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F I S C A L I M P A C T R E P O R T
SPONSOR Wirth
ORIGINAL DATE
LAST UPDATED
1/18/08
1/31/08 HB 51
SHORT TITLE Corporate Income Tax to Public School Fund
SB
ANALYST Francis
REVENUE (dollars in thousands)
Estimated Revenue
Recurring
or Non-Rec
Fund
Affected
FY08
FY09
FY10
$11,000.0
$90,000.0
$90,000.0 Recurring General Fund
($112,500.0)
($112,500.0) Recurring General Fund
$112,500.0
$112,500.0 Recurring Public School
Fund
(Parenthesis ( ) Indicate Revenue Decreases)
SOURCES OF INFORMATION
LFC Files
Responses Received From
Taxation and Revenue Department (TRD)
Public Education Department (PED)
Department of Finance and Administration (DFA)
SUMMARY
Synopsis of Bill
House Bill 51 distributes 20 percent of corporate income tax to the public school fund. Current
law allows unitary corporations, corporations that are made up of at least two integrated
corporations, to choose to file either as “combined" corporations or “consolidated" corporations.
HB51 repeals 7-2A-8.4 which allows consolidated returns and makes combined reporting
mandatory.
The provisions are effective with tax year beginning January 1, 2008.
FISCAL IMPLICATIONS
TRD estimates that requiring mandatory reporting would generate an additional 20 percent in
corporate income tax (CIT) collections. Using the December 2007 projection of CIT revenue, the
fiscal impact would be $90 million all of which would go to the general fund. It is assumed that
one quarter of FY08 would be subject to the new mandate.
pg_0002
House Bill 51 – Page
2
Current
Projections of
CIT ($M)
Additional Due to
Mandatory Combined
Reporting ($M)
20 percent to Public
School Fund ($M)
FY08
440.0
11.0
90.2
FY09
450.0
90.0
108.0
FY10
450.0
90.0
108.0
FY11
447.0
89.4
107.3
Source: Consensus Revenue Group Dec 2007 estimate
The Public School Fund is a separate fund that receives appropriations from the general fund and
the current school fund and distributed to school districts based on the state equalization
guarantee, transportation and supplemental appropriations. The amount to the Public School
Fund is 20 percent of the CIT so it is 20 percent of the base consensus forecast plus the new
revenue generated by HB51. This means that there will be a negative impact on the general fund.
The LFC has concerns with including continuing appropriation language in the statutory
provisions for funds outside of the general fund, as earmarking reduces the ability of the
legislature to establish spending priorities.
SIGNIFICANT ISSUES
The 2007 funding formula study task force sponsored HB51 as a way of providing additional
funding for a new public school funding formula. This option provides about 25 percent of the
estimated $360 million in new revenue deemed necessary by the task force to achieve sufficient
funding of all public school districts.
According to data from TRD, mining and manufacturing account for 12 percent of the returns
but 63 percent of the tax payments for all 19,875 CIT taxpayers. Of all taxpayers, 92.25 percent
file as “separate entities," 2.43 percent file as “combined" and 5.32 percent file as
“consolidated." The industry sector with the highest percentage (8.84 percent) of combined
reporting is the “Management of Companies" sector which accounts for about 10 percent of the
total amount of tax payments. Illustration one shows the details.
Combined Reporting: Most corporations only do business in one state and so their CIT filing is
relatively straight-forward and combined reporting is not an issue for them. Where combined
reporting is an issue is where companies have significant operations in a state but very little
income when they file as separate entities, an option for NM CIT reporting. The use of
subsidiaries called “passive investment companies," or PICs, has proliferated in the last decade
which is the primary reason states are moving towards requiring combined reporting. A PIC
generally has no economic activity other than the ownership of intangibles like trademarks,
logos, copyrights and patents. The PIC is a subsidiary of the parent corporation so only the
parent corporation benefits from the proceeds of the PIC.
pg_0003
House Bill 51 – Page
3
Illustra tion 1 : State Corporate Income Tax Returns and Tax Payments by Filing Method and Major Industry in 2005*
All Returns
Separate Entity
Combined
Consolidated
Tax
Tax Tax
Tax
Number Payments Number Payments Number Payments Number Payments
Maj or Industry**
Of
Returns ($000) of Returns ($000)
of
Returns ($000)
of
Returns ($000)
Number and Amount
Mining***
857 91,347 753 21,735
21 23,375 83 46,237
Manufacturing
1,569 117,180 1,389 97,962
63 3,441 117 15,776
Wholesale Trade
1,131 9,402 1,033 5,091
37 1,803 61
2,508
Retail Trade
1,548 11,739 1,436 7,065
36 1,092 76
3,581
Transportation and
Warehousing
543 10,436 502 1,797
10 7,330 31
1,310
Finance and Insurance
1,713 11,083 1,581 8,636
52 243 80
2,204
Real Estate, Rental and
Leasing
1,870 9,742 1,798 9,207
16 178 56
356
Management of Companies
and Enterprises
588 31,693 391 2,195
52 4,007 145 25,491
All Other
10,056 37,890 9,452 25,114 196 4,520 408
8,256
Totals 19,875 330,511 18,335 178,803 483 45,989 1,057 105,720
Percentage Distribution of Number and Amount by Filing Method
Mining***
4.31 27.64 4.11 12.16 4.35 50.83 7.85
43.74
Manufacturing
7.89 35.45 7.58 54.79 13.04 7.48 11.07
14.92
Wholesale Trade
5.69 2.84 5.63 2.85 7.66 3.92 5.77
2.37
Retail Trade
7.79 3.55 7.83 3.95 7.45 2.37 7.19
3.39
Transportation and
Warehousing
2.73 3.16 2.74 1.01 2.07 15.94 2.93
1.24
Finance and Insurance
8.62 3.35 8.62 4.83 10.77 0.53 7.57
2.08
Real Estate, Rental and
Leasing
9.41 2.95 9.81 5.15 3.31 0.39 5.30
0.34
Management of Companies
and Enterprises
2.96 9.59 2.13 1.23 10.77 8.71 13.72
24.11
All Other
50.60 11.46 51.55 14.05 40.58 9.83 38.60
7.81
Totals 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00
Percentage Distribution of Number and Amount by Size of Tax Payment
Mining***
100.00 100.00 87.86 23.79 2.45 25.59 9.68
50.62
Manufacturing
100.00 100.00 88.53 83.60 4.02 2.94 7.46
13.46
Wholesale Trade
100.00 100.00 91.34 54.15 3.27 19.18 5.39
26.67
Retail Trade
100.00 100.00 92.76 60.19 2.33 9.30 4.91
30.51
Transportation and
Warehousing
100.00 100.00 92.45 17.22 1.84 70.23 5.71
12.55
Finance and Insurance
100.00 100.00 92.29 77.92 3.04 2.19 4.67
19.88
Real Estate, Rental and
Leasing
100.00 100.00 96.15 94.51 0.86 1.83 2.99
3.66
Management of Companies
and Enterprises
100.00 100.00 66.50 6.93 8.84 12.64 24.66
80.43
All Other
100.00 100.00 93.99 66.28 1.95 11.93 4.06
21.79
Totals 100.00 100.00 92.25 54.10 2.43 13.91 5.32
31.99
Taxation and Revenue Department August 27, 2007 Tax Research and Statistics Office
* Tax payments are the total of estimated quarterly payments and payments with final returns for returns with fiscal years ending in 2005. Payments are
before any business tax credits.
** Ind ustries as defined by the North Americal Industry Classification System (NAICS). "Major" industries are those with state corporate income tax
payments in excess of $7 million in 2005.
*** Firms engaged in oil and natural gas production-related activities are typically classified in mining, but may be classified in a number of other industries
including transportation, retail trade, and professional, scientific and technical services.
For example, if two companies have competing retail operations in the state. Company A is
local and so all of their income is accounted for on their CIT return. Company B has a PIC in
Delaware (the host of many PICs since there is no corporate income tax) which owns the logo
and trademark that Company B uses to market its products. Company B leases the intangible
property from the PIC for an amount that roughly equals its net income. Company B now has a
competitive advantage over Company A because they have not paid any income tax in NM since
they shifted it to their PIC in a state where there is no income tax.
pg_0004
House Bill 51 – Page
4
Table 2: PIC Example
Company A Company B
Revenue
1,000,000 1,000,000
Operating Costs
500,000
500,000
Lease Costs for Intangibles and property (logos,
trademarks, REITs)
0
350,000
Net Income in NM (@ 5.8%)
500,000
150,000
NM Income Tax
29,000
8,700
As Table 2 shows, Company A has a competitive disadvantage since it is paying three times the
corporate income tax as company B. This is a very simplistic example to demonstrate the
problem. Actual corporate income tax filings are infinitely more complicated but the advent of
mandatory combined reporting occurred because of the aggressive tax planning multi-state
corporations have engaged in.
During testimony at the Revenue Stabilization and Tax Policy Interim Committee (RSTP) in
2006, TRD indicated that approximately 2 percent of corporations would be affected by
requiring combined reporting. Most corporations in New Mexico are single location companies
who will not be affected at all by combined reporting.
At the same RSTP meeting, representatives of the Association on Commerce and Industry (ACI)
indicated that the proposal unnecessarily complicates the tax system and would make New
Mexico uncompetitive in attracting economic development. Economic development
professionals have reported that this is one of the tools that they use to attract large companies to
the state and that companies use the flexibility of reporting as a factor in their location decisions.
TRD:
The availability of the election to use the SCE reporting method under current law is
considered a tax incentive to attract firms to New Mexico. Eliminating the election might
discourage some firms from locating or expanding in New Mexico.
TRD has provided additional information included as an appendix.
ADMINISTRATIVE IMPLICATIONS
TRD:
The allowance of “separate corporate entity" (SCE) reporting under current law creates
opportunities for controlled groups of corporations to shift profits to their out-of-state
affiliates by inflating or creating artificial inter-company charges to the in-state entity.
Because affiliated corporations almost always file a consolidated return for federal
income tax purposes, the inter-company charges are not subject to federal audit scrutiny.
Determining the legitimacy of these inter-company charges (for instance, the proper
amount of rent for an in-state store charged by a Delaware subsidiary) is very difficult
and time-consuming for TRD auditors.
The consolidated filing method reduces tax compliance costs for electing corporations,
reduces administrative cost for TRD, and allows corporations and TRD to rely on the
pg_0005
House Bill 51 – Page
5
results of IRS audits to determine the effect of audit adjustments on NM corporate
income tax liabilities. These benefits would be lost under the bill, which repeals the
option of filing a consolidated return.
TECHNICAL ISSUES
TRD:
Making the changes applicable to tax years beginning on or after January 1, 2008, would
change the tax reporting method required from many corporations for their current tax year,
which is already underway. These corporations would be required to change their tax
computations almost immediately in order to make estimated payments by June 15, 2008.
TRD would not be able to provide much guidance to affected companies; significant lead
time would be required to develop regulations and other guidance. A delayed applicability
date would allow corporations time to implement the change and TRD time to provide
crucial guidance.
DFA has provided an analysis of the legal terminology and possible technical issues:
It is unclear how the mandatory grouping of unitary corporations to be taxed by the state will
be determined. It would be quite easy to determine the grouping by referring to all
corporations included in a federal consolidated return. However, section 3 of the bill repeals
the current section permitting elective filing of a New Mexico return showing all members of
the federal consolidated group. We are left with the vague phrase, "combined return with
other unitary corporations" with no further hints about how the combined group will be
determined.
The concept of nexus is important here. It is likely that some members of a federal
consolidated group will not have direct or vicarious nexus with the unitary corporation
subject to the mandatory combined filing proposed in the bill. The state cannot tax
corporations that have no nexus with the state. Therefore, a mandatory consolidated rule is
not reasonable.
From the definitions section, "unitary corporations" means two or more integrated
corporations, other than any foreign corporation incorporated in a foreign country and not
engaged in trade or business in the United States during the taxable year, that are owned in
the amount of more than fifty percent and controlled by the same person and for which at
least one of the following conditions exists:
(1) there is a unity of operations evidenced by central purchasing, advertising, accounting or
other centralized services;
(2) there is a centralized management or executive force and centralized system of operation;
or
(3) the operations of the corporations are dependent upon or contribute property or services
to one another individually or as a group.
That definition seems to be useful for all concerned. Tax the unitary group as though it were
one corporation. Eliminate transactions among the members of the unitary grouping by
applying the federal consolidated filing rules. With this approach, the nexus is clear through
the control of the in-state member of the group, even though the holding company or parent
has no other connection with the state. The 50% ownership plus the other tests should be
sufficient to establish nexus for the unitary group. It is not clear if the phrase, "combined
pg_0006
House Bill 51 – Page
6
return with other unitary corporations" on lines 7 and 8, pg. 2 of the bill intends to extend the
reach of the New Mexico corporate income tax to a grouping larger than the unitary group so
carefully defined.
ALTERNATIVES
To ensure that there is no negative impact on the general fund, the percentage going to the public
school fund could be lowered.
ADDITIONAL POLICY DISCUSSION FROM TRD
All other Western states with a corporate income tax currently mandate combined reporting,
under which controlled groups of “unitary" (interdependent) U.S.-based corporations must file a
single return that eliminates all inter-company transactions. Texas recently adopted mandatory
combined reporting for their tax. The Blue Ribbon Tax Commission endorsed the concept of
mandatory combined reporting in 2003.
Eastern states have not generally adopted combined reporting, although in response to some
well-publicized “tax planning" techniques, a number of these states have recently adopted “add-
back" or “anti-passive investment company" legislation. These laws require taxpayers to
disallow the amounts of royalty and interest amounts paid to “intangible holding companies"
based in low-tax states like Delaware. The discretionary powers necessary to properly
implement both the “add-back" provisions and the “forced combination" techniques have
generated significant litigation. New York and West Virginia recently enacted mandatory
combined filing, and other Eastern states are considering it in response to budget shortfalls.
Background Information:
Current Law
Corporations with a taxable presence (“nexus") in the State must file a New Mexico corporate
income tax return. A corporation may elect to file as a "separate corporate entity" (SCE), or file
a return that includes affiliate corporations under one of two methods: "unitary combined" or
"federal consolidated". These filing-method options are sometimes referred to as "the ladder"
because when moving from SCE to combined to consolidated reporting, corporations generally
include larger amounts of corporate income in their New Mexico corporate income tax return
(before allocation and apportionment; see below). After the first filing year, corporations are
allowed to elect a different filing method without permission from TRD if the new filing method
is higher on the filing method "ladder". That is, a corporation is allowed to change from SCE
filing to combined or consolidated filing, or from combined to consolidated, without permission.
A corporation cannot, however, change from combined or consolidated to SCE, or from
consolidated to combined, without permission, and TRD generally does not approve such an
election unless the corporation has reorganized in a way that justifies the change or the proposed
new reporting method would better reflect industry practices than the corporation’s current
method.
pg_0007
House Bill 51 – Page
7
Top
Lowest Number of
State May State May Taxpayer May
State
Rate
Rate
Brackets Mandatory Require
Permit
Elect
Alabama
6.5
Consolidated
Alaska
9.4
1.0
10
Both
Arizona
6.968
Combined Consolidated Consolidated Consolidated
Arkansas
6.5
1.0
6
Consolidated
California
8.84
Combined Combined Combined Combined
Colorado
4.63
Combined
Consolidated
Connecticut
7.5
Consolidated Combined
Delaware
8.7
District of Colu
m
9.975
Consolidated
Florida
5.5
Consolidated
Georgia
6.0
Consolidated Consolidated
Hawaii
6.4
4.4
3
Both Consolidated
Idaho
7.6
Combined
Illinois
7.3
Combined
Indiana
8.5
Both
Combined
Iowa
12.0
6.0
4
Consolidated
Consolidated
Kansas
4.0
Combined Consolidated Combined
Kentucky
7.0
4.0
3
Consolidated
Louisiana
8.0
4.0
5
Both
Maine
8.93
3.5
4
Combined
Maryland
7.0
Massachusetts
9.5
Consolidated
Combined
Michigan
4.95
Consolidated Consolidated
Minnesota
9.8
Combined
Mississippi
5.0
3.0
3
Combined
Missouri
6.25
Consolidated
Montana
6.75
Combined
Consolidated Consolidated
Nebraska
7.81
5.58
2
Both
Nevada
New Hampshire 8.5
Combined
New Jersey
9.0
6.5
3
Consolidated
New Mexico
7.6
4.8
3
Both
New York
7.5
Combined
North Carolina
6.9
Both
North Dakota
7.0
2.6
5
Combined
Ohio
8.5
5.1
2
Combined Combined
Oklahoma
6.0
Consolidated Consolidated
Oregon
6.6
Consolidated
Pennsylvania
9.99
Rhode Island
9.0
South Carolina
5.0
Consolidated Combined
South Dakota
Tennessee
6.5
Both
Both
Texas
1.0
0.5
2
Combined
Utah
5.0
Combined
Vermont
8.5
6.0
3
Combined
Consolidated
Virginia
6.0
Consolidated
Washington
West Virginia
8.75
Combined
Consolidated
Wisconsin
7.9
Wyoming
Sources: Federation of Tax Administrators; 2007 Multistate Tax Guide , CCH Inc.; Web sites of State Tax Departments.
----- No Corporate Income Tax -----
----- No Corporate Income Tax -----
----- No Corporate Income Tax -----
----- No Corporate Income Tax -----
State Corporate Income Tax Rates and Reporting Methods
State Corporate Tax Rates
If Multiple Rates:
Combined and Consolidated Reporting
pg_0008
House Bill 51 – Page
8
All three filing methods require the allocation and apportionment of income under the Uniform
Division of Income for Tax Purposes Act (UDITPA). UDITPA and associated regulations
provide rules whereby a corporation (or affiliated group of corporations) operating in more than
one state divide income and expenses among the states in
which they operate. Generally, non-business income is
allocated whereas business income is apportioned using a
three-factor formula based on the separate ratios of property,
payroll and sales within a state to the total amount of the
respective factor in all states. UDITPA provides special
allocation and apportionment rules for certain industries,
including airlines, railroads, construction contractors, trucking
companies, broadcasters, and to firms in the publishing and
financial industries.
Unitary Business
A unitary business is generally regarded to be one that operates
as a unit; its branches are so dependent on the business as a
whole that their activities cannot be separated from those of
the main organization. A number of legal tests have been
developed for determining whether a group of businesses
constitutes a unitary business. The income of a group of
businesses that has been determined to be a unitary group can
only feasibly be sourced among states by combining the
incomes of all members of the group and apportioning that
combined income among states by formula. New Mexico
statutes currently allow firms some freedom in defining the
composition of their unitary businesses -- i.e., in defining whether affiliated firms are part of a
unitary business and filing taxes accordingly. As illustrated in the figure below, the amount of
business income subject to apportionment generally increases as a corporation moves from SCE
to combined to consolidated reporting.
The figure shows two affiliated corporations, Firm A and Firm B. Firm A operates partially
within both New Mexico and Colorado, but Firm B itself operates only in Colorado. However,
Firm B has four subsidiaries, three of which (Sub A, Sub B and Sub C) operate only in Colorado,
with the fourth (Sub D) operating in New Mexico. Firms A and B (but not necessarily B’s
subsidiaries) are assumed to be a unitary group (because of, for example, shared trademarks,
ownership, purchasing or other activities), and also to be a consolidated group for federal income
tax purposes.
Under “separate corporate entity" (SCE) reporting, Firm A is allowed to file its New Mexico
corporate income tax return as if it were a separate entity totally unrelated to Firm B or its
subsidiaries. All of Firm A’s income would be included in its return, but its business income
would be apportioned between Colorado and New Mexico using the three-factor apportionment
formula. The income and apportionment factors of Firm B and its subsidiaries would be
excluded from Firm A’s return. (Sub D would be required to file a New Mexico corporate
income tax return, which it is assumed would be filed using SCE reporting.)
Under “unitary combined" reporting, Firms A and B would combine their income and report as if
they were a single firm. If any of the subsidiaries of Firm B are not considered part of the
Firm B
Firm A
Colorado
New Mexico
Sub
A
Sub C
Sub B
Sub D
pg_0009
House Bill 51 – Page
9
unitary business, their incomes would not be included, nor would their property, payroll and sale
be included in the denominator of the apportionment factors. Under “federal consolidated"
reporting, Firms A and B and all of B’s subsidiaries would be included in the return (assuming
they all formed a federal consolidated group). Under both “unitary combined" and “federal
consolidated" reporting, the income of all included corporations would be included in the return,
with transactions among the included corporations eliminated. The return would also include the
apportionment factors of all the included corporations.
Effect of Reporting Method on Corporate Income Tax Liability
The movement from separate corporate entity to unitary combined to federal consolidated
reporting generally increases the taxable income reported on a return, which in itself would
increase income tax liability. However, as each affiliate’s income is added to the return, the
affiliate’s apportionment factors are also added to the return, which would decrease income tax
liability if the affiliate has no in-state activities. Whether a corporation’s income tax liability
increases or decreases under alternative reporting methods depends on whether the effect on
taxable income outweighs the effect on apportionment factors. It also depends on whether an
included affiliate has losses, which might reduce the taxable income that would be reported
under a lower reporting method on the “ladder".
Eliminating one or more of the elective filing method options available under current law would
be expected to increase revenues, on the assumption that firms have elected the filing method
that minimizes their corporate income tax liabilities over time. However, if the elimination of a
filing option resulted in some firms deciding to reduce their operations in the State, or new firms
deciding not to locate in the State, there could be some partially offsetting negative revenue
impact from eliminating options.
Numbers of Returns Filed by Reporting Method
As shown in the following table, in tax year 2005 approximately 18,000 firms filed New Mexico
corporate income tax returns as separate corporate entities (SCE). Approximately 500 returns
were filed as combined unitary, while 1,057 firms filed federal consolidated returns. SCE filers
paid approximately 54 percent of the tax, combined filers paid approximately 14 percent of the
tax obligations, and federal consolidated return filers paid approximately 32 percent of New
Mexico's corporate income tax. SCE filers tend to be relatively small firms, although they can be
quite large. The average tax liability among SCE filers was approximately $9,750, while
combined filers averaged approximately $95,000 per return and consolidated filers averaged
approximately $100,000 per return. Major SCE filers consisted primarily of firms in the mining
extraction and manufacturing industries. Firms in mining industries are also heavily represented
among combined and consolidated filers.
NF/bb