2003 Connecticut Tax Law Developments

JurisdictionConnecticut,United States
Publication year2021
CitationVol. 77 Pg. 219
Pages219
Connecticut Bar Journal
Volume 77.

77 CBJ 219. 2003 CONNECTICUT TAX LAW DEVELOPMENTS




219


2003 CONNECTICUT TAX LAW DEVELOPMENTS

BY JOHN R. SHAUGHNESSY AND GLENN G. RYBACKI(fn*)

I. LEGISLATIVE DEVELOPMENTS

In its 2003 sessions, the General Assembly was faced with significant projected deficits for the 2003-04 biennium. The reaction to this state of affairs led to passage of a number of revenue-enhancing measures, including decoupling from the newly enacted federal bonus depreciation and repeal of the sunset on computer and data processing services.(fn1) The session was also marked by missteps such as the repeal of the sales tax exclusion for media and cooperative direct mail advertising followed by repeal of the repealer after a scant three months.(fn2) Another was enactment of a Department of Revenue Services (hereinafter the "Department") proposal which would have forced a combined(fn3) return of all affiliates engaging in certain intracompany transactions. Resistance from the business community prevented this legislation from becoming effective, but budget considerations forced replacement with an interest add-back provision.

A. Corporate and Income Taxes

Throughout the history of the corporation business tax, Connecticut has been a separate return state, separately taxing each corporation having Connecticut nexus. Combined reporting by contrast requires the amalgamation in a single return of all related corporations, whether or not each of the corporations included in the return has nexus with the state.(fn4)

The Department's proposal required such a return, referred to as an alternate combined report ("ACR"), to be filed in the




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event of certain intercompany relationships or transactions.(fn5)

These included: transacting business to the extent of 50% or more of gross income among affiliates; providing any one of a number of services such as advertising, accounting, cash management, legal services, research and development, purchasing, manufacturing, distribution or administration of employee benefit programs; a relationship of indebtedness among affiliates to the extent of 20% of a corporation's debt; or the transfer to an affiliate of property producing operating income by the receipt of income therefrom. These conditions, any one of which triggered the ACR requirement, applied without regard to an arms-length charge among the affiliates in question, an omission which would have imposed the ACR requirement on corporations engaged in any number of ordinary management transactions.(fn6)

What made this proposal particularly onerous was the requirement that the combined group pay the higher of the separate return or ACR tax. However, the ACR legislation, although enacted, never actually became law. The governor signed it at the same time that he signed a replacement provision that contained a repeal of the ACR legislation and the interest add-back provision.(fn7) Under this legislation, a corporation must add back otherwise deductible interest expenses and costs allowed under Section 163 of the Internal Revenue Code of 1986, as amended (hereafter the "IRC"), if the interest expenses and costs are directly or indirectly paid, accrued or incurred to a related lender. To ameliorate the harsh result of this add-back, five exceptions are provided, modeled after a Massachusetts statute: (1) if the purpose of the transaction is not to avoid tax, the transaction reflects an arm's length rate and terms, and the related lender is subject to tax in another state or foreign jurisdiction at a tax rate no more than 3 percentage points below the Connecticut corporation business tax rate; (2) if the corporation establishes that the add-back adjustment is unreasonable; (3) if the corporation elects to file




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a unitary combined return, provided there are substantial intercorporate business transactions among the included corporations; (4) if the corporation paid, accrued or incurred interest to a related lender that is located in a country with which the United States has a comprehensive income tax treaty; and (5) the corporation may petition the Department of Revenue Services for approval of an alternate method of determining the combined measure of tax.(fn8) It remains to be seen how the Department will administer this statute.(fn9)

The General Assembly also sought to avoid a permanent increase to the corporation business tax by enacting a twenty per cent surtax for income years commencing in 2003(fn10) and a twenty-five per cent surtax for income years commencing in 2004,(fn11) both without reduction for credits. A permanent amendment to section 12-223f also raised the combined return penalty to a maximum of $250,000,(fn12) effectively eliminating the benefit of combined reporting for smaller corporate groups.

In addition to these changes to the corporation business tax, the General Assembly made several changes to the personal income tax, also designed to increase revenue. The resulting increases generally targeted upper income taxpayers, while avoiding increases at low-to-moderate income levels.

The highest marginal tax rate for individuals was increased from 4.5% to 5%.(fn13) This increase commences at $20,000 for joint filers, a threshold that was not changed. Additional legislation amended the Connecticut alternative minimum tax to be the lesser of nineteen per cent of the federal tentative minimum tax or 5.5%, an increase of one-half per cent, of the adjusted federal alternative minimum taxable income.(fn14)




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The legislature also enacted revenue enhancements by reducing exemptions and credits. The maximum credit for property tax was reduced from five hundred dollars to three hundred fifty dollars for taxable years commencing on or after January 1, 2003 and the one hundred dollar floor was removed.(fn15) However, some changes benefited taxpayers. Beginning with the 2004 taxable year, the personal exemption and personal tax credit applicable to single filers will increase annually through the 2009 taxable year.(fn16) Also beginning with the 2004 taxable year, thresholds used by single filers to determine the phase-out of the Connecticut property tax credit will increase annually through the 2009 taxable year.(fn17)

In 2002, Connecticut decoupled from the federal first-year bonus depreciation deduction and required individuals to add back the bonus depreciation taken on their federal income tax returns in computing their Connecticut adjusted gross income. In 2003, the General Assembly enacted legislation allowing individuals, who added back bonus depreciation, to subtract twenty-five per cent of that bonus depreciation from their adjusted gross income in each of the four succeeding taxable years beginning with the 2004 taxable year.(fn18)

B. Sales and Use Tax

Sales tax legislation was also aimed at deficit reduction, but not every effort met with success. On February 28, 2003, the exclusion from sales and use tax for media advertising and cooperative direct mail advertising was repealed, with tax imposed at the rate of 3%.(fn19) The repeal was effective April 1, 2003, but media interests persuaded the leadership to repeal the repeal and the exclusion was restored effective July 1, 2003.(fn20) The sales and use tax rate on non-media advertising and direct mail advertising services, other than cooperative direct advertising, was unaffected and remained at a tax




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rate of 6%. In a similar fashion, the exemption from sales and use tax for the sales of magazines by subscription and the sales of newspapers was repealed effective April 1, 2003,(fn21) but restored effective July 1, 2003.(fn22)

Changes that remained in effect after the Special Session included repeal of the annual one-week tax holiday that excluded from sales and use tax the sales of clothing and footwear costing less than three hundred dollars effective in 2004.(fn23) Legislation also extended the exemption for sales of tangible personal property or services to and by nonprofit charitable hospitals and certain other nonprofit healthcare facilities to include sales to and by for-profit acute care hospitals.(fn24)

A loophole-closing provision enacted during the legislative session provides that, effective October 1, 2003, services subject to sales and use tax may not be purchased in a nontaxable sale for resale when such resale will be exempt under section 12-412(62) as made to an affiliated person.(fn25)

Also, the scheduled termination of the 1% sales and use tax rate on computer and data processing services, which was to occur on June 30, 2004, was repealed and the tax rate on such services remains at 1%.(fn26)

There was one addition and a repeal of a planned addition to services that are subject to sales and use tax. Effective April 1, 2003, fees for health and athletic club services and certain fitness activities are subject to tax. An exclusion applies where such services are provided by a municipality or nonprofit organization described in Section 501(c) of the IRC. Also excluded are charges for court rentals for parties or events, participation or instruction in sporting activities, and other activities not directed to organized health and athletic activities.(fn27) However, the scheduled sales and use tax on patient care services which would have imposed a tax at a




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rate of five and three-fourths per cent and been effective July 1, 2003 was repealed and patient care services remain nontaxable. (fn28)

C. Property Tax

As military actions increased in the Middle East, measures were passed benefiting active military personnel and veterans. Municipalities were prohibited from charging or collecting interest for a period of one year on property tax payable by a resident who has been called to active service in the armed forces of the United States for military action against Iraq and...

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