October 4, 2022
North Carolina makes technical and clarifying changes to its franchise tax laws
North Carolina recently enacted House Bill 83 (the Bill), 1 which includes provisions affecting various taxes. This Tax Alert discusses the Bill's effect on the calculation of the North Carolina franchise tax.
The Bill's provisions are generally effective on June 29, 2022. 2
Corporate franchise tax
Currently, North Carolina's franchise tax is levied on the largest of three bases: (1) the taxpayer's North Carolina apportioned net worth; (2) 55% of the appraised value of all real and tangible personal property in the state; or (3) the taxpayer's total investment in tangible property in the state.3 Under all three bases, the tax is levied at a rate of $1.50 for every $1,000 of the tax base, with a $200 minimum.4 Effective for 2023 franchise taxes reported on 2022 income tax returns, the two franchise tax bases for property are eliminated, and the franchise tax will be levied on the taxpayer's North Carolina apportioned net worth.5
Before the Bill's amendments, N.C.G.S. Section 105-122(b)(2) required a corporation to increase the net worth tax base by affiliated indebtedness that "creates net interest expense" that is not "qualified interest expense" for income tax purposes. As the law was originally written, taxpayers could potentially avoid the addition modification for affiliated indebtedness by borrowing from affiliates on an interest-free basis since such indebtedness would not create net interest expense.
N.C.G.S. Section 105-122(b)(2), as revised by the Bill, requires an addition modification to the net worth tax base for affiliated indebtedness owed to a parent, subsidiary, affiliate, or a greater than 50%-owned noncorporate entity, unless the affiliated indebtedness creates qualified interest expense for income tax purposes.6 If the affiliated indebtedness creates qualified interest expense for income tax purposes, taxpayers do not have to make the addition modification to the net worth tax base for the indebtedness.
For income tax purposes, qualified interest expense is the net interest expense paid or accrued to a related member, limited to the proportionate share of the affiliated lender's interest expense paid or accrued to an unrelated party.7 The limitation does not apply under the exceptions listed in the statute,8 which generally include interest paid to an affiliate that is subject to income tax by North Carolina, another state as part of a separate company filing, or a United States treaty partner. Therefore, if the interest expense meets one or more of the exceptions, the interest is qualified interest expense. Given that this clarification is effective June 29, 2022, it affects 2022 franchise taxes reported on 2021 income tax returns, which are filed after that date.
Taxpayers should consult with their tax advisors and preparers on how the Bill and its reporting requirements will affect past or future transactions.
1 HB 83 was signed by Governor Roy Cooper on June 29, 2022.
2 Bill, Section 7.1.
3 N.C.G.S. § 105-122(d) effective until January 1, 2023.
5 N.C.G.S. Section 105-122(d) effective January 1, 2023.
6 Bill, Section 1.2
7 N.C.G.S. Section 105-130.7B(b)(4)