PA Tax Law News -- September 2013: PA Issues On Appeal – Corporate Taxes

by McNees Wallace & Nurick LLC

Under Pennsylvania’s tax appeals system, many issues are not resolved at audit or before the Department’s Board of Appeals and the Board of Finance and Revenue, resulting in numerous appeals to the Commonwealth Court. In court, most cases are resolved prior to argument, through negotiated settlement. Thus, to know whether your company is pursuing all reasonable issues, you must be aware of issues raised in appeals to the Commonwealth Court and, to the extent possible, how those issues have been resolved in settlements.

Many issues in court are susceptible of negotiated settlement. Occasionally, an issue cannot be resolved and the parties then pursue formal argument to the court. The article in this issue “PA Telecom Gross Receipts Tax Litigation Finally Moving” provides an example of issues going to argument before the Commonwealth Court.

If your company has an issue that another company is pursuing in a court appeal, and it is certain that the issue will not settle and have to be argued, your company may file protective petitions and have action on those cases deferred pending final resolution of the issue by the courts. In many instances, waiting to file until someone else has obtained a final decision will result in your company being closed out for many tax years by the statute of limitations for refund claims and assessment appeals. Pennsylvania courts have very tightly enforced the statutory limitations periods.

If your company has an issue which one or more other companies seem likely to settle in court, you may file your refund claim or assessment appeal and defer it temporarily while you wait to see what happens with the other cases. Or, what is generally a better choice, you can move your case through the administrative appeals boards and into court, assuming that by the time your case reaches court, you will have some idea what has happened in the cases ahead of yours.

Recently, a settlement process was implemented for cases before the Department’s Board of Appeals and, with implementation of changes to the Board of Finance and Revenue in April 2014, a similar process will be put in place at that level. However, unless you are prepared to offer the Department a “sweetheart deal” for the Commonwealth, we believe there will continue to be many issues that will not be resolved prior to negotiation with the Office of Attorney General after a court appeal is filed. And, of course, there always will be a few issues that will have to be formally resolved by the courts.

To understand the opportunities for your company, the first step is to identify issues which are being taken to court. Then you should discuss with your state tax legal advisors the best way to pursue the issues for your company.

To assist you in identifying possible issues for your company, the list below includes a number of arguments raised in Pennsylvania Corporate Net Income Tax, Capital Stock Tax and Franchise Tax appeals recently filed with the Commonwealth Court. Please contact a member of the McNees SALT group if you would like to discuss any of these issues.

  1. Equitable Apportionment:  Many cases assert that the standard apportionment formula, as applied to a particular company’s circumstances, does not fairly attribute income or capital stock value to Pennsylvania. Some cases request different composition or weighting of the standard Property, Payroll or Sales Factors, the addition of a fourth factor, or other alternative methodologies.
  2. Unconstitutional Distortion in Apportionment:  Often an assertion of unconstitutional distortion of income or value attributable to Pennsylvania is paired with an Equitable Apportionment argument. Note that, in Pennsylvania, the statutory Equitable Apportionment provision may be triggered at a lower threshold than is required to establish a constitutional violation.
  3. Apportionment - Sales Factor - Cost of Performance:  Right to exclude receipts from numerator where greatest proportion of income-producing activity was performed in state other than Pennsylvania.
  4. Apportionment - Sales Factor - Cost of Performance:  Revenue Department position equating income producing activity to where customer received benefit of service is contrary to the statute and represents the substitution of the Department’s policy judgment for the Legislature’s, in violation of state constitution.
  5. Apportionment - Sales Factor - Receipt of Benefit:  Attributing sales to PA when all or virtually all service activities were performed outside PA is unconstitutional.
  6. Apportionment - Sales Factor - Costs of Performance:  Revenue Department adoption of the new definition of “sales factor” without formal rulemaking is invalid.
  7. CNI - Net Loss Cap:  Net Loss cap is unconstitutional.
  8. CNI/Franchise - Multiformity/Unrelated Assets/Unitary:  Right to exclude income, assets and activities unrelated to PA activities; right to exclude subsidiary dividends from book income where unrelated to PA activities.
  9. Franchise - Distortion - Equitable Apportionment:  Right to include values from subsidiaries in apportionment factors in order to fairly attribute value to PA.
  10. Franchise/Capital Stock - Value - Extraordinary Gain:  Company should be taxed on the basis of appraised value where inclusion of extraordinary gain produced excessive Capital Stock Value.
  11. Franchise/Capital Stock - Book Income - Royalty Addback - Sham Transaction:  Department lacked authority to add back royalties deducted from book income and failed to establish the elements of a sham transaction.
  12. Franchise - Capital Stock Value - Book Income:  Right to recognize decline in value of assets on balance sheet in computing book income.
  13. Franchise - Capital Stock Value - Net Worth:  Right to recognize decline in value of assets on balance sheet.
  14. CNI - Insurance Co. Exemption - Foreign Captive:  Foreign captive insurance company conducting insurance business outside PA should be exempt from tax.
  15. CNI - Basis - Tax Benefit:  Right to adjust basis and reduce gains because prior period losses did not provide tax benefit.
  16. CNI - Separate Co. Depreciation:  Member of consolidated group for federal tax purposes is entitled to use different basis for separate company state tax purposes.
  17. Franchise/Capital Stock - Book Income - Reduction by LLC Distributions:  Where members of an LLC provided management, distribution and performed all other activities of LLC, distributions to members should have been deducted in calculating income; provision for deduction was not intended to apply only to small businesses, as asserted by Board of Finance and Revenue.
  18. Capital Stock - Single Factor Apportionment:  Company should be allowed to use end-of-year values instead of average values.
  19. Capital Stock/Franchise - Apportionment - Processing, R&D, Manufacturing:  Three-factor method is unconstitutional because it fails to exclude subsidiary values and values attributable to processing, R&D and manufacturing which in-state taxpayers may exclude using single-factor method.
  20. Franchise/CNI - Apportionment Bifurcation:  Right to apply single-factor pipeline factor to receipts/value from natural gas business involving gas transmission via pipeline and apply three-factor apportionment to other receipts.
  21. Franchise/CNI Apportionment - Sales Factor - Electricity:  Sale of electricity constitutes sale of intangible property, not tangible personal property, which should be sourced based on costs of performance rule.
  22. Franchise/CNI - Nexus - PL86-272-Electricity:  If sale of electricity constitutes sale of tangible personal property, PL 86-272 bars imposition of tax because PA activities were limited to solicitation.
  23. Franchise/CNI - Apportionment - Sales Factor:  Sales Factor should include gross receipts, not net inflows from “swaps” engaged in as electricity and natural gas hedging transactions.
  24. CNI - Apportionment - Sales Factor - Treasury Transactions:  Sales factor denominator should include proceeds from sales of loans, leases, receivables and from securitization transactions.
  25. Franchise - Apportionment - Payroll Factor - Distortion:  Right to exclude exercise of nonqualified stock options because inclusion distorts attribution of value to PA.
  26. CNI/Franchise - Apportionment - Property Factor:  Right to exclude inventory and other property in transit, destined outside of PA, from numerator.
  27. CNI/Franchise - Apportionment - Property Factor:  Right to exclude idle property and construction-in-progress.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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