I. 2022 LEGISLATIVE UPDATE
There are several notable tax developments from the Kentucky 2022 regular session, including House Bill 8 (“HB 8”), which passed over the Governor’s veto. HB 8 includes a proposal to reduce the individual income tax. Rather than reducing the individual income tax outright, HB 8 establishes a rate reduction evaluation, with any potential tax rate reduction beginning on January 1, 2023. Because Kentucky was able to reach the appropriate revenue threshold by September 5, 2022, the income tax rate will be reduced to 4.5% for the 2023 tax year.
HB 8 also continues to expand the sales tax base by imposing sales tax on more than thirty new services – especially significant are the taxation of marketing services and short term rentals of real property. Services to be taxed include cosmetic surgery services, marketing services, telemarketing services, photography and photo-finishing services, prewritten computer software access services, lobbying services, executive employee recruitment services, website design and development services, website hosting, certain repair services. Also, the exemption from sales and use tax for residential electricity, natural gas, fuels, water, and sewer services found in KRS 139.470(7) is amended to specify that these purchases are only exempt if they are “purchased and declared by the resident as used in his or her place of domicile.” HB 8 includes specific statutory definitions for only some of the additional services.
The Kentucky Department of Revenue has provided informal guidance in Kentucky Sales Tax Facts (June 2022) and Kentucky Sales Tax Facts (September 2022), which can be accessed at revenue.ky.gov/News/Publications/Pages/Sales-Tax-Facts.aspx. Additional informal guidance may be found at TaxAnswers.ky.gov.
Also included in HB 8 is a tax amnesty program, available to all taxpayers from October 1 through November 29, 2022, though the Department has not publicly announced this on its website.
Many were closely watching House Bill 260 (“HB 260”), which would have significantly impacted property tax assessments in Kentucky, likely resulting in an increase in property taxes for small and large businesses alike. As introduced, HB 260 proposed expanding the requirements of the income approach for property valuation to include the value of long-term leases, including triple net leases; though these proposed modifications have since been removed from the bill. In its current form, HB 260 would mandate market segmentation of properties, amending the sales comparison approach for property valuation by requiring sales or rentals that look the same or similar and operate similarly to be considered comparable properties and prohibiting the use of vacant properties in comparable sales. Additionally, HB 260 establishes new requirements for the appraisal of real property, a dramatic shift from the current system, and limits tax representation to Kentucky licensed attorneys, CPAs, or real estate brokers. Though the bill passed the House, it did not advance out of committee for a final vote in the Senate. It remains to be seen whether a similar bill will be introduced in the 2023 legislative session.
There are likely to be a number of tax-related bills on the agenda for the 2023 legislative session, which begins January 3, 2023, including the bourbon barrel tax credit, continued sales tax modernization, and a continued review of the Limited Liability Entity Tax. Local tax modernization is also something to watch. Modernization of Kentucky’s tax code continues to be a focus of the General Assembly.
II. EXECUTIVE & ADMINISTRATIVE UPDATES
KDOR ISSUES SOFTWARE AS A SERVICE GUIDANCE
Cloud-based computing has increasingly become the go-to for individuals and businesses looking to securely store their data, files, photos, and more. Given the ever-evolving nature of this technology, questions often arise as to how the sales and use tax applies to transactions related to cloud-based software and ancillary services. In Private Letter Ruling KY-PLR-21-01 (“PLR”), the Kentucky Department of Revenue (“KDOR”) recently determined that an application provided as part of a Software as a Service model, also known as SaaS, was not subject to Kentucky sales tax.
The taxpayer requesting the ruling provides web-based service via a SaaS model, which involves its customers accessing prewritten computer software hosted online with no physical download or transfer. In the PLR, the Department confirms that such transactions are not subject to Kentucky sales and use tax because there is no transfer or sale of tangible personal property. This is in contrast to the purchase of prewritten computer software via physical copy, for example, on a CD or thumb drive, which involves the transfer of tangible personal property and which is thus taxable.
The taxpayer requested guidance regarding a subsequent free offer of a downloadable prewritten computer software application which enhanced the primary software’s usefulness, but which ultimately provides limited functionality. Specifically, the taxpayer requested a ruling as to whether this download would change the original exempt nature of the taxpayer’s SaaS product.
KDOR found that offering the prewritten computer software application as part of the taxpayer’s SaaS did not create a transaction subject to Kentucky sales and use tax. KDOR specified that the SaaS remained available online and that the application did not transform the transaction into one involving tangible personal property. KDOR also found that providing the application along with the SaaS did not create a bundled transaction because the free software application was a de minimis part of the product the taxpayer provided to customers.
Because this guidance was issued in a private letter ruling, it is binding only to the specific taxpayer for which the ruling was issued. However, it may be instructive for similarly-situated taxpayers. It also illustrates the potential pitfalls to which such taxpayers may be exposed if they provide exempt SaaS products but offer additional ancillary products.
Notably, HB 8 extends the sales tax to prewritten computer software access services, effective January 1, 2023.
KENTUCKY GOVERNOR PROVIDES PROPERTY TAX RELIEF
Kentucky Governor Andy Beshear issued an executive order on February 16, 2022 intended to stop an increase in vehicle property taxes for 2022. Used car values in Kentucky have risen approximately 40% since last year, from $8,006 to $11,162. Under Governor Beshear’s order, taxpayers will pay a similar amount of tax to what they paid in 2021, assuming they own the same vehicle in the same condition and in the same county. The relief will continue through the next two years. If a taxpayer has already paid their 2022 property tax on their vehicle, they will receive a refund from their county clerk.
Kentucky law generally requires the General Assembly to exempt all or part of the personal property tax applied to vehicles. The Senate issued Senate Joint Resolution 99 (R.S. 2022) earlier this year that stated that the Governor could also provide vehicle property tax relief. Following that joint resolution, Governor Beshear issued his executive order.
Subsequently, on March 10, 2022, Governor Beshear signed related legislation into law. The law exempts from the January 1 assessment dates for 2022 and 2023, the portion of taxes computed on any increase in a motor vehicle’s valuation from January 1, 2021. It also entitles taxpayers who paid the tax on any increase in their vehicle’s valuation from 2021 to a refund of the tax overpayment. The law further requires the Department of Revenue and county clerks to establish procedures to enable taxpayers to receive refunds without making a written request and requires the refunds to be issued within 90 days of the effective date. The law took effect March 10, 2022.
KDOR ANNOUNCES DECREASE IN PROPERTY TAX RATE
On July 1, 2022, the Kentucky Department of Revenue announced it would be setting the 2022 real property tax rate at 11.5 cents per $100 of assessed value, a decrease from the 2021 rate of 11.9 cents per $100. The reduction of rate is the result of 7.36 percent estimated increase in revenue from real property assessments from 2021 to 2022; because the estimated increase in revenue is more than 4 percent, the 2021 rate must be reduced.
KENTUCKY TAX REGULATIONS
Regulation 103 KAR 43:340E, Excise Taxes on Gasoline and Special Fuels, freezes the average wholesale price and annual survey value of gasoline in June to prevent the state gas tax from increasing in July. By using the average wholesale price and annual survey value from the previous fiscal year, the freeze keeps the state gas tax at 26 cents per gallon and the state diesel tax at 23 cents per gallon. This freeze is anticipated to remain until the General Assembly reconvenes for the 2023 Regular Session in mid-January.
Electronic filing is here to stay. Regulation 103 KAR 1:160, Mandatory Electronic Filing And Payment Requirements, is a new tax regulation concerning electronic filing and electronic payment of income, sales and excise taxes implemented pursuant to KRS 131.250 and KRS 131.155 which also addresses penalties for noncompliance, and provides for waivers of electronic filing requirements.
Regulation 103 KAR 16:270, Apportionment; Receipts Factor, was amended to address, among other things, the receipts factor in the context of financial institutions, which are subject to the corporate income tax, effective for tax years beginning on or after January 1, 2021.
As related by the Department in Kentucky Sales Tax Facts (May 2018), labor and installation charges are included in the definition of “gross receipts” subject to Kentucky sales tax and sales of extended warranty services covering tangible personal property that is taxable at retail to the warranty holder are subject to sales and use tax, as a result of 2018 HB 487, effective July 1, 2018. Regulation 103 KAR 27:150, Repairers and Reconditioners of Tangible Personal Property, and Regulation 103 KAR 27:230, Motor Vehicle Body Shops, interprets the application of sales and use tax to repairers and body shops concerning, among other things, charges for installing or applying taxable repair parts and extended warranty services.
For manufacturers, it should be highlighted that Regulation 103 KAR 30:120, Machinery for New and Expanded Industry, was amended to address, among other things, exempt charges for labor or services to apply, install, repair, or maintain tangible personal property directly used in manufacturing or industrial processing. And, Regulation 103 KAR 30:140, Energy and Energy-Producing Fuels, implements amendments to KRS 139.480(3) in 2019 HB 354 which authorizes a manufacturer or industrial processor with tolling operations at a plant facility that meet certain criteria to exclude the cost of tangible personal property from the toller’s cost of production in computing its sales tax exemption for energy costs exceeding 3% of its cost of production.
Regulation 103 KAR 26:131, Landscaping Services, is a new regulation that addresses the application of sales and use tax to landscaping services. These became subject to Kentucky sales and use tax, effective July 1, 2018 pursuant to 2018 HB 487.
Regulation 103 KAR 26:100, Industrial Laundry and Linen Supply Services, amends a longstanding regulation concerning the Department’s interpretation of the application of sales and use tax to transactions involving industrial laundry and linen supply services; these services became subject to sales tax as a result of amendments effective July 1, 2018 to KRS 139.200(2) in HB 487. This Regulation merits a close read.
KRS 139.481, enacted effective January 1, 2021, requires farmers to apply for an Agriculture Exemption Number for use on exemption certificates that farmers must present to retailers when making sales tax exempt purchases. However, the amendments to Regulation 103 KAR 30:091, Sales to Farmers, do not appear to address KRS 139.481.
Curiously, for those who remember the Department’s tax policies and revenue circulars, Regulation 103 KAR 16:352, Corporation Income Taxes Policies and Circulars, was amended to identify additional Revenue Policies and Revenue Circulars that have been rescinded.
III. KENTUCKY TAXES & COVID-19: CONTINUED CHANGES AND TRENDS TO WATCH
Like many states and the federal government, Kentucky continues to respond to the impact of the Coronavirus pandemic. In 2020, Kentucky extended tax filing and payment deadlines, paused collection activity, and provided other relief. In addition, many of KDOR’s programs and services were altered or interrupted as a result of government office closures and health and safety mandates. While many of these services have now been restored and collections have resumed, following are updates concerning the continuing impact of Covid-19 on Kentucky tax law.
A. NEXUS AND TELECOMMUTING
The Covid-19 Pandemic brought about many changes, including where a business’s employees work. For employers employing Kentucky residents and/or nonresidents who reside in states with which Kentucky has a reciprocal agreement, they will not need to change their current withholding practices during the period when these employees are working from home. Requirements for withholding of tax in either case remain unchanged by restrictions related to the Covid-19 pandemic and resulting emergency procedures. KDOR will continue reviewing Kentucky income tax nexus determinations on a case-by-case basis, though companies should continue to keep in mind federal Public Law 86-272, which prohibits states from imposing income tax on a business’s income derived from interstate commerce if the business has only limited business activity in the state.
B. KENTUCKY ADOPTS FEDERAL TREATMENT OF PPP INCOME AND EXPENSES
In 2021 HB 278, the Kentucky General Assembly allowed for the same treatment of forgiven, covered PPP loans, deductions attributable to those loans, and tax attributes associated with the loans as allowed under P.L. No. 116-260, sec. 276 and 278. IRS Notice stated Loan Forgiveness Income Exempt and expenses deductible. Most notably, forgiven PPP loans not taxed and expenses paid with forgiven loans are deductible.
C. KDOR RESUMES COLLECTIONS
KDOR’s Division of Collections resumed collection activity on June 11, 2021. Collection action was previously suspended due to the COVID-19 emergency. The Department encourages those who owe a balance to contact the Department. Taxpayers may see increased collection activity as COVID-19 backlogs are resolved on both state and federal levels.
All of KDOR’s Coronavirus updates can be found at revenue.ky.gov/Pages/2019NovelCoronavirus.aspx.
IV. SELECT CASE UPDATES
Dept. of Rev., Finance and Administration Cabinet v. Marathon Pipe Line, LLC, No. 2021-CA-0626-MR (Ky. App. May 13, 2022), discretionary review filed, 2022-SC-0233 (June 14, 2022)
Marathon Pipe Line, LLC (Marathon) is a public service corporation (PSC) that owns or leases thousands of miles of pipeline throughout the United States, including a 265-mile long tract from Owensboro to a Catlettsburg refinery located in an activated Foreign Trade Zone (FTZ).
At issue in this case is whether the pipeline was real property or tangible personal property; tangible personal property located in an FTZ is taxed at a very favorable rate. The Department of Revenue, Finance and Administration Cabinet, Commonwealth of Kentucky (the Department) assessed the pipeline as real property, at $242 million in 2014, $225 million in 2015, and $240 million in 2016. Marathon protested and asserted the pipeline was taxable as tangible personal property with values of $120 million, $106 million, and $106 million respectively. Marathon appealed to the Kentucky Claims Commission, now the Kentucky Board of Tax Appeals (KBTA/KCC). KBTA/KCC bifurcated the appeal and concluded that the pipeline is tangible personal. The Franklin Circuit Court affirmed KBTA/KCC’s finding that Marathon’s pipeline is tangible personal property. The Department appealed to the Court of Appeals.
Because it was an appeal from an administrative agency, the Kentucky Court of Appeals reviewed the case under the clearly erroneous standard. The Department cites Cumberland Pipe Line Co. v. Lewis, 17 F.2d 167 (E.D. Ky. 1926), which held that a similar pipeline was real property, and 103 KAR 8:090 which states that a transmission pipeline is real property. However, the Court of Appeals agreed with KBTA/KCC and the circuit court, on the rationale that the pipeline was: not annexed to the realty as it is moveable; not adapted to the use or purpose of the land above it; and intended by the parties to be moved and not a permanent accession to the land.
Furthermore, the Court of Appeals found that the Department’s treatment of pipelines was not uniform, evidenced by its classification of MarkWest Energy’s pipeline as tangible personal property. The court also noted that 103 KAR 8:090 indicates that a transmission line should be classified as real property, but another type of pipeline used to transport crude oil (a gathering line) should be classified as personal property. As for the ad valorem tax, the court found no error in KBTA/KCC’s adoption of Marathon’s numbers as the final order specified how KBTA/KCC found Marathon’s expert testimony more persuasive than the Department’s.
The Department has filed a motion seeking discretionary review from the Kentucky Supreme Court.
Century Aluminum of Ky. v. Dep’t of Revenue, No. 19-CI-00424 (Franklin Cir. Ct. Feb. 3, 2020), affirmed 2020-CA-0301-MR (Ky. App. July 9, 2021), discretionary review granted, 2021-SC-0300 (Ky. Feb. 16, 2022) – Sales Tax – Manufacturing Supplies Exemption
On February 16, 2022, the Kentucky Supreme Court granted discretionary review in Century Aluminum of Ky. v. Dep’t of Revenue and will take up review of Kentucky’s manufacturing supplies exemption. Briefing has concluded and oral argument has been held as the parties await a final decision.
The case concerns the manufacturing supplies exemption from sales tax and certain items which were worn out during the manufacturing process. The Court of Appeals relied upon an exception from the supplies exemption, i.e., “‘Supplies’ does not include repair, replacement, or spare parts of any kind…” and “The exemption … does not include repair, replacement, or spare parts” to uphold the decision of the circuit court and find that the items were subject to Kentucky sales and use tax.
Century Aluminum argued that the items were not subject to Kentucky sales and use tax as tangible personal property for direct use in manufacturing or industrial processing and that the Department failed to distinguish between supplies and parts intended to be used up in the manufacturing process and supplies and parts which wear out and are subject to replacement. The Kentucky Claims Commission (now KBTA) (“KCC/KBTA”) held for Century Aluminum and adopted Century Aluminum’s four-part test which compares the useful life of the item at issue when the machine or equipment it allegedly maintains is operating with and without the introduction of the product being manufactured. If there is a difference in the useful life of the item, then the item is being consumed in the manufacturing process; if not, then the item is a repair or replacement part.
The Department appealed the Final Order of the KCC/KBTA to the Franklin Circuit Court, which rejected this test, stating that it “ignores the fact that all tangible personal property used in the manufacturing process wears down or is used up” and that it would “exempt nearly all tangible personal property used in the manufacturing process from the sales and use tax, which is clearly not the intent [of the exemption].” Rather, the Court concluded that “the proper test is whether the items are introduced into the manufacturing process to maintain, restore, mend, or repair a machine or equipment, or whether the items…are used up or consumed as a consequence of their involvement in the manufacturing process.”
The Court of Appeals agreed with the circuit court’s rejection of Century Aluminum’s proposed four-part test, finding that the Legislature intended for certain items in the manufacturing process to be tax-exempt and for other items, like the subject parts, to be taxable.
Notably, the Kentucky Association of Manufacturers, joined by the Kentucky Chamber of Commerce filed an amicus brief in support of Century Aluminum. Consistent with the taxpayer, amici argue, “Indeed, all text in the manufacturing supplies exemption and repair, replacement, or spare parts exception should be given effect, and the legislature’s objective to encourage manufacturing by providing the exemption must be effectuated… [and] [p]yramiding should be avoided….” Amici go on to argue, “The text ‘parts’ in the exception itself should be construed to limit its application to ‘parts’ and not literally ‘any tangible personal property’.”
The authors’ law firm represents amici in this action.
Louisville/Jefferson County Metro Revenue Commission v. Ventas, Inc., No. 19-CI-000899 (Jefferson Cir. Ct. Feb. 8, 2021), affirmed, No. 2021-CA-0235-MR (Ky. App. Feb. 11, 2022)
Ventas, Inc. (“Ventas”) is a national healthcare real estate investment trust (“REIT”) that transacts business in multiple jurisdictions, but is headquartered in Louisville, Kentucky. In 2019, Ventas filed a declaration of rights action seeking an order that it is entitled a variance from the standard apportionment formula used by Metro Revenue in calculating occupational license tax. Metro Revenue moved to dismiss the case on the grounds of sovereign immunity, mootness, and ripeness. The Jefferson Circuit Court denied the motion, and Metro Revenue appealed the sovereign immunity issue alone to the Kentucky Court of Appeals.
The Court of Appeals affirmed the Circuit Court, holding that the Revenue Commission was not entitled to sovereign immunity in a declaratory judgment action: “…the Revenue Commission [contends] that a refund claim is implicit in the declaratory judgment action filed by Ventas and that a refund ‘presents a harm to state or government resources that implicates sovereign immunity.’ However, the only claim presented in the complaint filed by Ventas is one for declaratory judgment….it simply asked the circuit court to decide whether it was entitled to relief in the form of an alternative and equitable apportionment. Consequently, the declaratory judgment action did not impinge upon the Revenue Commission’s governmental immunity.”
The original declaratory judgment complaint (which has since been amended) is proceeding at the Circuit Court.
The authors’ law firm represents the taxpayer in this action.
LWAGLVKY 1, LLC, et al. c/o Walgreen Co. v. Jefferson Co. PVA, et al., No. K19-S-88, 207-210 (Ky. Bd. Tax App. Aug. 25, 2021), on appeal 21-CI-005434 (Jefferson Cir. Co. Sept. 24, 2021) – Property Tax
The KBTA issued its Final Order in LWAGLVKY 1, LLC, et al. c/o Walgreen Co. v. Jefferson County PVA, No. K19-S-88, 207-210 (Ky. Bd. Tax App. Aug. 25, 2021) concerning the assessment value of 15 properties leased by Walgreens throughout the Louisville Metro Area. Walgreens obtained fee simple appraisals for each property, using local market conditions and market rent, and argued that the fee simple appraisals represented the fair cash values for the properties under Kentucky law. PVA put forth evidence of a leased fee valuation for each property, using above-market contract rent and national sales, arguing that the value of the leased fee represented the properties’ fair cash value for ad valorem tax purposes. The KBTA held that, through its presentation of evidence, Walgreens overcame the presumption in favor of the PVA’s valuation. The KBTA found in favor of Walgreens for the two Walgreens-owned properties, but sided with the PVA on the 13 properties with leases. The KBTA made no findings concerning Walgreens’ constitutional claims that the PVA’s assessments violate uniformity and equal protection when PVA’s assessments were double or more than those of comparable retail properties in the county. Walgreens appealed the KBTA’s order concerning the 13 leased properties and the constitutional claims to Jefferson Circuit Court, where the case has been briefed and is awaiting review.
The authors’ law firm represents the taxpayer in this action.
Kroger Ltd. P’ship I v. Scott Cnty. Prop’y Valuation Adm’r, et al, No. 2019-CA-01133-MR (Ky. App. July 17, 2020); remanded, Kroger Ltd. Partnership I v. Tim Jenkins, Scott Cty. Property Valuation Admr., K15-S-30 (Ky. Bd. Tax. App. May 28, 2021) – Property Tax
In a case involving the valuation of a big box grocery store, the Court of Appeals recently reversed the decision of the Scott County Circuit Court in Kroger Ltd. P’Ship I v. Scott Cnty. Prop’ Valuation Adm’r, holding that “Based upon [the Court of Appeals’] review of the properties relied upon by the PVA to determine comparable sales, we must agree with Kroger that the evidence it presented to counter the PVA’s assessment compels a finding that the Property was overvalued.”
The Property – which Kroger owns in fee simple – is located in Georgetown, Kentucky. It is 12.18 acres with a 130,600 square foot retail building of which just 1200 square feet, less than 1%, is leased to tenants other than Kroger, i.e., 99% non-leased. Kroger owns and operates a Kroger grocery store on the property. As the Court explained, “For the tax year of 2015, the PVA assessed the value of the Property at $15.2 million. Kroger sought review of the PVA’s assessment …Kroger asserted that the Property’s fair cash value as of January 1, 2015, was $6.6 million based upon an appraisal report from May 2014.” Kroger appealed to the BAA, which adjusted the PVA’s assessment slightly, to $14.094 million. Kroger again appealed, and after a hearing at which an expert appraiser testified for Kroger, the KBTA and Scott Circuit Court each upheld the BAA’s valuation. Kroger appealed to the Court of Appeals, asserting that this valuation was not based on substantial evidence.
The Court of Appeals ultimately agreed with Kroger. As the Court explained, “Kroger’s expert relied upon both the comparable sales approach and the income approach to reach his opinion on the valuation of the Property at $6.7 million.” The Court continued, “the properties the PVA relied upon were subject to leases, unlike the Property in this case. Kroger points out that a lease has its own value…and additional information is needed to value properties with leases….Because the PVA did not introduce any evidence of this type to apply the necessary adjustments, Kroger argues that the valuation was erroneous.”
The Court went on to hold “Based upon our review of the properties relied upon by the PVA to determine comparable sales, we must agree with Kroger that the evidence it presented to counter the PVA’s assessment compels a finding that the Property was overvalued.” The Court explained that, “As [Kroger’s expert] testified before the Board, each of the property sales the PVA relied upon were not comparable to the Property in this case. They were subject to leases or were parts of other specific transactions, such as being part of a portfolio sale or a 1031 exchange, or were not a big box store. Therefore, these sales could not provide a basis for the PVA’s assessment, and the circuit court erred in affirming the Board’s final order.” The Court “also [agreed] with Kroger that the statement of value by Kroger’s consultant in 2013 cannot be substantial evidence of its fair cash value as of January 1, 2015, two years later.”
Accordingly, the Court reversed the Circuit Court and remanded the case, and the KBTA issued its order valuing the property at Kroger’s value of $6.6 million on May 28, 2021.
The authors’ law firm represents the taxpayer in this action.
October 31, 2022
