United States: Out-Of-State Taxpayers Can Reduce Pennsylvania Franchise Tax Under Wynne; Conduct Manufacturing? Your Franchise Tax Should Be Zero

The Pennsylvania franchise tax has finally expired: 2015 is the last year that taxpayers are required to report and pay it. Because the tax rate has decreased over time, it can be little more than a nuisance for many out-of-state taxpayers. But if the statutory method produces any significant liability for the 2015 tax year, you should consider taking a return position based on the U.S. Supreme Court's decision in Wynne. Taxpayers that conduct manufacturing or research can particularly benefit from this position and may be able to reduce their tax to zero.

In addition to taking a return position for 2015, you may be able to file a refund claim for 2012 through 2014. The deadline for filing a refund claim is generally three years from the date you filed your return on extension.1

Taxable Asset Fraction Violates Internal Consistency

The opportunity involves the method for apportioning franchise tax. The standard method is to use an equally weighted apportionment factor based on property, payroll, and sales. But taxpayers have the option of using a single "taxable asset" fraction instead.2 The numerator of the fraction is the book value of the taxpayer's property (including intangible property) that has a situs in Pennsylvania; the denominator is the book value of the taxpayer's total assets everywhere. The situs of intangible property is determined based on the taxpayer's domicile; however, the Department's regulations provide that an out-of-state taxpayer is deemed to be domiciled in Pennsylvania for this purpose.3 If not for this fiction, the taxable assets fraction would result in lower apportionment than the traditional three-factor method for many out-of-state taxpayers. But because the regulation deems all intangible assets to be Pennsylvania assets, and thereby includes most of those assets in the numerator, almost no out-of-state taxpayers compute their franchise tax using the taxable assets fraction.

Treating out-of-state taxpayers as if they were domiciled in Pennsylvania violates the Commerce Clause of the U.S. Constitution, which requires that a tax be internally consistent. As recently explained by the U.S. Supreme Court in Wynne, the internal consistency test helps courts identify tax schemes that discriminate against interstate commerce by analyzing the structure of the tax at issue.4 A tax fails internal consistency if its identical application by every state would place interstate commerce at a disadvantage as compared with intrastate commerce.5

Pennsylvania's fiction of deeming all intangibles to be located in Pennsylvania fails this test. If every state were to adopt the same tax scheme as Pennsylvania, a multistate taxpayer would be required to include its intangible assets in the numerator of the apportionment factor of every state in which it does business. By contrast, a taxpayer that conducted business only in Pennsylvania would include those intangibles in its numerator only once. Although the Pennsylvania Commonwealth Court upheld Pennsylvania's single taxable asset fraction in Quality Markets,6 that decision can no longer be considered good law in light of Wynne. In Quality Markets, the Commonwealth Court applied only the external consistency test and did not consider internal consistency in deciding whether the Pennsylvania franchise tax was fairly apportioned.

To remedy the constitutional problem with Pennsylvania's regulation deeming all intangible assets to be sitused in Pennsylvania for purposes of the taxable asset fraction, an out-of-state taxpayer must be entitled to determine the situs of its intangibles based on actual domicile. An out-of-state taxpayer, therefore, should not include any intangible property in its numerator.

If You Conduct Manufacturing, Your Apportionment Should Be Zero

If not for the fiction of treating an out-of-state taxpayer as though it were domiciled in Pennsylvania, the taxable assets fraction would be zero for most taxpayers engaged in manufacturing or research. Pennsylvania provides an exemption for manufacturing and research, and the Department's long-standing policy is to apply this exemption very broadly. The exemption applies even if the taxpayer's manufacturing or research activities are conducted outside Pennsylvania. Further, property used primarily for administrative and sales functions is generally treated as exempt because those functions are considered necessary to support the taxpayer's manufacturing or research businesses. All property directly or indirectly related to manufacturing or research is thus excluded from the numerator of the taxable assets fraction.

As a result, if a taxpayer is domiciled outside Pennsylvania and conducts manufacturing or research activities anywhere, its taxable assets fraction, and thus its franchise tax, should be zero. If you have questions about whether your business may be able to reduce its franchise tax liability by electing to use the taxable asset faction for apportionment, please contact one of the authors of this Alert or the Reed Smith attorney with whom you usually work.


1.Mission Funding Alpha v. Commonwealth, 129 A.2d 614 (Pa. Cmwlth. 2015). This rule follows from the statute; however, the commonwealth has appealed the court's ruling to the Pennsylvania Supreme Court.

2. 61 Pa. Code § 155.10.

3. Id.

4. Comptroller of the Treasury v. Wynne, –– U.S. –––, 135 S.Ct. 1787, 1802 (2015),

5. Id.; Oklahoma Tax Comm'n v. Jefferson Lines, Inc., 514 U.S. 175, 185 (1995).

6. Quality Markets, Inc. v. Commonwealth, 514 A.2d 228 (Pa. Cmwlth. 1986), aff'd per curium, 526 A.2d 357 (Pa. 1987).

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

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