While the Department’s Information Notice focuses primarily on the sourcing of revenues from services, it also addresses the sourcing of receipts from intangibles – in a manner seeming to be directly at odds with previously published guidance.
For years prior to 2014, receipts from sales of services and intangibles were subject to the UDITPA-based “income-producing activity” and “costs of performance” analysis. Act 52 changed only the rules for services – receipts from intangibles remain subject to the “income-producing activity” and “costs of performance” rules. Under this approach, if the income-producing activity is performed in one or more states, in addition to Pennsylvania, the receipts are sourced to PA if the greater proportion of the income-producing activity, as measured by costs of performance, has occurred in PA. While the Department never published a regulation addressing this analysis, and while audits sometimes took inconsistent positions, the Department did publish two letter rulings applying these rules. The letter rulings focused on all of the activities performed by the taxpayer in producing the sales in question. Generally, the letter rulings indicated that receipts from intangibles, such as license fees, would be sourced to the commercial domicile on the basis that the state of commercial domicile is “where a taxpayer generally manages and maintains intellectual property.” Ruling No. CRP-06-004, 10/10/2006.
The Department’s new Notice, however, takes a much different approach, essentially sourcing receipts from intangibles licensing to the location where the intangible is used by the licensee. Furthermore, the Notice represents that the Department “has consistently applied” this approach, Notice ¶6.2.1, which obviously is called into question by the previously published letter rulings.
The Notice provides no explanation for the Department’s change in position. The Notice cites only to a Black’s Law Dictionary definition of “perform” as a basis for its new position. Given the long existence of the statutory provision being construed, and the absence of action by the Legislature to overturn the Department’s previously published, contradictory interpretation, it is difficult to believe that the Department’s recent discovery of a dictionary definition would be viewed by the courts as an adequate basis for its change of position. Furthermore, it seems that even the cited definition doesn’t necessarily support the Department’s new position, which seems to focus on the customer / licensee’s use of the intangible rather than the activities of the licensor – which are the “income producing activities” referenced in the statute.
The reality of the situation is that taxpayers now have two wildly divergent Departmental positions (we’ll ignore other inconsistent positions take on a case-by-case basis for the moment) to choose from in taking filing positions on the sourcing of receipts from intangibles! Apparently, no matter how justified a filing position may be, even on the basis of available guidance during the tax year in question (if it pre-dates the Notice), the Department’s taxing officers, auditors and hearing officers will be following the new Notice and taxpayers may face a long trek through the appeals process to defend their positions.
As noted in the accompanying main article, until the Department actually promulgates an official regulation, the Notice as well as all other similar publications are not binding as a matter of law and merely provide information to be considered by taxpayers. Taxpayers should consider not only the Notice and other informal Pennsylvania advice, but should look to interpretations in other jurisdictions as well for guidance.
