Companies doing business in Michigan have become accustomed to the infamous single business tax (SBT), which has a federal taxable income starting point and add-backs for compensation and depreciation expense. For a state dependent on the cyclical auto industry, this value-added tax provided a smooth revenue stream to the Department of Treasury. These same addbacks, however, generally resulted in a tax liability for businesses that would otherwise be in a loss position. In August 2006, the SBT was repealed, effective December 31, 2007. In its place, the Michigan business tax (MBT) was created, which applies to all business activity after December 31, 2007. This column briefly describes theprimary components of the new MBT and highlights three important issues for taxpayers to consider.
- The MBT is effective January 1, 2008 (unless otherwise indicated).
- The MBT has two tax bases, and taxpayers are subject to both: a business income tax (BIT) imposed at a rate of 4.95% and a modified gross receipts tax (GRT) imposed at a rate of 0.80% (collectively referred to here as the “BIT/GRT calculation”).
- The state claims jurisdiction to impose the MBT (and thus both the BITand GRT) on a low nexus standard, with taxability triggered by either (1) physical presence in Michigan for more than one day annually or (2) active solicitation in Michigan and $350,000 or more of Michigan-sourced gross receipts. Despite the low nexus standard, the BIT is not levied on taxpayers with Michigan activities that do not exceed the P.L. 86-272 safe harbors.
- Both the BIT and GRT are computed on a unitary combination basis.
- Apportionment of both BIT and GRT bases is on a 100% weighted sales factor.
- Substantial credits are provided for Michigan compensation, capital investment, and research and development (R&D).
- Financial institutions are subject to a 0.235% franchise tax on net capital. The nexus standard for the financial institutions franchise tax is the same as for the MBT.
- Insurance companies are taxed at 1.25% on gross direct premiums.
- Michigan personal property taxes levied after December 31, 2007, are considerably reduced: 24 mills on industrial personal property (roughly a 50% reduction) and 12 mills on commercial personal property.1
GRT Rate and Base
The new GRT is imposed at a rate of 0.80% on a taxpayer’s apportioned modified gross receipts tax base. The MBT definition of gross receipts closely follows the definition of gross receipts under the SBT.2 As was the case with the SBT, a long list of exclusions applies for revenues that are not considered gross receipts. However, a deduction is allowed for purchases from other firms. Deductible purchases include inventory, depreciable assets, and supplies.
BIT Rate and Base
In addition to the GRT, a separate business income tax of 4.95% is imposed on a taxpayer’s apportioned BIT base. The BIT base is essentially federal taxable income with various pre-apportionment adjustments, many of which are similar to adjustments required in other income tax states.3 However, Michigan adds a few unique modifications:
- Income from another entity that is, or otherwise would be, subject to the MBT is deducted, and such losses are added back.
- Royalty and interest expense paid to related parties (not otherwise included in a unitary business group) is added back.
- Partnerships are allowed to deduct 100% of any earnings that are net earnings from self-employment, except to the extent that those net earnings represent a reasonable return on capital.4
To the extent that a business income loss is generated, the available business loss may be carried forward and deducted from a taxpayer’s post-apportionment BIT base. The business loss carryforward is limited to 10 years.5
One of the overriding goals of the MBT is to create and maintain investment in Michigan. The MBT provides numerous credits, the more generally applicable of which include:
- A 0.37% credit for “compensation” paid in Michigan. The definition of compensation includes not only salaries and wages but also other items that generally were included as addbacks to the SBT base. This credit is also available to insurance companies, subject to certain limitations, in calculating the gross direct premiums tax.6
- A 2.9% investment tax credit (ITC), calculated on a taxpayer’s capital investment in assets physically located in Michigan. The calculation of eligible assets is virtually identical to the SBT ITC calculation and requires a recapture on the disposition of previously acquired ITC-eligible assets (both SBT and MBT ITC).7
- A 1.9% R&D credit, based on R&D expenses in Michigan. The term “research and development” is defined as in Internal Revenue Code Sec. 41(b).8
The wage and investment tax credits are limited to 65% of a taxpayer’s BIT/GRT liability, and the R&D credit (combined with the wage and investment tax credits) may not exceed 75% of the tax.9 The MBT does not provide for a carryforward of unused wage, ITC, or R&D credits.
In addition to the credits noted above, the MBT also provides for a refundable credit equal to 35% of the amount of personal property tax paid during the tax year on industrial personal property. Unlike the wage, ITC, and R&D credits discussed above, this property tax credit has no limitation. The property tax credit is in addition to the roughly 50% reduction in personal property tax liability that companies will experience beginning in 2008 on their manufacturing operations.
MBT Issues to Consider
The new MBT brings with it many complexities and new concepts. Three important issues for a taxpayer to consider when determining its MBT liability are the definition and scope of gross receipts, the GRT deduction for purchases from other firms, and changes in the sales factor calculation.
Gross Receipts May Draw on Historic SBT Interpretations
As noted above, the MBT definition of gross receipts is patterned after the SBT definition and includes an expanded list of fairly narrowly tailored exclusions. Considering that this definition is much more significant for MBT purposes than it historically has been for SBT purposes (because gross receipts is a required rather than an alternative component of the MBT), greater attention is now being focused on what should or should not be included for the GRT calculation. For example, the requirement in the gross receipts definition that amounts be “received” has been acknowledged as a significant qualifier in the SBT setting.10 As the same concept of “the entire amount received” appears in the MBT definition of gross receipts,11 it is conceivable that the actual receipt of items may be required for MBT purposes. In this context, consider the treatment of deemed dividends or items of partnership income that are separately reported on the K-1 of a partner—both are items of income that may be reflected on a federal tax return without actual receipt of cash, a cash equivalent, or other economic benefit.
Careful attention should also be paid to the numerous MBT exceptions from classification as gross receipts, such as amounts received in an agency capacity and the amount of proceeds from the sale of a capital asset that is not related to gain.12
Arriving at the GRT Base
The GRT deduction for purchases from other firms is broader than it might at first appear, and it includes not only inventory and raw materials but also depreciable or amortizable asset purchases. Since the deduction is not limited to purchases of tangible assets, software appears to qualify. In addition, supplies, repair parts, and fuel qualify. For taxpayers that satisfy the definition of “staffing companies,” the compensation cost of supplying personnel to customers is also treated as a “purchase from other firms.” Certain taxpayers (construction contractors, generally) may include “services purchased for a construction project under a contract specific to that project” in their computation of purchases from other firms.13
One point of caution: No provision exists within the MBT to carry forward a negative GRT base into subsequent tax years. This lack of a carryforward, combined with what appears to be required full recognition of expenditures in the year incurred, could have unique consequences. For example, large expenditures (e.g., for depreciable real estate) may result in a GRT deduction that exceeds gross receipts for the year of the expenditure. The excess may not be carried forward to subsequent periods, thus limiting the taxpayer’s future offset of gross receipts. While other factors (including business needs and the related tax and accounting impact) certainly must be weighed, taxpayers may wish to consider the timing of significant purchases to maximize the benefit of the deduction.
Sales Factor Changes
Both components of the BIT/GRT calculation are apportioned to Michigan based on a single factor that is derived by dividing the taxpayer’s total sales in Michigan by its total sales everywhere.14 For unitary business groups, Michigan sales includesales in Michigan by each person that is a member of the group “without regard to whether the person has nexus” in Michigan.15
As under the SBT, sales of tangible personal property under the MBT are sourced on an ultimate destination basis. For the sale of services, sales are sourced to Michigan to the extent that the recipient receives benefit of the services in Michigan. This is a notable change from the SBT’s “all or nothing” cost-of-performance approach for services.16
A similar approach is applied to the sourcing of “[r]oyalties and other income received for the use of intangible property,” which are sourced “to the state in which the property is used by the purchaser.”17 The statute indicates that use in the state by the purchaser (or licensee) has no relationship to the location of the purchaser’s (or licensee’s) customers.
Although the MBT offers many changes from the SBT, it also brings its own set of complexities. Guidance from Treasury and the courts will be necessary to put many of these provisions into context.
Scott Salmon is a Partner for KPMG LLP, Washington, DC
Mr. Salmon is the chair of the AICPA Tax Division’s State & Local Taxation Technical Resource Panel.
For more information about this column, contact Mr. Wright at firstname.lastname@example.org.
Author’s note: This article does not constitute tax, legal, or other advice from Deloitte Tax LLP, which assumes no responsibility with respect to assessing or advising the reader as to tax, legal, or other consequences arising from the reader’s particular situation.
1 Mich. Comp. Laws §§208.1201(1); 208.1203(1); 208.1200(1); 208.1117(6), 208.1201(3), 208.1203(3), 208.1511; 208.1301(2), 208.1303(1); 208.1403, 208.1405; 208.1263(1); 208.1235(2); 380.1211(1), 380.1211(4), 211.903(3).
2 Mich. Comp. Laws §§208.1203(1); 208.7(3).
3 Mich. Comp. Laws §§208.1201(1); 208.1105(2); 208.1201(2).
4 Mich. Comp. Laws §§208.1201(2)(e); 208.1201(2)(f); 208.1201(2)(h).
5 Mich. Comp. Laws §§208.1201(4).
6 Mich. Comp. Laws §§208.1403(2), referring to an insurance company described in §208.1239(2) and subject to tax under §§208.1235–208.1243.
7 Mich. Comp. Laws §208.1403(3).
8 Mich. Comp. Laws §208.1405.
9 Mich. Comp. Laws §§208.1403(1); 208.1405.
10 Ford Credit Int’l, Inc., 716 NW2d 593 (Mich. Ct. App. 2006).
11 Mich. Comp. Laws §208.1111(1).
12 Mich. Comp. Laws §§208.1111(1)(a), (b), (o).
13 Mich. Comp. Laws §§208.1113(6)(d), (e).
14 Mich. Comp. Laws §208.1303(1).
15 Mich. Comp. Laws §208.1303(2) (referred to by practitioners as the “Finnigan rule” after the California State Board of Equalization decision in Appeal of Finnigan Corp., 88-SBE-022 (8/25/88)).
16 Mich. Comp. Laws §§208.1305(2)(a); 208.53(b) (repealed, effective after 12/31/07).
17 Mich. Comp. Laws §208.1305(1)(e).