Shortly after issuance of our last newsletter in early December, the Pennsylvania Department of Revenue published Information Notice Corporation Taxes 2014-01 (http://www.revenue.pa.gov/GeneralTaxInformation/TaxLawPoliciesBulletinsNotices/Documents/Informational%20Notices/info_notice_ct_2014-01.pdf), providing official guidance on the apportionment changes made by Act 52 of 2013.  Effective for tax years beginning after December 31, 2013, the Act provides new rules for the sourcing of receipts from services in the corporate net income tax and franchise tax sales factors.  In early summer, a draft of the information notice was circulated to organizations representing business and industry, the bar and CPAs.  Extensive comments were submitted at the end of July.  The Department has now revised and finalized the notice, providing discussion of general rules as well as numerous examples.  Taxpayers will find the notice helpful in understanding the thinking of the Department but, in some respects, the notice raises questions as well as providing answers.

Background.  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.  If the income-producing activity was performed in one or more states, in addition to Pennsylvania, the receipts from those activities were sourced to PA if the greater proportion of the income-producing activities, as measured by costs of performance, occurred in PA.  Unfortunately, the Department never adopted a formal regulation addressing this analysis and the Department’s auditors, as well as the administrative appeals boards, sometimes took inconsistent positions from one case to the next.

Act 52 Rules Sourcing Services based on Delivery Location.  Under Act 52, receipts from sales of services are now attributed to Pennsylvania if “delivered to a location” in PA.  The Department’s notice essentially restates the following statutory rules:

1. General Rule:  “Sales from the sale of service [are treated as Pennsylvania sales] if the service is delivered to a location in this State.  If the service is delivered both to a location in and outside this State, the sale is in this State based upon the percentage of the total value of the service delivered to a location in this State.”  72 P.S. §7401(3)2.(a)(16.1)(C)(I).
2. Default Rule for Sales to Non-proprietor Individuals:  “If the state or states of assignment under [No. 1] cannot be determined for a customer who is an individual that is not a sole proprietor, a service is deemed to be delivered to the customer’s billing address.”  Id. at (16.1)(C)(II).
3. Default Rule for Services to Business Customers:  “If the state or states of assignment under [No. 1] cannot be determined for a customer, except for a customer under [No. 2], a service is deemed to be delivered at the location from which the services were ordered in the customer’s regular course of operations.  If the location from which  the services were ordered in the customer’s regular course of operations cannot be determined, a service is deemed to be delivered at the customer’s billing address.”  Id. at (16.1)(C)(III).

The Department believes the default rules will rarely have to be invoked.  Notice ¶5.0.  However, little guidance is provided concerning how much effort a service vendor must invest to capture sourcing data over and above what is now captured in the ordinary course of business.

The Department’s Notice cites language from a legislative fiscal note, as well as from the Pennsylvania Supreme Court’s decision in Gilmour Manufacturing Co. v. Commonwealth, 573 Pa. 143, 822 A.2d 676 (2003) for the proposition that the sales factor, and the new language in particular, is intended to reflect the market for the taxpayer’s services.  While there may be support for the Notice’s position, there also may be room in a given case for a contrary argument.  Gilmour, in fact, addressed somewhat different language applicable to the sourcing of receipts from sale of tangible personal property.  Generally, courts will not look behind plain statutory language, even to actual legislative debates as well as other documents which are not incorporated into the statute itself.  The key question therefore, would be to determine, in the first instance, whether a service is “delivered to a location” in Pennsylvania, under the plain meaning of that phrase.

The Department attempts to put a “market” gloss on this analysis in stating that “delivery to a location not representative of where the customer for the service is located does not represent completed delivery of the service.”  Notice ¶3.2.  Where delivery of the product of the service is made by a third party, the Department says delivery “from the customer’s perspective occurs at the location where the customer representative of the market for this service actually receives it.”  Id. ¶3.3.  Where the vendor delivers to “an intermediate party or agent, whether or not … legally affiliated with the customer, is not representative of the market” and “is not completed at the location of the intermediate party or agent.”  Id.  We suspect there may be fact situations where these statements are not consistent with the common meaning of “delivery location.”

Services to Real and Tangible Property.  The Notice provides many examples which likely will be most helpful to taxpayers.  In the case of services performed to real property, such as plumbing repairs, construction services and landscaping services, the Department’s examples provide that delivery occurs as the location of the property, with the sales being allocated where the property is in more than one state.  Notice ¶¶3.2, 4.11.  In the case of tangible personal property, which may be transported from the customer’s location to the vendor for service, and then back to the customer, the location of property at the time the service is performed is ignored and the service receipt is sourced to the customer’s address. Notice ¶3.2.  However, where the customer actually picks up the repaired property (e.g., repaired auto) at the vendor location, the delivery is deemed to occur at the location where picked up by the customer.  Id.  We note that the latter example may or may not comport with the “market” concept, but most likely would represent the common conception of the place of service delivery.

Transportation Services.  Act 52 did not change the special apportionment provisions for railroads, motor carriers, bus lines, and airlines, for pipeline and natural gas companies and for water transportation companies.  These companies continue to apportion on the basis of “revenue miles,” “ton miles,” “barrel miles,” “cubic feet miles,” “cubic foot capacity” or “port days” ratios, as applicable.  Notice ¶¶4.13-4.15.  To the extent not covered by special apportionment rules, the Department has indicated it will source receipts from services involving the moving of tangible personal property to the address of the recipient.  Notice ¶3.2.

Personal and Professional Services.  Personal services, such as the provision of temporary help, are sourced to the location(s) where the services are performed.  Notice ¶3.2.  Services such as consulting, counseling, personal advice, training, speaking and entertainment are sourced to the location(s) of the persons benefitting from the service, even if “provided from a remote location and/or delivered via electronic means.”  Notice ¶4.1.

However, the Department seems to distinguish between certain other types of personal and professional services.  For example, “trade or business services,” such as services benefitting a company’s administrative, management, marketing, sales, manufacturing, distribution and other operations supporting the business should be sourced to the “business location(s) containing the actual customers for the service.”  An example of a “trade or business service” would be a payroll processing service, which the Department would source to the location of the corporation’s headquarters and human resources function.  Apparently, this would be the case even if the payroll information was provided to the service provider from customer locations in multiple states – which could be somewhat questionable under a plain meaning approach to delivery of the service.

For reasons not entirely clear, the Department would take a different approach to certain “employee services,” sourcing the receipts based on the employee locations in multiple states.  The Department seems to view these services differently than “trade or business services” because the “employee services” are “designed and intended for employees’ personal use and benefit, rather than for directly benefitting the normal trade or business operations of the company….”  See, Notice  ¶4.2.2.  The statutory basis for this distinction is not explained.  Where the actual value of services delivered to each state cannot be determined, the Department would allow an allocation based on the number of employees in each state.  Id.

Services Represented by Delivery of Property of Incidental Value.  One of the most difficult questions, we believe, is posed where a service is performed remotely for a multistate enterprise and is represented in the delivery of a tangible product to the customer, such as a marketing report delivered in paper or on disk or other physical medium.  In one example, the Department says the receipts from such services are sourced to the address where the customer takes physical possession of the tangible product.  Notice ¶¶ 3.2, 4.10.  However, in an “In-Transit Delivery” example the Department would source the sale to Pennsylvania when a company’s New Jersey purchasing office procures services to benefit the company’s Pennsylvania office but the service output is delivered to the New Jersey office before being forwarded to Pennsylvania, Id. ¶3.3.1 – the example does not explain how the service vendor is to know the New Jersey office will be forwarding the output to the Pennsylvania office.

Electronic Delivery.  In  the case of services provided electronically, the Notice indicates that the Department will accept sourcing based on an electronic address (email address, IP address, etc.) where street addresses are not available.  Notice ¶3.4.  Where the use will be in multiple states, the Department would look for sourcing “in a reasonable and proportionate manner” considering multiple factors.  Id.

Multijurisdictional Sourcing Methodologies.  The Department indicates that multijurisdictional sourcing may be based on “expected usage,” “actual usage” or “value of the usage,” with the understanding that the method must be used consistently.  Notice ¶3.5.  The Department does not indicate why the default rules should not be implicated if actual value of usage data is not available – e.g., why would “expected usage” trump the statutory default rules?

Data Processing, Internet Access, Data Storage and Information Services.  The Department would source streaming audio or video, access to stored data, corporate shared services and similar services to the location(s) of the users.  This user-based sourcing would apply even when the service provider delivers its data services to a specific server, including in “the cloud.”  Notice ¶4.9.

Other Specific Services Examples.  The Department’s notice provides several examples for other specific services:

• Retail Telecommunication Services will be sourced based on the “place of primary use” standard where the telecom company is subject to the federal Mobile Telecommunications Sourcing Act (MTSA).  If the MTSA does not apply, sourcing will be based on the service address.  Notice ¶4.12,
• Brokerage Services to businesses are sourced to the principal business address of the purchaser unless the broker deals primarily with another business location.  Notice ¶4.4.
• Subscription Services may be sourced based on the proportion of subscribers in PA or the number of licenses received by customers in PA, if the actual usage in each state cannot be determined.  Notice ¶4.6.
• Mutual Fund Service Providers should source their receipts based on the locations of the fund shareholders.  Notice ¶4.7.
• Advertising Services involving distribution and delivery of advertising to a target audience should be sourced based on the location of the target audience members – reasonable estimates will be accepted.  Notice ¶4.8.

Limited Authority.  While the publication of the Notice by the Department provides guidance to taxpayers, it will not be binding until promulgated and legally adopted as a formal regulation.  We understand that the Department does plan to pursue approval through the regulatory process, but this likely will take many months.  In the meantime, 61 Pa. Code §3.4 provides that this sort of guidance “is issued for informational purposes only and should not be relied upon or used in tax appeals.”