Franchise Tax Refund Opportunity

Corporations subject to North Carolina’s franchise tax have an opportunity to seek refunds of their 2021 and 2022 franchise taxes but should act promptly to preserve their rights.

North Carolina’s Pre-2023 Franchise Tax

Before 2023, the North Carolina franchise tax was imposed on the highest of three amounts: (i) the taxpayer’s apportioned net worth, (ii) 55% of the appraised value of the taxpayer’s real and tangible personal property in North Carolina and (iii) the taxpayer’s total actual investment in tangible property in the state. The law was amended effective January 1, 2023, to eliminate the two property bases, and the tax is now computed solely on the taxpayer’s apportioned net worth.

Commerce Clause Violation

Under United States Supreme Court precedent, a tax like North Carolina’s pre-2023 franchise tax that is imposed on alternative bases may violate the Commerce Clause of the federal Constitution. The Commerce Clause expressly grants Congress the power “[t]o regulate Commerce . . . among the several States . . .” In addition to this express grant of authority, the Supreme Court has long held that the Commerce Clause prohibits some state interference with interstate commerce even in the absence of Congressional action.

The Supreme Court has developed an “internal consistency” test to determine whether a state tax statute violates the Commerce Clause. In applying the test to a particular tax statute, the courts ask whether, if every state had the same statutory scheme, interstate businesses would run the risk of more burdensome taxation than purely local businesses. Importantly, the internal consistency test is used to expose the risk of greater taxation on interstate commerce. The presence of such a risk is enough to invalidate the statute even without evidence that interstate commerce is in fact taxed more heavily than intrastate commerce.

Taxes imposed on alternative bases are vulnerable to internal consistency analysis. This is because, while a purely intrastate taxpayer will never pay tax on more than 100 % of the highest tax base, if all states adopted the same taxing scheme, a multistate taxpayer would face the risk of being taxed on more than this amount.

For instance, assume that a taxpayer is engaged in manufacturing and that its highest tax base is its total investment in tangible property. If the taxpayer operated only in North Carolina, it would pay North Carolina franchise tax on 100% of its investment in tangible property. If that same taxpayer, with all of its property in North Carolina, operated in multiple states, it still would pay North Carolina franchise tax on 100% of its investment in tangible property. However, if each state adopted North Carolina’s franchise tax statute, the taxpayer would also pay tax to every other jurisdiction where it operated on its net worth apportioned to each of those states.

The same problem could arise if the taxpayer’s highest tax base was its apportioned net worth. Again, assume that a taxpayer is engaged in manufacturing and sells all its output to a single customer in North Carolina. If the taxpayer operated only in North Carolina, it would pay North Carolina franchise tax on 100% of its net worth. If the taxpayer’s manufacturing facilities were located in one or more states outside North Carolina, the taxpayer still would pay North Carolina franchise tax on 100% of its net worth (because all of its customer base was here). However, assuming each state adopted North Carolina’s franchise tax, the taxpayer would also pay tax on one of the two property bases to each state where its property was located.

Tennessee Example

Until recently, Tennessee’s franchise tax resembled North Carolina’s pre-2023 franchise tax. It was computed on the higher of two bases: (i) apportioned net worth and (ii) the book value of the taxpayer’s real and tangible personal property owned or used in Tennessee. In 2022, Toyota Corporate Credit Corp. filed an action against the Tennessee Department of Revenue arguing that the alternative bases of the franchise tax rendered the tax unconstitutional under the Commerce Clause. A coalition of at least 80 taxpayers who paid the tax on the alternative property base later filed refund claims making the same argument. In response to these cases and claims, in May of this year, the Tennessee legislature repealed the alternative property base. The legislation also authorized refunds for all taxpayers who had paid the franchise tax on the alternative property base for years ending on or after March 31, 2020, equal to the excess of the tax computed on the property base over the tax computed on the apportioned net worth base. The total authorized refunds are estimated to equal $1.6 billion.

Claims for Refund

Following the events in Tennessee, a number of North Carolina franchise taxpayers are believed to have filed claims for refund of pre-2023 franchise taxes for open years, and their claims remain pending at the Department of Revenue. All multistate taxpayers, regardless of which tax base they used, should consider filing refund claims for open years. Even purely intrastate taxpayers may wish to consider filing refund claims to preserve their rights in the event a court were to strike down the entire law.

Open Years

The general statute of limitations for claiming refunds is the later of three years from the due date of the franchise tax return and two years from the date of payment. For most taxpayers, the limitation period will be computed by reference to the due date of the return. Corporate franchise and income taxes are both reported on Form CD-405. These returns are due on the 15^th day of the fourth month of the year following the income tax year, but the due date is automatically extended for six months for taxpayers who extend their federal returns.

Thus, for calendar year taxpayers, the return is due on April 15 but may be extended to October 15. This means that calendar-year taxpayers who filed their returns on the original due date have only one open franchise tax year computed under the old law (the 2022 franchise tax year reported on the 2021 return), and this year will close on April 15, 2025. However, for taxpayers who filed their 2020 returns under extension, the 2021 franchise tax year reported on the 2020 income tax return also remains open but will close on October 15 of this year.

Please contact Bill Nelson at Smith Anderson if you would like to learn more.