On May 20, 2015, Tennessee Gov. Bill Haslam (R) signed into law the Revenue Modernization Act. This Act makes several noteworthy and potentially far-reaching changes to Tennessee tax law that will impact anyone “doing business” in Tennessee with or without a physical presence. As discussed more fully below, the Act (i) expands the nexus standards for a number of different state taxes; (ii) increases the sales factor in the apportionment formula; (iii) applies market-based sourcing principles to sales of services and sales of intangible property; and (iv) subjects cloud computing and “video game digital product” to sales and use tax.
Expanded Nexus Standards
With the stated goals of “making out-of-state businesses pay their fair share of taxes” and “helping Tennessee-based businesses”, the Act codifies a new “substantial nexus” standard for franchise and excise taxes and the business tax. In addition, the Act introduces “click-through” nexus for sales and use taxes.
Substantial Nexus Standard. [effective January 1, 2016] The Act defines “substantial nexus in this state” to include the following five non-exclusive factors:
- The taxpayer is organized or commercially domiciled in Tennessee;
- The taxpayer owns or uses its capital in Tennessee;
- The taxpayer has systematic and continuous business activity in Tennessee that has produced gross receipts attributable to Tennessee customers;
- The taxpayer licenses intangible property for use by another party in Tennessee and derives income from that use of intangible property in Tennessee; or
- The taxpayer has “bright-line presence” in Tennessee.
Of these factors, the last two factors are the most noteworthy because neither requires a physical presence in the state. Moreover, as explained below, the “bright-line presence” test adopts relatively low thresholds to determine whether a taxpayer has in Tennessee. “Bright-line presence” in Tennessee occurs if any one of the following tests is satisfied:
- Sales. The company’s gross receipts in Tennessee exceed the lesser of (a) $500,000 or (b) 25% of its total receipts;
- Property. The average value of the company’s real and tangible personal property owned or rented in Tennessee exceeds the lesser of (a) $50,000 or (b) 25% of the average value of the company’s total real and tangible personal property; or
- Payroll. The total amount paid by the company for compensation in Tennessee exceeds the lesser of (a) $50,000 or (b) 25% of the company’s total compensation.
Through this definition of substantial nexus, Tennessee has adopted an economic nexus standard, which reflects a significant expansion of the nexus threshold for franchise and excise tax purposes. This standard extends the franchise and excise tax to services that are delivered to customers in the state, regardless of the seller’s location.
Click-Through Nexus. [effective July 1, 2015] Following a growing trend that began in 2008 in New York, Tennessee now includes a presumption of nexus, for sales and use tax purposes, when a remote online retailer enters into an agreement with one or more persons in Tennessee whereby, in exchange for a fee, commission or some other type consideration, such Tennessee person routes potential customers to the remote online retailer and such retailer’s gross sales from such referrals exceed $10,000 over a 12-month period. Once this sales threshold has been satisfied, the remote online retailer is required to collect sales and use tax from its Tennessee customers.
While the substantial nexus standard, with its bright-line presence test and click-through nexus, arguably “levels the playing field” for Tennessee-based businesses, the unanswered question is whether these nexus changes will make goods and services ultimately more expensive for Tennesseans.
Changes to the Apportionment Formula
Triple-Weighted Sales Factor. [effective July 1, 2016] The Act changes the apportionment formula (property, payroll and sales) for franchise and excise taxes from a double-weighted sales factor to a triple-weighted sales factor.
Market-Based Sourcing. [effective July 1, 2016] The Act changes the method for sourcing sales of services and sales of intangible property, for franchise and excise tax purposes, to market-based sourcing principles, which look to where the consumer is located to determine whether a sale should be sourced to Tennessee (i.e., where the service is delivered or the intangible property is used). With this statutory change, Tennessee joins a near majority of states that have adopted some form of market-based sourcing principles.
As a result of this change, out-of-state businesses providing services or selling intangible property to Tennessee consumers should prepare for an increase in their Tennessee sales factor, which in turn makes it more likely for such businesses to cross the sales threshold in the “bright-line presence” test for franchise and excise tax nexus.
Sales/Use Tax on Cloud Computing and Video Games
Cloud Computing. [effective July 1, 2015] Amounts changed to “access and use computer software that remains in the possession of the dealer who provides the software or in the possession of a third-party on behalf of such dealer” are subject to the Tennessee sales/use tax. Cloud computing is often marketed and referred to by software vendors to customers as “SaaS” or “software as a service.”
This statutory change appears to expand the sales/use tax base to include cloud computing, which would affect both Tennessee and out-of-state providers of cloud computing.
Video Game Digital Product. [effective July 1, 2015] The sale of “video game digital products” is also subject to Tennessee sales/use tax. The Act defines a “video game digital product” as the right to access and use computer software that facilitates human interaction with a user interface to generate visual feedback for amusement purposes, when possession of the computer software is maintained by the seller or a third party, regardless of whether the charge for the service is on a per use, per user, per license, subscription, or some other basis.
Key Effective Dates of the Tennessee Revenue Modernization Act
|July 1, 2015||January 1, 2016||July 1, 2016|
|Click Through Nexus for Sales/Use Tax||Substantial Nexus Standard for Franchise and Excise Tax and Business Tax||Triple-Weighted Sales Factor in Apportionment Formula|
|Sales/Use Tax on Cloud Computing||Market-Based Sourcing for Sales of Services and Sales of Intangible Property|
|Sales/Use Tax on Video Game Digital Products|
If you have any questions about how the Revenue Modernization Act may affect your business, please contact Brian S. Masterson.