Promoting Economic Growth and Job Creation Through Technology Act of 2014
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Rate Reduction for D.C. QHTC Capital Gains to Begin… in 2019

Investors keeping a close eye on pending legislation (the Promoting Economic Growth and Job Creation Through Technology Act of 2014, Bill 20-0945) promoting investments in D.C. Qualified High Technology Companies (QHTC) will be happy to know it passed—but not without a serious caveat. While the bill was originally set to allow investors to cash in their investments after being held continuously for a 24-month period, the enrolled Act (D.C. Act 20-514) was amended to make the rate reduction applicable January 1, 2019 (at the earliest).

Background

In September 2014, the D.C. Council began reviewing a proposal from Mayor Gray that would lower the tax rate to 3 percent for capital gains from the sale or exchange of eligible investments in QHTCs, as previously discussed by the authors here. As introduced, the bill was set to be applicable immediately; however, all that changed when an amendment was made on December 2 that restricts applicability of the Act to the latter of:

  • January 1, 2019 to the extent it reduces revenues below the financial plan; or
  • Upon implementation of the provisions in § 47-181(c)(17).

As noted in the engrossed amendment, this was done to “ensure that the tax cuts . . . codified by the 2015 Budget Support Act (BSA) take precedence.” These cuts, previously discussed by the authors here and here, include the implementation of a single sales factor, a reduction in the business franchise tax rate for both incorporated and unincorporated businesses, and switch from cost of performance sourcing to market-based sourcing for sale of intangibles and services.

The Act was quickly passed on December 22 with the amendment language included and a heavy dose of uncertainty regarding when the reduced rate will apply (if at all), since it is tied to the financial plan and BSA. Practically, this leaves potential investors with the green light to begin purchasing interests in QHTCs, since the Act is effective now, yet leaves these same investors with uncertainty about the applicability of the reduced rate.

Practical Questions Unresolved 

The enrolled Act retains the same questionable provisions that were originally present upon its introduction, raised by the authors here. Specifically the language provides that the Act applies “notwithstanding any other provision” of the income tax statute and only to “investments in common or preferred stock.” The common or preferred stock provisions appear to arbitrarily exclude investments in pass-through entities, despite the fact that they are classified as QHTCs, disallowing investors that otherwise would be able to take advantage of the rate reduction. In addition, the Act lacks clarity regarding the practical application of basic tax calculations, such as allocation and apportionment. The Act seems to stand for the proposition that the investments should be set apart from the rest of the income of an investor, but to what extent? Absent regulations or guidance from the Office of Tax and Revenue (OTR), taxpayers [...]

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D.C. Bill Ostensibly Lowers Tax on Capital Gains from QHTC Investments… But How?

On September 23, District of Columbia Council Chairman Mendelson introduced the Promoting Economic Growth and Job Creation Through Technology Act of 2014 (Bill 20-0945 , hereinafter the “Act”) at the request of Mayor Vincent Gray.  This marks the second time that the Council has considered the introduced language; it was originally included as part of the Technology Sector Enhancement Act of 2012 (Bill 19-747), but was deleted prior to enactment.  The Act would add a new provision to the D.C. Code (§ 47-1817.07a) to impose a lower tax rate on capital gains from the sale of an investment in a Qualified High Technology Company (QHTC) beginning in 2015.  The rate would be 3 percent as compared with the current rate of 9.975 percent for business taxpayers.  Notably the proposed provision is limited in scope and only applies when the following three elements are satisfied:

  1. The investment was held by the investor for at least 24 continuous months;
  2. The investment is in common or preferred stock or options of the QHTC Company; and
  3. During the taxable year, the investor disposed or exchanged of some or all of his or her investment in the QHTC.

As introduced, the proposed tax is explicitly applied “notwithstanding” any provision of the income tax statutes.

Good Thought, Poor Drafting

The intent of this legislation is clear, but the practical application is not.  As a threshold matter, the second element requires the investment to be “in common of preferred stock or options,” which by definition excludes partnerships and limited liability companies since only corporations can issue stock.  On its face, the language of the bill appears to be limited to investments in a QHTC organized as a corporation, despite the fact that other entities are eligible for QHTC status under D.C. law.  Therefore, limited partners and members investing in pass-through QHTC’s appear to fall outside the scope of the proposed legislation.

Second, by imposing a different rate on only a certain type of income and by taxing the gains notwithstanding any other provision of the income tax statute, the proposal fails to account for basic tax calculations necessary to arrive at taxable income in the District for a business taxpayer.  For example, the allocation and apportionment provisions would seem to be negated both practically and legally.   What part of a multistate taxpayer’s gain from a QHTC is subject to the 3 percent rate?  Is it all of the gain; an apportioned part of the gain – and if so, based on whose apportionment percentage?  What if the gain would have been categorized as non-business income and the taxpayer is a non-resident?  The answer is certainly not obvious from the legislation.  Similarly, how do a taxpayer’s losses, both in the current year and carried over, affect the amount of gain available to tax?  Can all of the losses be used against other types of income first?  Can the losses be used at all against the QHTC gain?

Third, how is a taxpayer [...]

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