How Oregon’s new corporate activity tax affects the timber industry

Oregon’s newest state-level tax, the Corporate Activity Tax (CAT), became effective Jan. 1, 2020. In contrast to its title, it applies to all forms of business, including individuals, partnerships, limited liability companies (LLCs), and trusts.

Background

Oregon Governor Kate Brown signed the CAT into law in June 2019. In June 2020, she signed House Bill (HB) 4202, which clarified and modified the CAT statute. Oregon’s Department of Revenue has also published final versions of several rules interpreting the CAT statutes and providing guidance to taxpayers. Several provisions are of particular interest to the timber industry, from harvest to sale of finished lumber.

Although several other states — including Hawaii, Kentucky, Nevada, New Mexico, Ohio, Tennessee, Texas, and Washington — impose a tax on gross receipts or modified gross receipts, Oregon’s mechanism for determining the CAT base is unique.

Unitary groups

The CAT applies to a unitary group, which includes one or more legal entities that engage in activities constituting a unitary business. In general, a unitary business is a business enterprise where there’s a sharing or exchange of value between the various parts of the enterprise.

Entities are often considered to be a unitary business if they operate with the following:

• Centralized management
• Centralized administrative services
• Transactions involving inter-entity exchanges of goods or services

Entities engaged in a unitary business are a unitary group if they have more than 50% common ownership, either direct or indirect. It’s important to note that for CAT, a unitary group can include several types of entities, which can be:

• Partnerships
• S corporations
• Regular C corporations

Example

An individual may own 100% of an S corporation that owns a sawmill. The S corporation may in turn own 51% of a partnership that invests in timberland and 75% of a corporation that acts as a sales company. The individual may separately own 80% of an LLC that owns property used by the sawmill.

This entire enterprise would likely be seen as engaging in a unitary business, and due to the greater than 50% common ownership, would comprise a unitary group. This is quite different from Oregon’s income tax, which would impose tax on the C corporation separately and require each partnership and the S corporation to issue K-1s to the owner.

Under CAT, this group of taxpayers would file one unitary CAT return and four separate income tax returns.

Common ownership

Oregon hasn’t provided clarification on certain aspects of common ownership. For example, if three family members each own equal shares of two S corporations that engage in a unitary business, it remains unclear if the two S corporations comprise one unitary group.

The CAT base

The CAT base comprises three elements:

• Oregon-sourced sales
• Property brought into Oregon from outside the state
• Apportioned deduction

A $1-million exclusion applies to each separate return filer or unitary group.

Oregon-sourced sales

The starting point for the CAT is Oregon commercial activity. A sale of tangible property is Oregon commercial activity if the property is delivered to a purchaser within Oregon, whether it’s transported by seller, purchaser, or common carrier, regardless of the free on board (FOB) point or other conditions of sale.

Sellers with customers that pick up their product at an Oregon location and transport it directly outside of Oregon should capture and retain documentation of these sales so they aren’t included in the CAT base.

Conversely, sellers with a physical location outside Oregon that have customers that pick up product and transport it to Oregon should capture this data so that these receipts may be appropriately reported.

This introduces a potential challenge for sourcing, particularly for sales to large national accounts that pick up their purchases at Oregon seller locations. Sellers that believe their customers take these purchases directly outside Oregon must develop procedures that accomplish the following:

• Identify these sales
• Obtain documentation
• Capture the information in a system that can produce reports of Oregon and non-Oregon sales

Without these procedures, sellers risk either over-reporting receipts subject to CAT or receiving CAT assessments if the documentation isn’t retained in a manner that can be retrieved during an audit.

It’s important to note that the purchasers must transport their purchases directly outside Oregon. If the purchaser brings its product to an Oregon warehouse, reship facility, treatment plant, or any other point in Oregon before exporting it outside the state, it’s an Oregon-sourced sale and included in CAT unless another exception applies.

In contrast to the income-tax calculation, sales thrown back to Oregon aren’t Oregon commercial activity.

Exclusions

The CAT statute excludes over 40 specific transactions from the definition of commercial activity, four of which are particularly important to the timber industry.

Transactions between a unitary group

Any transactions between members of a unitary group are eliminated.

Sales to wholesalers

If a wholesaler provides certification at the time of sale that it will re-sell the property outside Oregon, a seller can exclude these sales from taxable commercial activity.

Oregon defines a wholesaler as a person primarily doing business by merchant distribution of tangible personal property to retailers or other wholesalers. This is widely understood to mean that the property must be re-sold, not used as input for another manufactured product.

An Oregon sawmill that purchases logs, for example, would likely not be able to issue this certification to its supplier — even if it sold its entire output outside Oregon. Further clarification on this point is pending.

However, if the sawmill sells its lumber to a broker that resells the lumber outside Oregon, the broker could issue a certificate to the sawmill. Oregon published detailed requirements for the certification in Rule 150-317-1400, including the requirement that the certification be obtained at the time of sale. The Department of Revenue has confirmed informally that it views the requirement as applying to each individual transaction; in other words, at this time a wholesaler can’t provide a blanket certification.

It's common for wholesalers and brokers to purchase commodities from several suppliers and re-sell to several buyers. If a buyer can’t identify a specific purchase with a specific exported sale, the buyer may estimate the exempt purchases by referring to its previous year actual data for Oregon sales and total sales.

HB 4202 simplified this exclusion for certain agricultural businesses. Timber, however, is specifically excluded from the definition of agriculture for the simplified method.

Amounts received by agents

The term agent is defined in Rule 150-317-1100 as “a person who’s acting on behalf of another and is subject to that person’s control.” Agents may exclude amounts received in this capacity from commercial activity. Brokers that facilitate transactions between producers and buyers should carefully review this rule and assess their contract terms if they think the agent classification may apply.

Receipts from the disposition of assets

The CAT excludes receipts from the disposition of assets described in Internal Revenue Code (IRC) Section 1221 or 1231. Sales of plants and equipment by a timber or lumber business should be reviewed to determine the amounts included in and excluded from the CAT.

IRC Section 631 is of particular importance. IRC Section 1231(b)(2) includes timber whenever Section 631 applies, which means receipts recognized pursuant to Section 631(a) or (b) appear to be excluded from CAT.

Taxpayers that elect to recognize the value of timber cut during the year as a sale of the timber then have basis in the timber equal to the value recognized. When the timber or lumber is ultimately sold, this basis is incorporated in cost of goods sold (COGS). This means these taxpayers have a COGS subtraction to partially offset CAT receipts. Taxpayers that don’t make this election may not have an equivalent COGS subtraction.

Property brought into Oregon

Oregon’s CAT is a pyramiding gross receipts tax, similar to Washington’s Business and Occupations tax. It’s designed to apply at each step of a transaction with no exclusions — other than exclusions for exported property — for wholesale sales.

To circumvent the possibility that vendors avoid the tax by delivering property to Oregon businesses outside Oregon, the CAT contains a provision requiring Oregon taxpayers to increase their Oregon gross receipts by the value of any property brought into Oregon within one year of purchase. This could have significant implications for wood-products businesses that purchase raw material inventory — such as logs — or equipment from outside Oregon and then bring it into the state. The CAT law, however, contains an exception to this rule if the taxpayer can demonstrate that avoiding Oregon tax wasn’t the purpose of the transaction structure.

Any business that purchases property, including raw materials, and equipment outside Oregon should document its business purpose for doing so and consider requesting a ruling from the Department of Revenue regarding the taxability of its purchases.

Apportioned deduction

The CAT is a modified gross receipts tax. After determining receipts subject to CAT, a taxpayer may subtract 35% of the higher of COGS or labor costs, apportioned to Oregon.

Deduction for COGS

Oregon defines COGS as “the cost of goods sold as calculated in arriving at federal taxable income” under the IRC. With certain exceptions, misclassifying a deduction as another category of deduction as opposed to an element of COGS carries little exposure on a federal income tax return because it doesn’t change taxable income.

The opposite is also true — with certain exceptions, misclassifying a deduction as an element of COGS carries little income tax risk. Taxpayers should review their tax return data to verify that COGS is appropriately identified. First, to capture the highest possible subtraction, and second, to limit audit risk because Oregon may have authority to categorize items it deems inappropriately included.

Deduction for labor costs

Oregon defines labor costs as the total compensation for all employees, which is capped at $500,000 for any one employee. Employees must be W-2 employees; contractors and partners in a partnership or LLC members who receive guaranteed payments aren’t included.

Compensation is defined broadly, and includes benefits and other employee payments, excluding payroll taxes. A taxpayer that includes labor in its COGS deduction should also include this labor in its labor-cost calculation.

Fiscal-year taxpayers

The CAT is a calendar-year tax, even for fiscal-year taxpayers. The Department of Revenue has published rules and HB 4202 contains provisions for certain safe harbors.

Apportionment of deduction

COGS or labor costs, whichever is higher, must be apportioned to Oregon. The rules for apportioning the subtraction are complex and contain some ambiguities.

The calculation can be particularly complex for entities with multistate operations or excluded sales and unitary business groups. These taxpayers will want to consult their tax advisor to review the current status of the apportionment rules and how they apply to the particular business.

The apportioned subtraction is multiplied by 35% and then subtracted from Oregon commercial activity. Each taxpayer is allowed an annual $1 million exemption, although only one exemption is allowed per each unitary group. The balance is subject to the 0.57% CAT rate.

What steps to take

Taxpayers anticipating at least $10,000 in CAT liability for 2020 must make quarterly estimated payments. This $10,000 threshold decreases to $5,000 for 2021 and future years. Estimates are due on the last day of the month following each calendar quarter:

• April 30
• July 31
• Oct. 31
• Jan. 31

In response to the COVID-19 pandemic, Oregon followed the lead of many states and the IRS in extending its tax deadlines for income tax, though it didn’t extend any CAT deadlines. However, the Department of Revenue has published Rule 150-317-1500, Good Faith Effort. This rule, specific to the 2020 calendar year, provides that a taxpayer that can document COVID-19 prevented it from reasonably estimating, calculating, or paying its CAT liability may use this information to assert it made a good-faith effort to comply with the estimate requirements.

Through April 30, 2020, the Department of Revenue made several statements regarding CAT estimated payments and penalties. Rule 150-317-1500 can be interpreted as narrowing the scope of these initial statements as they apply to penalty abatement, so taxpayers impacted by COVID should review this rule and ensure they retain documentation of their good faith efforts.