation on the extension of time for filing a sales tax return. As a result, extensions to file sales and use tax returns are now governed by N.C.G.S. Section 105-263.²³

The Bill amends N.C.G.S. Section 105-164.27A(a) relative to the use of general direct pay permits issued by the Department of Revenue. As amended, a general direct pay permit may be used if the place of business where the item will be stored, used or consumed "in the State" is not known at the time of the purchase and a different tax consequence applies depending on where the item is used "in the State" or the manner in which the item will be stored, used or consumed "in the State" is not known at the time of purchase and one or more of the potential uses is taxable but others are not taxable "in the State."²⁴ As amended, use of a general direct pay permit does not apply when such items are initially received in the State for subsequent storage, use or consumption outside the State, excluding inventory items purchased and held for sale.

The Bill amends N.C.G.S. Section 105-244.3(a) to extend the grace period under the Sales Tax Base Expansion Protection Act for an additional year and adds additional transactions to the grace period that were not originally included.²⁵ As extended, the grace period ends for tax due on certain transactions for a filing period ending before January 1, 2019.

Employment tax

The Bill amends N.C.G.S. Section 105-163.7 to restore the "out-of-business" provision, requiring an employer that goes out of business to file the NC-3 Form within 30 days from the last day the taxpayer has payroll. This provision was inadvertently lost in 2015, when the General Assembly changed the due date for filing the NC-3 Form from the federal due date to January 31.²⁶

Personal income tax

The Bill expands N.C.G.S. Sections 105-153.5(b) and 105-130.5(b) to provide a State income tax deduction for both individual and business taxpayers, equal to the amount paid to the taxpayer from the State Emergency Response and Disaster Relief Reserve Fund for hurricane relief or assistance. The deduction does not include payments for goods or services provided by the taxpayer.²⁷ This change is effective for tax years beginning on or after January 1, 2017.

The Bill expands N.C.G.S. Section 105-153.5(b) to provide a North Carolina state income tax deduction for loan amounts forgiven under the Trooper Training Reimbursement Program. Under current law, these amounts are included in taxable income.²⁸ This change is effective for tax years beginning on or after January 1, 2018.

The Bill repeals N.C.G.S. Section 115C-595(c), which excluded scholarship funds held in a Personal Education Savings Account (PESA) from income. As N.C.G.S. Section 105-153.5 allows a North Carolina state tax deduction for amounts deposited into a PESA account during the tax year, taxpayers would recognize a double income tax benefit. This change corrects this issue and is effective for tax years beginning on or after January 1, 2018.²⁹

Property tax

The Bill amends N.C.G.S. Section 105-282.1(a) to add the following recently created property tax exemptions to the single application requirement: real property occupied by charter schools, certain energy mineral interests, property located on lands held in trust by the United States for the Eastern Band of Cherokee Indians, and mobile classrooms or modular units used exclusively for educational purposes by a school.³⁰

The Bill amends N.C.G.S. Section 105-395.1 to adjust the due date for certain property tax deadlines. Currently, if the last day for taking property tax-related actions (e.g., listing of property or payment of taxes) is a Saturday, Sunday, or a holiday, then said action is due on the next business day. Under the Bill, the due date will be the next business day if the actual due date is on a day that meets these conditions: the tax office is closed, the taxpayer certifies in writing that the US Postal Service did not provide service to their address, and a disaster declaration is declared by a gubernatorial, county, or municipal declaration. This provision is effective for tax years beginning on or after July 1, 2018.³¹

Excise tax

The Bill creates N.C.G.S. Section 105-113.4E to provide an excise tax rate reduction for modified risk tobacco products. A "modified risk tobacco product" is a "tobacco product that is sold or distributed for use to reduce harm or the risk of tobacco-related disease associated with commercially marketed tobacco products." For products issued a risk modification order by the federal Food and Drug Administration (FDA) under 21 U.S.C. 387k(g)(1), the rate is reduced by 50%. For products issued an exposure modification order by the FDA pursuant to 21 U.S.C. 387k(g)(2), the rate is reduced by 25%.³²

The Bill creates N.C.G.S. Section 105-113.83A, providing a mechanism for the Department to require certain Alcohol Beverage Commission (ABC) permittees holding commercial permits to comply with state tax obligations. Under the Bill, these permit holders must file a registration form with the Department and must notify the Department in writing of ownership changes or if they discontinue operations.³³ This change is effective October 1, 2018.

Other changes

The Bill amends N.C.G.S. Section 105-263 to provide an automatic extension to file a North Carolina income and franchise tax return to taxpayers that are granted an automatic extension to file a federal income tax return. This provision applies to tax years beginning on or after January 1, 2019.³⁴

The Bill amends N.C.G.S. Section 105-236(a) to: (1) modify the existing penalty for failure to file certain informational returns, (2) create a $200 penalty for failure to file an informational return in the proper format, and (3) set the maximum penalty at $1,000.³⁵

The Bill creates N.C.G.S. Section 105-241A to give the Department a framework to offer electronic filings, including the authority to waive electronic submissions requirements, while also requiring the Department to annually publish a list of returns on its website that are required or permitted to be filed electronically during the next calendar year. The Department also must prescribe how the taxpayer or paid preparer signs an electronically filed return.³⁶ The Bill also modifies N.C.G.S. Section 105-263 to require the Department to prescribe when a return, report, payment or any other document that is submitted electronically to the Department is deemed to be timely filed.³⁷

The Bill amends N.C.G.S. Section 105-130.20 (corporate taxpayers) and N.C.G.S. Section 105-159 (individual income taxpayers) to clarify when a taxpayer must notify the Department of an amended federal return, whether the result of a federal determination or voluntarily filed. Under current law, taxpayers must file an amended return with the Department within six months of being notified of a correction or final determination by the federal government. The Bill updates the statutory language to define "final determination" as a change or correction of federal tax due resulting from an audit by the IRS Commissioner. The Bill also requires taxpayers that voluntarily file amended federal returns increasing North Carolina tax payable to file an amended North Carolina return; however, the amended North Carolina return is optional if the North Carolina tax payable decreases.³⁸ The Bill also provides an exception to the general statute of limitations related to assessments proposed from adjustments voluntarily filed with the IRS. N.C.G.S. Section 105-241-.8(b) is amended so that the Department has until the later of one year after the amended return was timely filed or three years after the original return was filed or due to be filed to propose an assessment. In the event that the amended return is not timely filed, the period for proposing an assessment of tax due is three years after the date the amended federal return was filed with the IRS.³⁹

The Bill amends N.C.G.S. Section 105-230(b) to clarify that a corporation or LLC that is subject to a revenue suspension is not relieved of its state tax filing obligations or its North Carolina tax liabilities.⁴⁰

Lastly, the Bill amends N.C.G.S. Sections 105-228.3, 105-228.4A, and 105-228.5(g) to clarify that non-North Carolina captive insurance companies, defined as those licensed and taxed in another state, are not subject to the captive insurance, corporate income, franchise, or gross premiums taxes in North Carolina.⁴¹

Implications

Of notably importance is the updating of North Carolina's IRC conformity date. Although other provisions of the Bill decoupled North Carolina from many of the new foreign tax provisions of the IRC provided under the TCJA (e.g., the transition tax, GILTI and FDII), companies may still be affected by other provisions, such as the 30% business interest expense limitation provisions under IRC Section 163(j) coupled with North Carolina's own existing limitation on net interest paid to related parties under N.C.G.S. Section 105-130.5(a)(25). The applicability of North Carolina's attribution of expense provision should also be considered when performing the subtraction modification in accordance with N.C.G.S. Section 105-130.5(b)(3b).

 Companies that have partnerships electing to be treated as corporations for federal income tax purposes should note that these partnerships are now subject to North Carolina franchise tax under the Bill just as if they were corporations.

In addition to income and franchise tax changes, companies should consider the sales and use tax changes applicable to their businesses. The Bill makes technical and clarifying changes to the exemption statutes and the sourcing statute. Additionally, the Bill makes technical changes to provisions regarding RMI services, admission charges, qualified farmers, as well as other sales and use tax provisions.

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Contact Information For additional information concerning this Alert, please contact:   State and Local Taxation Group • Kerry Matthews Funderburk (704) 350-9175 • Eric Wayne – Sales and Use Tax (919) 791-1724

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ENDNOTES

¹ Bill, Section 38.1.(b).

² Bill, Section 38.1.(b).

³ Bill, Section 38.1.(b).

⁴ Bill, Section 38.1.(b).

⁵ Bill, Section 38.1.(e),(f),(g).

⁶ Bill, Section 38.2.(a).

⁷ Bill, Section 38.2.(b).

⁸ Bill, Section 38.2.(b).

⁹ Bill, Section 38.2.(b).

¹⁰ Bill, Section 38.2.(c).

¹¹ Bill, Section 38.2.(c).

¹² Bill, Section 38.2.(c).

¹³ Bill, Section 38.5.(b).

¹⁴ Bill, Section 38.5.(d).

¹⁵ Bill, Section 38.5.(e).

¹⁶ Bill, Section 38.5.(h).

¹⁷ Bill, Section 38.5.(j).

¹⁸ Bill, Section 38.5.(x) and (y).

¹⁹ Bill, Section 38.5.(j).

²⁰ Bill, Section 38.5.(u).

²¹ Bill, Section 38.5.(k).

²² Bill, Section 38.5.(c).

²³ Bill, Section 38.5.(n).

²⁴ Bill, Section 38.5.(o).

²⁵ Bill, Section 38.5.(q).

²⁶ Bill, Section 38.10.(n).

²⁷ Bill, Section 5.6.(j) and (k).

²⁸ Bill, Section 35.25.(g).

²⁹ Bill, Section 38.10.(m) and (s).

³⁰ Bill, Section 38.10.(d).

³¹ Bill, Section 38.9.(a) and (b).

³² Bill, Section 38.7.(a).

³³ Bill, Section 38.6.(c).

³⁴ Bill, Section 38.4.(a) and (b).

³⁵ Bill, Section 38.10.(p).

³⁶ Bill, Section 38.10.(r).

³⁷ Bill, Section 38.10.(q).

³⁸ Bill, Section 38.3.(a), (b), and (g).

³⁹ Bill, Section 38.3.(e).

⁴⁰ Bill, Section 38.10.(a).

⁴¹ Bill, Section 38.2.(e), (f), and (g).