Reed Smith’s State Tax Group has been representing clients in Pennsylvania for more than 30 years. We have extensive experience with all types of Pennsylvania taxes. We settle controversies with the Department of Revenue and the attorney general’s office, we obtain favorable letter rulings, we win cases at the Board of Appeals and the Board of Finance and Revenue, and we win cases in court.
But despite our long history of success in Pennsylvania tax matters, we don’t get complacent or rest on our laurels. Our State Tax team continually adapts to changes in Pennsylvania tax policy and stays up to date on the latest issues and arguments advancing their way through audits and appeals. We merge this unparalleled knowledge with the latest technological innovations, such as automation, machine learning and artificial intelligence, and data analytics, to provide an exceptional client experience and to maximize results. In short, we use the right tools at the right times to help clients pay the least amount of Pennsylvania tax.
Given our inside view into Pennsylvania state taxes, we have unparalleled insights to Department positions and otherwise unavailable information, so that we can deliver accurate and timely information to clients. Consequently, we are able to anticipate the effects of certain legislative changes and legal opinions, allowing us to best advise clients on their state tax planning and controversies in Pennsylvania.
Here is a brief summary of some Pennsylvania corporate net income tax and sales and use tax issues and opportunities:
Net Operating Losses
Pennsylvania’s cap on deducting net operating losses (NOLs) violates the state constitution for tax years prior to 2017. Taxpayers should compute their NOL deduction for these years without regard to the cap. We have prevailed on this issue at the Pennsylvania Supreme Court and are currently litigating related follow-up cases on behalf of our clients. If the cap has prevented your company from using any of your NOLs, we think you are entitled to a refund.
Market-Based or Cost-of-Performance Sourcing? Your Choice
Taxpayers selling services may choose the most beneficial method of sourcing receipts from those sources for sales-factor purposes (through 2013), because the Department of Revenue does the same. Taxpayers should take a page from the Department’s book. Taxpayers located in Pennsylvania should use market sourcing and those outside Pennsylvania should use cost-of-performance sourcing. This opportunity is only available through 2013; after that, the state switched to market-based sourcing for services.
Where is the “Benefit Received” for Sales Factor Apportionment?
For market sourcing years (2014-forward), there is inconsistent guidance on how to determine the location where a customer receives the benefit of a service for sales factor apportionment purposes. For example, the Department has been inconsistent in arguing whether intercompany services should be sourced to the headquarters of the affiliate or another location. Taxpayers have flexibility in determining where the benefit of a service is received and should adopt the apportionment approach that works best for them.
This opportunity can also be particularly beneficial for taxpayers that are required to look to a customer’s billing address to source a service, such as telecommunications providers. We’ve been successful in using innovative technological approaches and data analytics to source these types of services more accurately to the location where the customer actually benefits from the service.
The Department has been aggressive in adding back royalties, interest, and management fees paid to affiliates since the enactment of the add-back statute (effective 1/1/2015) and for prior years under a sham transaction theory. We’ve handled dozens of these cases and we leverage our prior experience to assist taxpayers in understanding the opportunities presented by the broad exceptions to addback.
Tax Cuts and Jobs Act (“TCJA”)
In the years since the enactment of the federal Tax Cuts and Jobs Act, we’ve been on the forefront of issues surrounding Pennsylvania’s conformity to the TCJA, including opportunities around the treatment of global intangible low-taxed income (GILTI), foreign-derived intangible income (FDII), and interest limitations under IRC § 163(j).
Taxpayers have a choice when it comes to bonus depreciation: (1) follow federal bonus depreciation, (2) compute Pennsylvania depreciation without regard to federal bonus depreciation, or (3) compute Pennsylvania depreciation using the statutory “3/7” method (i.e., per the return instructions). If your company would benefit from one of these options, contact one of our lawyers.
Despite the Westinghouse case, we believe taxpayers that file consolidated federal returns are entitled to make different elections at the state level. Whether it’s electing the reduced federal research credit; making an IRC section 59(e) election; or electing MACRS instead of straight-line depreciation; it’s your choice.
Refunds for Remotely Accessed Software, Digital Goods, and Cloud Computing
If you paid sales or use tax on software, you may have a refund opportunity. Under a Department-issued letter ruling, software is subject to Pennsylvania tax only to the extent that it is used in Pennsylvania. Under this ruling, a taxpayer that houses software on a server in Pennsylvania but has only 10 percent of its users located in Pennsylvania, should consider filing a refund claim if it paid tax on the full price of the software.
However, the Department itself has been inconsistent with the manner in which it applies its letter ruling. Following the Department’s inconsistent policies may also create refund opportunities for any taxpayer that houses its software outside Pennsylvania, even if all, or a substantial amount, of users are located within the state.
Sales and Use Tax Paid on Manufacturing Equipment or Services
Pennsylvania has a broad manufacturing exemption that encompasses R&D, processing, and mining. The Department has historically limited the scope of the exemption by taking a narrow approach to determining the beginning and end of the manufacturing process. Recent administrative decisions suggest that the manufacturing exemption is broader than the Department’s view, which creates ample refund opportunities for taxpayers engaged in manufacturing.