Early this morning, the House adopted a budget that made significant changes to Rhode Island corporate income taxes.
In order to make Rhode Island more competitive to attract and retain businesses, the corporate tax rate was reduced from 9% to 7%, beginning January 1, 2015. Even though few businesses paid the full 9% rate – due to tax credits and exemptions in existing law, such as the jobs tax credit - legislators were concerned that companies look to the base tax rate in determining whether Rhode Island should make the short list for locating or expanding their businesses. The new Rhode Island rate will be lower than both Massachusetts (at 8%) and Connecticut (at 7.5%).
A reduction in the corporate tax rate, of course, reduces state revenues. To fund the rate reduction, combined reporting was introduced. Combined reporting changes the way that businesses allocate their income to Rhode Island to pay state income tax. After a two-year study required by the legislature in 2011, the Tax Administrator reported in March that millions of dollars could be raised by instituting combined reporting, even taking into account the costs required to implement and administer it (including increased staff, new forms, and potential litigation). This increased revenue will offset the reduction of the corporate tax rate.
Combined reporting requires businesses that earn money in Rhode Island to report the combined income of their “combined group”. Generally, this means their affiliates located within the US, in foreign countries that don’t have a tax treaty with the US, and in so-called “tax haven” countries. The corporation will then pay taxes on its share of that “combined income” that is allocated to Rhode Island.
A few things to note.
First, these changes do not affect S corporations, partnerships, or LLCs – only C corporations.
Second, these changes only affect C corporations with affiliates outside of Rhode Island; businesses that are located only within Rhode Island are not affected.
Third, these changes do not affect any C corporations already exempt from the corporate income tax (e.g. banks, insurance companies, nonprofit corporations).
Fourth, to minimize the impact on C corporations that have significant ties to Rhode Island, the legislation also changed the allocation method for businesses that operate in multiple states, jettisoning the current three-factor apportionment (sales, property and payroll) in favor of the so-called “single sales factor”. This change means that property owned in Rhode Island, and payroll paid in Rhode Island, are ignored in calculating a business’ Rhode island corporate tax, so that a business can hire employees or build a plant here without incurring any additional corporate income tax.
Fifth, affiliates are only included in the combined group if they are “unitary”, generally meaning that the affiliates are integrated in a way that makes them work as a single economic enterprise.
Sixth, for foreign affiliates, they are included only if their sales factors in the US are 80% or more.
Finally, for foreign affiliates located in “tax haven” jurisdictions, the General Assembly and Tax Administrator agreed to language that will permit businesses to exclude those affiliates from the combined group if the “tax haven” has a treaty with the US, and the business can show that the affiliate is located in a “tax haven” for legitimate business reasons, rather than for avoidance of Rhode Island taxes, or that inclusion is otherwise unreasonable.