QHTC in D.C., Are you Eligible?

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January 15, 2016

QHTC in D.C., Are you Eligible? D.C. Finally Issues Guidance on High Technology Tax Incentives

The District of Columbia (D.C. or “the District”) finally released guidance on the scope of activities that will enable taxpayers to receive Qualified High Technology Company (QHTC) credits and incentives. The District created the QHTC certification in 2000, as an incentive aimed at retaining existing technology companies doing business in the District, and attracting new investments. In October of 2015, a Declaratory Order (“the Order”) and D.C. Court of Appeals were issued, both of which clarified the activities that will qualify a business for QHTC tax benefits. Such benefits include a five-year franchise tax exemption and a reduced tax rate thereafter, breaks on property and sales taxes, as well as various wage credits.

To qualify for the tax incentives, a taxpayer must be engaged in the following activities:

  • Internet-related services and sales, which includes services that may be considered e-commerce, but does not include online brick and mortar retail stores;
  • information and communication technologies;
  • advanced materials and processing technologies;
  • engineering, production, biotechnology, and defense technologies; or
  • electronic and photonic devices and components.

Prior to October of 2015, the District did not define the scope of these service categories, leaving many taxpayers unsure of their status. The ambiguity has become increasingly problematic given the ever-growing role of technology in the business landscape. The Declaratory Ruling (DO 2015-2) and Court of Appeals decision (NBC Subsidiary WRC-TV, LLC v. D.C. Office of Tax and Revenue) address two different QHTC categories.

The recent Declaratory Order provides an interpretation of the “internet services and sales” category of QHTC activities. The taxpayer in question provided promotion and marketing services through an online platform to sellers of admittance, or “licenses,” to various events. The taxpayer’s primary sources of revenue came from service fees earned when an end-user purchased a license through the Company’s online platform. The Order reasoned that the term “internet related services and sales” requires more than just a transaction occurring over the internet. A taxpayer’s services and sales must be performed “with regard to the internet.” The Order also concluded that the Company’s income derived from the sale of licenses over the internet met the definition of “e-commerce.”

Ultimately, the Order agreed with the taxpayer in that it was engaged in qualifying “internet services and sales” because the taxpayer’s income was derived from licenses sold on it platform. A key fact in the ruling appears to be that the Company created the online platform for the sellers to promote and sell the licenses.

The D.C. Court of Appeals decision addressed the “information and communication technologies” category of QHTC qualifying services. The court concluded that a local television station’s mere purchase and use of technological equipment and systems did not qualify it for QHTC incentive. The Court reasoned that “information and communication technologies” requires a “much closer nexus” between the QHTC activities and the revenues derived. The court provided the following four factors to distinguish a QHTC:

  • High proportion of scientists, engineers, and technicians as employees;
  • high proportion of employees engaged in R&D;
  • production of high-tech products; and
  • use of high-tech production methods.

It is clear from both of these decisions that merely using high-tech equipment or simply selling items over the Internet will not qualify a taxpayer as a QHTC. The income derived by a taxpayer must bear a close relationship to the development and production of high technology product or services in order for such taxpayer to qualify as a QHTC. Still, the “internet services and sales” category received a rather broad interpretation in the Declaratory Order given the expansive definition it gave to “e-commerce.” Thus, Taxpayers’ need to carefully consider whether their products and services fit into one of categories listed above. The recent guidance issued in D.C. by no means make a QHTC determination an easy one, but taxpayers now have two fact patterns to compare their business to when deciding whether to check that “QHTC” box on their franchise tax return.

If your company has questions about the D.C. Qualified High Technology Company rules, or you think your company may qualify, please contact your Aronson Tax Advisor, Michael L. Colavito, Jr., or Patrick M. Deane at 301.231.6200.