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Massachusetts tax law changes could create accounting headaches for N.H. businesses

Mass. Gov. Deval Patrick, left, accompanies British Prime Minister David Cameron up the steps into the Massachusetts Statehouse in Boston, Monday, May 13, 2013. (AP Photo/Elise Amendola)

Mass. Gov. Deval Patrick, left, accompanies British Prime Minister David Cameron up the steps into the Massachusetts Statehouse in Boston, Monday, May 13, 2013. (AP Photo/Elise Amendola)

New Hampshire, without either a sales tax or an income tax, has long promoted itself as an alternative to Massachusetts. But what happens in Massachusetts doesn’t always stay in Massachusetts.

On July 24, the Massachusetts legislature overrode a veto from Gov. Deval Patrick and passed a transportation funding bill that raised the cigarette tax by $1 a pack and increased the gas tax by 3 cents a gallon.

It also made more subtle changes to tax laws, extending Massachusetts’s 6.25 percent sales tax to computer and software services (what opponents have labeled the “tech tax”) and changing sourcing rules for the state’s income tax. The former took effect July 31, and the latter takes effect in the 2014 tax year.

Those changes could affect New Hampshire businesses with customers in the Bay State, creating a “compliance nightmare,” said Kathryn Michaelis, a member of the tax practice group at the law firm of Rath, Young and Pignatelli.

The Monitor sat down with Michaelis last week to get the details on these two tax-law changes, and what they could mean for companies based in the Granite State.

Let’s start with the so-called “tech tax.” How does that work?

Basically, the tech tax is an extension of Massachusetts’s 6.25 percent sales and use tax to cover certain computer and software services. . . . We obviously don’t have a sales and use tax here in New Hampshire, but historically, those states that had a sales and use tax really applied the tax to tangible things. You go into a store, you buy something, you see the tax. They did not historically apply the sales and use tax to services, and so this has been a trend over the last decade or so, where states are looking – or I should say, grappling with trying to find new sources of revenue, and one of the avenues that they’re using is to look at their sales and use tax base and try to expand it to cover stuff other than just tangible, personal property.

So this is what Massachusetts did, because before the tech tax, the sales and use tax only applied to one service, telecommunications services, which is pretty narrow. They’ve now expanded this to attempt to cover this new type of service, which, again, is computer and software services, and there are some long definitions and it’s highly confusing. . . . There’s two types of services that it covers. The first one is called computer system design, and that is planning, consulting, designing of computer systems that integrate computer hardware, software and communication technologies. . . . The second one is software modification services. So if you go in and modify, integrate, enhance, provide updates to software, it covers that as well.

Unfortunately, the legislation was not clear on exactly what they mean by this.

So how does this affect New Hampshire businesses?

New Hampshire businesses, tech businesses in particular, are going to be subject to the tech tax if, essentially, three things occur.

One, if it provides taxable computer and software services. . . . Two, if they are conducting those types of services, they have to ask, “Well, is it sourced to Massachusetts?” . . . Unfortunately, those rules are somewhat complex as well.

The third one, and this is really the critical one for New Hampshire businesses or any business outside of Massachusetts, is if that New Hampshire business has “nexus” with Massachusetts. And when I say nexus, what that really means is, does the business have a physical presence in Massachusetts? That can be anything from an office, it can be anything from no office but I have employees down there running around, sales people that are visiting customers – even if it’s for a few days, that constitutes physical presence.

That last one is key for New Hampshire businesses to know, because if the New Hampshire business has no physical presence in Massachusetts, it has no legal obligation to collect and remit the tech tax.

So, how does the change that Massachusetts made to its income tax rules work? And again, how will that apply to New Hampshire once that goes into effect in 2014?

That’s the first point, is, it doesn’t go into effect until 2014. But New Hampshire businesses should really start to look at what they’re doing, and where they’re doing it, now so they can prepare.

The change that happened on the income tax side was basically a shift from what we call “cost of performance” to “market-based” sourcing. I’ll give you a simple example: . . . Let’s say I’m a consulting firm in Concord, N.H., and this is my only office. If I provide services to Massachusetts customers, the old rule would look to where I performed those costs: right here in Concord, so that would be sourced to New Hampshire and Massachusetts would not include that income in their tax base. Under a market-based rule, it looks to where the customer is located. So if I’m up here in New Hampshire only, and I haven’t set foot in Massachusetts, but my clients and my customers are in Massachusetts, that is now a Massachusetts sale.

The income tax sourcing is going to affect New Hampshire service businesses. It’s going to affect everything from law firms, accounting firms, engineering firms, unfortunately the same tech firms we talked about under the tech tax are going to get hit with this – any other service-based business that provides services and has Massachusetts customers.

Again, the old rule looked to where you performed the services. The new rule says, “We don’t care about that. We’re just going to look to where your customer is, and if your customer is in Massachusetts, that income is sourced to Massachusetts for the purpose of its income tax.”

Doesn’t it raise constitutional questions if Massachusetts is trying to reach across the border and collect taxes in a state that has chosen not to have an income or a general sales tax?

Hopefully, they will administer it within the constitutional boundaries, with respect to the sales and use tax. I will say on that point, though, we are definitely going to have cross-border issues with regard to the tech tax. . . . But I think there are benefits that we might derive, too, long-term benefits based upon what Massachusetts has done. I think that we might see a migration of companies that might come up here because the compliance burden, the tax burden, might be significant in their businesses. And it also might give New Hampshire tech firms a competitive advantage over Massachusetts tech firms, because they won’t have a 6.25 percent sales tax. . . .

The problem we have, on the cross-border issue here, is that our consulting firm we just used as our example? It’s now going to be subject to tax in both New Hampshire and Massachusetts on the same income, because New Hampshire has the cost of performance rule. So if I’m up here, with my only office in New Hampshire, New Hampshire taxes that under the Business Profits Tax. Now, that same income is going to go in the tax base for Massachusetts.

So it’s not dollar-for-dollar double taxation, but it is double taxation in the sense that the same income is being taxed by more than one state.

What’s your advice to companies that might be affected by one of these two changes?

I think right now, in particular for the tech tax, New Hampshire businesses need to assess whether or not they’re providing taxable services, how they’re providing it to Massachusetts customers, and determine whether or not their business systems are currently capturing the type of information they need in order to properly determine whether or not it’s a Massachusetts sale. And they need to do that right now, obviously, because if they are subject to tax, the first return is due Sept. 20.

The other thing they need to do, for the tech tax, is really take a long, hard look at whether or not they have Massachusetts presence, and whether or not that’s worth it, given the compliance burden and tax costs that they might have to carry.

On the income tax side, it’s really a matter of looking at where you’re doing business and where your customers are and whether your business systems are able to capture that sufficiently.

(Ben Leubsdorf can be reached at 369-3307 or
bleubsdorf@cmonitor.com or on Twitter @BenLeubsdorf.)

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