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Gross Receipts Taxes Face Policy and Legal Challenges

“Generally, the only places with gross receipts taxes today are U.S. states and developing countries.” –Professor Richard Pomp, University of Connecticut

As the economy shifts to a digital one, we are finding that states are turning toward unconventional revenue options. One trend we’re seeing is the surprising comeback of the gross receipts tax (GRT):

  • Oregon’s new Commercial Activity Tax (CAT) takes effect January 1, 2020. Oregon officials are currently writing rules to implement it. Portland, Oregon also adopted a 1% gross receipts tax, imposed only on big businesses, starting January 1, 2019.

  • San Francisco voters imposed an additional gross receipts tax on businesses with receipts of more than $50 million beginning January 1, 2019. This is on top of the gross receipts tax that was phased in from 2014 to 2018 to replace the city’s payroll tax.

  • Nevada’s Commerce Tax took effect July 1, 2015, imposing differing tax rates on 26 categories of business with over $4 million in receipts. Part of the revenue was to reduce the state’s MBT payroll tax, but legislators suspended those reductions this year; it’s now in court.

  • Serious proposals to adopt a statewide gross receipts tax keep coming, with the last three years including LouisianaMissouri, Oklahoma , West Virginia and Wyoming. A San Jose, California gross receipts tax proposal was approved to gather petition signatures in 2016 but eventually morphed into a business license tax overhaul.

These enactments join the longstanding Delaware Gross Receipts Tax and Washington Business & Occupation (B&O) Tax, the relatively new Ohio Commercial Activities Tax (CAT) and Texas Margin Tax, and local gross receipts taxes in Pennsylvania, Virginia, Washington and West Virginia.

The resurgence of GRTs is surprising, given they had all but disappeared by the end of the 20th century. Kentucky, Michigan, New Jersey and West Virginia had recently repealed theirs. Every country that had a gross receipts tax, or turnover tax as they were historically called, recognized their flaws and switched to other forms of taxation by the 1970s. Public finance scholars are very critical of gross receipts taxes for the incredible damage they inflict on an economy, their lack of transparency, their imposition even on unprofitable businesses, and the economic distortions that come from the tax’s inherent “cascading” or “pyramiding”—embedding taxes within taxes, through each stage of the production chain. Adam Smith, writing in The Wealth of Nations, blamed Spain’s alcavala gross receipts tax for their national economic decline, and studies have found that developing countries adopt gross receipts taxes but switch away from them once their economy and tax collection system mature.

So, why the sudden popularity? It’s simple, really: GRTs raise enormous sums of revenue with a deceptively low tax rate, and are collected by a relatively small number of taxpayers (businesses). Oregon, for instance, estimates that their new 0.57% CAT will raise over $1 billion per year for Oregon schools, compared to the $736 million raised by the 7.6% corporate income tax. San Francisco expects to raise $250 million annually from a recent gross receipts tax increase, imposed on just 400 firms. GRTs are also a way to shift the overall tax burden from in-state businesses onto businesses with capital-intensive production, or businesses that sell nationwide or worldwide.

If GRTs in practice don’t strike you as simple, you’re not alone. Firms doing business in states that have adopted GRTs face legal and compliance issues such as easy-to-trigger nexus thresholds, how to handle nexus questionnaires, apportionment, whether to pass it forward to customers, definitional disputes, whether to adjust business processes to minimize liability, and a ramp up in administrative rulemaking. Some states have ratcheted up complexity as they try to mitigate pyramiding—for example, the Nevada Commerce Tax has 27 different tax rates—and which category a business falls in can be a difference of tens of millions of dollars in tax liability.

Recent GRTs also have serious constitutional flaws. The most popular flaw is one where the jurisdiction seeks to impose tax liability only on large businesses, which are defined by an arbitrary dollar level of revenues nationwide. While this may be politically popular—tax out-of-state and out-of-town companies more heavily than in-state businesses—a long history of cases have struck down efforts to use extraterritorial receipts to discriminate against interstate businesses and in favor of hometown businesses. Portland, San Francisco and Washington state have all adopted new gross receipts taxes with unconstitutional thresholds targeting big business based on their size outside of the taxing jurisdiction. While no one has yet sued to invalidate these new tax regimes, many taxpayers are discussing whether, when, and where to do so.  San Francisco’s GRT is also fending off a lawsuit for passing without a two-thirds voter majority.

For taxpayers concerned about the trend to adopt unconstitutional GRTs, we encourage them to contact the authors to discuss an effort underway to invalidate such laws.

© 2019 McDermott Will & Emery

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About this Author

Stephen P. Kranz Lawyer McDermott Will
Partner

Stephen P. Kranz is a partner in the law firm of McDermott Will & Emery LLP and is based in the Firm’s Washington, D.C., office.  He engages in all forms of taxpayer advocacy, including audit defense and litigation, legislative monitoring, and the formation and leadership of taxpayer coalitions.  Steve is at the forefront of state and local tax issues, including developments arising in the world of cloud computing and digital goods and services.  He assists clients in understanding planning opportunities and compliance obligations for all states and all tax types. ...

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Counsel

Diann Smith is counsel in the law firm of McDermott Will & Emery LLP and is based in the Firm’s Washington, D.C., office.  Diann focuses her practice on state and local taxation with an emphasis on tax challenges relating to compliance, controversy, planning and legislative activity.   

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Joe Bishop-Henchman, State & Local Tax , Tax Controversies DC
Counsel

Joe Bishop-Henchman counsels clients on tax compliance, policy and controversy matters.

Prior to joining McDermott, Joe spent 14 years at the Tax Foundation, directing its state policy and legal programs, and where he most recently served as executive vice president. He has worked with elected officials and stakeholders to achieve major state-level tax changes, advised on the interplay between federal and state tax policy changes, and assisted nonprofits and business groups in studying and developing tax proposals.

A distinguished thought leader in his industry, Joe...

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