Georgia's New Withholding Rules
In the summer of 1993, Jerry Jackson, Deputy Commissioner, contacted the Taxation Section of the State Bar and the Atlanta Bar Tax Section requesting the Bars' participation in the formation of a new committee to solicit comment from tax professionals with respect to issues of importance. In response to this invitation, a committee, which has been designated as the Joint Liaison Committee jointly sponsored by the Atlanta and State Bar Tax Sections has been formed. Appointments from the Bar are made by the Chairs of the State Bar and Atlanta Bar Tax Sections respectively. In addition, invitations have been extended to and several members of the Georgia Society of CPAs have been included in this membership. The current membership of the Joint Liaison Committee from the private sector is: Charles R. Beaudrot, Jr., Bobby L. Burgner, Albert Caproni, Raymond P. Carpenter (Co-Chairman, State Bar), N. J. Citron, John L. Coalson (Co-Chairman, Atlanta Bar), Frank DeLuca, Peter Fishman, CPA, Stephen E. Forbes, Tim Gillis, Gary Hickman, Joann Jones, Patrick G. Jones, Richard M. Morgan, Linda W. Munden, James L. Underwood, CPA, Michael L. Wood, CPA.
The formation of the Joint Liaison Committee represents an intelligent and laudable effort on the part of the Revenue Department to solicit comments and assistance with respect to proposed regulations and issues of concern to businesses and their tax advisors in Georgia.
I. Withholding on Distributions to Nonresident Members of Partnerships, Subchapter S Corporations and Limited Liability Companies.
A. Legal Background of Uncertainty to the Statute. The taxation of nonresident shareholders of S corporations and nonresident partners of partnerships has long been an extremely murky area. There is much lore and little law. Much of the "law" is little more than instructions to various tax forms and unwritten Revenue Department policies. For an excellent review of a number of salient issues with respect to taxation of nonresident partners and S corporation shareholders, see Patrick G. Jones, "Georgia Taxation: Partners and S Corporation Shareholders", The Atlanta Lawyer, Volume 40, No. 1, p. 14 et seq. (1973).
B. Practical Problems. For some years the State of Georgia has had audit teams specifically assigned to the audit and assessment of Georgia income tax against nonresident partners and S corporation shareholders. Perhaps the most frequent pattern is that of the nonresident individual partner who has an interest in a syndicated Georgia partnership or entity. For a number of years the partnership would show a series of losses or small amounts of income until the year of the sale (or foreclosure) of the underlying assets. Frequently, the nonresident partner would report any income from the Georgia partnership on the tax return of the state of his domicile assuming, erroneously, that such income is analogous to dividend income from stocks, the income of which is generally taxable in the state of domicile of the holder of the interest. Similarly, such partners generally did not file any returns in Georgia.
Under this scenario, the nonresident partner often found himself in the following unhappy position:
The Revenue Department has similarly been frustrated by the practical inability of reaching nonresident partners and shareholders of S corporations, especially in those cases where the tax liability is modest and collection impractical.
C. The Legislative Response. In response to these continuing difficulties, the Revenue Department sponsored and obtained the passage in the 1993 legislative session of a statute codified as O.C.G.A. §48-7-129.
The following questions are some of those frequently asked on LLCs. Many of these topics deserve an extensive discussion. The "answers" are included only to alert the practitioner to certain issues and to give him or her a start on the analysis.
D. Problems of Interpretation of the Statute and Regulatory Response. The statute is replete with a variety of inherent ambiguities. The regulations adopted under this section appear at Reg. §560-7-8-.34 and attempt to clarify several issues. The regulations make substantial progress in this regard. By no means do they resolve all of the issues.
E. Forms. Attached are copies of the statute and the regulations, as well as forms developed by the Revenue Department for implementation of the new statute.
II. Withholding Tax on Sale or Transfer of Real Property and Associated Tangible Personal Property by Nonresidents.
At the same time as the legislature was enacting the partnership and S corporation withholding rules, the legislature also enacted a new withholding tax with respect to transfers of real property by nonresidents. The new withholding tax on sale or transfer of real property by nonresidents is in a sense a "mini-FIRPTA" as far as Georgia is concerned. Withholding at 3% is imposed with respect to all sales or transfers by nonresidents unless they can meet the statutory definition of resident or deemed resident as contained in O.C.G.A. §48-7-128.
A. Relief from Withholding. The transferor is permitted to avoid the withholding obligation upon receipt of an affidavit signed under oath swearing or affirming that the seller or transferor meets the following tests:
B. Limitation of Withholding. In all other cases there is a 3% withholding obligation as to the purchase price paid. However, if the amount required to be withheld exceeds the net proceeds payable, the withholding is limited to the net proceeds actually payable. The Q&A indicate the common sense net proceeds means amounts paid to Seller. Alternatively, O.C.G.A. §48-7-128(c) specifically permits that by providing an appropriate affidavit computing the actual amount of gain withholding can be calculated at 3% of such amount. Under Reg. §560-7-8-.35(3)(a), in order to take advantage of this reduced withholding, a form IT-AFF2 must be used in such calculation. A copy of such form is attached. The Q&A's affirm that only taxable transactions are subject (Q&A - 9).
C. Exceptions From Withholding. There are a number of important exceptions from withholding under O.C.G.A. §48-7-128(d) that solve some of the most chronic problems. These exceptions include:
D. Definition of Residents and Nonresidents. The regulations go to some length to clarify unanswered questions as to the status of residents and nonresidents. For instance they make clear that joint tenants are to be tested separately. Reg. §560-7-8-.35(1)(a). Similarly, a trust administered outside of Georgia is a nonresident, presumably irrespective of the state of creation. Reg. §560-7-8-.35(a).
E. Installment Obligations. The regulations specifically do not address the issue of how to deal with withholding on installment obligations. Presumably the 3% withholding, if it can be funded from the initial payment, will be due in full at closing. If not, the resolution is unclear. It is to be hoped the Department will agree to a procedure whereby the withholding can be collected ratably from the payments as made. The recent draft Q&A's take this position (Q&A - 11).
F. Forms. The regulations are liberal as to use of forms and documentation. They specifically state that not only can the officially sanctioned forms be used, but any closing statement, transfer statement or other documents containing all of the requisite information can be used.
G. Like Kind Exchanges. The regulations and forms are silent as to the tax treatment of like kind exchanges. It would appear, however, that as long as the exchange qualifies as a non-taxable exchange under O.C.G.A. §48-7-27(b)(6), then such withholding is excused provided that the appropriate IT-AFF2 gain affidavit is produced. To the extent of gain (i.e., boot), presumably this will be subject to withholding. Bear in mind, however, that exchanges for purposes of O.C.G.A. §48-7-27(b)(6) are considerably narrower than the federal test in that the replacement property must be located in Georgia. Also, the forms do not really address the issue. The Q&A's adopt this approach (Q&A - 7).
H. Appendix. The statute, regulations developed by the Revenue Department and suggested forms developed by the Revenue Department for use under this new section are attached.
III. Taxation of Computer Software for Ad Valorem Tax Purposes.
A. Background on the Problem. An issue of continuing interest and concern for the high tech industry in Georgia has been the taxation of computer software for ad valorem tax purposes.
Administratively, certain Georgia taxpayers had been assessed with respect to the book value of the capitalized costs of their software. Assessors in certain counties, mainly in Metro Atlanta, took the position that capitalized software constituted tangible personal property and was therefore subject to tax as personal property.
Whether such software was taxable as "tangible personal property" for ad valorem tax purposes was highly debatable. Historically, the Revenue Department itself has drawn a distinction between a so-called "custom" or "canned or prewritten software" for purposes of whether such assets constitute tangible personal property for sales tax purposes. The Revenue Department's current position is that "canned" or "prewritten" software is taxable for sales tax purposes, but that "custom" software is not. What is "custom" as opposed to "canned" was and is less than clear.
More generally, there was a fundamental question as to why software would not be properly categorized as an intangible. Specifically, pursuant to O.C.G.A. §48-6-21(9), even as it existed prior to the 1993 amendment described below, intangible personal property included a category of property including "patents, copyrights, franchises, and all other classes and kinds of intangible personal property not otherwise enumerated." There was no Georgia case law or interpretation with respect to whether the concept of intangible property should include software. It did not take a vast extension of existing case law to argue, however, that the physical embodiment of software in a tangible form, such as in a diskette, should no more make the underlying software taxable as tangible personal property than embodiment of Gone With the Wind in the covers of the book or in a videotape makes the copyright of Gone With the Wind (as distinguished from the book or videotape itself) taxable as tangible personal property. Cf. Turner Communications Corporation v. Chilivis, 239 Ga. 91, 236 S.E.2d. 251 (1971). [Videotapes are tangible personal property for sales tax purposes even though they consist of at least three different components: tangible medium, intangible contents and limited right to use the encoded program.]
The Revenue Department had indicated, at least informally, that custom computer software should constitute intangibles and not be subject to the ad valorem regime. However, the Revenue Department also had indicated that the county administrative offices were free to examine the issue and would not preclude their efforts to assess taxpayers.
Some commentators had urged that the line could be drawn between software inventoried physically in diskettes for sale, which would be subject to taxation based upon the rules applicable to inventory, versus the intangible residual inherent in the software as intellectual property. See Beaudrot, "Current Issues in State Taxation of Computer Software -- The Georgia Experience," The Atlanta Lawyer, Volume 40, No. 1 (1993).
B. H.B. 350. The high tech industry in Georgia made a top priority for the 1993 legislative session an effort to obtain relief in this area. In this regard, the industry was most fortunate to enlist the support of Governor Miller. The result, H.B. 350, is codified in O.C.G.A. §48-1-8 and amendments to O.C.G.A. §48-6-21 and represents an interesting grafting of several concepts. First, computer software is defined in O.C.G.A. §48-1-8(a) for the first time as follows:
Second, computer software is defined to constitute personal property for ad valorem and intangible tax purposes only to the extent of the medium in which stored. O.C.G.A. §48-1-8(b) provides as follows:
Finally, amendments to O.C.G.A. §48-6-21 classify computer software, as so defined, as an intangible, thus removing it from the domain of the county tax assessors.
The net result is that software is valued only to the extent of the medium and is taxed as an intangible. This "double whammy" means that in most cases, little or no tax will ever be due with respect to software.
C. Implications of H.B. 350 in Other Contexts. One of the most interesting aspects of O.C.G.A. §48-1-8(c) is the "inventory" exception to this rule.
(c) Nothing herein shall be deemed to affect the taxation under Chapter 5 or Chapter 8 of this title of copies of computer software held as inventory in a tangible medium ready for sale at retail by one who is a dealer with respect to such property and the sale of which is subject to sales and use taxation.
Such inventory is then subject to normal rules (i.e. implicitly subject to ad valorem and sales tax). This section raises interesting implications about the taxability for Georgia Sales and Use Tax of other "non inventory" software.
IV. Use of Passive Investment Companies.
Aaron Rents, Inc. v. Collins, Fulton County Superior Court, Case No. D096025 and Merck v. Collins, Fulton County Superior Court E-3677.
Delaware permits companies which limit their instate activity to receipt of a passive investment income ("Passive Investment Companies" or "PICs") to pay no income tax on the earnings from these activities. Such passive income can include interest, dividends, and license and royalty fees with respect to patents, copyrights, trademarks, trade names, service marks or other intangible assets.
A number of tax planners have actively marketed the establishment of Delaware PICs and the transfer of intangible assets to such holding companies in consideration for future payments of licenses or royalties. This can result in a reduction of Georgia taxable income to the Georgia company, thus substantially reducing tax.
In the Aaron Rents case, Aaron Rents paid its PIC 2% of its gross sales as a royalty on the "Aaron Rents" trade name. According to the report contained in the pleadings, this resulted in 90% decrease in Georgia taxable income. The auditor disallowed the royalty deduction and assessed tax on Aaron Rents for additional taxes as if no royalty payment had been made.
In Geoffrey, Inc. v. South Carolina Tax Commissioner, 437 S.E. 2d 13, (S. Ct. S.C., July 6, 1993), the South Carolina Supreme Court upheld the imposition of South Carolina income tax on payments to Geoffrey, Inc., a wholly owned second tier subsidiary of Toys R Us, Inc. with respect to payments made as royalties for use of the "Toys R Us" trade name and related marks against claims that such tax violated the due process and interstate commerce clause. The court concluded that the licensing of the trademarks alone created nexus in South Carolina. A petition for certiorari to the Supreme Court was denied on November 29, 1993 (114 S.Ct. 550, 62 USLW 3374).
Aaron Rents was argued in March before Judge Eldridge who has referred the case to Roland Barnes as magistrate. A decision is expected at any time. Merck is still in discovery and negotiation of the stipulation of facts.
V. Equitable Apportionment.
Bechtel Power Corporation v. Collins, Fulton Superior Court No. D-81178.
O.C.G.A. §48-7-31 provides for the methods of apportioning income as to companies doing business both within the state and outside of Georgia. As you know, the three factor method of sales, payroll and property is generally applicable to businesses selling tangible personal property. A single factor (gross receipts) is used for dealers in intangibles (including stock brokers). Companies which do not fit any of the foregoing fall under a third method that requires "equitable apportionment." Thus, businesses providing only services have no statutorily mandated methodology.
As a policy matter, but with no regulatory sanction, the Revenue Department generally insists that service companies use a three factor formula and be done with it. However, some service companies would prefer to use only gross receipts.
The state has consistently refused to adopt regulations which would resolve these issues. Apparently, the taxpayer in this case has taken the position that as long as the state does not write regulations, it can adopt any method which "equitably apportions" and, thus, that the gross receipts method is appropriate and permitted.
The case was tried before Judge Long this spring and final post trial briefs submitted. A decision is awaited at any time.
VI. Consolidated Returns.
American Telephone & Telegraph Company, et al. v. Collins, Fulton County Superior Court, Case No. D-90621.
O.C.G.A. §48-7-58 permits the Commissioner to require a unitary method of filing income tax returns by related corporations if other methods will result in distortion of income. On the other hand, the right to file a consolidated return is subject to consent by the Commissioner. The AT&T case raises the issue of whether the Commissioner abuses his discretion by refusing to permit a taxpayer to file on a consolidated basis if it is a unitary operation and if this will result in more accurate representation of business level activity and, incidentally this will also reduce Georgia tax.
The case was tried before Judge Langham in September and briefed before Thanksgiving. A decision is expected at any time.