This article is reproduced with permission from Spidell Publishing, Inc.
The FTB released Legal Ruling 2017-01, explaining when taxpayers may claim the Other State Tax Credit (OSTC) or a deduction for taxes paid to another state. The ruling outlines the general rules for claiming the OSTC or deducting other state taxes, and then goes through specific fact patterns addressing taxes paid to Arizona and business taxes paid to Tennessee, Texas, Manhattan, Kentucky, and New York.
Credit or deduction
The ruling states that the determination as to whether the payment of a tax to another state is eligible for the OSTC or is deductible for California purposes, turns on:
- Whether the tax is properly characterized as a tax on, or according to, or measured by income; and, if it is, then
- Whether the tax is properly characterized as a net income tax.
If the tax is not properly characterized as a tax on, or according to, or measured by income, then the inquiry ends, and the taxpayer may claim a California deduction for the tax (assuming all other requirements are met), but the taxpayer may not claim the OSTC.
If the tax is properly characterized as a net income tax, a further determination must be made as to whether the tax is imposed by and paid to the other state such that the taxpayer may claim the OSTC. If the other state’s tax is not a single, indivisible tax, but rather a multifaceted tax consisting of a conglomeration of “separate and independent taxes,” each of the separate taxes is analyzed independently. Therefore, it is possible for some portion of a multifaceted tax to be based on net income and eligible for the OSTC and not deductible, while another portion is not based on income and is deductible but not eligible for the OSTC.
The Revised Texas Franchise Tax (RTFT)
In the ruling, the FTB states that the RTFT does not qualify for the OSTC because it is not a tax on, or according to, or measured by income, regardless of the manner in which the entity’s taxable margin is determined. The FTB states that the tax is a single, indivisible tax, because a taxpayer can only be subject to paying one tax on one base in any year, regardless of the number of activities in which the business engages. This is true even though the taxpayer may compute multiple margins in order to comply with the requirement that the lesser margin be utilized as the base upon which the tax is computed.
As a result, the FTB has found that each computation method cannot be analyzed on its own, but the tax as a whole must be analyzed to determine its character. The RTFT is a tax on many types of business activities, including manufacturers, merchandisers, miners, and service providers, so there is a potential for cost of goods sold (COGS) to be included in the tax base. Although the RTFT offers several methods for computing the taxpayer’s margin, not all of the methods remove COGS from the tax base, and that is the FTB’s basis for their determination that the tax is not on, or according to, or measured by income. The analysis states that all RTFT taxpayers must calculate and compare their respective margins under Texas Tax Code Section 171.101 to determine their respective lowest taxable margin, which is apportioned and used as the measure of tax, which could result in a measure not constituting net or gross income for some taxpayers subject to the RTFT. Although the tax does not qualify for the OSTC, it would be a deductible tax under this analysis.
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