Ohio Department of Taxation Information Release

CF 1994-02 -Newly-enacted Investment Tax Credit Law - October 14, 1994

Note:  Amending legislation is currently being discussed. However, at this time no such legislation has been introduced.

Amended Substitute Senate Bill 269 enacts Ohio Revised Code (ORC) sections 5733.31 and 5747.26 to create a nonrefundable franchise tax credit and a nonrefundable individual income tax credit for manufacturers that during the eighteen-month period January 1, 1995 through June 30, 1996 purchase new manufacturing machinery and equipment that the taxpayer will both locate in Ohio and use as a manufacturer. The franchise tax credit applies only if the aggregate cumulative cost of the new manufacturing machinery and equipment purchased for locations in Ohio during the eighteen-month period by the taxpayer or component members of the taxpayer's federal controlled group equals or exceeds a threshold of 20% of the aggregate cost of all tangible personal property located in the United States and owned by the taxpayer or component members of the taxpayer's federal controlled group at the close of the taxpayer's most recent taxable year ending before the eighteen-month period. The credit equals 20% of the cost of such new manufacturing machinery and equipment purchased by the taxpayer during the eighteen-month period. The maximum credit allowed to a taxpayer or to a controlled group of corporations of which the taxpayer is a component member is $500,000. The credit first applies to tax year (report year) 1996 for taxable years that end in 1995.

If a taxpayer is a direct or indirect partner in a partnership, the taxpayer is allowed its distributive share of the credit available through the partnership's purchases of new manufacturing machinery and equipment during the eighteen-month period provided that all of the conditions set forth below are satisfied:

1. The partnership's purchases of new manufacturing equipment will be located in Ohio and will be used by the partnership in manufacturing.

2. The partnership's cumulative cost of the new manufacturing machinery and equipment purchased for locations in Ohio during the eighteen-month period equals or exceeds 20% of the aggregate cost of all the partnership's tangible personal property located in the United States at the close of the partnership's most recent federal taxable year ending before the eighteen-month period.

3. The taxpayer's distributive share of the partnership's cumulative cost of such new manufacturing machinery and equipment, when added to the cumulative cost of any other such new manufacturing machinery and equipment purchased for locations in Ohio by the taxpayer or by other component members of the taxpayer's federal controlled group equals or exceeds 20% of the aggregate cost of all tangible personal property located in the United States and owned by the taxpayer or by other component members of the taxpayer's controlled group at the close of the taxpayer's most recent taxable year ending before the eighteen-month period.

Analysis and Interpretation

• The credit is not limited to qualifying purchases that exceed the 20% threshold. That is, if the 20% threshold test is satisfied, the credit applies to all purchases of qualifying equipment¹ during the eighteen-month period.
        
• The Department interprets the term "tangible personal property" as including every tangible thing except real property. Real property is defined as land, growing crops, all buildings, structures, improvements and fixtures on the land. Inventory is tangible personal property.
      
• The term "new manufacturing machinery or equipment" means manufacturing machinery or equipment, the original use of which commences with the taxpayer or with a partnership of which the taxpayer is a partner. A taxpayer or partnership that purchases a reconditioned or rebuilt machine is not the original user of that machine and as such, the machine is not "new" and does not qualify for the credit. However, manufacturing machinery and equipment will generally be considered "new" if it does not contain more than 20% used materials and parts. In determining whether manufacturing machinery and equipment is "new", the Department will rely on the federal regulations, revenue rulings and case law pertaining to the federal investment tax credit provided in IRC section 46.
     
• The term "purchase" has the same meaning as in IRC section 179(d)(2). If a lease is treated as a purchase under IRC section 179(d)(2), it is also treated as a purchase for purposes of the credit.
  
  In the Department's view there is a qualifying "purchase" during the eighteen-month period beginning January 1, 1995 and ending June 30, 1996 under either of the following conditions:
  

• During the period beginning July 22, 1994 (the effective date of the new law) and ending December 31, 1994 the taxpayer places a purchase order or otherwise enters into a legally binding obligation or contract to purchase such property and the taxpayer places it in service in manufacturing in Ohio during the period beginning January 1, 1995 and ending June 30, 1996.
       
• During the period beginning January 1, 1995 and ending June 30, 1996 the taxpayer places a purchase order or otherwise enters into a legally binding obligation or contract to purchase such property regardless of when the taxpayer actually places it in service in manufacturing in Ohio.

The Department maintains that if prior to July 22, 1994 the taxpayer placed the purchase order or entered into a legally binding obligation or contract to purchase such property, the taxpayer will not be entitled to the credit even if the taxpayer takes delivery of such manufacturing equipment during the period beginning January 1, 1995 and ending June 30, 1996.

• The term "cost" has the same meaning as in IRC section 179(d)(3).  For example, if qualifying property is purchased for $4,000 cash plus the trade-in of an old machine that has an adjusted basis of $5,000 the credit applies only to $4,000.
      
• The terms "manufacturer" and "manufacturing machinery and equipment" have the same meaning as in ORC section 5711.16.  As such, property tax law (both statutory law and case law) applies for purposes of determining whether a taxpayer is a manufacturer and whether property is used in manufacturing. In addition, since the ORC section 5711.16 personal property tax definitions of "manufacturer" and "manufacturing machinery and equipment" also apply to the credits under ORC section 5733.061 and 5747.051 for property used in manufacturing, case law pertaining to those credits also applies to the new credit. Thus, pursuant to Stoneco Inc. v. Limbach (1990), 53 Ohio St. 3d 170 the "integrated plant test"² applies to the new credit for purposes of determining whether or not property is used in manufacturing.
     
• A taxpayer may not claim the credit on its purchases of otherwise qualifying equipment if the taxpayer leases the property to another. The taxpayer that claims the credit must purchase the property and must use the property "as a manufacturer". (In contrast, the ORC section 5733.061 credit for manufacturing property did not require that the purchaser use the qualifying property in manufacturing; it merely required that the property be used in manufacturing. Thus, if an owner-lessor leased qualifying property to a manufacturer-lessee, the owner-lessor was entitled to the ORC section 5733.061 credit--not so for the new credit.)
     
• In determining whether the 20% threshold test is met, the cost of new manufacturing machinery and equipment purchased for locations outside Ohio is not considered. The 20% threshold test compares the cost of new manufacturing machinery and equipment purchased during the eighteen-month period for locations in Ohio to 20% of the cost (not the depreciated book value) of all tangible personal property (not merely manufacturing machinery and equipment) located in the United States (not merely Ohio) as of the close of the taxpayer's most recent taxable year that ended before the eighteen-month period. As noted above, "tangible personal property" includes inventory.
     
• The new law requires that members of a controlled group of corporations compute the 20% threshold test on a consolidated basis. This precludes a corporation not otherwise qualifying for the credit from forming a new subsidiary whose purchases on a stand-alone basis would qualify for the credit.

The 20% threshold test is determined ". . . at the close of the taxpayer's most recent taxable year ending before the eighteen-month period." Although a new corporation organized during the eighteen-month period technically will not have a taxable year³ that ends before the eighteen-month period, a new corporation will be treated as having no property on the threshold date. Accordingly, new manufacturing corporations organized during the eighteen-month period and first acquiring property during the eighteen-month period are always entitled to the credit on their purchases of qualifying property during the eighteen-month period since new corporations have no threshold below which their purchases do not qualify (20% of zero is zero) and any purchase of qualifying property will exceed the threshold (assuming that the new corporation is not a component member of a federal controlled group that on a consolidated basis does not meet the 20% threshold test).

Also, a corporation that has been doing business outside Ohio prior to the eighteen-month period and that first becomes an Ohio taxpayer during the eighteen-month period is entitled to the credit on its purchases of qualifying equipment during the eighteen-month period if those purchases satisfy the 20% threshold test at the close of the taxpayer's most recent federal taxable year ending before the eighteen-month period.

• The term "component member" has the same meaning as in IRC section 1563(b). The determination of what corporations are component members of the same controlled group is made at the end of each of the two or three taxable years that include any portion of the eighteen-month period. That is, for each taxable year the taxpayer must carry out the following steps:

1. Determine all the component members of the controlled group that includes the taxpayer.
       
2. Add up the cost of qualifying assets purchased by each component member (see Step #11, above) purchased during the period beginning on January 1, 1995 and ending on the earlier of ...

1. The last day of the taxable year or
      
2. June 30, 1996

3. Add up the cost of tangible personal property owned by each component member (see Step #1) as of the last day of the taxpayer's taxable year ending prior to January 1, 1995.
      
4. Multiply the amount in Step #3 by 20%.
       
5. Is the amount in Step #2 equal to or greater than the amount in Step #4?

If "yes", then each taxpayer is eligible for the credit on its purchases of qualifying equipment.

If "no", then each taxpayer is not eligible for the credit.

• The Department maintains that for purposes of determining whether the 20% threshold test is met under ORC section 5733.31(B)(2) the "... aggregate cost of all tangible personal property located in the United States and owned by the taxpayer or by other component members of the taxpayer's controlled group at the close of the taxpayer's most recent taxable year ending before the eighteen-month period" must include the taxpayer's and its component members' proportionate share of the cost of tangible personal property owned by any partnership in which the taxpayer or its component members held an interest.
     
• The term "controlled group" has the same meaning as in IRC section 179(d)(7). Generally, a controlled group of corporations is a group of two or more corporations connected through stock ownership of at least 50% of the total combined voting power of all classes of stock.
     
• The taxpayer may allocate the amount of the credit among any of its taxable years that end after the purchase is made and that include any portion of the eighteen-month period.

The Department interprets this provision as follows:

• If by the date the taxpayer files its franchise tax report for a taxable year that includes a portion of the eighteen-month period the taxpayer's cumulative purchases of qualifying equipment during the eighteen-month period equal or exceed the required threshold, the taxpayer may claim on that report a credit for its purchases of qualifying equipment during the portion of the eighteen-month period included in the taxable year reflected on that report. The taxpayer may claim the credit in spite of the fact that its purchases of qualifying equipment during the portion of the eighteen-month period included in the taxable year did not equal or exceed the required threshold.

• The taxpayer may not allocate the credit for a qualifying purchase to a taxable year that ended before the purchase was made.

• If by the date the taxpayer files its franchise tax report for a taxable year that includes a portion of the eighteen-month period the taxpayer's cumulative purchases of qualifying equipment do not equal or exceed the required threshold, the taxpayer may not claim on its original franchise tax report a credit for its purchases. However, if after the date the taxpayer files its report the cumulative purchases of qualifying equipment during the eighteen-month period equal or exceed the required threshold, the taxpayer may either: (i) file an amended report for the taxable year of the purchase or (ii) claim the credit for the purchase on the report for a subsequent taxable year.

The following examples and their illustrations explain the Department's interpretation of this portion of the new law:

Example I - See Illustration

Assume the following facts:

• A Inc. is a small manufacturer that has operated entirely in Ohio for several years. A Inc., is not a component member of a controlled group of corporations nor is it a partner in a partnetship.
    
• The taxpayer has a 3/31 fiscal year end. The close of the taxpayer's most recent taxable year that ended before the eighteen-month period is 3/31/94 and as of that date the total cost of the taxpayer's tangible personal property located in the United States is $2,500,000.
    
• The taxpayer's taxable years that include portions of the eighteen-month period and the dates that the taxpayer filed the franchise tax reports for those taxable years are as follows:

Taxable Year	Tax Year (Report Year)	Date Report Filed
4/1/94 - 3/31/95 4/1/95 - 3/31/96 4/1/96 - 3/31/97	1996 1997 1998	5/31/96 5/31/97 5/31/98

 

• 20% of the taxpayer's cost of all tangible personal property located in the United States at 3/31/94, which is the close of the taxpayer's most recent taxable year that ended before the eighteen-month period, is $500,000 (20% X $2,500,000). Thus, in order for the credit to apply to the taxpayer's purchases of qualifying equipment, the cumulative cost of those qualifying purchases during the eighteen-month period must equal or exceed the $500,000 threshold.
       
• During the period 1/1/95 to 3/31/95, which is the portion of the eighteen-month period included within the taxpayer's taxable year that ended 3/31/95, the taxpayer purchased $100,000 of qualifying equipment.
     
• During the taxable year 4/1/95 to 3/31/96, which is entirely within the eighteen-month period, the taxpayer purchased an additional $420,000 of qualifying equipment. The cumulative cost of the taxpayer's purchases through 3/31/96 of the eighteen-month period is $520,000 ($100,000 + $420,000).
    
• During the period 4/1/96 to 6/30/96, which is the portion of the eighteen-month period included within the taxpayer's taxable year that ended 3/31/97, the taxpayer purchased an additional $60,000 of qualifying equipment. The cumulative cost of the taxpayer's purchases during the eighteen-month period is $580,000 (100,000 + 420,000 + 60,000).
     
• For each of the taxable years that includes a portion of the eighteen-month period the taxpayer's total tax due before payments exceeds the taxpayer's total nonrefundable credits.

Since the $580,000 cumulative cost of the taxpayer's qualifying purchases during the eighteen-month period equals or exceeds the $500,000 threshold, the credit applies to all of the taxpayer's qualifying purchases during the eighteen-month period.

On its 1996 franchise tax report for the taxable year 4/1/94 to 3/31/95 the taxpayer may claim a credit of $20,000 (20% of the $100,000 cost of its qualifying purchases. Although, the $100,000 cumulative cost of the taxpayer's qualifying purchases during the period 1 /1 /95 to 3/31/95 did not equal or exceed the required $500,000 threshold, the taxpayer may nevertheless claim the credit for the $100,000 of qualifying purchases on its 1996 report because by 5/31/96, the date that it filed its 1996 franchise tax report, the taxpayer had made additional qualifying purchases sufficient to satisfy the $500,000 threshold requirement. However, on its 1996 franchise tax report for the taxable year 4/1/94 to 3/31/95 the taxpayer may not claim a credit for the $420,000 of qualifying purchases made during its taxable year 4/1/95 to 3/31/96 because a taxpayer may not allocate the credit to a taxable year before the purchase.

On its 1997 franchise tax report for the taxable year 4/1/95 to 3/31/96 the taxpayer may claim a credit of $84,000 (20% of the $420,000 cost of its qualifying purchases during the period 4/11/95 to 3/31/96).

On its 1998 franchise tax report for the taxable year 4/1/96 to 3/31/97 the taxpayer may claim a credit of $12,000 (20% of the $60,000 cost of its qualifying purchases during the period 4/11/96 to 6/30/96).

Example 2 - See Illustration

Assume the same facts as in Example I except that the taxpayer's qualifying purchases during the eighteen-month period are as follows:

Period

Cost of Qualifying Purchases

Cumulative Cost of Qualifying Purchases

1/1/95 - 3/31/95 4/1/95 - 3/31/96 4/1/96 - 5/31/96 6/1/96 - 6/30/96

$100,000 350,000 40,000 90,000

$100,000 450,000 490,000 580,000

On its 1996 franchise tax report for the taxable year 4/11/94 - 3/31/95 the taxpayer may not claim a credit for its $100,000 of qualifying purchases during the period 1/1 /95 to 3/31/95 because by 5/31/96, the date that the taxpayer filed its 1996 franchise tax report, the $490,000 cumulative cost of the taxpayer's qualifying purchases did not equal or exceed the $500,000 threshold.

Once the $500,000 threshold has been satisfied (sometime during the period 6/1/96 - 6/30/96), the taxpayer may claim the $20,000 credit for its $100,000 of qualifying purchases during the period 1/1/95 - 3/31/95 by either:  (i) filing an amended 1996 franchise tax report, or (ii) including the credit on its 1997 report.

On its 1997 franchise tax report filed 5/31/97 the taxpayer may claim the $70,000 credit for its $350,000 of qualifying purchases during its 4/1/95 -3/31/96 taxable year. As noted above, if the taxpayer elects not to file an amended 1996 franchise tax report for its purchases of qualifying equipment during the period 1/1/95 - 3/31/95, the taxpayer may claim the credit for those purchases on its 1997 report.

On its 1998 franchise tax report filed 5/31/98 the taxpayer may claim the $26,000 credit for its $130,000 of qualifying purchases during the period 4/1/96 to 6/30/96, the portion of the eighteen-month period included in the taxpayer's 4/1/96 to 3/31/97 taxable year.

• The aggregate credit allowed to a taxpayer, or if the taxpayer is a component member of a controlled group of corporations, to the controlled group, may not exceed $500,000. (The $500,000 credit limitation is a total limitation for all years combined; it is not a per-year limitation.)

Once a taxpayer and its component members satisfy the 20% threshold requirement on a consolidated basis, each taxpayer then separately determines and claims its own credit for its purchases. If the sum of the separately determined credits for the component members exceeds the controlled group's $500,000 credit limitation, the group must allocate the $500,000 credit among the component members whose purchases generated the credit. The group may allocate the credit among the taxpayers in any manner it elects, but the group may not allocate more credit to a taxpayer than was generated by the taxpayer's purchases. The election, however made, may be changed any time within the three-year statute of limitations.

The following example illustrates the Department's interpretation of this portion of the new law.

Example 3

Taxpayer corporations A, B and C are component members of a controlled group of corporations that has no additional component members. Each corporation has a December 31 year end and during the eighteen-month period each corporation purchased new machinery and equipment that the corporations locate in Ohio and use in manufacturing. The purchases of qualifying equipment during the eighteen-month period and the tangible personal property located in the United States as of December 31, 1994 (the close of the taxpayers' most recent taxable year that ended before the eighteen-month period) are as follows:

Corporation

Cost of Qualifying Purchases during the Eighteen-month period

Cost of Tangible Personal Property Located in the U.S. as of 12/31/94

A B C TOTAL

$100,000 50,000 2,600,000 $2,750,000 $2,750,000

>

$700,000 1,000,000 12,000,000 $13,700,000 x          .20 $2,740,000

The controlled group's aggregate cost of qualifying purchases during the eighteen-month period equals or exceeds 20% of the controlled group's aggregate cost of all tangible personal property located in the United States as of December 31, 1994 (the close of the taxpayers' most recent taxable year that ended before the eighteen-month period). Accordingly, each member of the group may claim a credit for its purchases of qualifying property.

The separately determined credit for each member of the group determined without regard to the limitation is shown in the table below.

Corporation	Cost of Qualifying Purchases	X	Credit %	=	Credit Prior to Allocation
A B C	$100,000 50,000 2,600,000	x x x	20% 20% 20%	= = = TOTAL	$20,000       10,000       520,000       $550,000

Since the sum of the separately determined credits for the component members of the controlled group exceeds the controlled group's $500,000 credit limitation, the group must allocate the $500,000 credit among the component members whose purchases generated the credit. The controlled group may allocate its $500,000 credit in any manner it elects, but the group may not allocate more than $20,000 to A and $10,000 to B because the group may not allocate more credit to a taxpayer than was generated by the taxpayer's purchases.

• The new law does not contain a recapture provision for property that is sold or transferred outside Ohio after the credit is claimed.
     
• A franchise taxpayer must claim its nonrefundable credits (and when applicable, its unused credit carryforward amounts) in the order set forth in ORC section 5733.98. The order is important because certain credits have no carryforward or a limited carryforward period after which the unused amount expires.

The amount of the ORC section 5733.31 nonrefundable credit not used in the taxable years that include the eighteen-month period may be carried forward for three taxable years following the last taxable year that includes any portion of the eighteen-month period. Of course, the amount of credit used in any taxable year is deducted from the balance carried forward. Amounts not used within the three-year carryforward period expire.

The following example explains the Department's interpretation of this portion of the new law.

Example 4

Assume the same facts as in Example I except for the following:

• The taxpayer's tax due before considering any credits and payments is $50,000 for tax year 1997 (taxable year 4/1/95 - 3/31/96) and $20,000 for tax year 1998 (taxable year 4/1/96 - 3/31/97).
       
• The taxpayer is not entitled to any of the credits that precede the ORC section 5733.31 credit in the order established by ORC section 5733.98.

On its 1997 report the taxpayer may use only $50,000 of the $84,000 credit generated from its qualifying purchases during the taxable year because a nonrefundable credit may not reduce the tax liability (before considering any payments) below zero. The $34,000 of unused 1997 credit is carried forward to the 1998 report.

The total available credit for 1998 is $46,000 (the $34,000 carried forward from 1997 plus $12,000 generated from the taxpayer's $60,000 of qualifying purchases during the period 4/1/96 to 6/30/96 (which falls within the taxable year 4/1/96 - 3/31/97). On its 1998 report the taxpayer may use only $20,000 of its $46,000 available credit because a nonrefundable credit may not reduce the tax liability (before considering any payments) below zero. So, following the 1998 report the unused credit carryforward is $26,000.

Since the taxable year 4/1/96 to 3/31/97 is the last taxable year that includes any portion of the eighteen-month period, the taxpayer may carry forward its $26,000 of unused credit to its three taxable years ending 3/31/98, 3/31/99 and 3/31/2000. The amount of credit carryforward used in any taxable year is deducted from the balance carried forward to the next year. Any remaining credit that is not used on the report for the taxable year ending 3/31/2000 expires.

*   *   *   *   *

Tax Information Releases are not "Opinions of the Tax Commissioner" within the meaning of ORC section 5703.53. However, the above discussion does reflect the Income Tax Audit Division's interpretation of the law.

For more information about this new law, call the numbers listed below:

1-614-433-7617
Ohio Relay Service for the hearing-impaired: 1-800-750-0750

____________________________

¹For purposes of this summary and analysis the term "qualifying equipment" means new manufacturing machinery or equipment that the taxpayer locates in Ohio and uses in manufacturing. The term "qualifying purchase" means a purchase of qualifying equipment.²Machinery and equipment is part of an integrated plant if it is essential to production and is integrated into a synchronized system of manufacturing whether or not it actually causes a physical change in raw materials.

³The term "taxable year" is defined in ORC section 5733.04(E) as ". - - the year or portion thereof upon the net income of which the value of the taxpayer's issued and outstanding shares of stock is determined or the year at the end of which the total value of the corporation is determined." A corporation that is not subject to the franchise tax does not have a taxable year. In Litton Industrial Products, Inc. v. Limbach 1991), 58 Ohio St. 3d 169 the Ohio Supreme Court applied a strict literal interpretation of the term "taxable year" when it held that a surviving corporation to a merger was not entitled to the net operating losses incurred by the nonsurvivor during the nonsurvivor's fiscal year ending in the merger year because the loss was not incurred in a taxable year.