Q&A: How to Navigate the Oregon Corporate Activity Tax

Rob O’Neill spoke to Oregon Transformation: Ideas for Growth and Change for their December 2019 Newsletter. Following is an adaptation of his interview, which is republished with permission.

In May 2019, Oregon Governor Kate Brown signed into law House Bill (HB) 3472A, the Oregon Corporate Activity Tax (CAT). The new tax will be imposed on businesses that have “the privilege of doing business in Oregon” at a rate of 0.57% of receipts less deductions on sales over $1 million.

Following are some of the major questions the CAT introduces and insight Oregon businesses and individuals can apply to navigate the new law.

You’re a partner at Moss Adams and co-chair of 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 took effect on January 1, 2020. Why did you take on the assignment?

I’ve 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 think that my deep technical background in state tax made me a good resource for the role at OBI.

Oregonians will hear the CAT being called 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 (the 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. The CAT was sold as a tax on businesses and, technically, it’s imposed on businesses.

However, the law imposing the tax doesn’t prevent these businesses from passing their increased costs that result from this new tax on to their customers. Whether businesses choose to actually do this remains to be seen. Each industry is scrambling to address this right now. Most are reviewing their contracts with their suppliers and customers to give them flexibility when making the decision to pass on the tax.

For example, car dealers will put a new line on their dealer invoice for an estimated amount 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’s called pyramiding because 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, the manufacturer pays the CAT tax on the pair of shoes if it lands in a store in Oregon.

This pair of shoes is then 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% of the ultimate retailer’s $100 purchase price, the actual CAT effective rate on a $110 pair of shoes would be approximately 1.5%. In some industries, there can be as much as five layers of pyramiding with effective tax rates reaching between 5%–6%.

So that's how it affects businesses. But how will average, mostly unsuspecting, Oregonians be impacted? 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 groceries because the term is defined in federal SNAP—also known as food stamp—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 aren’t considered 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 or 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.

There’s also a possibility that rents could tick upward as 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.

Will this tax discourage investment in Oregon?

Since the tax is imposed on Oregon sales regardless of where it’s sold from, it will impact everyone pretty much the same. So 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 Federal Public Law (PL) 86-272. The state has taken the position, and most practitioners think it’s likely valid, that this preemption doesn’t protect out-of-state sellers from the Oregon CAT.

As to 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 will make some policy decisions in the future to provide further incentives for companies to make these investments in our state; these companies and the jobs they bring are critical to our economy.

In 1999, former Oregon Governor 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 US unitary group, which is sometimes called a water’s edge filing method.

Oregon doesn’t directly impose its income tax on a company’s foreign affiliates. In contrast, there’s 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 US foreign tax treaties are targeted at income-based taxes and don’t protect these companies from the CAT.

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 PL 86-272. I know several attorneys who are looking to test some of the boundaries of this new tax for their clients.

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.” (Read more from the Oregonian.) 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?

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 a few stores are located in Oregon. 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 should 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 of 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 profit. Though his sales were in the millions, national big-box chains were squeezing profit margins close to zero. Does the new CAT sales tax put 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 operative, 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 a profit of only 1%–2% of their revenue.

If you put a 0.57% tax on that, you’re essentially imposing a tax of up to 50% 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 nongrocery 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’re forced to compete.

It’s hard to say with any certainty if 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 on to their customers could struggle and potentially choose to no longer operate in Oregon.

At one point, Senator 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?

OBI was advocating for the BAT, which was modeled after a similar tax 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 because they’re both broad-based in that they’re imposed on gross receipts less purchases, 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’s imposing the CAT on top of all existing taxes that businesses and individuals already pay. OBI advocated for a repeal and replace, which wasn’t successful because of the super majority.

Oregon has had a strong economy for several years. But state government has been growing by a whopping 20% 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 state Medicaid expenses.

It does seem that this growth is unsustainable, and some real focus needs to shift to the expenditure side. Significant cost-cutting will likely be the focus of the Republicans during the next two legislative sessions. Whether it’s actually accomplished depends on whether there’s greater balance in the Legislature.

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. We also have our Public Employee Retirement Systems (PERS) obligations that make the revenue needs even greater. The solution can’t always be more revenue.

On January 1, 2020, average Oregonians will begin feeling the impacts of this $1 billion-per-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 possibly be a technical corrections bill in the upcoming short session, which begins on February 3, 2020. There are a number of fixes that will be necessary, but it may be challenging for industries to lobby to make the law better or mitigate certain unintended consequences.

However, there’s some speculation this new tax will raise considerably more money than estimated by the LRO. If this is the case, certain policy changes may be on the table.

The quicker we treat this as a sales tax the better. I don’t expect most businesses to absorb this new tax through taking margin hits. They will pass it on one way or another.

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For more information about the CAT tax and possible implications for you or your business, read our alert or contact your Moss Adams professional.