Decoding the new Ohio commercial activity tax: what CAT means to business taxpayers.

• Author: Engel, Mark A.

Governor Bob Taft's signature on Ohio's $51.25 billion budget bill (1) this summer effectively rewrote the state's tax code for the first time in more than 70 years. The new code phases out the tax on tangible personal property over four years and the corporate franchise tax over five years. The new code also reduces all personal income tax rates by 21 percent over five years. In addition to substantially modifying the code, the budget bill increased various excise taxes and eliminated the 10-percnent rollback on real estate taxes for most commercial and industrial property.

Revenue lost through the elimination of tangible personal property and corporate franchise taxes is to be made up by the centerpiece of Ohio's new tax code: the commercial activity tax (CAT). The CAT is a broad-based, low-rate (.26 percent) tax on the gross sales receipts of Ohio businesses, including service providers. Many commentators believe that, like its feline namesake, the new tax sneaked upon the scene.

Since the CAT is entirely new animal, tax executives responsible for their company's complying with the CAT must understand the practical applications of this stealth-like tax.

After reviewing the transition to and operation of the CAT, practical examples are used to illustrate the effect of the CAT on business taxpayers and provide a framework for estimating its effect.

Gross Receipts

For purposes of the CAT, gross receipts are the total amount realized, without any deduction, from a transaction that contributes to the production of gross income, including the fair market value of any property and any services received and any debt transferred or forgiven as consideration. (2) There is a short, yet fairly broad, list of includible receipts in the statute (3) and a lengthy list of excluded receipts. (4)

Excluded Receipts

Notable exclusions from gross receipts are interest (except interest received as part of a credit sale), dividends and distributions received, capital gains, contributions to retirement plans and charitable institutions, and compensation paid to employees (including deferred amounts).

Other excluded receipts are federal and state excise taxes paid on alcohol and tobacco, the "handle" from race track betting, (5) amounts from the sale of lottery tickets, hunting fees for agents of the department of natural resources, and receipts from automobiles transferred between dealers for resale. In addition, the commission paid to a real estate broker is excluded to the extent it is shared with another broker. (6)

Because the tax is imposed on gross receipts, there is no deduction for expenses or for amounts that are reimbursed to another. For example, a seller that passes freight costs paid to a shipper through to its customer is not permitted to deduct the amounts paid to the shipper. Amounts received by an agent on behalf of another that are in excess of the amount of any retained commission, however, are excluded. (7)

Receipts from the sale of tangible personal property delivered into or shipped from a "qualified foreign trade zone area that includes a qualified intermodal facility" are excluded from the definition in an uncodified section of the bill. (8) A "qualified foreign trade zone area" means a warehouse that is located within one mile of the boundary of an international airport and is located in a foreign trade zone. A "qualified intermodal facility" is a transshipment station that is capable of receiving and shipping freight by rail, highway, and air transportation.

Receipts from the sale of motor fuel are also excluded from the CAT until July 1, 2007. (9) At that time, the tax commissioner is to provide information to the general assembly regarding the constitutionality of taxing such receipts.

Calculating Gross Receipts

Gross receipts are calculated on the same basis that the taxpayer uses for federal income tax purposes. (10) Allowances are made for cash discounts taken, returns, bad debts, and amounts received from the sale of a receivable to the extent the receipts from the underlying transaction were included in the taxpayer's gross receipts. (11)

Taxable Gross Receipts

Taxable gross receipts are those gross receipts allocated to Ohio. (12) In the case of sales of tangible personal property, the receipts are allocated to Ohio if the goods are finally delivered to customers in Ohio. Receipts from property that is brought into Ohio, and then removed from Ohio to another location, are not considered Ohio receipts.

Receipts from services are allocated to Ohio to the extent the benefit of the service is received in Ohio. The place where the purchaser ultimately uses or receives the service shall be paramount in determining the portion of the benefit received in Ohio. The tax commissioner is expected to promulgate several rules relating to the receipt of legal, accounting, engineering, and other services.

Receipts from the right to use intellectual property, such as copyrights, patents, and trademarks, are allocated to Ohio to the extent the receipts are based on the use of, or on the right to use, the property in Ohio. The use of an alternate method is permitted if these rules do not accurately reflect commercial activity in Ohio. The tax commissioner is also given express authority to promulgate rules regarding the allocation of receipts for specific industries.

If a person receives property outside Ohio for its own use and brings it into Ohio within one year, the value of the property must be included in its taxable gross receipts. (13) Similarly, for property brought into Ohio by one member of a consolidated elected or combined taxpayer and used by it or another member of the group, the value must be...