United States: Pennsylvania Tax Developments (August 2015)

Is Pennsylvania bringing back its tax on "computer-related services"? Pennsylvania's new "Netflix" tax (enacted as part of Act 84 of 2016) covers more than just digital downloads and streaming services. Effective August 1, 2016, Pennsylvania sales and use tax is imposed not only on digital downloads and streaming services, but also on satellite radio subscriptions and software maintenance and support services. All of these items have been added to Pennsylvania's definition of taxable tangible personal property.

Note that in the 1990s, Pennsylvania taxed software support and "computer-related services" by including those items in the statutory list of enumerated taxable services. The legislature removed those items from the scope of taxable services in 1997 after significant controversy over the scope of such services.1 Now, 20 years later, Pennsylvania is resuscitating its attempt to tax these items, but this time it is attempting to accomplish the same result by deeming the items to be tangible personal property.

Not only does the new law explicitly impose tax on more than digital downloads and streaming services, but it also contains ambiguous provisions that may be interpreted expansively by the Department—just as the Department expansively interpreted the provisions of the computer services tax in the 1990s. For example, Act 84 contains a provision that explicitly taxes "apps." Does that just mean an app of the type that can downloaded from iTunes? If so, that transaction seems to be covered elsewhere in Act 84 by the Act's explicit taxation of canned software—so, under that interpretation, Act 84's provision regarding the taxation of "apps" seems superfluous. Or, more ominously, does an "app" include services, like information services, delivered over an app? In our view, that was not the intention of the legislature, and we hope that the Department exercises restraint in interpreting this new law.

Compensation Cap Will Cost Vendors Millions Effective August 1, 2016, Act 84 imposes a $300 annual cap on the amount of compensation vendors can receive from the state for prompt collection and remittance of sales tax.2 Under prior law, vendors received this compensation in the form of an uncapped credit equal to 1% of sales tax timely collected and remitted.3 The new $300 cap is estimated to generate an additional $55.5 million of revenue for the state in FY2016-17, making it the largest non-tobacco tax increase in the recent tax code legislation.

The cap will have a greater impact on vendors with higher sales volumes.4 It seems hard to believe that economies of scale can justify such a significant difference in liability. The legislature justified the cap on the basis that it is a way to shore up budget deficits without increasing the tax rate paid by voters.5

Other states have enacted similar caps on vendor compensation in recent years. Kentucky's cap is currently being challenged on state constitutional grounds.6

Unconstitutional NOL Cap—Commonwealth Court Reiterates and Liberalizes Nextel Decision On June 15, a panel of the Commonwealth Court issued a decision in RB Alden Corp. v. Commonwealth,7 following the court's November 2015 decision in Nextel.8 Recall, in Nextel, Reed Smith convinced the unanimous seven-judge Commonwealth Court en banc panel, that the net loss cap violated the Uniformity Clause of the Pennsylvania Constitution. Two judges dissented on remedy, including Judge Pellegrini. See our alert on the court's decision in Nextel and for more information on Pennsylvania's unconstitutional NOL cap.

The RB Alden panel decision was written by Judge Pellegrini—the judge who had dissented on the "remedy" issue in Nextel. In RB Alden, Judge Pellegrini followed Nextel, and further concluded that RB Alden had established a uniformity violation even though nothing in the record showed actual discrimination in the tax year at issue. Further, Judge Pellegrini ordered a refund for RB Alden. The RB Alden panel therefore liberalized the burden for taxpayers following the Nextel decision.

Meanwhile, Reed Smith lawyers will be appearing before the Commonwealth Court August 8 in a conference to determine whether and how a factual record must be developed in other NOL cap cases pending in court. For any company with a case held pending Nextel, we encourage you to contact a Reed Smith lawyer for guidance concerning the factual record in your case. Although Judge Pellegrini concluded in RB Alden that no factual record was necessary, the five-judge majority of the court had concluded that Nextel won its case "as applied," and in that case, a detailed factual record was, in fact, presented by Reed Smith.

RB Alden involved a taxpayer whose sole activity was owning a general partnership interest and a limited partnership interest in a partnership whose sole asset was an apartment complex in Pennsylvania. The taxpayer managed and controlled the partnership and the apartment complex. During the tax year at issue, 2006, the taxpayer sold a portion of its limited partnership interest, and reported the gain as nonbusiness income. The Department disagreed and issued an assessment increasing the tax by including the gain as apportionable business income. The taxpayer appealed and argued: (i) the gain was nonbusiness income that is allocable to the taxpayer's commercial domicile, which was New York; (ii) the gain should be excluded from the tax calculation under the doctrines of multiformity and unrelated assets; (iii) if the gain is included in the calculation as apportionable business income, it must be sourced to New York under the statutory income-producing activity and costs-of-performance test; and (iv) the amount of the gain must be recomputed in accordance with tax benefit principles. The Commonwealth Court ruled against the taxpayer on all of these issues; but, as noted above, the taxpayer still prevailed based on Nextel and the unconstitutionality of the NOL cap.

On July 14, the taxpayer filed exceptions to the Commonwealth Court's decision. On July 15, the Commonwealth also filed exceptions to the decision.

Is IP Now Taxable Tangible Personal Property? In Downs Racing, LP v. Commonwealth, the Commonwealth Court held that a license for intellectual property used in a video poker machine was taxable as a sale of tangible personal property for sales and use tax purposes.9 The court reasoned that "just because the [tax statute] does not expressly mention 'intellectual property' in its definition of 'tangible personal property' does not mean that it does not constitute tangible personal property."

In its brief, the commonwealth argued that "the object of the transaction in the case presently before the Court is personal property, in this case operable gaming machines."10 So, while the literal language of Downs Racing states that a license to intellectual property is taxable, the holding of this case should be limited to sales or licenses of intellectual property that are integrated with a sale of tangible personal property.

The Latest in Pennsylvania Tax Controversy:

NOL LitigationNextel Communications of the Mid-Atlantic, Inc. v. Commonwealth – In a case argued by Reed Smith, the Commonwealth Court held that Pennsylvania's net loss deduction cap is unconstitutional, and the taxpayer is entitled to deduct an uncapped net loss for the 2007 tax year. The commonwealth has appealed this decision to the Pennsylvania Supreme Court, and briefing is completed in this appeal. For more information, see the discussion of RB Alden above.

Refund on Extended Return FilingMission Funding Alpha v. Commonwealth – In another case argued by Reed Smith, the Commonwealth Court held that a corporate tax refund claim is due within three years from the return filing date (not within three years from the original return due date.) The commonwealth has appealed this decision to the Pennsylvania Supreme Court. The parties have filed their initial briefs, and the commonwealth's reply brief is due August 8. For more information on this case, see our earlier alert.

Servers Located in Pennsylvania but Accessed Elsewhere – As the Department has explained, "[t]he sale and use of software that otherwise would be subject to tax is not subject to sales tax if the end user of the software is located outside of the Commonwealth, even if the cloud server that hosts the software is located in Pennsylvania."11 Applying the same logic to servers, the commonwealth recently settled an appeal where a server was located in Pennsylvania but was accessed by remote users outside Pennsylvania.

Production of Distilled and Purified WaterDS Waters of America, Inc. v. Commonwealth – This case pending before the Commonwealth Court involves the issue of whether producing and bottling distilled and purified water qualifies for the manufacturing exemption from sales and use tax. Briefing is completed, and the court has tentatively scheduled argument for October 2016.

Amended Return RefundQuest Diagnostics Venture LLC v. Commonwealth – The Commonwealth Court found that the taxpayer's amended return did not qualify as a "petition for refund" and, therefore, the taxpayer did not timely request a refund of overpaid taxes. The taxpayer has appealed this decision to the Pennsylvania Supreme Court, and briefing is completed.

Guardrail Fasteners and BlocksGreen Acres Contracting Company, Inc. v. Commonwealth - This case was argued before Commonwealth Court June 6 and the parties are now awaiting a decision as to whether guardrail fasteners and blocks are exempt building machinery, and equipment for sales and use tax purposes. The taxpayer also argued that it paid taxes to Virginia and West Virginia that are creditable against its Pennsylvania sales and use tax liability.

Interesting Board of Finance and Revenue Decisions:

DOR's Basis of Assessment Too Narrow – The Department of Revenue has argued that a taxpayer filing a petition for reassessment may only contest the specific issues identified by the Department as the basis for the assessment. At audit, the Department increased the taxpayer's property and sales factors. The taxpayer filed a petition for reassessment requesting an adjustment to the payroll factor. The Board of Finance and Revenue ruled that a taxpayer was entitled to raise the payroll factor issue because the Department "too narrowly defined the basis of assessment," and that the payroll factor was part of the basis of assessment because it "impact[s] the amount of tax assessed."

Taxpayer with $0 Tax Liability, Still on the Hook for Third-Party Collection Charges – Even though the Board (and Department of Revenue) agreed that a taxpayer's tax liability was $0, the Board found that it could not waive or otherwise abate the collection charges imposed by the a third-party collector acting as an agent for the state.

Sales-factor sourcing: Unreasonable to be 100% Pa.? – In a recent decision on sales-factor sourcing for sales of services, the Board stated that it would be "wholly unreasonable and perhaps absurd" for an out-of-state business to source all of its receipts outside Pennsylvania (when computing its sales factor), so it should instead source such receipts based on customer location. Part of the Board's explicit reasoning was that otherwise, a Pennsylvania-based business "would be 100 percent taxable in Pennsylvania," and that would be "an equally unreasonable, absurd and unfair result." Under the Board's reasoning, no taxpayer with receipts from services or intangibles should ever have a 100% receipts factor in Pennsylvania based on costs of performance.

Estimated Assessments Do Not Toll Statute of Limitations for Assessments – The Board vacated a corporate tax assessment as untimely because it was not issued within the three-year statute of limitations period. The Department argued that it issued an estimated assessment within three years, and that kept the statute of limitations open for assessment. The Board disagreed and struck the assessment in its entirety.

More Things You Should Know:

Department's Computer System Issuing Erroneous Notices – The Department's new computer system has recently resulted in the issuance of a large number of erroneous notices reflecting corporate tax liabilities. If you aren't sure of the basis for a liability reflected in a notice you receive, it is best to speak to the Department directly before making a payment. Reed Smith has significant experience handling these notices and would be happy to answer any questions you have regarding them.

Payments Lost? – It is now essential for taxpayers to keep detailed records of their Pennsylvania tax payments. The Department of Revenue's computer system has been automatically offsetting payments against open liabilities—even liabilities that are under appeal or still appealable—yet the Department has not been providing taxpayers detailed account history to enable taxpayers to track the movement of money within their account. Reed Smith is in active discussions with Department personnel working through these issues.

Amended Return Is Still Not a Substitute for a Refund Petition – In spite of a recent statutory change regarding amended returns, an amended return is still not a substitute for a petition for refund. Under Act 84, an amended report may not be filed if it "takes a position that is contrary to law or published department policy." As a consequence, a taxpayer that files an amended return runs the risk that the Department will assert that the amended return is not valid, because it takes a position that is contrary to law or published department policy. A taxpayer with a refund claim should instead err on the side of caution and file a petition for refund instead of an amended return.

Proof of Payment for Use Tax Refunds – The Board of Appeals is now requiring proof of payment for use tax refunds covering all transactions in the refund claim. The Board's previous policy was to allow proof of payment for a sample.

New First Deputy Attorney General – After being appointed as Solicitor General (a specially created position), Bruce Castor was formally appointed First Deputy Attorney General, replacing Bruce Beemer in the role, and is now the acting Attorney General for Attorney General Kathleen Kane.

Board of Finance and Revenue Regulations are Final – New regulations governing practice and procedure before the Board of Finance and Revenue took effect July 9.12 The new rules establish strict deadlines for process at the Board, including deadlines for submitting proof and handling compromises. We encourage any company with a significant matter before the Board to contact any Reed Smith attorney for guidance regarding these rules.


  1. 1997, May 7, P.L. 85, No. 7, § 1, effective July 1, 1997 (removing software support and "computer-related services" from the list of enumerated taxable services).
  2. Act 84 of 2016, HB 1198.
  3. 72 P.S. § 7227.
  4. See Pennsylvania Budget and Policy Center, Reforming an Antiquated Sales Tax Perk for Big Retailers (June 5, 2012) ("Capping the vendor discount preserves the incentive for small businesses while limiting how much big companies can collect.")
  5. See Rep. Scott Conklin, Conklin introduces bills to close 'Delaware Loophole,' end retailers' vendor discount, available at http://www.pahouse.com/InTheNews/NewsRelease/?id=72860 (Dec. 9, 2015) (sponsor of bill eliminating vendor compensation stated that "[n]ot one penny, not one dime of" revenue raised from eliminating vendor compensation "would come from you, me or any Pennsylvanian").
  6. See Wal-Mart Stores East, LP v. Department of Revenue, 2015-CA-001054 (pending, Ky. Ct. App.).
  7. 73 F.R. 2011.
  8. Nextel Communications of the Mid-Atlantic, Inc., v. Commonwealth, 98 F.R. 2012, on appeal, 6 EAP 2016.
  9. 201 & 202 FR 2013 (July 11, 2016).
  10. Brief of Respondent at 19, Downs Racing, LP v. Commonwealth, 201 & 202 FR 2013 (May 2, 2016).
  11. See Pennsylvania Sales and Use Tax No. SUT-12-001 (May 31, 2012).
  12. 46 Pa. Bull. 3646 (July 9, 2016).

This article is presented for informational purposes only and is not intended to constitute legal advice.

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