Summary
This week, Delaware Governor Jack Markell signed into law HB 235, otherwise known as the Delaware Competes Act of 2016. HB 235 was passed by the Delaware State House of Representatives on January 14, 2016 and the Delaware State Senate on January 21, 2016. HB 235 amends Delaware’s business tax code to accomplish three major objectives: (1) incentivize job creation and investment in Delaware, (2) make Delaware’s tax structure more competitive with other states, particularly regionally, and (3) support small businesses by making tax compliance less burdensome.
Changes to Corporate Income Tax Calculation
HB 235 accomplishes the first two objectives by restructuring the current corporate income tax.
Prior to the adoption of HB 235, multi-state firms were taxed in Delaware using a three-factor apportionment, which took the average of three factors (weighing each factor evenly): (a) the percentage of property a firm owned in Delaware vs. the rest of the United States, (b) the percentage of a firm’s payroll in Delaware vs. the rest of the United States and (c) the percentage of a firm’s sales in Delaware vs. the rest of the United States. Delaware was one of only nine states that still used this three-factor apportionment, and the only state on the East Coast to do so.
The use of property and payroll, in addition to sales, had been criticized because firms that created jobs in Delaware by building or buying facilities (increasing property ownership) and hiring new personnel (increasing payroll) were likely to see their apportionment rise, which ultimately increased their corporate income tax – thus creating a disincentive to invest in Delaware.
Section 8 of the Act reduces and then eliminates three-factor apportionment to encourage multi-state firms to invest in property and employees in Delaware by first doubling the weight on the sales factor in tax year 2017 and then gradually moving toward exclusive reliance on the sales factor beginning in 2020. Specifically, in 2017, sales would be weighted at 50 percent, increasing thereafter: in 2018 at 60 percent, 2019 at 75 percent, and 2020 and onwards at 100 percent.
Changes to Help Small Businesses
The bill accomplishes the third objective of supporting Delaware’s small business community by simplifying its tax compliance requirements and expanding the corporate income tax safe harbor.
Previously, most Delaware small businesses had to make monthly gross receipts tax and withholding filings. As adopted, HB 235 doubles the outdated thresholds that determine which businesses have to make the monthly filings, enabling most small businesses to file on a quarterly basis instead. Furthermore, the tax calculations will be indexed for inflation to prevent thresholds from becoming outdated again.
HB 235 also restructures and simplifies the tax payment schedule for small businesses. Previously, all Delaware businesses paid 50 percent of their total tax liability for each year by April 1, another 20 percent by June 15, another 20 percent in the third quarter, and 10 percent in the fourth quarter. Now, businesses with receipts of less than $20 million will be able to instead pay 25 percent per quarter, easing cash flow issues for many businesses.
HB 235 updates the corporate income tax safe harbor. The safe harbor shields small companies from penalties related to failures to estimate income tax liability correctly. The bill will increase the threshold, for the first time since the 1980s, from $200,000 to $20 million of taxable income.
Impact on Foreign Companies
Finally, HB 235 clarifies that, for the purposes of income attribution, only U.S.-based assets are part of the calculation. Sections 7 and 8 of HB 235 provide that businesses organized under the laws of foreign countries that do business in the U.S. may not dilute their property and payroll factors by including property and payroll that is located outside of the United States in the average under the three-factor apportionment system.
Additional Options for Delaware-based Corporations and Telecommunications Companies
Section 9 provides that, starting in 2017, telecommunications corporations and corporations with their worldwide headquarters located in Delaware that make capital investment in those facilities may choose to use either three-factor apportionment or single sales factors.
The Delaware Competes Act of 2016 was passed with the strong support of the Delaware State Bar Association, whose current president is Saul Ewing Partner Richard Forsten.
View Document(s):
