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Tax in the Bluegrass

Welcome to the first rendition of our new regular column in The Kentucky CPA Journal on tax developments of interest to Kentucky CPAs. In other words, Tax in the Bluegrass. I imagine that the column will evolve over time; however, its primary focus will be what’s going on in Kentucky taxes, primarily corporation and personal income taxes, but also in the sales and use and property tax areas. Sometimes, the column will focus on a particular topic; other times, it will be an update of what’s going on, and this column attempts to do just that.

First, let’s go over legislation. Kentucky’s General Assembly meets in the first part of each year unless the governor calls a special session, and he did just that on two occasions this year. The Regular Session produced legislation which “re-connected” the Kentucky income taxation of passthrough entities with the federal model. The 2007 Extraordinary Session resulted in no legislation, and the 2007 Second Extraordinary Session resulted in legislation signed into law by Governor Fletcher in late August that provides for, among other things, tax incentives to a company for alternative fuel, gasification or renewal energy facilities.

On the regulatory front, the Kentucky Department of Revenue, which has a relatively new commissioner, John May, (formerly Jefferson County’s Property Valuation Administrator) and Deputy Commissioner, Elyse Weigel (most recently, the director of the Division of Corporation Tax), has been relatively quiet. However, the Department did file several proposed administrative regulations regarding it’s your future the 2007 Legislation on Tax Increment Financing (TIF) and on property taxes.

By way of background, the new State Tax Increment Financing Commission oversees and has the power to approve applications which meet the requisite statutory criteria for participation in one of three statelevel TIF programs: Commonwealth Participation Program for State Real Property Ad Valorem Tax Revenues; Signature Project Program; and Commonwealth Participation Program for Mixed Use Redevelopment in Blighted Urban Areas. In August, the Office of Tax Increment Financing within the Department filed two sets of proposed and companion emergency administrative regulations regarding the state-level TIF funding programs: 103 KAR 50:020 (Application for state participation in tax increment financing projects) which incorporates by reference applications for the three state-level TIF programs provided, and 103 KAR 50:040 (General Administration) which provides for criteria for determining a project footprint and addresses land preparation.

Also in August, the Department filed three proposed administrative regulations, which address the property tax exemption for machinery actually engaged in manufacturing for the coal industry, 103 KAR 8:130 (Ad valorem taxation of machinery engaged in the manufacturing of coal), the crushed stone industry, 103 KAR 8:140 (Ad valorem taxation of machinery actually used in the manufacturing of crushed stone, sand and gravel) and the hot mix asphalt industry, 103 KAR 8:150 (Ad valorem taxation of machinery actually used in the manufacturing of hot mix asphalt). These regulations have been in the works for some time now.

In a nutshell, the coal regulation proposes to identify the beginning and end of the manufacturing process and to treat machinery used in the crushing, sizing, blending, chemically treating and washing of coal as machinery actually engaged in manufacturing subject to state tax only, with no local tax. The other two regulations similarly identify the beginning and end of the respective manufacturing processes as well as manufacturing machinery by function. All three proposed regulations have a fiscal note (that is, they will cost the Commonwealth money), which may indicate that the proposed regulations depart from the current administration of the manufacturing machinery exemption in favor of taxpayers.

Noticeably absent is a proposed administrative regulation regarding the new limited liability entity tax, the “LLET,” and the new withholding requirements. I would think that Kentucky CPAs would welcome additional guidance from the Department on these topics. In the meantime, Gary Morris of the Department, Stephen Lukinovich and I will present on this topic at the Kentucky Institute on Federal Taxation on Nov. 9, 2007. The threeday program has two days of federal income tax topics and one day of state tax topics.

CPAs and other tax practitioners across the country are holding their breath waiting on how the United States Supreme Court will ultimately rule in Davis v. Department of Revenue, 197 S.W.3d 557 (Ky. App. 2006) cert. granted (May 21, 2007). In Davis, the Kentucky Court of Appeals struck down Kentucky’s system of exempting Kentucky bond interest while taxing out-of-state bond interest, holding that it violated the Commerce Clause because it gave more favorable treatment to domestic (that is Kentucky) bonds than to bonds issued by Kentucky’s sister states. The Department sought discretionary review with the Kentucky Supreme Court, which was denied, and it then sought review with the U.S. Supreme Court, which was granted on May 21, 2007. Oral argument is set for November.

Meanwhile, Kentucky’s Courts have been churning out several significant tax decisions. I would like to highlight several.

In Department of Revenue v. Marquette Transportation Co., Civil Action No. 05-CI-993 (Franklin Cir. Ct. July 26, 2007), the Franklin Circuit Court affirmed the Order of the Kentucky Board of Tax Appeals that Marquette’s towboat employees performed no services in Kentucky and thus their compensation was excluded from the Kentucky numerator of Marquette’s payroll factor. This case is procedurally complex and I know the details intimately, but I’ll spare you the saga, except to say that it is actually the second time that a Circuit Court has upheld at least part of the Board’s Order. I think that it is one of the few cases in the country concerning the corporation income tax payroll apportionment factor.

Another income tax case that many have been watching is Revenue Cabinet v. Asworth Corp., No. 06- CI-00288 (Franklin Cir. Ct., Div. II, Jun. 14, 2007). Over the summer, the Franklin Circuit Court held that Kentucky’s corporation income tax statutory scheme imposed tax upon non-resident corporate partners, even though their only connection with Kentucky was receiving income from investment interests in partnerships located in Kentucky. Asworth filed a Motion To Alter, Amend or Vacate the Court’s Order because it did not address: (1) whether Kentucky’s imposition of tax on Asworth with no physical presence in Kentucky violated the Commerce Clause or the Due Process Clause; and (2) whether Asworth is entitled to the immediate payment of tax refunds and interest prior to the final appellate disposition of the case. The Court heard that Motion in early August.

The Kentucky Supreme Court in Revenue Cabinet v. GTE South, Inc., Nos. 2003-CA-000773 and 2005-SC- 000223-DG (Ky., Aug. 23, 2007), reversing the Court of Appeals’ very pro-taxpayer opinion, held (in an Opinion designated to be published) that the Department’s notice of sales tax due to GTE South, Inc. was both timely and sufficient. This case had the potential to put some bigger teeth in the Kentucky Taxpayers’ Bill of Rights.

In a big win for religious institutions, in St. Andrew Orthodox Church, Inc. v. Thompson, Nos. 2006-CA-000305-MR & 2006- CA-000458-MR (Ky. App. Aug. 10, 2007), the Kentucky Court of Appeals (in an Opinion designated to be published) held that real property owned and used by St. Andrew Orthodox Church for church purposes was exempt from property tax pursuant to Kentucky Constitution Section 170, which exempts real property from taxation if “owned and occupied” by “institutions of religion.” My firm represented the taxpayer pro-bono in this case. Notably, this is the first published case on this constitutional amendment.

The Kentucky Circuit and Appellate Courts as well as the Kentucky Board of Tax Appeals have many more pending cases, which may be of interest to you and your clients.

About the author: Mark A Loyd, Esq., CPA, is an associate in the tax and finance practice group of Greenebaum Doll & McDonald in Louisville. He is a member of the KyCPA board of directors, editorial board and industry task force; and former chair of the taxation committee. He can reached at mal@ gdm.com; 502.587.3552.

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