United States: Indiana Income And Sales Tax Legislation Enacted

Indiana Governor Mike Pence has signed several bills that significantly change elements of the Indiana income and sales tax laws. Changes to the corporation income tax include the elimination of the throwback rule, an expansion to the definition of business income and modifications to the intercompany addback rules. With respect to the sales tax, numerous exemption provisions have been expanded, including the manufacturing and agricultural exemptions, while the research and development exemption has been narrowed. Finally, the Indiana Department of Revenue will administer a broad tax amnesty program at some point in 2015 or 2016.¹ Unless otherwise noted, all of the legislative changes are effective on January 1, 2016.

Income Tax Legislation

Elimination of Throwback Rule

The Indiana "throwback rule" applies to situations where a seller ships products from an Indiana location to a destination state where the seller is not subject to tax. In Indiana (as in many states), these sales historically have been "thrown back" and included in the sales factor numerator when computing the Indiana apportionment factor. The legislation eliminates the throwback rule, which will benefit taxpayers shipping products from Indiana locations.²

Business Income Definition

The legislation expands the definition of business income. Under current law, the term "business income" is defined as "all income arising from transactions and activity in the regular course of the taxpayer's trade or business and includes income from tangible and intangible property if the acquisition, management, and disposition of the property constitutes integral parts of a taxpayer's regular trade or business operations." Under the expanded definition, "business income" includes "all income that is apportionable to the state under the Constitution of the United States."³ Following the trend seen in other states, this new provision will make it more difficult for a taxpayer to use allocation rather than apportionment as a means to source a gain from a non-recurring transaction fully outside Indiana.

Intercompany Expense Addbacks

Under current law, intercompany interest expense is required to be added back to Indiana adjusted gross income only in situations where the intercompany interest was the result of transactions involving intangible assets. Under the recent legislation, all intercompany interest, not just interest related to intangibles, must be added back to Indiana adjusted gross income in situations where the recipient of the interest income loaned the funds out of amounts received from the taxpayer, an affiliated company, or a foreign corporation.⁴ However, the legislation creates an exception to the addback rule when the recipient of the income corresponding to the directly related interest expenses is subject to the Indiana financial institutions tax, files that tax return and apportions items of income corresponding to the intangibles and interest expenses in accordance with the financial institutions tax.⁵

Apportionment of Receipts from Computer Software

Under the legislation, sales by business taxpayers of computer software will explicitly be treated as sales of tangible personal property for purposes of computing Indiana's sales apportionment factor.⁶ This definition is in line with the current interpretation used by the Indiana Department of Revenue.

Venture Capital Investment Credit

Effective on July 1, 2015, the Venture Capital Investment Credit is extended to allow a credit for qualifying investments made before January 1, 2021.⁷ Prior to this legislation, the deadline to make qualifying investments was December 31, 2016.

Internal Revenue Code Conformity

Effective on January 1, 2015, Indiana's conformity to the Internal Revenue Code is revised to the Internal Revenue Code as it existed on January 1, 2015.⁸

Sales Tax Legislation

Expansion of Manufacturing Exemption

The manufacturing exemption is expanded to include material handling equipment purchased for the purpose of transporting materials for a taxpayer's direct use in the production, manufacture, fabrication, assembly, extraction, mining, processing, refining, or finishing of tangible personal property. In addition, the exemption is expanded to include the cutting of steel bars into billets, and the felling of trees for further use in production or sale in the definition of processing tangible personal property.⁹

Expansion of Agricultural Exemption

The purchase of machinery, tools and equipment for agriculture is exempt from the state gross retail tax. The exemption has been expanded to include equipment that is used for transporting materials from one location to the next, if the materials being transported are for the direct production, extraction, harvesting or processing of agricultural commodities.¹⁰

Temporary Storage Exemption

Tangible personal property stored in Indiana for 180 days or less for the purpose of being used solely outside of Indiana is not subject to Indiana use tax.¹¹ Previously, there was no time limitation on the exemption.

Energy Refund Claim Limitation Repealed

Effective July 1, 2015, the 36-month limitation on refunds related to overpayment of tax on electrical energy, artificial and natural gas, water, and steam is repealed.¹² The standard statute of limitations will apply after that date.

Medical Equipment Exemption

Effective July 1, 2015, a variety of changes are made to expand and clarify the exemption for medical equipment and supplies. The exemption for durable medical equipment, mobility enhancing equipment, and prosthetic devices is expanded to include repair or replacement parts, as well as other medical supplies or devices used exclusively for medical treatment of a medically diagnosed condition.¹³ The exemption for hearing aid devices is specified to include items including parts, attachments, batteries or accessories reasonably necessary for use of a hearing aid device.¹⁴ Sales of legend or nonlegend drugs dispensed by a registered pharmacist or sold by a licensed practitioner to a patient are exempt.¹⁵ Likewise, food, food ingredients and dietary supplements sold by a licensed practitioner or pharmacist are exempt.¹⁶ Finally, several types of transactions where the patient acquires certain types of property for his or her own use without a prescription or drug order are exempt.¹⁷

Research and Development Exemption

The research and development exemption is changed to specify that a research and development activity that qualifies for the exemption "includes design, refinement, and testing of prototypes of new or improved commercial products before sales have begun for the purpose of determining facts, theories, or principles, or for the purpose of increasing scientific knowledge that may lead to new or enhanced products."18 This provision serves to limit items eligible for the exemption, and newly enumerated items that are specifically excluded from the exemption include nontechnical activity research, market and sales research, product market testing, evaluating the value of a potential investment by acquiring, investigating or evaluating a patent, model, process or product, and sales services or other services.¹⁹ The legislation explicitly states that a research and development activity is devoted to experimental or laboratory research and development (and exempt) if "the activity is considered essential and integral to experimental or laboratory research and development."20

Recycling Exemption

Effective July 1, 2015, the exemption for recycling machinery, tools, and equipment is replaced with an exemption for tangible personal property purchased by a person for direct use in processing recycled materials, and who is occupationally engaged in the business of recycling. Recycling carts, defined as manually propelled containers with a capacity of 100 gallons or less, are specifically made exempt.²¹

Tax Amnesty

The Department is required to establish a tax amnesty program for certain taxpayers with unpaid tax liabilities in a tax period ending before January 1, 2013. A taxpayer who participates in the program will be granted a waiver of all penalties, interest, collection fees, and other costs that would ordinarily be due. In addition, any current liens will be released, and the Department will not seek civil or criminal prosecution of the taxpayer. The Department has not yet determined the dates for the tax amnesty program. Under the legislation, the program is limited to an eight-week period and must end no later than January 1, 2017.²²

Commentary

With respect to the corporate income tax provisions, the elimination of the "throwback rule" should have a significant beneficial impact on Indiana-based sellers of property. The repeal of throwback is consistent with legislators' stated desire to make Indiana a more tax-friendly location for manufacturers and distributors. Changes in business income definitions and intercompany expense treatment may generally indicate a desire to obtain more revenue from non-Indiana based taxpayers.

The substantial changes in sales and use tax exemptions should be analyzed by all taxpayers doing business in Indiana. As many of these changes will be implemented during 2015, the time frame to modify taxability determination documentation and systems is relatively short.

Footnotes

1 S.B. 441, Laws 2015, enacted May 6, 2015; H.B. 1472, Laws 2015, enacted May 6, 2015; H.B. 1001, Laws 2015, enacted May 7, 2015.

2 S.B. 441, § 14, amending IND. CODE § 6-3-2-2(e)(2).

3 S.B. 441, § 13, amending IND. CODE § 6-3-1-20.

4 S.B. 441, § 24, amending IND. CODE § 6-3-2-20(a)(2), (b)(2).

5 S.B. 441, § 24, adding IND. CODE § 6-3-2-20(c)(2).

6 S.B. 441, § 14, amending IND. CODE § 6-3-2-2(e).

7 S.B. 441, § 30, amending IND. CODE § 6-3.1-24-9(b).

8 H.B. 1472, § 15, amending IND. CODE § 6-3-1-11.

9 S.B. 441, §§ 10, 11, amending IND. CODE §§ 6-2.5-5-3; 6-2.5-5-4.

10 S.B. 441, §§ 9, 11, amending IND. CODE §§ 6-2.5-5-2; 6-2.5-5-4.

11 H.B. 1472, § 6, amending IND. CODE § 6-2.5-3-1(b), (d).

12 H.B. 1472, § 7, amending IND. CODE § 6-2.5-5-5.1.

13 H.B. 1472, § 8, amending IND. CODE § 6-2.5-5-5.18(c)(1)-(4).

14 H.B. 1472, § 8, amending IND. CODE § 6-2.5-5-5.18(c)(5).

15 H.B. 1472, § 8, amending IND. CODE § 6-2.5-5-5.18(a), (b), (c)(6). Also, nonlegend drugs dispensed upon an original prescription or drug order to an ultimate user confined to a hospital or health care facility are exempt. H.B. 1472, § 8, amending IND. CODE § 6-2.5-5-5.18(c)(7).

16 H.B. 1472, § 8, amending IND. CODE § 6-2.5-5-5.18(c)(8).

17 H.B. 1472, § 8, amending IND. CODE § 6-2.5-5-5.18(d).

18 H.B. 1472, § 11, amending IND. CODE § 6-2.5-5-5.40(a).

19 H.B. 1472, § 11, amending IND. CODE § 6-2.5-5-5.40(a)(6), (8)-(11).

20 H.B. 1472, § 11, amending IND. CODE § 6-2.5-5-5.40(d). A list of non-qualifying activities is provided in IND. CODE § 6-2.5-5-5.40(e).

21 H.B. 1472, § 12, amending IND. CODE § 6-2.5-5-45.8(a)(4), (5), (b), (c).

22 H.B. 1001, § 91, amending IND. CODE § 6-8.1-3-17.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.