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The municipal net profit throwback rule, which was first enacted in 1957, has been a contentious issue between taxpayers, tax practitioners, and municipal tax administrators for many years. The current version of the biennial budget bill, House Bill 49, proposes to eliminate the municipal net profit throwback rule. Over the next several months, members of the Ohio General Assembly have the opportunity to address this issue.
Municipal Net Profit Apportionment
To understand the impact of the throwback rule, a basic foundation in municipal net profit tax law is necessary. In general, a taxpayer is subject to income tax in each jurisdiction in which the taxpayer is doing business. Each of those jurisdictions may subject a portion of the taxpayer's income to tax based on the apportionment formula. For Ohio municipal net profit tax, income is apportioned by computing the average ratio of a taxpayer's property, payroll, and sales in a municipality to the average ratio of a taxpayer's property, payroll, and sales everywhere. After computing the apportionment percentage for a municipality, a taxpayer multiplies that percentage by taxable income to determine the amount of income subject to tax in the municipality. The apportioned income is then multiplied by the tax rate to determine the total amount of tax due to that municipality.
Sales Apportionment Ratio
One of the factors in computing the apportionment formula is the sales factor. A detailed and thorough analysis of the sales factor must be completed by taxpayers on an annual basis to determine where sales should be sitused for municipal net profit tax purposes. For sales of tangible personal property, sales are sitused to a municipality in one of three methods:
The property is shipped to or delivered within a municipal corporation from a stock of goods located within the municipal corporation,
The property is delivered within a municipal corporation from a location outside the municipal corporation, if the taxpayer is regularly engaged in the solicitation or promotion of sales within the municipal corporation and the sales result from the solicitation or promotion, or
The property is shipped from a place within the municipal corporation to purchasers outside the municipal corporation, provided that the taxpayer is not, through its own employees, regularly engaged in the solicitation or promotion of sales at the place where delivery is made.
The third method of situsing a sale of tangible personal property is referred to as the throwback rule. Under this municipal throwback rule, a sale is deemed to be made in the municipality from which the product is shipped if a taxpayer is not, through its own employees, regularly engaged in the solicitation or promotion of sales at the place where the delivery of the product is made. Below are several examples to illustrate how the throwback rule operates.
A taxpayer has a manufacturing operation in Defiance, Ohio. The taxpayer also has a warehouse in Defiance from which it ships its finished products. These products are sold by employee sales representatives, independent sales representatives, and through the taxpayer's website.
Sale 1: A sales representative, who is an employee, engages in the solicitation of sales at the warehouse of a retailer in Columbus, Ohio. The taxpayer ships the product from its warehouse in Defiance to the retailer's warehouse in Columbus. To which jurisdiction would this sale be sitused for municipal net profit tax purposes?
Answer: Since the taxpayer is engaged in the solicitation of sales through its own employee at the place of delivery in Columbus, the throwback rule does not apply and the sale would be deemed to be a Columbus sale.
Sale 2: A sales representative, who is an employee, engages in the solicitation of sales at the headquarters of a retailer in Columbus, Ohio. The taxpayer ships the product from Defiance to the retailer's warehouse in Cleveland. To which jurisdiction would this sale be sitused for municipal net profit tax purposes?
Answer: Although the taxpayer used its own employee to solicit the sale, the sale is "thrown-back" and deemed to be a Defiance sale because the employee solicited the sale at the headquarters of the customer in Columbus, not the customer's warehouse, which was the place of delivery, in Cleveland.
Sale 3: An independent sales representative solicits a sale on behalf of the taxpayer in Seattle, Washington. The taxpayer ships the product from its warehouse in Defiance to Seattle to the location where the independent sales representative solicited the sale. To which jurisdiction would this sale be sitused for municipal net profit tax purposes?
Answer: Since the taxpayer used an independent representative to solicit the sale, not its own employee, the sale is "thrown-back" and deemed to be a Defiance sale for Ohio net profit tax purposes. It is also important to note that Washington imposes a Business and Occupation ("B&O") tax, similar to the Ohio Commercial Activity Tax, and the sale would also be subject to B&O tax in Washington. Further, the City of Seattle imposes a local B&O tax, similar to the Ohio Commercial Activity Tax, and would also impose the local B&O tax on the sale. Thus, tax would be imposed on the sale in Defiance, Washington, and Seattle.
Sale 4: A customer located in England purchases a product through the taxpayer's website. The taxpayer ships the product from its warehouse in Defiance to the customer's location in England. To which jurisdiction would this sale be sitused for municipal net profit tax purposes?
Answer: Since the taxpayer solicited the sale through its website, not its employee, the sale is "thrown-back" and deemed to be a Defiance sale. This example portrays one of the hurdles Ohio faces in attracting internet companies. Companies that only sell over the internet will likely be required to include all sales of tangible personal property, regardless of the ultimate destination of the product, in the sales apportionment formula of the municipality from which the product is shipped.
The examples portray the complexities of determining the proper situsing of sales of tangible personal property for municipal net profit tax purposes. Taxpayers that use a mix of employee sales representatives, independent sales representatives, and a website to solicit sales have a monumental task every tax filing season to determine where sales of tangible personal property should be sitused. Further, the municipal throwback rule particularly impacts Internet-based companies that locate their warehouses in Ohio, thereby making Ohio less attractive to this growing industry.
Many states have adopted a throwback rule (but Ohio has not). However, the majority of states in which the throwback rule applies, the sale is typically required to be thrown-back to the jurisdiction from which it is shipped only if the sale is to the United States Government or the seller is not subject to tax in the jurisdiction to which the sale is shipped. There are no states that determine if a sale must be thrown-back based upon the person that solicited the sale or whether the person solicited the sale at the delivery location.
The use of throwback rules by states has come under fire by policy makers. For example, Indiana previously imposed a throwback rule which required a taxpayer to throwback the sale to Indiana if the taxpayer was not taxable in the state of the purchaser. In 2014, then Governor Mike Pence held a conference on Tax Simplification and Competiveness as a way to review Indiana's tax structure. One of the recommendations from this conference was to eliminate the throwback rule. The report issued by the conference cited that the Indiana Economic Development Corporation determined that the state was less likely to attract certain companies to the state because of the throwback rule. Ultimately, as part of a tax reform package in 2015, Indiana eliminated its throwback rule effective January 1, 2016. More states may follow Indiana's lead as a way to attract companies to locate in the state. Ohio should not be left behind.
The proposal to eliminate the Ohio municipal throwback rule has been a significant topic of debate during this biennial budget process. If the General Assembly decides to eliminate this rule, Ohio could have additional selling points for businesses to locate in Ohio. However, it is expected that the elimination of the throwback rule will continue to receive major resistance from local governments and lawmakers. Therefore, businesses may want to consider ways to support the elimination of this rule.
If you would like to discuss the throwback rule, please contact Adam Garn, Tom Zaino, or one of our ZHF professionals.