Q and A with Rob O’Neill, CPA Partner, Moss Adams
Chair, OBI Committee on Tax and Fiscal Policy
In May 2019, Gov. Brown signed into law the new Oregon Corporate Activity Tax. The new tax will be imposed on businesses who have “the privilege of doing business in Oregon” at a rate of 0.57% of receipts less deductions on sales over $1 million.
You are a partner at Moss Adams accounting firm, and you also co-chair the Oregon Business and Industry (OBI) Committee on Tax and Fiscal Policy. As the chair, you now have the urgent role of helping businesses navigate Oregon’s new $2 billion tax increase which takes effect the first of January. Why did you take on the assignment?
I have been working in state and local tax for over 20 years in Oregon. I was also born, raised and went to public high school in Oregon. I care deeply about our state and want to make sure we have a vibrant business community and a fair and evenly distributed state tax structure. Being in this role has been a great honor and I felt that my deep technical background in state tax made me potentially a good resource.
Oregonians will hear this tax called the CAT, or a gross receipts tax. But isn’t this really a sales tax? Despite multiple past rejections by statewide voters, does the public know the Oregon Legislature imposed a sales tax on them in 2019 without a vote of the people?
I think the general public has no idea this is coming. It was sold as a tax on businesses. And technically, the CAT is imposed on these businesses. However, the law imposing the tax does not prevent these businesses from passing their increased costs due to this new tax on to their customers. Whether each business chooses to actually do this remains to be seen. Each industry is scrambling to address this issue right now. Most are reviewing their contracts with their suppliers and customers to give them flexibility when making the decision to pass the tax on. For example, I would expect most if not all new car dealers will put a new line on their dealer invoice for an estimated amount of their cost of their CAT starting as soon as January 1, 2020.
Executive Director Shaun Jillions of the Oregon Manufacturers and Commerce told the Oregonian, “A gross receipts tax (CAT) is very unfair to manufacturers because at every step in the supply chain you are applying the tax.” What is “pyramiding” and why does it cause so much concern to businesses? Can you illustrate how this tax structure affects a specific company?
Pyramiding is a known problem with a gross receipts tax. It is called pyramiding as there are multiple layers of tax that apply in a product’s life cycle beginning with all the raw materials that are incorporated into a manufacturer’s finished product. Take a tennis shoe as an example. All the leather, rubber and materials necessary to make the shoe in Oregon are subject to CAT when the manufacturer purchases these items. Then when the pair of shoes is sold to a store such as Dick’s, the manufacturer pays the CAT tax on the pair of shoes if they land in a store in Oregon. Then this pair of shoes is taxed again when the store sells the shoes to the ultimate customer. All of the freight costs required to get materials and product from seller to buyer are also subject to CAT.
In this example, the pair of shoes is taxed multiple times and the actual tax is much greater than 0.57%. If the raw materials constitute 50 percent of the ultimate retailer’s $100 purchase price, the actual CAT effective rate on a $110 pair of shoes would be approximately 1.5 percent. In some industries there can be as much as five layers of pyramiding with effective tax rates reaching between 5 and 6 percent.
So that’s how it affects businesses. But how will average, mostly unsuspecting, Oregonians be affected? As consumers, how will they feel this tax? Can you give a couple of examples that demonstrate how this is actually a sales tax?
While the statute exempts about 47 different types of receipts, most of the exemptions are narrowly targeted. The broadest exemption is probably the exemption for “groceries,” as the term is defined in federal SNAP (often referred to as “food stamps”) guidelines.
This is bad news for beer and wine drinkers; the price of beer and wine will go up while the price of soda will remain the same because beer and wine are not groceries, while soda is. Additionally, food sold by a grocery store is exempt, but the same item served hot or for on-premise consumption, such as in a restaurant, is taxed. Whether we start to see the new CAT on our restaurant bills will likely depend on the individual restaurant or chain. I know several restaurant groups are considering whether to add it and others are considering whether to show the increased cost on the bill, but make payment voluntary, like we see at some restaurants that are also impacted by the recent minimum wage increases.
I would even expect rents will tick upwards as all the landlords will see increased taxes from the new CAT. Bottom line, the average consumer in Oregon will feel this tax through higher prices – for almost everything.
In a note to their clients, CPAs Brandon Newton of Kansas City, Missouri, and Lisa Becker of Chicago sent this cautionary note about Oregon’s new law: “The new tax appears to be another example of a state ‘outsourcing the tax base’ by placing an increasingly higher relative burden on out-of-state persons and businesses.” Newton and Becker added, “Wholesalers and retailers of tangible personal property should specifically examine their level of activity and sales in Oregon … ” Will this tax discourage investment in Oregon? Should Oregonians be concerned about these warnings?
Since the tax is imposed on Oregon sales regardless of where they are sold from it will impact everyone pretty much the same. So at least the tax is seemingly fair. If you have a large market for your products in Oregon then you will feel it more. And because the law contains an economic test for when you become subject to the CAT, Oregon will add a lot of new taxpayers to its rolls. These out of state companies currently don’t pay Oregon income taxes, due to a federal preemption called P.L. 86-272. The state has taken the position, and most practitioners think it is likely valid, that this preemption does not protect out-of-state sellers from the Oregon CAT.
As for whether it will curtail investment, Oregon still has some nice property tax incentives for companies making certain types of investments in the state. I certainly think companies will evaluate whether the same or similar investment could be made in surrounding states, especially since the CAT will increase the costs to expand in Oregon. I don’t expect it to have a large impact as long as the rate stays low. Hopefully the legislature makes some policy decisions in the future to provide further incentives for companies to make these investments in our state as these companies and the jobs they bring are critical to our economy.
Back in 1999, Gov. Vic Atiyeh discussed how he engineered Oregon’s miracle economic comeback of the 1980s. Atiyeh said, “We also encouraged Asian investment by repealing Oregon’s Unitary Tax, which taxed companies on their in-state business.” Now the Oregon Legislature has readopted a unitary tax. What’s a unitary tax? Why did the legislature choose this?
We already have a unitary income tax. I think the practice you might be referring to is Oregon’s limitation of its unitary income tax to a company’s United States unitary group – this is sometimes called a “water’s edge” filing method. So Oregon doesn’t directly impose its income tax on a company’s foreign affiliates. In contrast, there is no water’s edge language in the CAT law. So this technically does subject these foreign companies to the economic tests for when a company is subject to the CAT. Additionally, most of the United States’ foreign tax treaties are targeted at income based taxes – they don’t protect these companies from the CAT. I would expect some litigation could arise from this uncertainty – some taxpayers could argue the CAT is an income tax and therefore not only treaty protected, but limited by P.L. 86-272. I know several attorneys that are looking for new clients to test some of the boundaries of this new tax.
Prior to the CAT’s passage, the Oregonian noted a very unlikely supporter – Nike. Intel, on the other hand, opposed the tax. OBI was neutral, though CEO Sandra McDonough said, “We think the gross receipts tax is very harmful and would do a lot of damage.” Why wasn’t the Oregon business community united in opposing Oregon’s new sales tax? Are any businesses or industries exempt? Did Nike get special treatment?
The legislature had a Democrat supermajority and because of that, it was very hard for the Republicans to prevent the legislature from passing this new tax. OBI had created its own legislative concept called the Business Activity Tax or the BAT. It proposed to raise a similar amount of money, but without the harmful impacts of pyramiding and compounding. This idea was scrapped during the session. However, we were able to negotiate some deductions from the CAT base. All CAT taxpayers are entitled to subtract the greater of 35 percent of apportioned cost of goods sold or payroll. We were hoping for a greater percentage, but were unsuccessful. Allowing a full subtraction from the tax base largely mitigates the impact of pyramiding.
Certain companies like Nike and Intel are unique in Oregon. They have large employee bases here, but very few sales to customers here. Nike doesn’t have a distribution center and only few stores are located in Oregon. I’m also guessing few of its customers have warehouses in Oregon which minimizes their exposure to the CAT. Intel is similar in that most if not all of their customers are other manufacturers and few if any of its sales would be to customers taking delivery of their product in Oregon. This means both Nike and Intel have limited exposure to the new Oregon CAT. However, they won’t be fully insulated. Nike is building several new buildings at its corporate headquarters and Intel is always updating its manufacturing facilities in Oregon. All these construction contracts will be subject to the Oregon CAT. Additionally, Intel’s supply chain will be taxed in Oregon. As a result, all the items it purchases and incorporates into its products will have a layer of CAT in them.
Recently, a large local Oregon retailer sold his business because of shrinking profits. Though his sales were in the millions, national big box chains were squeezing profit margins close to zero. Explain how the new CAT sales tax puts local Oregon retailers and other businesses at risk because of these competitive pressures? Will Oregonians see job losses, bankruptcies and closures from businesses both small and large?
In order for companies to remain operating, they must make a profit. Retailers are especially vulnerable to margin pressures caused by gross receipts taxes. This is because retail businesses must be very competitive in their pricing to bring shoppers to their stores. Many retailers may earn profits of only 1 to 2 percent of their revenue. If you put a 0.57% tax on that, you’re essentially imposing a tax of up to 50 percent on net income and it does jeopardize whether that business can operate in Oregon and make enough profit based on the amount of risk the business is taking by operating here. Grocery stores and trucking companies are two essential businesses that tend to run on very thin margins. Although sales of groceries are exempt, sales of all non-grocery items are taxed.
Large companies may be able to push back on a supplier’s pass-through of cost increases. Local retailers, however, may not have the same purchasing power and may experience greater margin pressure as they are forced to compete. It is hard to say with any certainty whether there will be actual job losses. However, the Oregon Legislative Revenue Office (LRO) did predict there would be modest job losses. The businesses that don’t have the ability to raise their prices or pass the CAT onto their customers will struggle and I would not be surprised if several decide to no longer operate in Oregon.
At one point Sen. Mark Hass, the author of the new CAT tax, argued that a statewide value added tax would be better. Do other states have better ways of taxing businesses? Why does Oregon now have a high income tax, relatively high property taxes, and a brand new pyramid sales tax?
I was not a big fan of the CAT. OBI was advocating for the BAT, which was modeled after a similar tax that was used for many years in Michigan. Texas has also been using something similar for a number of years. These taxes are effective in raising revenue as they are both broad-based in that they are imposed on gross receipts less purchases or costs of goods sold or payroll. Ohio has a gross receipts tax, the Commercial Activity Tax, also called the CAT, which is a 0.26% tax on all gross receipts with very few exemptions and no subtraction for cost inputs or labor.
However, when Michigan, Ohio and Texas adopted these taxes, they phased out or eliminated other corporate taxes and simplified their overall taxing regimes. Oregon is unique in that it is imposing the CAT on top of all existing taxes that businesses and individuals already pay. OBI advocated for a repeal and replace, but really did not have a shot at this because of the super-majority.
Oregon has had a strong economy for several years. But state government has been growing by a whopping 20 percent per biennium. Does this massive government growth explain the need for a new $2 billion tax? Where is all this new government spending going?
One of the biggest drivers is the loss of federal monies to fund Medicaid expenses of the state. It does seem that this growth is unsustainable and some real focus needs to shift to the expenditure side. Meaningful cost-cutting will likely be the focus of the Republicans during the next two legislative sessions. Whether it is actually accomplished depends on whether there is greater balance in the legislature. Unfortunately, it seems in the near term we may see more revenue generated through a Cap and Trade bill that will likely be the top priority of the Democrat-controlled legislature. Of course we also have our PERS obligations that make the revenue needs even greater. The solution cannot always be more revenue.
On January 1, average Oregonians will begin to carry the weight of this $2 billion a year tax. Is there any way out for Oregon voters? Are there efforts to improve, amend or repeal this tax?
As a result of a compromise during the session, there was no serious effort by the business community to refer this bill to the ballot. The fact that the money is supposed to be spent on funding our schools would make a vote to repeal the tax unlikely. There will be a technical corrections bill in the upcoming short session. There are a number of fixes that will be necessary. Whether certain industries can lobby to make it better or mitigate certain unintended consequences will be a little challenging. However, there is some speculation this new tax will raise considerably more than estimated by the LRO. If this is the case, it may be that certain policy changes are on the table. The best way to get out of this tax is to pass the increased cost on to your customers. The quicker we treat this like a sales tax the better from my perspective. I don’t expect most businesses to absorb this new tax through taking margin hits. They will pass it on one way or another. Hopefully you bought your new car before the new year.