On May 21, 2019, Washington Governor Jay Inslee signed into law bills HB 2167, HB 2158, SB 6016 and SB 5998, which are discussed in this Alert.

The Washington legislature has approved, and sent to Governor Jay Inslee, bills that would increase taxes on various businesses. The bills would impose an additional business and occupation (B&O) tax on specified financial institutions, impose B&O tax surcharges on over 40 services (with a higher surcharge imposed on select advance computing businesses), narrow the qualifications for the B&O preferential tax rate for international investment management companies, and establish a graduated real estate excise tax.

A summary of these changes follows.

B&O tax rate increases and surcharges

Rate increase for specified financial institutions

Beginning January 1, 2020, HB 2167, if enacted, would impose an additional 1.2% B&O tax (in addition to the current rate of 1.5%) on the gross taxable service and other income of specified financial institutions. A "specified financial institution" is defined as a financial institution that is a member of a consolidated financial institution group that reported on its consolidated financial statement for the prior calendar year annual net income of at least $1 billion, not including net income attributable to noncontrolling interests.¹ If specified financial institutions are no longer required to file a consolidated financial statement, a specified financial institution means any person that was subject to the additional tax in at least two of the prior four calendar years.

A "financial institution" is defined as:

1. Any corporation or other business entity charted under the Washington Commercial Bank Act (Revised Code of Washington (RCW), tit. 30A), Washington Trust Institutions Act (RCW, tit. 30B), Miscellaneous Loan Agencies (RCW, tit. 31), Washington Savings Bank Act (RCW, tit. 32) or Washington Savings Association Act (RCW, tit. 33), or registered under the federal Bank Holding Company Act of 1956 or registered as a savings and loan holding company under the federal National Housing Act
2. A national bank organized and existing as a national bank association under the National Bank Act (12 U.S.C. Section 21 et seq.)
3. A savings association or federal savings bank (as defined in 12 U.S.C. Section 1813(b)(1))
4. Any bank or thrift institution
5. Any corporation organized under the provisions of 12 U.S.C. Sections 611 through 631 to do foreign banking
6. Any agency or branch of a foreign depository (as defined in 12 U.S.C. Section 3101) that is not exempt under RCW 82.04.315
7. Certain production credit associations organized under the federal Farm Credit Act of 1933
8. Any corporation or other business entity that receives gross income subject to tax under RCW 82.04.290 (i.e., tax imposed on international investment services or other business service activities), and whose voting interests are more than 50% owned (directly or indirectly) by any person or business described in sections i-vii, other than an insurance company subject to the insurance premiums tax
9. A corporation or other business entity that receives more than 50% of its total gross income for federal income tax purposes from finance leases (as defined by the provision)
10. Any other person or business entity (other than certain insurance general agents, insurance businesses exempt from the B&O tax, real estate brokers, securities dealers or international investment management companies) that receives 50% of its gross receipts from business activities that persons described in sections ii-vii and ix are authorized to transact

B&O tax surcharges

Beginning with business activities occurring on or after January 1, 2020, HB 2158, if enacted, would impose B&O tax surcharges — at rates of 20%, 33.33% and 66.66% — on income from certain services.

A 20% workforce education investment surcharge applicable to business activities taxed under RCW 82.04.290(2), before application of any tax credits, would be imposed on "specified persons." A "specified person" is any person primarily engaged within Washington in any combination of over 40 enumerated activities. Some of the activities to which the surcharge would apply include:

• Computers and software
• Research and development
• Securities and commodities
• Information technologies
• Financial and investment services
• Telecommunications services, telecommunications networks
• Library or archive services, including operating web search portals
• Architectural, engineering and related services
• Nonstore retailing (e.g., catalogs, phone, electronic media, internet, catalog showroom, mail-order house)
• Advice and assistance to businesses and other organizations on management, environmental, scientific, and technical issues
• Web hosting, streaming services, application hosting, data processing services
• Legal and paralegal services
• Insurance and employee benefits
• Merchant wholesale distribution of various business and professional equipment and supplies
• Broadcasting
• Publishing
• Business-to-business electronic markets that bring together buyers and sellers
• Design
• Manufacturing related to aircraft, missiles, aerospace
• Advertising and public relations
• Accounting and auditing
• Health care (not including hospitals)
• Office administrative services
• Professional, scientific or technical services

For persons that report under more than one tax classification, the surcharge would only apply to business activities taxed under RCW 82.04.290(2). For purposes of the surcharge, a person is primarily engaged within Washington in any combination of the enumerated activities if more than 50% of the person's cumulative gross amount reportable (i.e., total value of products, gross proceeds of sales, and gross income of the business, reportable to the revenue department before application of any tax deductions) under this chapter during the entire current or immediately preceding calendar year was generated from engaging in one or more of these activities.

Additionally, the higher surcharges would be imposed on select advance computing businesses (i.e., a person that is a member of an affiliated group with at least one member of the affiliated group engaged in the business of advanced computing). The surcharge would be 33.33% for an affiliated group with worldwide gross revenue of more than $25 billion but not more than $100 billion, during the entire current or immediately preceding calendar year. The surcharge would increase to 66.66% for worldwide gross revenue over $100 billion. The combined surcharge paid by all members of an affiliated group could not be less than $4 million or more than $7 million annually. The term "advanced computing" is defined as "designing or developing computer software or computer hardware, whether directly or contracting with another person, including modifications to computer software or computer hardware, cloud computing services, or operating an online marketplace, an online search engine, or online social networking platform."

Lastly, the Legislature made clear that it "intends the provisions of this act to be applied broadly in favor of application of the surcharges," and recommended that any provision of the act deemed ambiguous by a court, the tax appeals board, or any other judicial or administrative body "be construed in favor of application of the surcharges."

International investment management companies

Effective July 1, 2019, SB 6016, if enacted, would narrow the qualifications for the international investment management services (IIMS) preferential B&O tax rate (0.275%, instead of the general service rate of 1.5%) by adding additional requirements. As revised, a person would be engaged in the business of providing qualifying IIMS if:

• The person is engaged primarily in the business of providing investment management services
• At least 10% of the person's gross income derives from providing such services to: (i) collective investment funds commercially domiciled outside the United States (US), or (ii) collective investment funds with at least 10% of their investments located outside the US
• More than 25% of the person's employees are located in Washington
• The person is a member of an affiliated group that collectively has: (i) 10 or more offices located in at least 8 foreign countries; (ii) at least 500 full-time employees worldwide; (iii) more than $400 million in worldwide gross revenue during the entire current or immediately preceding calendar year, and (iv) average assets under management of more than $200 billion during the entire current or immediately preceding calendar year. (emphasis added to highlight new additional requirements)

An affiliate of a person engaged in the business of providing qualifying IIMS is deemed to be providing qualifying IIMS if certain qualifications are met.

SB 6016 would add a clawback provision. Under the clawback provision, a qualifying IIMS that no longer met the Washington employment eligibility requirement, would have to pay an amount equal to the lesser of:

• The entire economic benefit accruing to the person as a result of the preferential rate for the current calendar year and the preceding nine consecutive calendar years or
• The consecutive calendar years since the effective date of the act.

This amount would be immediately due and payable. Further the Washington Department of Revenue would be required to assess interest, but not penalties, on the amount due under this provision.

SB 6016 would also expand and extend the sales and use tax exemption for the purchase of standard financial information by a qualifying international investment management company (QIIMC). The exemption would be extended through July 1, 2031 (from July 1, 2021), and expanded to include the sale of standard financial information to a QIMMC's affiliate.

Real estate excise tax (REET) rate changes

The State of Washington and various localities impose the REET on the transfer of Washington real property, including the transfer of controlling interests in entities that own Washington real property. The combined State and local REET rate in most areas is 1.78%, with the State component equal to a flat tax rate of 1.28%. SB 5998, if enacted, would establish new, graduated REET State rates, which would replace the current flat rate of 1.28%. Beginning January 1, 2020, the REET would be imposed as follows: (1) 1.1% if the selling price is $500,000 or less; (2) 1.28% on the portion of the selling price over $500,000, but less than or equal to $1.5 million; (3) 2.75% on the portion of the selling price over $1.5 million, but less than or equal to $3 million; and (4) 3% on the portion of the selling price that exceeds $3 million. Timberland and agricultural land would remain taxable at 1.28%. In 2022 and every fourth year thereafter, the selling price thresholds would be adjusted to reflect the lesser of 5% or the growth in the consumer price index. The thresholds would not be adjusted if the growth is zero (or below).

SB 5998 would also increase the aggregation period for transfers of economic interests in real estate entities. The REET would apply to any transfer or acquisition of a "controlling interest" (i.e., 50% or more) in an entity with Washington real property by aggregating transactions made within a rolling 36-month period (currently, the aggregation period is 12 months). Lastly, recognizing that some taxpayers may attempt to avoid or reduce REET liabilities, the bill would authorize the revenue department to disregard the form of transaction(s) and determine proper tax treatment based on substance, considering several factors.

Implications

The B&O tax rate increase on certain financial institutions, as well as the B&O tax surcharges on over 40 services would be in addition to taxes already imposed. Taxpayers should review the list of activities subject to the B&O tax surcharges to determine whether they will be liable for additional Washington state taxes.

Taxpayers qualifying as an international investment management services business should review the changes to the qualifications, as they have been significantly narrowed to limit the number of taxpayers that will qualify for the preferential rate. Accordingly, many taxpayers that previously qualified for the preferential rate will no longer qualify under the revised provisions.

Finally, buyers and sellers of Washington real property (whether directly or indirectly through legal entities) should take note of the change to graduated REET state rates, which may result in significant increases in REET liability on real estate transactions.

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ENDNOTES

¹ The terms "net income" and "noncontrolling interests" have the same meaning as used in the consolidated financial statement.