The ins and outs of the Ohio CAT
Ohio lawmakers sought to make Ohio more attractive to businesses by replacing the existing corporate franchise tax and tangible personal property tax with a broad-based, low-rate excise tax on Ohio gross receipts.
The state tax revisions signed into law on June 30, 2005 dramatically changed Ohio tax reporting as we knew it. As a component of an omnibus tax reform package, a gross receipts tax on Ohio business activity called the Commercial Activity Tax (CAT) was enacted. Effective July 1, it is a tax assessed for the privilege of doing business in Ohio.
Birth of the CAT
Reacting to criticism that high corporate tax rates were a deterrent to Ohio business growth, Ohio lawmakers sought to make Ohio more attractive to businesses by replacing the existing corporate franchise tax and tangible personal property tax with a broad-based, low-rate excise tax on Ohio gross receipts. The personal property tax on inventory was already slated to be repealed, although at a more protracted schedule.
The new CAT applies to gross receipts, not net income, in Ohio for:
- Sales, exchanges, or dispositions of property used in Ohio, including goods or property shipped in from an out-of-state vendor and used in the state. Permissible deductions for gross receipts are cash discounts allowed and taken, returns and allowances, and bad debts from receipts upon which CAT was paid in a prior period.
- Services rendered to the extent the benefit is received in Ohio or the use is in Ohio, other than in an employee capacity.
- Rentals, leases, or other permissible uses of a taxpayer’s property or capital to the extent the foregoing is used by a taxpayer in the state.
The tax does not apply to:
- Nonprofit organizations, other than a for-profit subsidiary, or other than a for-profit disregarded entity
- Insurance companies that pay insurance premium tax – captive insurance companies that do not pay the Ohio insurance premium tax because there is no risk-shifting or there is a lack of risk diversification are subject to the CAT
- Banks; financial institutions; dealers in intangibles, savings and loans; and most financial services companies
- Public utilities that pay the public utility excise tax
- Receipts from assets for which capital gain treatment is given, as well as 1221 or 1231 assets
- Interest income except on credit sales
- Dividends and distributions from corporations
- Damages from certain litigation or certain life insurance proceeds
- Services that are performed in the state for use outside Ohio or goods shipped out of state even though the company selling the goods is located in Ohio
Many issues regarding use of receipts and what constitutes a receipt are still in the process of being interpreted by the department of taxation. These are issues that are being clarified pending future information releases.
A shift in burden
Previously, only corporations were subject to a business tax. Pass-through entities such as S corporations, LLCs, trusts, or sole proprietorships were taxed only at the individual taxpayer level. The new CAT applies to all business activity regardless of form. Federal tax rules are disregarded.
As a result, now partnerships, LLCs, S corps, associations, joint ventures, clubs, societies, disregarded entities, trusts, and even individuals engaged in business activity singularly or as a group are liable for this tax. Individuals holding pass-through interests, such as partnerships, will now pay tax at the entity level and again at the individual income tax level.
The CAT in practice
The CAT is being phased in over a five-year period and is adjusted for the current half-year. All business interests under a “taxpayer” that are more than 50 percent owned by that taxpayer must be combined. This combination disregards entity status resulting in, for example, the combination of S corporations with disregarded entities or independent contractor business activity. 1
In determining attribution of ownership, federal tax rules do not apply. Therefore, even a husband and wife who may file jointly for federal and state income tax purposes can, in certain circumstances, be considered separate “taxpayers” for CAT purposes.
Only Ohio businesses that are more than 50 percent owned by a taxpayer are to be combined, When combined, all the members of that group are treated as a single taxpayer entitled to a single $150,000 exclusion and a single $1 million floor since combined businesses are treated as one taxpayer for this purpose.
Where taxable entities have a common owner at a level of at least 50 percent of value, an election can be made to file on a consolidated basis and eliminate any inter-entity transactions. Related party or inter-company transactions cannot be eliminated on combination; only on consolidation.
Combination is mandated only where ownership is in excess of 50 percent. Consolidation can be elected at the 50 percent level, and as a result, one could have consolidation without combination.
Federal ownership attribution rules do not apply. For example, a family business has been divided up among several family members, consolidation is precluded. If three family members each own one-third of two businesses, which generate inter-entity transactions such as an LLC owning land and a building that is leased to an operating business, no consolidating election eliminating these receipts can be made. A reorganization of the business ownership would have to be considered.
Consolidation can also be made at just the 80 percent level, limiting includable businesses to only those where ownership is no less than 80 percent.
Once filed, the consolidation election is binding for two years. However, this election requires that all related domestic entities or businesses be included, whether or not they would otherwise be taxable in Ohio. Only offshore business entities can be excluded at the taxpayer’s option.
The CAT is limited to Ohio gross receipts, so where a consolidation election is made, and includes an out-of-state business that has no gross receipts in Ohio, that business still has no CAT liability. On the other hand, where an out-of-state business that is not otherwise taxable by Ohio does have Ohio gross receipts and is included in an Ohio consolidation, a CAT liability for Ohio business receipts will result.
The election to file on a consolidated basis or designation of companies filing on a combined basis must be made by November 15. The department of taxation has indicated that there will be leniency in the event that elections would have to be changed on or before February 10, 2006, the due date of the first CAT returns.
Impact of the CAT
Since the projected revenues from CAT were made with some belt-tightening in mind, there is concern that the current low rate will increase and the proportionate tax effects will be heightened. Although touted as a tax simplification measure, in departing from the federal rules, CAT has added compliance work in situations that did not exist before.
For example, taxpayers with gross receipts over $1 million will be required to report and remit quarterly and not just complete one annual return that ties into the federal return as before. Federal tax entity rules are now disregarded in favor of a separate classification regime that is unique to Ohio under the consolidation/combination rules.
This classification may be troublesome for parties who are related and so report under the federal rules. For such taxpayers, a separate accounting may be required strictly for Ohio state tax reporting purposes.
Finally, the state’s definition of a gross receipt may or may not tie into gross receipts as reported on the federal return, generating additional compliance work for some taxpayers. The few states that have passed tax legislation, categorized as an “excise tax” in most cases, tie into federal entities on the 1120, facilitating compliance reporting.
Pursuant to CAT provisions, the tax commissioner must increase or decrease the CAT rate upon analysis of the revenues generated over a prescribed period. No approval by the Ohio Legislature is required. This provision is a built-in mathematical adjustment based on revenues received. There is no limitation on the amount of rate adjustment, raising issues as to the appropriateness of the delegation of legislative authority among other constitutional matters.
As the CAT is being phased in over a five-year period, the corporate franchise tax is being phased out at a 20 percent reduction per year.
The schedule is as follows:
|Applicable Tax Year
||Applicable Phase-Out Percentage |
|Balance of 2005
||100 percent |
||80 percent |
||60 percent |
||40 percent |
||20 percent |
|2010 and after
||Fully phased out |
Over the same five-year phase-out, personal property taxes are being repealed. Effective July 1, all new machinery and equipment purchased in 2005 will no longer be subject to the tax. The exemption for patterns, jigs, dies and drawings is retained for most taxpayers, as well as in-transit inventory not used for business in state.
Telephone company personal property taxes are phased out over a later five-year period commencing in 2007. The listing percent in that year of 20 percent of true value decreases by 2010 to 5 percent of true value.
The following schedule details by year the rates and adjustments:
|Applicable Tax Year
||Listing Percentage of True Value |
||25 percent; 23 percent for inventory |
||18.75 percent |
||12.50 percent |
||6.25 percent |
|2009 and later
||0 percent |
State individual income tax rates are being reduced incrementally to total a 21 percent rate reduction. Therefore, in five years, the individual income tax rate will cap at roughly 5.9 percent.
The changes are detailed in chart 4.
The state sales tax rate has also been reduced by .5 percent. On the other hand, temporary taxes on trust income have been made permanent and the 10 percent rollback on real estate taxes has been repealed for any commercial real estate property. Close attention should be paid to the nexus rules for trusts as they too are very broad-based.
|Applicable Tax Year
||Top Marginal Rate |
||4.2 percent reduction across all brackets
||7.185 percent |
||8.4 percent reduction from 2004 rates
||6.87 percent |
||12.6 percent reduction from 2004 rates
||6.555 percent |
||16.8 percent reduction from 2004 rates
||6.24 percent |
|2009 and after
||21 percent reduction from 2004 rates
||5.925 percent |
A temporary amnesty period has also been created for January 1 through February 15, 2006, with respect to delinquent state taxes, tangible personal property taxes, county and transit authority sales taxes, and school district income taxes. Amnesty does not apply to any taxes for which a notice of assessment or bill has been issued or for which an audit is open.
With such significant changes, businesses need to look closely at this new legislation and plan implementation.
1 Consolidation at the individual level can occur where individual receipts are $4,500 or more.