Governor Tate Reeves this week signed into law H.B. 549 to enact a new sales tax exemption for items manufactured in the state and exported for first use in another state, regardless of the party or means by which those goods are delivered. While Mississippi already offered a broad 48-hour vehicle export exemption and also an interstate commerce exemption for goods shipped out of state by the manufacturer or common carrier, the state considered other transactions on par with ordinary taxable retail sales if the purchasers picked the items up at the manufacturer’s facility and took them home.
This restrictive and somewhat arbitrary policy placed Mississippi manufacturers at a competitive disadvantage by discouraging out of state customers from traveling to the state for instruction, training or inspection of locally-manufactured products prior to taking possession. To avoid the tax, the parties would have to arrange and pay for separate shipping even though the purchaser could more cost effectively take the product home themselves. This new law, codified as Miss. Code Ann. § 27-65-101(yy), allows the customer to come into Mississippi to retrieve the product if that is more beneficial, and expressly provides that any in-state instruction, training or inspection of the product does not constitute a taxable first use of the product.
(yy) The gross proceeds from the sale of any item of tangible personal property by the manufacturer or custom processor thereof if such item is shipped, transported or exported from this state and first used in another state, whether such shipment, transportation or exportation is made by the seller, purchaser, or any third party acting on behalf of such party. For the purposes of this paragraph (yy), any instruction to, training of or inspection by the purchaser with respect to the item prior to shipment, transportation or exportation of the item shall not constitute a first use of such item within this state.
The Mississippi Manufacturers Association and several local manufacturing enterprises supported and encouraged this legislation, and the bill received unanimous approval in both chambers of the Legislature. The bill is effective July 1, 2023.
The Mississippi House of Representatives yesterday amended S.B. 2449 to adopt comprehensive provisions regarding the sales and use taxation of remote software and related services.
This amendment codifies the Department of Revenue’s existing regulation that “computer software maintained on a server located outside the state and accessible for use only via the Internet is not a taxable retail sale.” In essence, it would confirm that Mississippi only taxes software that is physically downloaded or delivered into the state, and excludes remote cloud-based applications. It takes a similar approach in taxing only those computer software services actually performed within the state, so computer support activities performed remotely would not fall within the scope of the tax.
The bill is expected to go back to the Senate for concurrence and, if approved, could go to the Governor for signature shortly thereafter.
A Long and Winding Path . . .
This legislation is the culmination of well over a year of debate and study of the remote software taxation issue. Readers may recall prior coverage of the Department’s attempt to capture remote software such as SaaS in late 2021 via a proposed sales tax regulatory amendment. That effort would have deleted from the Department’s current regulations the longstanding provision acknowledging that the tax does not apply to “software maintained on a server located outside the state and accessible for use only via the Internet.” The Mississippi business community vocally opposed this proposal, viewing that attempted amendment as a broad and illegal sales tax increase without legislative approval. Following that backlash, the Department withdrew the proposed regulation but continued to instruct vendors to collect sales tax on these products and services – arguably in direct contravention of existing law.
H.B. 968, a companion bill originally introduced in the House, would have implemented a legislative study committee’s recent recommendation to adopt a broad exclusion for all software and related services used as business inputs. That study committee, established by the 2022 Legislature, conducted multiple public hearings throughout last year and issued its comprehensive final report to the Legislature on October 1. The study committee’s recommendations to exclude these business inputs from sales and use tax reflected the significant compliance complexity associated with constantly changing technology, long-term economic development considerations, and a desire to thwart the rapid expansion of the state’s sales and use tax into ordinary business overhead and administrative expenses.
Following the introduction of the original House bill, a substitute version was adopted in committee that explicitly would have expanded the sales tax to encompass these remotely accessed goods and services, basically adopting the Department’s original position. This amendment caused widespread alarm throughout the business community because it would have represented a significant tax increase on their operations, created a material disincentive to locate, expand or even continue to maintain technology-intensive business activities in the state, and was a major departure from historic Mississippi tax policy related to remotely accessed computer software products and services.
The bill contains many important changes and features, including the following:
Inserts language clarifying that taxable retail sales of tangible personal property include only those items that are “physically or electronically delivered or located within this State.” The bill also codifies in both the sales and use tax codes the Department’s existing regulation that “computer software maintained on a server located outside the state and accessible for use only via the Internet is not a taxable retail sale.”
Clarifies that Mississippi only taxes “computer software services actually performed within this state” as distinguished from those performed remotely from locations outside the state.
Adopts formal definitions of computer software, computer software services, and information and data processing services, with multiple illustrative examples. Information and data processing services are expressly excluded from taxation.
Direct accrual and reporting by end users – The bill requires the Department to offer software users the equivalent of a direct pay permit that they can provide to their vendors and services providers, relieving those third parties of their obligation to collect sales or use tax. Instead, the user will self-accrue and report the appropriate taxes based on their use of taxable items and services within the state.
Each user can elect whether to utilize this process or follow the traditional methods of paying taxes to their vendors. This process already exists for manufacturers and certain other industries, and should be easily implemented.
This removes the vendor or provider from the collection process, which should significantly streamline compliance and allow for the direct recovery of any overpayments by the end user.
Exclusion for PaaS and Iaas – Clarifies that computer software does not include charges for the use of or right to use physical computer equipment, infrastructure, servers, platforms and other tangible computer devices, including but not limited to items commonly referred to as “platform as a service” or “infrastructure as a service.” Thus, remote cloud-based services such as PaaS and IaaS would not be taxable as long as the underlying equipment resides outside Mississippi.
Bundled transactions – Authorizes taxpayers to “unbundle” transactions comprised of both taxable and nontaxable computer software or services. Importantly, the new law would expressly bar any presumption that the entire fee or payment is taxable because it encompasses both taxable and nontaxable elements.
Multistate allocations – The new version authorizes taxpayers to determine that portion of a multistate license fee or payment attributable to computer software located within the state, or to computer software services which are actually performed within the State of Mississippi. The law provides several “safe harbor” methods taxpayers can use in making this allocation.
While the Department is authorized to audit a taxpayer’s method of unbundling or allocating multistate software or service usage, the bill includes language protecting against arbitrary audit positions. As long as the taxpayer’s method was supported by its books and records, the Department will have to establish by a preponderance of the evidence (a) that the allocation method utilized by the seller, service provider, user, or consumer was not a reasonable method of allocation and (b) that the allocation method proposed by the commissioner is the most reasonable of all available or alternative methods. This language should be similar to the income tax alternative apportionment provisions adopted nearly a decade ago.
Intercompany exemption – The amendment enacts a rule that computer software and computer software services provided by one legal entity to another commonly owned, related, or affiliated entity shall be treated as nontaxable transfers between different segments of one legal entity. This is intended to protect internal corporate IT and technical support groups from triggering a sales tax liability. The language states clearly that it does not exempt the purchase of those items from third parties, as those external transactions would remain taxable based on the above rules.
Credit for taxes paid to other states – The bill provides a sales tax credit mechanism for taxes paid on these items to other states. The use tax code already includes this provision, but it was necessary to incorporate similar rules in the sales tax statutes to prevent double taxation across multiple states.
Transition provisions / effective date – The bill would be effective July 1, 2023, in order to allow the Department to update its direct pay permit process and for taxpayers to update their compliance platforms. These changes are prospective only, and do not impact any assessment, refund, etc. proceedings applicable to periods prior to the effective date.
While the bill appears to have momentum for ultimate passage, Jones Walker LLP will continue to monitor and report on any developments.
The Mississippi Legislature has taken up two bills this session [HB 1668 / SB 3102] intended to correct several technical issues contained in last-year’s pass-through entity (“PTE”) election legislation. See our prior coverage of the original PTE legislation here and here, as well as concerns about estimate payment penalties here.
As of this date, both chambers have passed their respective bills and transferred those bills to the other chamber. While some technical differences exist between the two proposals, they are the result of joint efforts of the Mississippi Society of Certified Public Accountants and the Department of Revenue, and are intended to address the following practical issues:
Clarifies that any PTE credits that exceed an owner’s income tax liability are refundable or can be taken as a credit carryforward into subsequent tax periods. The original legislation did not expressly address this important practical issue, and the feature should also help preserve the benefit of the rate differences between corporate and individual owners of a PTE. The PTE tax is computed at a flat 5% rate, but in 2022 the state reduced the individual income tax rate by eliminating the 4% tax bracket and enacting scheduled reductions of the top 5% rate to 4% by 2026. Following that rate reduction, an individual owner’s flow-through credit would be based on the 5% PTE tax rate, calculated at the entity level, but their individual liability would have been calculated at the lower 4% rate. If the PTE credit is not refundable, an individual owner could effectively lose the benefit of that earlier rate reduction.
Removes a potential “double-dipping” scenario. The original legislation stated that income of a PTE is exempt at the owner level, but also provided that the owners receive a credit equal to the taxes paid at the PTE level. A strict reading of that could lead to an unintended double benefit, so the proposed legislation would clarify that the owner includes its share of the PTE income in calculating the owner’s gross Mississippi income tax liability, and then claims the credit for the taxes paid at the entity level. There are differences between the two bills on the specific mechanics of that, but the eventual legislation is expected to ensure that no credits are able to be used twice (once at the PTE level and again at the owner level) and that the calculations function to ensure that non-corporate owners receive the benefit of the lower tax rates applicable to individuals.
Confirms that the PTE credit is calculated prior to application of any PTE-level tax credits. A concern under the original law was that if it were interpreted that an owner-level credit for tax paid by the PTE is calculated based on the amount of tax paid after the application of PTE-level credits, that might effectively nullify the benefit of the entity-level business credit (such as Ad Valorem or Children’s Promise Credits). The following example helps to illustrate the issue:
Assume the PTE has $1,000,000 of taxable income, so its initial entity-level income tax liability would be $50,000 (assuming flat 5% rate for model purposes). If it generated and claimed a $50,000 ad valorem tax credit, its net entity-level tax liability would be $0.
Also assume the PTE has two equal owners. Each owner gets an equal allocation of $500,000 of taxable income but will not receive any credit for tax paid at the PTE level if that credit is based on the PTE’s final tax liability. When the owners compute their separate owner-level tax liabilities, they have $500,000 of income x 5% rate (assuming the maximum corporate rate) resulting in each having a tax liability of $25,000. But each owner’s share of the PTE credit for tax paid at the PTE level is $0, so they have a net $25,000 shortfall and effectively lose the benefit of the entity-level tax credit.
The House bill’s solution is to allow the PTE credit to be calculated based on the gross entity-level tax determined prior to the application of any business credits at the PTE level. In the above example, each owner could claim a PTE credit of $25,000, fully offsetting the liability associated with that PTE income. The owners also would claim their pro-rata share of the ad valorem tax credit (or any other credits generated at the PTE level), thereby ensuring that they receive the full benefit of the rate differential and the value of those credits.
On this point, the primary difference between the current House and Senate bills is that the House bill was updated to reflect follow-up discussions with the Department related to what level the business credits would be claimed (i.e., the entity versus owner levels). Those changes have not been incorporated into the Senate bill yet but may be added before final passage.
Modifies the election process to account for different PTE internal voting requirements. To make or revoke an election, the original legislation required that there be “a vote by or written consent of the members of the governing body of the entity as well as a vote by or written consent of the owners, members, partners or shareholders holding greater than fifty percent (50%) of the voting control of the entity, within the time prescribed in this subsection.” Thus, the approval must be made at two levels even though management decisions may or may not be centralized in a board or other governing body, the vote must pass by a specified threshold that may not be consistent with other voting rights/thresholds provided under an entity’s governance documents, and the votes must take place within a specified period. A strict reading of the statutory election requirement also posed questions whether a simple manager governance structure constitutes a centralized board or “other governing body.” The proposed legislation should accommodate other internal management and voting arrangements.
Transition language. The House bill provides that the changes shall take effect and be in force from and after January 1, 2023, and shall be applicable to any income tax returns the original due date of which are on or after such date. That should make the technical revisions applicable to the vast majority of PTE returns that would be filed for the 2022 tax year. This language is missing from the Senate bill but may be added during the amendment process.
Estimated Payment Issue Still Unresolved
One important practical issue the current bills do not address is the concern over estimated tax penalties. Under the current scheme, it may be necessary in an election or revocation year to make duplicate estimated payments at both the entity and partner/member level to avoid estimated tax penalties. For example, if an entity is contemplating making the election for the 2022 tax year (due no later than March 15, 2023 for most entities), the PTE should have been making estimated payments throughout 2022 at the entity level to avoid estimated tax penalties even though the owners may have been making their own estimates based on their anticipated flow-through income. Many of those eligible companies, however, still may not have decided whether to make the election and until now did not have the benefit of the full year’s financial results to enable them to quantify any benefits of the election.
The practical problem is that in the event a PTE election is not made, to avoid their own penalties the partners/members should be making their own estimated payments based on the possibility that the PTE income could be taxed at their level and included in their returns as in prior years. It is very unlikely that DOR will “move” estimated payments from an individual account to an entity account to avoid double payment and/or penalties, which means refund claims will be likely at one level or the other once the final filing position is determined and liability is calculated.
DOR previously indicated informally that they will likely waive any penalties that might apply for having failed to make entity-level 2022 Q1 and Q2 estimated payments due to the effective date of the original legislation and the lack of an election mechanism at that time. Penalties related to the failure to make entity-level estimates for Q3 and Q4, however, may be more difficult to abate.
Jones Walker will continue to monitor the progress of this legislation and report out as events further develop.
Alysse McLoughlin, a partner on the JW SALT team in the New York office, spoke at the Wall Street Tax Association’s 2022 Fall Tax Conference on November 22, at the New York Marriott Marquis. Alysse spoke on the “State and Local Taxation Panel” regarding an update on draft regulations and other trends in New York, proposed legislation in New Jersey, market sourcing, and other multi-state tax opportunities and issues.
Bill will speak on the panel “The New Frontier in Mergers and Acquisitions”, which will cover unique issues on diligence, discuss how to navigate the role of representations and warranties insurance, and provide practical guidance to successfully close a transaction from both a buy-side and sell-side perspective.
Alysse will speak on the panel “Allocation: Double Taxation and Other Issues”, which will address these tricky allocation issues with a particular focus on the problems that arise with sourcing investment income.
Jones Walker SALT partner, John Fletcher, was quoted in the article “Calif. Pork Law Fight May Guide Post-Wayfair Tax Challenges,” published by Law360 on October 14, 2022. The article covers an ongoing US Supreme Court Case regarding interstate commerce, previous tax litigation, and whether California’s importation of pork from other states violates a voter-approved initiative regarding in-state meat sales. John discussed the case in relation to the US Supreme Court’s decision in South Dakota v. Wayfair, which allows states to tax purchases from out-of-state sellers. He addressed the possible burdens placed on amateur sellers to comply with additional state sales tax regimes and reviewed the Justices’ attitudes toward the costs and benefits of interstate commerce.
John was also quoted in the article “Miss. Shouldn’t Tax Software Used as Biz Input, Report Says,” published by Law360 on October 3, 2022. The article discussed the implications of Mississippi providing sales and use tax exemptions for business input software and cloud computing services, and John explained that the state would be prohibited from automatically imposing a tax on software with an administrative service that used to be tax-free.
Jones Walker SALT Team members Jay Adams, Jeff Birdsong, Cami Fergus, John Fletcher, Matt Mantle, and Alysse McLoughlin attended and spoke at the 2022 Institute for Professionals in Taxation (IPT) Sales Tax Symposium in Boston, MA. The Institute, founded in 1976, is a 501(c)(3) not-for-profit educational association serving more than 6,000 members representing approximately 1,200 corporations, firms, or taxpayers throughout the United States and Canada. It is the only professional organization that educates, certifies and establishes strict codes of conduct for state and local income, property, sales & use, and value added tax professionals and credits& incentives practitioners who represent taxpayers (government officials or organizations do not qualify for membership).
At the Supreme Court early with my great friend Pat Reynolds of COST. Following National Pork Producers case, will it be a sleeper SALT case? Will Pike balancing test be toast? Is the dormant Commerce Clause really a “dead letter”? Looking forward to watching my first oral arguments.