A version of this article was previously published in the August 2019 edition of Tax Notes State.
In November 2018, Portland voters approved Measure 26-201, the Portland Clean Energy Community Benefits Initiative, to accomplish two goals: meet Portland’s clean energy targets and address the underemployment and other social welfare issues of historically disadvantaged groups. To fund those goals, Measure 26-201 imposed a 1% tax—now known as the Clean Energy Surcharge, or CES—on the gross receipts of certain large retailers.
Although deemed a surcharge, the CES is a new tax that combines features of sales, gross receipts, and apportioned net income taxes, and appears to be without precedent among United States jurisdictions. Oregon, moreover, is one of five states without a general sales or transaction tax, although the Corporate Activity Tax (CAT) imposes a modified gross receipts tax effective January 1, 2020. The CES may, therefore, present unique challenges to the administrative bodies tasked with enforcing it and the taxpayers who must comply with it. In fact, proponents of the measure originally claimed it would cost businesses operating in Portland approximately $30 million per year—and that the impact would be largely felt by international big-box retailers. As City of Portland personnel further examine the ramifications of their new tax, however, the cost is rising and the scope of the tax is expanding beyond big-box retailers. Revised projections indicate the total cost to businesses may be closer to the $79 million per year originally estimated by independent economists. Portland residents are already seeing the tax passed through on their garbage bills, and the City has admitted the CES will apply to public works projects, increasing the costs of building schools, affordable housing projects, and other infrastructure work by millions of dollars.
The authors discussed the basics of this new tax in a May 2019 article. In this article, the authors take a deeper dive into some of the administrative complexities and ambiguities as well as discuss potential litigation risks related to the validity of certain provisions adopted by the Portland City Council without voter approval.
The City of Portland, Oregon (City) lies largely within Multnomah County (County). Both the City and the County impose a business license tax on apportioned net income. The City Revenue Division (Division) administers the business license taxes for both the City and the County and will administer the CES as well.
As noted above, the business license tax is based on apportioned net income. Both the City and County employ a single sales factor to apportion the net income base and define the denominator of the factor with reference to the Oregon sales factor rules.
The CES is imposed on certain retail sales of large retailers. A “Large Retailer” is defined as “a business that: 1. is subject to the Portland Business License Tax; 2. has total gross income . . . from Retail Sales of $1 billion or more in the tax year; and 3. has Portland gross income . . . from Retail Sales of $500,000 or more in the tax year.”
The statute defines retail sales broadly, as sales, including services, to a consumer for use or consumption, and not for resale. Retail banking services are specifically included within the ambit of retail services.
Certain narrow categories are exempt: food products; medicines, drugs, medical devices; and health care services.
These exemptions contain some ambiguities. The CES excludes food products, defined with reference to the U.S. Department of Agriculture (USDA) SNAP, which defines the items consumers may purchase with SNAP benefits. SNAP’s definition of food includes items commonly known as food, but incorporates several additional items, including certain seeds and plants, and hot meals and prepared foods sold to members of defined groups such as narcotics addicts served by drug addiction programs, and fishing rods, harpoons, and knives sold to certain residents of Alaska within its definition of food.
It is uncertain whether the food products exemption encompasses all items defined as food by SNAP, or whether food products are a subset of food and, if so, exactly which items are included in food products. Large retailers with significant Portland sales of goods such as fruit and vegetable plants (or fishing rods and hunting knives to Alaska residents) may want to perform a detailed stock-keeping unit (SKU) analysis to ensure the CES tax base isn’t overstated and that all exemptions are properly documented.
The medicine, drug, medical device, and health care services exemption contains more areas for potential conflict. The Code exempts qualified medicine or drugs, which means “medicine, drugs, or medical devices that are regulated by the U.S. Food and Drug Administration as a medicine or drug.” Presumably, the drafters intended to exempt devices regulated by the U.S. Food and Drug Administration (USFDA), but as regulated devices are not regulated as a medicine or drug, further regulations would be helpful to clarify the scope of this exemption.
Although ambiguities exist in the exemptions for food and medical items, the definitions do refer to objective third-party standards, such as the SNAP rules and USFDA regulations. The exemption for health care services does not contain such a reference and appears to be quite broad in scope, including but not limited to visits to doctors, medical clinics, and hospitals as well as all related services. It appears the law exempts any charges for a service that is health-related, whether or not it is performed by a licensed provider.
Resale Sales and Services
The Division has published a proposed Business Tax Administrative Rule (BTAR) addressing the distinction between retail sales and other sales. The Division asserts in the BTAR that “(a)ll business activity is either goods-producing or service-providing” and notes that, absent a specific exemption or exclusion in the CES law or the BTAR, the receipt is subject to tax.
Exempt sales for resale are defined narrowly, as applying only to situations in which:
- A good is manufactured or purchased by one business and then resold to a second business as new merchandise or combined with other components and resold to a second business as a constituent component of another new manufactured good;
- A service is resold in the same manner as goods; or
- Goods and services are resold together in the same manner as either a sale of stand-alone goods or services.
Examples in the BTAR indicate that the Division views a service as analogous to the sale of tangible property. A service procured by one entity and sold to another is treated as a resale. Similarly, a service incorporated in the value of an item to be sold, such as construction sub-contracting, may be a sale for resale.
This very narrow exclusion for services implies that essentially all service receipts will likely be subject to tax, including interest receipts, professional services provided to businesses, and, as many Portland residents have been recently surprised to discover, garbage services. Essentially any business receipt that is not specifically excluded, whether it is a service, sale of property, or intangible receipt, is likely subject to the CES.
Although many advocates of the tax, including national commentators, referred to the CES as a tax on big-box retailers, it is becoming increasingly clear that Portland may subject receipts to the tax using a broader scope than advocates of the tax may have communicated.
Taxpayers must document sales made for resale. The Division has neither published a certificate nor referred to commonly-available certificates, such as the Streamlined Sales Tax Agreement’s Certificate of Exemption or the Multistate Tax Commission’s Uniform Sales and Use Tax Certificate. While no specific form is prescribed, an acceptable certificate must include the name and address of the purchasing business, a description of the item or items being purchased for resale, and the name and title of the person signing for the purchasing business. The certificate should be signed and dated by the purchaser and include a certification by the purchaser that the items or services are being purchased for resale in the purchaser’s regular course of business.
It is unclear whether a seller may accept certificates for multiple purchases made over time, or whether the purchaser must issue a new, original certificate for each purchase,
Further, the BTAR requires that a taxpayer must have “reasonable certainty that the good or service will be resold by the purchaser and not consumed or used by the purchaser.” It is unclear whether a taxpayer may accept a statement conforming with the requirements above in good faith, or whether the statement merely documents an exempt sale and does not excuse the seller from performing additional procedures to ensure the sales are for resale. As the incidence of the CES falls on sellers, not purchasers, any burden of proof remains with the seller.
Sales of Real Property
Many have expressed concerns regarding the treatment of real property sales—unsurprising, as the Portland residential and commercial markets have seen high levels of activity for several years. The BTAR clarifies that “incidental sales of real property outside the normal course of business” are not retail sales, but other sales of real property, such as those made by a developer or a construction contractor, are subject to the tax.
Apportionment Factor Complexity
The Division, through regulation, has adopted a taxpayer’s reported numerator and denominator as the tests for determining whether a taxpayer is subject to the CES. While it isn’t clear, it appears that the Division intends to start with a taxpayer’s reported numerator, then subtract exempt items in a top-down approach.
The hybrid nature of this tax may present an initial challenge. The starting point for the City’s determination of the tax base is a business’s Portland apportionment factor numerator. However, the tax base isn’t determined by apportioned Portland sales, but by identifying taxable retail receipts at the transaction level. Businesses may need to be prepared to reconcile taxable retail transactions to the apportionment factor numerator by documenting not only wholesale and nontaxable transactions, but any GAAP adjustments that are incorporated in the apportionment factor calculation that aren’t tied to a specific transaction.
Portland’s apportionment factor regime introduces additional complexity to this calculation.
Portland has not adopted market-based sourcing for sales of other than tangible personal property, instead adopting a general income-producing activity rule.
Under the general rule, taxpayers that perform personal services must prorate their receipts to Portland based on hours worked in Portland to total hours. To illustrate, an advertising agency in Portland providing services to international clients would prorate its receipts based on hours spent in Portland to total hours, regardless of the customer location.
The general rule is modified, however, for many common transactions. For example, a freight carrier that either picks up or delivers freight to a Portland address must source 50% of the gross receipts from the transaction to the City. An interstate carrier may partially offset these receipts by up to 50%. An interstate trucking company moving freight from Florida to Portland, therefore, would be taxed on 25% of its gross receipts from this move. Companies that contract with others for freight movement, such as logistics companies, are specifically prohibited from using this apportionment method and presumably must use the personal services method described above.
Taxpayers engaging in banking are also subject to special rules that determine Portland banking income by computing a ratio of deposits in the City to deposits everywhere.
The State of Oregon has adopted market sourcing rules for revenues received from activities other than the sale of tangible personal property for tax years beginning after 2017. The overlay of Portland’s income-producing activity law and BTARs providing for special apportionment with Oregon’s market sourcing rules could produce some counterintuitive results.
- An advertising firm headquartered in Portland serving worldwide clients could have nearly all of its receipts subject to the CES under the hours methodology prescribed by the BTAR, but could find only a small fraction of its net income subject to Oregon income tax.
- An interstate trucking company could be required to pay the 1% CES on at least 25% of its total receipts, even if only a minuscule portion of its total miles are subject to Oregon tax.
- A technology consulting firm located in Portland and serving foreign clients remotely would have all of its receipts subject to the City CES, but none of its receipts sourced to Oregon.
- A technology consulting firm located in Gresham, Oregon—within the County but outside the City—providing services remotely to Portland clients would have no receipts subject to the CES but all of its receipts sourced to Oregon.
The CES measure that Portland voters passed defined a large retailer subject to the tax as, in part, a business with gross receipts from retail sales “from all locations in the United States where the taxpayer conducts business that exceed $1 billion ($1,000,000,000) in the prior tax year.
The City Council, however, expanded the retail sales base from United States sales to all worldwide sales, and it changed the measurement time frame from the previous year to the current year.
This has two implications: first, the population of retailers subject to the tax is likely expanded. Second, changing the measurement period from the previous year to the current year creates uncertainty. A taxpayer can become subject to the tax during the current year, and would not have the opportunity to adjust its pricing or its system to pass the tax through to its customers.
Oregon, like most states, follows the federal treatment of pass-through entities (PTEs). Portland, however, taxes entities that are not disregarded, such as limited liability companies that file federal partnership returns. Under current law, the $1 billion/$500,000 thresholds would apply to each taxable entity.
A business with investments in partnerships that include the distributive share of net income and apportionment factors from the partnerships should evaluate its apportionment in light of this new tax. Structuring opportunities may exist to reduce the overall Portland tax burden.
CES receipts are directed to a new Portland Clean Energy Community Benefits Fund (Fund). The Fund will be administered by a new committee charged with supporting clean energy projects, regenerative agriculture, and programs that support training and workforce development for certain groups, including communities of color, women, persons with disabilities, and the chronically underemployed. Funding priority is to be given to businesses owned or operated by such groups. The City has filled several key positions and anticipates awarding grants beginning in July 2020.
The characteristics necessary to qualify as belonging to one of the identified groups have not been defined, but the law does not appear to bar a large retailer from participating in a Fund project, such as mitigating the additional costs of a clean energy or green building project through working with a contractor who is a member of one of the identified groups. Training initiatives focused on increasing the marketable skills of members of the identified groups may also be eligible for cost mitigation.
Businesses operating in the clean energy industry or planning a project that aids Portland in meeting the plan’s goals with respect to clean energy and the social justice aspects will want to review the full measure to identify how the fund may be available to mitigate costs.
A Layered and Complex Tax Regime
Portland has enacted additional taxes applicable to taxpayers in specific situations. Businesses operating vehicles over 26000 pounds must pay Portland’s Heavy Vehicle Use Tax. A publicly traded corporation that compensates its CEO over certain city-approved ratios must pay a surcharge on its license tax.
Oregon has also instituted a tax on modified gross receipts, called the Corporate Activity Tax, or CAT, based on Oregon-sourced gross receipts, to begin in 2020. Oregon has employed destination (excluding throwback) and market-sourcing concepts for determining the receipts subject to the tax.
Due to the interplay of the City’s unique sourcing rules for its license tax and the CES, the geographic proximity of the City and County, Oregon’s adoption of market sourcing principles for its net income tax, and the new Oregon CAT, a taxpayer may find that one item of income may be subject to up to seven layers of taxes and fees:
- Oregon CAT
- Oregon net income tax/minimum tax
- Portland license tax
- Multnomah license tax
- Portland CES
- Portland CEO surcharge
- Portland-heavy-vehicle-use tax
As a location may be in the City and County, the County but not the City, or (less commonly) in the City but not the County, any taxpayer with worldwide receipts exceeding $1 billion dollars may want to pinpoint any and all Oregon locations where it could have sales, either of tangible property or of services, to ensure all taxes are appropriately remitted and not overpaid.