On March 19, 2021, the Pennsylvania Commonwealth Court ruled that the City of Allentown, Pennsylvania incorrectly imposed local business privilege tax (BPT) on a non-profit corporation operating in the city due to its status as a purely public charity for Pennsylvania state tax purposes.1 Affirming the lower court’s order rejecting the city’s tax assessment, the Court found that the taxpayer did not meet the definition of a business under the city’s taxing ordinance that would have warranted imposition of BPT on most of the taxpayer’s revenue streams.
The taxpayer, Good Shepherd Rehabilitation Services, Inc. (Good Shepherd), is a Pennsylvania non-profit corporation based in Allentown, Pennsylvania. For federal income tax purposes, Good Shepherd is a tax-exempt organization under Sec. 501(c)(3) of the Internal Revenue Code. The taxpayer is the parent and controlling entity of three subsidiaries also organized as Pennsylvania non-profit corporations that provide healthcare services throughout the region. All entities are recognized as institutions of purely public charity for Pennsylvania sales and use tax purposes.
Good Shepherd was organized in part to provide various administrative and financial services for its subsidiaries. If Good Shepherd did not provide such services, the subsidiaries would be required to provide the services themselves by hiring additional staff or contracting with third parties. Instead of invoicing and receiving payment for these services, Good Shepherd allocates the incurred costs based on each subsidiary’s share of generated revenues. The taxpayer separately owns a rental property from which it receives rental income.
In 2017, Allentown audited several non-profit organizations operating in the city, taking the position that such non-profits, including Good Shepherd, were subject to Allentown BPT.2 Under audit, the city issued an initial assessment for underpayment of BPT for the 2007-2016 tax years. The city later adjusted its assessment period to the 2012-2016 tax years, resulting in a $788,082 assessment.
Good Shepherd appealed the tax assessment to Allentown’s Tax Appeal Board (Appeal Board), which reduced the amount of the assessment, but generally upheld the deficiency. Ruling that Good Shepherd was not exempt from BPT, the Appeal Board agreed with Good Shepherd that BPT did not apply to donations received. As such, the Appeal Board reduced the assessment to $704,348 and upheld the remaining deficiency.
On appeal to the trial court, Good Shepherd requested a de novo hearing, and the court granted the taxpayer’s request without explaining its reason for doing so.3 Agreeing with Good Shepherd and reversing the Appeal Board, the court reasoned that BPT applied only to gross rents received from Good Shepherd’s rental properties, which Good Shepherd did not dispute. The city appealed the decision to Commonwealth Court, arguing that the trial court should not have granted a de novo hearing and that BPT applied broadly to Good Shepherd’s activities.
In an unpublished opinion,4 the Commonwealth Court ruled in favor of Good Shepherd and upheld the trial court’s decision. The Court reasoned that the trial court properly granted the de novo hearing and that Good Shepherd’s activities were not subject to BPT.
Analyzing Allentown’s BPT ordinance, the Court determined that Good Shepherd did not qualify as a “business” as defined under the law. Allentown’s ordinance defines a “business” as “any activity carried on or exercised for gain or profit in the City,” including the performance of services.5 However, the Court noted that the taxpayer’s status as a purely public charity was a “critical factor” in determining its subjectivity to BPT. In its brief, the city conceded that nonprofit corporations operating as purely public charities are expressly excluded from BPT. As such, the Court determined that a purely public charity is, by definition, not a “business” for Allentown BPT purposes. Additionally, in pre-trial stipulations, both parties agreed that Good Shepherd was classified as a purely public charity for Pennsylvania sales and use tax purposes. For these reasons, the Court found that Good Shepherd was a purely public charity not subject to Allentown BPT.
While stipulating to Good Shepherd’s status as a purely public charity for sales and use tax purposes, the city argued that Good Shepherd nonetheless did not qualify as a purely public charity for BPT purposes. Specifically, the city argued that the taxpayer’s compensation scheme revealed a private profit motive, thus disqualifying the entity as a purely public charity under Pennsylvania law. Under the Pennsylvania Constitution, non-profit corporations seeking tax-exempt status in Pennsylvania must qualify as a purely public charity.6 In Hospital Utilization Project v. Commonwealth (HUP), the Pennsylvania Supreme Court established that an organization must satisfy the following five factors in order to qualify as a purely public charity:
- Advance a charitable purpose
- Donate or render gratuitously a substantial portion of its services
- Benefit a substantial and indefinite class of persons who are legitimate subjects of charity
- Relieve the government of some of its burden
- Operate entirely free from private profit motive7
Citing to several Pennsylvania lower court cases, Allentown argued that Good Shepheard’s management functions on behalf of its subsidiaries did not advance a charitable purpose under the HUP test.8
Rejecting Allentown’s arguments, the Court again observed that the city conceded Good Shepherd qualified as a purely public charity. If Good Shepherd was exempt from sales and use tax as a purely public charity, the Court reasoned, then Good Shepherd was likewise tax-exempt for local BPT purposes. Unpersuaded by the city’s argument that a purely public charity exemption from sales and use tax did not extend to an exemption from BPT, the Court determined that an entity’s status as a purely public charity applies to all forms of taxation in Pennsylvania. For these reasons, the Court concluded that Good Shepherd was exempt from BPT as a purely public charity on the revenue streams at issue.
Allentown next argued that Good Shepherd was doing business as defined in the Allentown BPT ordinance based on the payments for services provided to its nonprofit subsidiaries. Noting that Good Shepherd provides services and then allocates such costs based on the proportionate share of revenues generated by the subsidiaries, the Court agreed with the trial court that the services are provided as an accommodation to the controlled entities. As such, the Court refused to disturb the trial court’s finding that such activities did not amount to doing business for Allentown BPT purposes.
The Commonwealth Court next rejected the city’s arguments that Good Shepherd’s compensation and organizational structure demonstrated the company had a private profit motive, based on Good Shepherd’s payment of bonuses contingent on financial benchmarks. The Court reasoned that the trial court’s factual findings did not support the finding of a private profit motive.
The city also challenged the trial court’s reliance on School District of Philadelphia v. Frankford Grocery Co.9 In Frankford, the Pennsylvania Supreme Court ruled that a corporation making bulk purchases and passing the cost savings onto related entities was not subject to tax. The city argued that Shelburne Sportswear, Inc. v. City of Philadelphia,10 a Pennsylvania Supreme Court ruling upholding the taxation of affiliated entities based on providing services in exchange for the payment of operating expenses, controlled. Looking to the substance of the transaction, the Court rejected the comparison to Shelburne, instead holding that Frankford controlled. In doing so, the Court concluded that “there is no logical basis to tax Good Shepherd where it provides . . . services without profit and allocates the cost among the subsidiaries that receive the services.”
Finally, the city argued that certain passive income streams, including investment income, expense reimbursement income and lab revenue, should be separately taxable under the Allentown BPT ordinance, because Good Shepherd uses the related assets to generate income. However, the Court refused to address this issue based on Good Shepherd’s status as a purely public charity.
In the HUP decision and its progeny, Pennsylvania courts have developed robust case law defining the elements necessary to qualify as a purely public charity. In an effort to provide greater certainty regarding which entities qualify as purely public charities, Pennsylvania enacted the Institutions of Purely Public Charity Act in 1997 (Act 55).11 However, in Mesivtah Eitz Chaim of Bobov v. Pike County Board of Assessment Appeals, the Pennsylvania Supreme Court held that Act 55 could not supplant the HUP test, and instead holding that both the constitutional HUP test and the Act 55 requirements must be satisfied in order to qualify as a purely public charity.12
In Good Shepherd, the taxpayer’s status as a purely public charity was largely not at issue, even though the Court addressed and rejected Allentown’s arguments that Good Shepherd failed to meet certain HUP factors that prevented exclusion from BPT. The fact that the city conceded Good Shepherd’s purely public charity status and later stipulated that point before the trial court was ultimately fatal to its position. The Court ultimately concluded that a holding company formed for the purpose of reducing costs for its non-profit subsidiaries did not rise to the level of carrying on any activity for profit or gain for Allentown BPT purposes, and that compensation for services provided or a competitive bonus structure based on performance goals are not disqualifying factors. Although the Good Shepherd decision was released as “unreported,” the decision may potentially be used as persuasive authority by non-profit companies having similar facts and circumstances and facing tax assessments in other local Pennsylvania jurisdictions imposing a BPT. At the same time, it remains to be seen whether Allentown will appeal the decision to the Pennsylvania Supreme Court.
On a broader scale, the Good Shepherd case highlights an aggressive trend by local taxing authorities seeking to tax non-profits operating in their jurisdictions. For this reason, litigation over a non-profit’s tax-exempt status may increase in frequency. Despite the favorable outcome in Good Shepherd, the tests established in HUP and Act 55 generally remain a high bar for unwary taxpayers seeking status as a purely public charity in Pennsylvania. Simply incorporating as a non-profit corporation and qualifying for tax-exempt status for federal income tax purposes does not automatically qualify a taxpayer as tax-exempt for all Pennsylvania taxes. Non-profit organizations operating in Pennsylvania should be aware of the HUP and Act 55 requirements as local taxing authorities seek to expand their tax bases.
1 Good Shepherd Rehabilitation Network, Inc. v. City of Allentown, No. 1646 C.D. 2019, Pennsylvania Commonwealth Court, Mar. 19, 2021.
2 Allentown imposes a BPT on businesses operating in the city that is measured based on gross receipts. Allentown Bus. Regulation & Tax. Code, § 333.01 et seq.
3 In a de novo hearing, the court does not look to the prior record and makes findings of fact and law based on the evidence presented before that court.
4 As an unpublished opinion, this ruling is of limited precedential value, but Pennsylvania courts may use it as persuasive authority.
5 Allentown Bus. Reg. & Tax. Code § 333.02.01.
6 PA. CONST. art. VIII, § 2(a)(v).
7 Hosp. Utilization Project v. Commonwealth, 487 A.2d 1306, 1317 (Pa. 1985).
8 Sacred Heart Healthcare System v. Commonwealth, 673 A.2d 1021 (Pa. Commw. Ct. 1996); Pinebrook Services for Children & Youth v. Whitehall Township, No. 97-C-2046, Pa. Ct. Com. Pl. Lehigh Co. (1999).
9 103 A.2d 738 (Pa. 1954).
10 220 A.2d 798 (Pa. 1966).
11 Act 55 of 1997, 10 PA. STAT. § 371 et seq.
12 Mesivtah Eitz Chaim of Bobov, Inc. v. Pike County Bd. of Assessment Appeals, 44 A.3d 3 (Pa. 2012).
Matthew D. Melinson
Matthew Melinson is a partner in Grant Thornton's Philadelphia office and the national leader of the SALT practice's indirect tax services. Melinson is responsible for all aspects of multistate tax consulting and planning and compliance related to income tax, franchise tax, sales and use tax, credits and incentives, real estate tax, and personal property tax.
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Jamie C. Yesnowitz
Jamie Yesnowitz, principal serving as the State and Local Tax (SALT) leader within Grant Thornton's Washington National Tax Office, is a national technical resource for Grant Thornton's SALT practice. He has 22 years of broad-based SALT consulting experience at the national and practice office levels in large public accounting firms.
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