Corporate Income Tax

Issue

How should Minnesota’s corporate income tax be structured to make Minnesota more attractive to own and operate a business?

Policy

Minnesota should repeal its corporate income tax because it is a competitive problem for Minnesota businesses, it is an impediment to investment in the state, and it has a negative effect on entrepreneurial activity and the gross state product. In 2009, the latest data available, Minnesota had the 12th highest corporate income tax collections per capita and the 18th highest per $1,000 of personal income. Minnesota’s corporate income tax rate (9.8 percent) is fourth highest in the nation, and the combined state and federal rate is fourth highest in the Organisation for Economic Co-operation and Development countries. The state also apportions income to the full extent of the Constitution.

If the corporate income tax cannot be repealed, the Minnesota Chamber recommends the following to minimize the anti-competitive nature of the tax:

• Corporate income tax structure. The Legislature should maintain the dividends received deduction, the foreign royalty deduction and not make any more changes hindering the viability of foreign operating corporations. The Legislature should not enact a throwback rule, a throw out rule, or a Finnigan style method for determining the sales factor of the apportionment formula . The deductions, lack of a throwback rule and foreign operating corporation structure were, originally, tax policy decisions made by the Legislature. They were intended to encourage exports, avoid taxing foreign and domestic income without sufficient nexus to Minnesota, avoid multiple taxation of income, and encourage corporations to locate and retain corporate headquarters and major facilities in the state.

• Sales-only apportionment. The Legislature should accelerate the phase-in of a sales-only apportionment formula. In 2005, such a formula was phased in over eight years beginning with tax year 2007. Doing so will improve the competitive position of businesses with significant investments in property and payroll in Minnesota.

• Corporate income tax rate. The Legislature should substantially reduce the corporate income tax rate. Research shows that high rates have negative effects on aggregate investment, entrepreneurial activity and gross state product.

• Refund delay. The Legislature should not use the delay of refund claims as a means to address the state’s cash-flow needs.

• Economic substance. Any legislation codifying an economic substance doctrine should be limited to the corporate income tax and have a prospective effective date.

• Interest tax. The Legislature should not enact special taxes on interest received. Doing so would either further tighten credit and/or increase costs to consumers. As drafted, the 2009 proposal was also potentially unconstitutional because it appeared to be an unapportioned gross receipts tax.

• Capital gains exclusion. The Legislature should exclude from Minnesota taxation a percentage of a corporation’s capital gain income. This will make Minnesota more attractive to locate a business because the tax consequences of selling property at a gain will be less than in most other states.

• Corporate alternative minimum tax. The Legislature should eliminate the corporate alternative minimum tax (AMT). Doing so would greatly simplify Minnesota’s corporate tax system. Few corporations currently pay the AMT each year. It is needlessly complicated and does not result in any long-term revenue gain to the state. It only changes the timing of corporate tax payments for a few firms.

Business Impact

Repealing the corporate income tax should put Minnesota in a much better position to attract new businesses and keep and expand existing ones.

Speeding up the phase-in of a sales-only apportionment formula, reducing the corporate income tax rate, enacting a capital gains exclusion and eliminating the corporate alternative minimum tax will improve the competitiveness of Minnesota’s corporate income tax, improve the tax equity among C-corporations and businesses that flow business income through a personal tax return, and ease the administrative burden of the tax. In order to make sure that all corporations benefit from changes to the corporate income tax, all four changes must be enacted over time.

Eliminating – or reducing – the dividends received deduction, repealing the foreign royalty deduction, enacting a throwback rule, a throw out rule, or Finnigan method of determining the sales factor of the apportionment formula, or making the use of foreign operating corporations an ineffective corporate structure would increase the corporate tax liability of employers that have significant operations in the state and sell nationally or worldwide. As a result, this would discourage these businesses from having major facilities such as corporate headquarters in Minnesota.

The Minnesota Supreme Court in the HMN v. Commissioner of Revenue refused to judicially adopt an economic substance doctrine. The court ruled that the Department does not have “the authority to attribute income and assess taxes to a business that structured itself to comply with the letter of the relevant tax statutes” even though it was motivated to do so by reducing its tax liability or tax avoidance. If an economic substance doctrine is legislated, it should be done only in a prospective manner and be limited to the corporate income tax. Otherwise, it would give more power than warranted to the Department and change the rules retroactively.

Enacting a tax on interest would have a negative impact on consumers and businesses that offer credit. Many consumers would be worse off because interest rates would likely increase or credit would be more difficult to get. Businesses that offer credit also could see reduced sales opportunities. They would need to track the portion of credit card debt that is subsequently sold to investors that originated from Minnesota consumers and potentially track debt that has a “high” interest rate. This would be a significant administrative burden.