A BILL TO BE ENTITLED
AN ACT TO EXCLUDE FROM INCOME TAX CERTAIN GAINS FROM INVESTMENTS IN TECHNOLOGY BUSINESSES AND OTHER QUALIFIED SMALL BUSINESSES.
The General Assembly of North Carolina enacts:
SECTION 1.  This act is the Small Business Exclusion of Gain Act.
SECTION 2.  G.S. 105‑130.5(b) is amended by adding a new subdivision to read:
"(22)	The amount of the exclusion of gain for qualified businesses allowed under Part 5 of this Article, to the extent included in federal taxable income."
SECTION 3.  G.S. 105‑134.6(b) is amended by adding a new subdivision to read:
"(18)	The amount of the exclusion of gain for qualified businesses allowed under Part 5 of this Article."
SECTION 4.  G.S. 105‑163.013 and G.S. 105‑163.015 are recodified as G.S. 105‑163.010A and G.S. 105‑163.010B, respectively.
SECTION 5.  Part 5 of Article 4 of Chapter 105 of the General Statutes, as amended by this act, reads as rewritten:
"Part 5. Tax Incentives for Qualified Business Investments.
"Subpart 1. General Provisions.
"§ 105‑163.010.  Definitions.
The following definitions apply in this Part:
(1)	Affiliate. – An individual or business that controls, is controlled by, or is under common control with another individual or business.
(2)	Business. – A corporation, partnership, limited liability company, association, or sole proprietorship operated for profit.
(3)	Control. – A person controls an entity if the person owns, directly or indirectly, more than ten percent (10%) of the voting securities of that entity. As used in this subdivision, the term "voting security" means a security that (i) confers upon the holder the right to vote for the election of members of the board of directors or similar governing body of the business or (ii) is convertible into, or entitles the holder to receive upon its exercise, a security that confers such a right to vote. A general partnership interest is a voting security.
(4)	Equity security. – Common stock, preferred stock, or an interest in a partnership or limited liability company, or subordinated debt that is convertible into, or entitles the holder to receive upon its exercise, common stock, preferred stock, or an interest in a partnership or limited liability company.
(5)	Financial institution. – A business that is (i) a bank holding company, as defined in the Bank Holding Company Act of 1956, 12 U.S.C. §§ 1841, et seq., or its wholly owned subsidiary, (ii) registered as a broker‑dealer under the Securities Exchange Act of 1934, 15 U.S.C. §§ 78a, et seq., or its wholly owned subsidiary, (iii) an investment company as defined in the Investment Company Act of 1940, 15 U.S.C. §§ 80a‑1, et seq., whether or not it is required to register under that act, (iv) a small business investment company as defined in the Small Business Investment Act of 1958, 15 U.S.C. §§ 661, et seq., (v) a pension or profit‑sharing fund or trust, or (vi) a bank, savings institution, trust company, financial services company, or insurance company. The term does not include, however, a business, other than a small business investment company, whose net worth, when added to the net worth of all of its affiliates, is less than ten million dollars ($10,000,000). The term also does not include a business that does not generally market its services to the public and is controlled by a business that is not a financial institution.
(5b)	Information technology. – Providing goods or services relating to electronic data processing, telecommunications, microprocessors, the Internet, software, information processing, or automated office systems.
(6)	North Carolina Enterprise Corporation. – A corporation established in accordance with Article 3 of Chapter 53A of the General Statutes or a limited partnership in which a North Carolina Enterprise Corporation is the only general partner.
(7)	Pass‑through entity. – An entity or a business, including a limited partnership, a general partnership, a joint venture, a Subchapter S Corporation, or a limited liability company, all of which is treated as owned by individuals or other entities under the federal tax laws, in which the owners report their share of the income, losses, and credits from the entity or business on their income tax returns filed with this State. For the purpose of this Part, an owner of a pass‑through entity is an individual or entity who is treated as an owner under the federal tax laws.
(8)	Qualified business venture. – A business that (i) engages primarily in manufacturing, processing, warehousing, wholesaling, research and development, or a service‑related industry, and (ii) is registered with the Secretary of State under G.S. 105‑163.010A.
(9)	Qualified grantee business. – A business that (i) is registered with the Secretary of State under G.S. 105‑163.010A and (ii) has received during the preceding three years a grant or other funding from a federal agency under the Small Business Innovation Research Program administered by the United States Small Business Administration or from an organization that meets any of the following qualifications:
a.	It is a domestic or foreign corporation that (i) is tax‑exempt pursuant to section 501(c)(3) of the Code, (ii) has as its principal purpose the stimulation of the development of the biotechnology industry, and (iii) in furtherance of that purpose has received, or is a successor in interest to an organization that has received, direct appropriations from the State in at least three fiscal years.
b.	It is a domestic or foreign corporation that (i) is tax‑exempt pursuant to section 501(c)(3) of the Code, (ii) has as its principal purpose the stimulation of the development of the microelectronics and communication industries, and (iii) in furtherance of that purpose has received, or is a successor in interest to an organization that has received, direct appropriations from the State in at least three fiscal years.
c.	It is an institute that (i) is administratively located within a constituent institution of The University of North Carolina, (ii) is financed in part by a domestic or foreign corporation that is tax‑exempt pursuant to section 501(c)(3) of the Code, (iii) has as a principal purpose the stimulation of economic development based on the advancement of science, engineering, and technology, and (iv) funds, either directly or in collaboration with other entities, small businesses engaging in developing technology.
(9b)	Qualified North Carolina business. – A qualified business venture or a qualified grantee business.
(10)	Real estate‑related business. – A business that is involved in or related to the brokerage, selling, purchasing, leasing, operating, or managing of hotels, motels, nursing homes or other lodging facilities, golf courses, sports or social clubs, restaurants, storage facilities, or commercial or residential lots or buildings is a real estate‑related business, except that a real estate‑related business does not include (i) a business that purchases or leases real estate from others for the purpose of providing itself with facilities from which to conduct a business that is not itself a real estate‑related business or (ii) a business that is not otherwise a real estate‑related business but that leases, subleases, or otherwise provides to one or more other persons a number of square feet of space which in the aggregate does not exceed fifty percent (50%) of the number of square feet of space occupied by the business for its other activities.
(10a)	Related person. – A person described in one of the relationships set forth in section 267(b) or 707(b) of the Code.
(11)	Security. – A security as defined in Section 2(1) of the Securities Act of 1933, 15 U.S.C. § 77b(1).
(12)	Selling or leasing at retail. – Any of the following:
a.	Selling or leasing any service of any nature from a store or other location open to the public generally.
b.	Selling or leasing services of any nature by means other than to or through one or more other businesses.
c.	Reselling or leasing at retail products that are purchased or leased at wholesale and then resold or leased substantially unmodified.
(13)	Service‑related industry. – A business is engaged in a service‑related industry, whether or not it also sells a product, if it provides services to customers or clients and does not as a substantial part of its business engage in a business described in G.S. 105‑163.010A(b)(4). A business is engaged as a substantial part of its business in an activity described in G.S. 105‑163.010A(b)(4) if (i) its gross revenues derived from all activities described in that subdivision exceed twenty‑five percent (25%) of its gross revenues in any fiscal year or (ii) it is established as one of its primary purposes to engage in any activities described in that subdivision, whether or not its purposes were stated in its articles of incorporation or similar organization documents.
(14)	Subordinated debt. – Indebtedness that is not secured and is subordinated to all other indebtedness of the issuer issued or to be issued to a financial institution other than a financial institution described in subdivisions (5)(ii) through (5)(v) of this section. For the purposes of Subpart 2 of this Part only, except as provided in G.S. 105‑163.014(d1), any portion of indebtedness that matures earlier than five years after its issuance is not subordinated debt.
"§ 105‑163.010A.  Registration.
(a)	Repealed by Session Laws 1993, c. 443, s. 4.
(b)	Qualified Business Ventures. – In order to qualify as a qualified business venture under this Part, a business must be registered with the Securities Division of the Department of the Secretary of State. To register, the business must file with the Secretary of State an application and any supporting documents the Secretary of State may require from time to time to determine that the business meets the requirements for registration as a qualified business venture. A business meets the requirements for registration as a qualified business venture if all of the following are true as of the date the business files the required application:
(1)	Repealed by Session Laws 1996, Second Extra Session, c. 14, s. 7.
(1a)	Reserved for future codification purposes.
(1b)	Either (i) it was organized after January 1 of the calendar year in which its application is filed or (ii) during its most recent fiscal year before filing the application, it had gross revenues, as determined in accordance with generally accepted accounting principles, of five million dollars ($5,000,000) or less on a consolidated basis.
(2)	Repealed by Session Laws 1996, Second Extra Session, c. 14, s. 7.
(3)	It is organized to engage primarily in manufacturing, processing, warehousing, wholesaling, research and development, information technology, or a service‑related industry.
(4)	It does not engage as a substantial part of its business in any of the following:
a.	Providing a professional service as defined in Chapter 55B of the General Statutes.
b.	Construction or contracting.
c.	Selling or leasing at retail.
d.	The purchase, sale, or development, or purchasing, selling, or holding for investment of commercial paper, notes, other indebtedness, financial instruments, securities, or real property, or otherwise make investments.
e.	Providing personal grooming or cosmetics services.
f.	Offering any form of entertainment, amusement, recreation, or athletic or fitness activity for which an admission or a membership is charged.
(5)	It was not formed for the primary purpose of acquiring all or part of the stock, other ownership interest, or assets of one or more existing businesses.
(6)	It is not a real estate‑related business.
The effective date of registration for a qualified business venture whose application is accepted for registration is 60 days before the date its application is filed. No credit or exclusion of gain is allowed under this Part for an investment made before the effective date of the registration or after the registration is revoked. For the purpose of this Article, if a taxpayer's investment is placed initially in escrow conditioned upon other investors' commitment of additional funds, the date of the investment is the date escrowed funds are transferred to the qualified business venture free of the condition.
To remain qualified as a qualified business venture, the business must renew its registration annually as prescribed by rule by filing a financial statement for the most recent fiscal year showing gross revenues, as determined in accordance with generally accepted accounting principles, of five million dollars ($5,000,000) or less on a consolidated basis and an application for renewal in which the business certifies the facts required in the original application.
Failure of a qualified business venture to renew its registration by the applicable deadline results in revocation of its registration effective as of the next day after the renewal deadline, but does not result in forfeiture of tax credits previously allowed to taxpayers who invested in the business except as provided in G.S. 105‑163.014. The Secretary of State shall send the qualified business venture notice of revocation within 60 days after the renewal deadline. A qualified business venture may apply to have its registration reinstated by the Secretary of State by filing an application for reinstatement, accompanied by the reinstatement application fee and a late filing penalty of one thousand dollars ($1,000), within 30 days after receipt of the revocation notice from the Secretary of State. A business that seeks approval of a new application for registration after its registration has been revoked must also pay a penalty of one thousand dollars ($1,000). A registration that has been reinstated is treated as if it had not been revoked.
If the gross revenues of a qualified business venture exceed five million dollars ($5,000,000) in a fiscal year, the business must notify the Secretary of State in writing of this fact by filing a financial statement showing the revenues of the business for that year.
(c)	Qualified Grantee Businesses. – In order to qualify as a qualified grantee business under this Part, a business must be registered with the Securities Division of the Department of the Secretary of State. To register, the business must file with the Secretary of State an application and any supporting documents the Secretary of State may require from time to time to determine that the business meets the requirements for registration as a qualified grantee business. The requirements for registration as a qualified grantee business are set out in G.S. 105‑163.010(9).
The effective date of registration for a qualified grantee business whose application is accepted for registration is the filing date of its application. No credit or exclusion of gain is allowed under this Part for an investment made before the effective date of the registration or after the registration is revoked.
To remain qualified as a qualified grantee business, the business must renew its registration annually as prescribed by rule by filing an application for renewal in which the business certifies the facts required for initial registration.
(d)	Application Forms; Rules; Fees. – Applications for registration, renewal of registration, and reinstatement of registration under this section shall be in the form required by the Secretary of State. The Secretary of State may, by rule, require applicants to furnish supporting information in addition to the information required by subsections (b) and (c) of this section. The Secretary of State may adopt rules in accordance with Chapter 150B of the General Statutes that are needed to carry out the Secretary's responsibilities under this Part. The Secretary of State shall prepare blank forms for the applications and shall distribute them throughout the State and furnish them on request. Each application must be signed by the owners, a manager, or an executive officer of the business. There shall be annexed to the application the affirmation of the person making the application in the following form: "Under penalties prescribed by law, I certify and affirm that to the best of my knowledge and belief this application is true and complete." A person who submits a false application is guilty of a Class 1 misdemeanor.
The fee for filing an application for registration under this section is one hundred dollars ($100.00). The fee for filing an application for renewal of registration under this section is fifty dollars ($50.00). The fee for filing an application for reinstatement of registration under this section is fifty dollars ($50.00).
An application for renewal of registration under this section shall indicate whether the applicant is a minority business, as defined in G.S. 143‑128, and shall include a report of the number of jobs the business created during the preceding year that are attributable to investments that qualify under this section for a tax credit and the average wages paid by each job. An application that does not contain this information is incomplete and the applicant's registration may not be renewed until the information is provided.
(e)	Revocation of Registration. – If the Securities Division of the Department of the Secretary of State finds that any of the information contained in an application of a business registered under this section is false, it shall revoke the registration of the business. The Secretary of State shall not revoke the registration of a business solely because it ceases business operations for an indefinite period of time, as long as the business renews its registration each year as required under G.S. 105‑163.010A.
(f)	Transfer of Registration. – A registration as a qualified business venture or qualified grantee business may not be sold or otherwise transferred, except that if a qualified business venture or qualified grantee business enters into a merger, conversion, consolidation, or other similar transaction with another business and the surviving company would otherwise meet the criteria for being a qualified business venture or qualified grantee business, the surviving company retains the registration without further application to the Secretary of State. In such a case, the qualified business venture or qualified grantee business shall provide the Secretary of State with written notice of the merger, conversion, consolidation, or similar transaction and the name, address, and jurisdiction of incorporation or organization of the surviving company.
(g)	Report by Secretary of State. – The Secretary of State shall report to the Revenue Laws Study Committee by October 1 of each year all of the businesses that have registered with the Secretary of State as qualified business ventures and qualified grantee businesses. The report shall include the name and address of each business, the location of its headquarters and principal place of business, a detailed description of the types of business in which it engages, whether the business is a minority business as defined in G.S. 143‑128, the number of jobs created by the business during the period covered by the report, and the average wages paid by these jobs.
"§ 105‑163.010B.  Sunset.
Subpart 2 of this Part is repealed effective for investments made on or after January 1, 2004. Subpart 3 of this Part is repealed effective for investments made on or after January 1, 2008.
"Subpart 2. Tax Credits for Qualified Business Investments.
"§ 105‑163.011.  Tax credits allowed.
(a)	No Credit for Brokered Investments. – No credit is allowed under this section for a purchase of equity securities or subordinated debt if a broker's fee or commission or other similar remuneration is paid or given directly or indirectly for soliciting the purchase.
(b)	Individuals. – Subject to the limitations contained in G.S. 105‑163.012, an individual who purchases the equity securities or subordinated debt of a qualified business venture or a qualified grantee business directly from that business is allowed as a credit against the tax imposed by Part 2 of this Article for the taxable year an amount equal to twenty‑five percent (25%) of the amount invested. The aggregate amount of credit allowed an individual for one or more investments in a single taxable year under this Part, whether directly or indirectly as owner of a pass‑through entity, may not exceed fifty thousand dollars ($50,000). The credit may not be taken for the year in which the investment is made but shall be taken for the taxable year beginning during the calendar year in which the application for the credit becomes effective as provided in subsection (c) of this section.
(b1)	Pass‑Through Entities. – This subsection does not apply to a pass‑through entity that has committed capital under management in excess of five million dollars ($5,000,000) or to a pass‑through entity that is a qualified grantee business, a qualified business venture, or a North Carolina Enterprise Corporation. Subject to the limitations provided in G.S. 105‑163.012, a pass‑through entity that purchases the equity securities or subordinated debt of a qualified grantee business or a qualified business venture directly from the business is eligible for a tax credit equal to twenty‑five percent (25%) of the amount invested. The aggregate amount of credit allowed a pass‑through entity for one or more investments in a single taxable year under this Part, whether directly or indirectly as owner of another pass‑through entity, may not exceed seven hundred fifty thousand dollars ($750,000). The pass‑through entity is not eligible for the credit for the year in which the investment by the pass‑through entity is made but shall be eligible for the credit for the taxable year beginning during the calendar year in which the application for the credit becomes effective as provided in subsection (c) of this section.
Each individual who is an owner of a pass‑through entity is allowed as a credit against the tax imposed by Part 2 of this Article for the taxable year an amount equal to the owner's allocated share of the credits for which the pass‑through entity is eligible under this subsection. The aggregate amount of credit allowed an individual for one or more investments in a single taxable year under this Part, whether directly or indirectly as owner of a pass‑through entity, may not exceed fifty thousand dollars ($50,000).
If an owner's share of the pass‑through entity's credit is limited due to the maximum allowable credit under this section for a taxable year, the pass‑through entity and its owners may not reallocate the unused credit among the other owners.
(c)	Application. – To be eligible for the tax credit provided in this section, the taxpayer must file an application for the credit with the Secretary on or before April 15 of the year following the calendar year in which the investment was made. The Secretary may grant extensions of this deadline, as the Secretary finds appropriate, upon the request of the taxpayer, except that the application may not be filed after September 15 of the year following the calendar year in which the investment was made. An application is effective for the year in which it is timely filed. The application shall be on a form prescribed by the Secretary and shall include any supporting documentation that the Secretary may require. If an investment for which a credit is applied for was paid for other than in money, the taxpayer shall include with the application a certified appraisal of the value of the property used to pay for the investment. The application for a credit for an investment made by a pass‑through entity must be filed by the pass‑through entity.
(d)	Penalties. – The penalties provided in G.S. 105‑236 apply in this Part.
"§ 105‑163.012.  Limit; carry‑over; ceiling; reduction in basis.
(a)	The credit allowed a taxpayer under G.S. 105‑163.011 may not exceed the amount of income tax imposed by Part 2 of this Article for the taxable year reduced by the sum of all other credits allowable except tax payments made by or on behalf of the taxpayer. The amount of unused credit allowed under G.S. 105‑163.011 may be carried forward for the next five succeeding years. The fifty thousand dollar ($50,000) limitation on the amount of credit allowed a taxpayer under G.S. 105‑163.011 does not apply to unused amounts carried forward under this subsection.
(b)	The total amount of all tax credits allowed to taxpayers under G.S. 105‑163.011 for investments made in a calendar year may not exceed six million dollars ($6,000,000). The Secretary of Revenue shall calculate the total amount of tax credits claimed from the applications filed pursuant to G.S. 105‑163.011(c). If the total amount of tax credits claimed for investments made in a calendar year exceeds six million dollars ($6,000,000), the Secretary shall allow a portion of the credits claimed by allocating a total of six million dollars ($6,000,000) in tax credits in proportion to the size of the credit claimed by each taxpayer.
(c)	If a credit claimed under G.S. 105‑163.011 is reduced as provided in this section, the Secretary shall notify the taxpayer of the amount of the reduction of the credit on or before December 31 of the year following the calendar year in which the investment was made. The Secretary's allocations based on applications filed pursuant to G.S. 105‑163.011(c) are final and shall not be adjusted to account for credits applied for but not claimed.
(d)	The taxpayer's basis in the equity securities or subordinated debt acquired as a result of an investment in a qualified business venture or qualified grantee business shall be reduced for the purposes of this Article by the amount of allowable credit. "Allowable credit" means the amount of credit allowed under G.S. 105‑163.011 reduced as provided in subsection (c) of this section.
"§ 105‑163.013.  Recodified as G.S. 105‑163.010A.
"§ 105‑163.014.  Forfeiture of credit.
(a)	Participation in Business. – A taxpayer who has received a credit under this Part for an investment in a qualified business venture or qualified grantee business forfeits the credit if, within three years after the investment was made, the taxpayer participates in the operation of the qualified business venture or qualified grantee business. For the purpose of this section, a taxpayer participates in the operation of a qualified business venture or a qualified grantee business if the taxpayer, the taxpayer's spouse, parent, sibling, or child, or an employee of any of these individuals or of a business controlled by any of these individuals, provides services of any nature to the qualified business venture or qualified grantee business for compensation, whether as an employee, a contractor, or otherwise. However, a person who provides services to a qualified business venture or a qualified grantee business, whether as an officer, a member of the board of directors, or otherwise does not participate in its operation if the person receives as compensation only reasonable reimbursement of expenses incurred in providing the services, participation in a stock option or stock bonus plan, or both.
(b)	False Application. – A taxpayer who has received a credit under this Part for an investment in a qualified business venture or a qualified grantee business forfeits the credit if the registration of the qualified business venture or qualified grantee business is revoked because information in the registration application was false at the time the application was filed with the Secretary of State.
(c)	Repealed by Session Laws 1996, Second Extra Session, c. 14, s. 7.
(d)	Transfer or Redemption of Investment. – A taxpayer who has received a credit under this Part for an investment in a qualified business venture or a qualified grantee business forfeits the credit in the following cases:
(1)	Within one year after the investment was made, the taxpayer transfers any of the securities received in the investment that qualified for the tax credit to another person or entity, other than in a transfer resulting from one of the following:
a.	The death of the taxpayer.
b.	A final distribution in liquidation to the owners of a taxpayer that is a corporation or other entity.
c.	A merger, conversion, consolidation, or similar transaction requiring approval by the owners of the qualified business venture or qualified grantee business under applicable State law, to the extent the taxpayer does not receive cash or tangible property in the merger, conversion, consolidation, or other similar transaction.
(2)	Except as provided in subsection (d1) of this section, within five years after the investment was made, the qualified business venture or qualified grantee business in which the investment was made makes a redemption with respect to the securities received in the investment.
In the event the taxpayer transfers fewer than all the securities in a manner that would result in a forfeiture, the amount of the credit that is forfeited is the product obtained by multiplying the aggregate credit attributable to the investment by a fraction whose numerator equals the number of securities transferred and whose denominator equals the number of securities received on account of the investment to which the credit was attributable. In addition, if the redemption amount is less than the amount invested by the taxpayer in the securities to which the redemption is attributable, the amount of the credit that is forfeited is further reduced by multiplying it by a fraction whose numerator equals the redemption amount and whose denominator equals the aggregate amount invested by the taxpayer in the securities involved in the redemption. The term "redemption amount" means all amounts paid that are treated as a distribution in part or full payment in exchange for securities under section 302(a) of the Code.
(d1)	Certain Redemptions Allowed. – Forfeiture of a credit does not occur under this section if a qualified business venture that engages primarily in motion picture film production makes a redemption with respect to securities received in an investment and the following conditions are met:
(1)	The redemption occurred because the qualified business venture completed production of a film, sold the film, and was liquidated.
(2)	Neither the qualified business venture nor a related person continues to engage in business with respect to the film produced by the qualified business venture.
(e)	Effect of Forfeiture. – A taxpayer who forfeits a credit under this section is liable for all past taxes avoided as a result of the credit plus interest at the rate established under G.S. 105‑241.1(i), computed from the date the taxes would have been due if the credit had not been allowed. The past taxes and interest are due 30 days after the date the credit is forfeited; a taxpayer who fails to pay the past taxes and interest by the due date is subject to the penalties provided in G.S. 105‑236.
"§ 105‑163.015.  Recodified as G.S. 105‑163.010B.
"Subpart 3. Exclusion of Gain for Qualified Business Investments.
"§  105-163.020.  Exclusion of gain allowed.
(a)	Any gain recognized for federal income tax purposes from the sale or exchange of qualified securities is excluded from taxation under this Article if the sale or exchange occurs on or after January 1, 2006.
(b)	A taxpayer that is an owner of a pass-through entity may exclude from the taxpayer's income taxable under this Article an amount equal to the taxpayer's allocated share of the exclusion for which the pass-through entity is eligible under subsection (a) of this section.
"§ 105-163.021.  Qualified securities.
(a)	Qualified Security. – Except as otherwise provided in this section, any equity security or subordinated debt instrument issued by a qualified North Carolina business is a qualified security if it satisfies all of the following conditions:
(1)	It is originally issued by the business on or after January 1, 2003.
(2)	As of the date of issuance, the issuing business is a qualified North Carolina business.
(3)	The security or instrument is acquired by the taxpayer at its original issue in exchange for any tangible or intangible property or benefit to the business, including cash, promissory notes, services performed, contracts for services to be performed, or other equity securities of the business.
(b)	Registration. – Securities of a qualified North Carolina business acquired more than 60 days before the effective date of its registration are not qualified securities. Revocation of the registration of a qualified North Carolina business pursuant to G.S. 105-163.010A does not affect the exclusion of gain from qualified securities acquired while the registration was in effect or within 60 days before it became effective.
(c)	Effect of Redemptions and Other Distributions. – An equity security or subordinated debt instrument is not a qualified security to the extent the taxpayer purchased it with the proceeds of a redemption, dividend, or distribution made by the business that issued the security or instrument. For the purpose of this subsection, when a business makes a redemption, dividend, or distribution during the four-year period beginning two years before the issuance of securities or instruments to a taxpayer, the taxpayer is considered to have used the proceeds of the redemption, dividend, or distribution toward the purchase of the securities or instruments. A redemption, dividend, or distribution occurs when the business issuing the security or instrument does one of the following:
(1)	Purchases, directly or indirectly, any of its outstanding equity securities or subordinated debt, other than qualified securities, from the taxpayer or a related person.
(2)	Declares a dividend or makes a distribution with respect to any of its outstanding equity securities or subordinated debt, other than qualified securities, to the taxpayer or a related person. This subdivision does not apply, however, to a distribution in connection with one of the following:
a.	The reimbursement to the taxpayer of the reasonable costs of forming, syndicating, managing, and operating the business.
b.	An increase in the taxpayer's taxes, penalties, or interest to the extent the increase is caused by the allocation to the taxpayer of income of the business.
The repayment of principal on subordinated debt is a purchase of the debt except to the extent the repayment is repayment of principal due on the subordinated debt at its maturity pursuant to the terms of the subordinated debt instrument. If a transaction is treated under section 304(a) of the Code as a distribution in redemption of the equity securities of a business, that business has, for the purpose of this subsection, purchased an amount of its equity securities equal to the amount treated as such a distribution under section 304(a) of the Code.
(d)	Conversion of Other Securities. – Any equity security or subordinated debt instrument issued by a business and acquired by the taxpayer solely through the conversion of another equity security or subordinated debt instrument that was issued by the business and was a qualified security in the hands of the taxpayer is considered, for the purpose of this section, a qualified security in the hands of the taxpayer and acquired by the taxpayer on the date the taxpayer acquired the converted qualified security.
(e)	Transfers. – In the case of a transfer by gift, by death, or from a pass-through entity to one of its owners, the transferee is considered, for the purpose of this section, to have acquired the qualified security in the same manner as the transferor and to have held it during any continuous period immediately preceding the transfer during which it was held or treated as held by the transferor.
In the case of a transaction described in section 351 of the Code or a reorganization described in section 368 of the Code, if qualified securities are exchanged for other securities, the other securities are considered, for the purpose of this section, qualified securities acquired on the date the exchanged qualified securities were acquired. In the case of a transaction described in section 351 of the Code, the newly acquired securities are considered qualified securities, however, only if, immediately after the transaction, the corporation issuing the securities owns, directly or indirectly, securities representing control, within the meaning of section 368(c) of the Code, of the corporation whose securities were exchanged.
"§ 105-163.022.  Limitations.
(a)	Contributions and Exchanges of Property. – In the case of a transaction described in section 351 or 721 of the Code or a reorganization described in section 368 of the Code, if a taxpayer contributes property to or exchanges property with a qualified North Carolina business, the following rules apply:
(1)	Qualified securities exchanged for property. – Except as otherwise provided in subdivision (3) of this subsection, a taxpayer who transfers property to a business in exchange for qualified securities in the business must, for purposes of determining North Carolina taxable income, recognize gain equal to the amount by which the fair market value of the property exceeded the taxpayer's basis in the property on the date the property was exchanged for the qualified securities. This gain must be recognized for the years for which the taxpayer claims an exclusion of gain under this Part with respect to the disposition of qualified securities received in exchange for the property.
(2)	Contributions to capital. – Except as otherwise provided in subdivision (3) of this subsection, if the adjusted basis of a qualified security is adjusted due to a contribution to capital after the date the qualified security was issued originally, for purposes of determining North Carolina taxable income, the taxpayer must recognize gain equal to the amount by which the fair market value of the contributed property exceeded the taxpayer's basis in the property on the date the property was contributed. This gain must be recognized for the years for which the taxpayer claims an exclusion of gain under this Part with respect to the disposition of the qualified securities.
(3)	Disposition of contributed property. – If a qualified North Carolina business disposes of property contributed to it, the disposition occurs before the taxpayer who contributed the property claims an exclusion of gain pursuant to this Part with respect to qualified securities affected by the contribution, and the taxpayer recognizes gain from the disposition, then for purposes of subdivisions (1) and (2) of this subsection, the taxpayer's basis in the contributed property is increased by any gain the taxpayer recognized from the disposition.
(b)	Short Positions. – If a taxpayer has an offsetting short position with respect to any qualified securities, there is no exclusion of gain under this Part from the sale or exchange of the qualified securities unless the taxpayer established the short position on or after January 1, 2006, and elects to recognize gain as if the qualified securities were sold at fair market value on the date the taxpayer first established the short position. For the purposes of this subsection, a taxpayer has an offsetting short position with respect to qualified securities if one of the following conditions is satisfied:
(1)	The taxpayer or a related person has made a short sale of substantially identical property.
(2)	The taxpayer or a related person has acquired an option to sell substantially identical property at a fixed price.
(3)	The taxpayer has entered into any other transaction that the Secretary has identified in guidelines adopted under this section as one that substantially reduces the risk of loss from holding the qualified securities.
(c)	Guidelines. – The Secretary of Revenue must adopt guidelines identifying transactions that substantially reduce the risk of loss from holding qualifying securities for the purpose of subsection (b) of this section. In addition, the Secretary must adopt guidelines identifying activities and situations designed to avoid the purpose of this Part through split‑ups, shell corporations, partnerships, or otherwise. There is no exclusion of gain otherwise allowable under this Part to the extent a taxpayer has engaged in an activity or created a situation identified by the Secretary in guidelines as one that is designed to avoid the purpose of this Part."
SECTION 6.  This act is effective when it becomes law. Notwithstanding the provisions of G.S. 105‑163.010A as recodified by this act, if a qualified North Carolina business files its application for registration within 60 days after the effective date of this act and the application is accepted, the effective date of the registration is the later of January 1, 2003, or the date the business first issues equity securities or subordinated debt.