For out-of-state businesses evaluating potential income tax nexus in Pennsylvania, the importance of understanding the sales factor landscape in Pennsylvania cannot be overstated. For example, consider the sourcing of the following types of receipts:

• Intangibles:

• Although Pennsylvania statutorily switched to “market-based” sourcing for receipts from services in 2014, that switch did not impact the sourcing rule applied to receipts from intangibles². Pennsylvania still has an all-or-nothing costs-of-performance rule for sourcing receipts from intangibles.³
• This means an out-of-state business earning receipts from intangibles - e.g., royalty payments in exchange for licensing intellectual property, interest, or franchise fees—may not have any Pennsylvania-source receipts if it incurs a greater proportion of the costs of performance relating to its income-producing activity in a state other than Pennsylvania.
• There is ongoing litigation in Pennsylvania involving the costs-of-performance test, so this is a particularly important area to watch.

• Software & Digital Goods/Services:

• If software is treated as an intangible, then out-of-state businesses licensing software for use in Pennsylvania should source receipts from those licenses under a costs-of-performance analysis, as discussed above.
• On the other hand, if software is treated as tangible personal property - as it is for Pennsylvania sales tax purposes⁴ - then out-of-state businesses licensing software for use in Pennsylvania should consider whether they can claim protection from the imposition of Pennsylvania's corporate net income tax under P.L. 86-272.
• A similar analysis might also apply to receipts from other digital goods and services.

Pennsylvania’s announcement of economic nexus for corporate income tax purposes follows the lead of other taxing jurisdictions (e.g., Hawaii, Philadelphia, San Francisco, Texas) in extending the application of Wayfair to taxes other than sales taxes.

If you have questions, please contact one of the authors of this alert or the Reed Smith attorney with whom you usually work.

1. A copy of Corporation Tax Bulletin 201904 is available at revenue.pa.gov.
2. 72 P.S. § 7401(3)2.(a)(16.1)(C).
3. 72 P.S. § 7401(3)2.(a)(17).
4. Dechert LLP v. Commonwealth, 606 Pa. 334 (2010); 72 P.S. § 7201(m) (eff. Aug. 1, 2016).

Client Alert 2019-241