Ohio’s recently enacted budget has eliminated the throwback rule, which means that businesses are no longer taxed by the city in which they are located for a sale made outside of their home city. In fact, in most situations, the transaction is not taxed at all.
“The rule change should save Ohio businesses money,” says Larry D. Friedman, CPA, MT, director of taxation at Barnes Wendling CPAs. “However, companies will need to closely monitor sales activities to ensure they’re able to take full advantage of the rule change.”
Smart Business spoke with Friedman about the throwback rule and what its elimination means for businesses.
What is the throwback rule?
The throwback rule, which relates to city income tax, states that if a business ships goods to a customer outside of its home municipality — the municipality in which the business is physically located — the sale is taxed in the business’s home municipality.
The law was designed with municipalities in mind to counter nowhere income, or an income stream that was difficult to attribute for tax purposes. Throwback rules made it so all sales were considered to originate at the factory, as long as the company doesn’t have solicitation somewhere other than where the goods were produced.
What counts as solicitation?
Solicitation is typically considered regular sales visits — at least once per month — or a permanent office. If there is enough activity to qualify as solicitation, the municipality in which the solicitation takes place can, under the current rules, tax the sale. Passive sales, such as when transactions are made through a website, do not qualify to be taxed.
There have been discussions around creating a nexus in one form or another that would act as a presence for tax purposes, but nothing has been settled. For now, the rule relies primarily on physical presence.
What businesses will be affected?
The change affects businesses that sell goods outside of the borders of their home city. It relates only to sales of tangible personal property — service providers are treated differently. Companies that sell goods outside of their primary location and have solicitation in another municipality will continue to have tax obligations in those locations.
There is some relief for companies with solicitation in multiple locations. The state is enacting a centralized option for net-profit municipal filings. Rather than a company filing in multiple locations, a business can choose to file one return with the state, which will process the returns and dole out the income taxes owed to municipalities.
How should affected businesses adjust?
Businesses should pay close attention to where sales occur. They will need to keep a close eye on what their sales people are doing, how often they’re soliciting customers in municipalities outside the company’s hometown, and by what means.
Each municipality has its own tax rate, so how this affects a company comes down to the rates, if any, that now affect it. There will be situations in which transactions are taxed because the company has solicitation. The difference between the rates of those municipalities will determine if there is a net savings or increase.
Generally, however, companies most likely will realize a smaller city income tax burden, less tax overall and more net income.
Are municipalities expected to challenge the change to the throwback rule?
It’s unlikely that municipalities will be happy with the change since it could mean a loss of tax revenue for many of them. It’s hard to say, at the moment, if they’ll police transactions more aggressively or if they’ll press for a legislative solution.
The potential exists for municipalities to undertake more audits on companies to look for unreported or under reported revenue streams to make up the difference. But again, there has not yet been a clear signal that will happen.
The elimination of the throwback rule is another example of Ohio attempting to become more business friendly. For most businesses, this change represents tax relief, but in order to take full advantage of the opportunity, its incumbent on companies to ensure they’re documenting transactions better than they have in the past. ●
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