Massachusetts Enacts Single Sales Factor As Part Of Legislative Compromise - Sales Taxes: VAT, GST

Key takeaways

On October 4, 2023, Governor Maura Healey (D) signed House Bill 4104 into law, which moves Massachusetts to a single sales factor apportionment regime for multi-state business corporations and financial institutions.

The Massachusetts corporate excise tax will have a new apportionment scheme effective January 1, 2025. Beginning on that date, taxpayers will be required to apportion net income using a single sales factor. This is a departure from current law, under which financial institutions and business corporations (but not corporations classified as manufacturing corporations and defense corporations) apportion their net income using a formula comprised of a property factor, payroll factor, and a double-weighted sales factor. Business corporations and financial institutions will now be required to apportion net income using a single sales factor, although the distinctions in sourcing methods for certain receipts of financial institutions (e.g., interest, receipts from loans, etc.) have been retained in the statute. The move to single sales factor will not be phased in gradually.

The adoption of single sales factor is a result of a compromise that has been months in the making. As was the case in prior years, this spring, multiple bills were introduced relating to the implementation of single sales factor apportionment. One bill, which included single sales factor among a host of other tax changes, was voted on favorably by the House, but the Senate amended the bill to, in part, remove the single sales factor provisions. After the House refused to concur with the Senate's amendments, the bill was referred to a Joint Committee for discussion and debate. However, the bill failed to pass prior to the July break for summer recess.

Once the legislature reconvened, the Joint Committee reached an agreement on the tax package to fill the gaps in the budget. (The FY 2024 budget was enacted on August 9 – it appropriated $580 million in tax relief but left the contours of the tax package to be determined later). The compromise reached in the Joint Committee adopted the single sales factor change and the resulting bill proceeded to a vote in both houses. The bill was approved by both houses and was signed into law by the governor on October 4, 2023, as Chapter 50 of the Acts of 2023. The new law instructs the Department of Revenue ("Department") to promulgate regulations to implement the change to single sales factor, so additional guidance may be forthcoming.

Reed Smith Takeaways:

Bigger impact on non-financial institutions: The Massachusetts corporate excise tax has two components: a tax on income and a franchise/capital tax on tangible property or net worth. Most multistate taxpayers pay the tax based on net worth. The net worth component of the tax is apportioned using the same statutory scheme as the income-based component of the tax. Therefore, the change to single sales factor will impact the net worth component of the tax in a similar manner as the income-based component. Financial institutions, however, are not subject to the franchise/capital tax and, as a result, may feel less of an impact from the move to single sales factor as compared to other taxpayers.
New discretionary power for the Department: The enacted law includes new powers for the Department under Subparagraph (j) of the apportionment statute, which provides that "[i]f a corporation maintains an office, warehouse or other place of business in a state other than the commonwealth for the purpose of reducing its tax under this chapter, the commissioner shall . . . adjust the sales factor to properly reflect the amount which the factor ought reasonably to assign to the commonwealth."

This specific grant of discretionary powers to the Department is new and takes effect simultaneously with the move to single sales factor. It remains to be seen how the Department will choose to exercise this power going forward. However, taxpayers should review their corporate structure and product flow and, if necessary, consult with their advisors before single sales factor takes effect.
Fiscal year taxpayers: The change to single sales factor apportionment is effective January 1, 2025. It is not clear how the change will apply to fiscal year taxpayers with a tax year ending on a date other than December 31. If read literally, House Bill 4104 would require such taxpayers to use a bifurcated apportionment method for their first tax year ending on or after January 1, 2025, with net income earned before January 1, 2025 apportioned using the current, three-factor formula and net income earned on or after January 1, 2025 apportioned using a single sales factor. However, as a practical matter, the Department may opt to only require the use of single sales factor for fiscal years ending on or after January 1, 2025.

There could also be a position that the change to single sales factor apportionment is effective for tax returns due on or after January 1, 2025, which could support a position that single sales factor is effective for calendar year 2024.
Manufacturing corporations will no longer receiving different apportionment treatment: Under current law, manufacturing corporations are already required use a single sales factor apportionment formula, whereas, as mentioned above, business corporations and financial institutions use a three-factor formula. In recent years, this disparate treatment has given rise to a large number of disputes over the question of whether taxpayers were properly classified as manufacturing corporations. The move to a unified single sales factor regime will eliminate this distinction beginning on January 1, 2025.
Legislation leaves room to seek three-factor through alternative apportionment: Single sales factor means that the sole measure of a taxpayer's Massachusetts' business activity is its market. Yet, the standard applicable to invoke alternative apportionment is whether the statutory formula is "reasonably adapted to approximate the net income derived from business carried on" in Massachusetts. For certain taxpayers, a market-only factor may never reasonably approximate their income from business carried on in Massachusetts—in particular capital-intensive business whose income is largely attributable to property and people. By not amending the alternative apportionment standard to parallel the market-based single sales factor formula, the legislature has arguably left room for taxpayers to seek to use three-factor through alternative apportionment.
Special Industry Apportionment Regulations Still Valid? Our view is that the passage of single sales factor apportionment causes the previously-promulgated special industry apportionment regulations to become invalid. The Department has promulgated several special apportionment regulations for industries such as airlines, telecommunications, and the electricity industry under the authority granted by G.L. c. 63, § 38(j) (renumbered as §38(k) by this bill). However, this permits the Department to promulgate alternative apportionment rules for specific industries only if the statutory apportionment rules "are not reasonably adapted to approximate the net income" of a particular industry in Massachusetts.

The previously promulgated industry-specific regulations are arguably valid before January 1, 2025, because the Department has already determined that the statutory apportionment rules in effect for those years, including the use of the three-factor formula, did not meet the "reasonable approximation" standard.

However, when single sales factor becomes effective, any prior findings by the Department are moot. Absent the promulgation of new regulations finding that statutory apportionment using a single sales factor is not reasonably adapted to approximate the net income of a particular industry, the special industry rules should have no effect.

This should be good news for taxpayers. In our view, when single sales factor apportionment becomes effective, any taxpayer that would qualify for special industry apportionment will have a choice of apportioning net income using a single sales factor with market sourcing or apportioning net income using the applicable special industry apportionment regulation. Of course, the Department could always attempt to re-promulgate the special industry apportionment regulations or issue a statement that the special industry apportionment regulations are still needed to reasonably approximate the net income of taxpayers in the covered industries. (That is what the Department did following the enactment of the market-based sourcing for scheme for receipts from services.)