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Pennsylvania enacts economic nexus standard

$500,000 gross receipts threshold applies to corporate net income tax

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On Sept. 30, 2019, the Pennsylvania Department of Revenue (Department) issued Corporation Tax Bulletin 2019-04 (Bulletin), in which it announced an economic nexus standard with a $500,000 gross receipts threshold for purposes of establishing a corporate net income tax (CNIT) filing requirement for tax years beginning on or after Jan. 1, 2020.1 The Department relied on the United States Supreme Court’s decision in South Dakota v. Wayfair2 as justification for imposing the new nexus standard. With this pronouncement, Pennsylvania becomes the latest state to use Wayfair to assert a bright-line economic nexus standard for corporate income tax. Questions remain as to how Pennsylvania will implement the Bulletin and if other states will follow Pennsylvania’s lead in applying Wayfair to corporate income taxes.

Background In the Wayfair decision, the U.S. Supreme Court overturned the requirement that a business must have a physical presence in a state for sales and use tax purposes. The case concerned a South Dakota sales and use tax law requiring out-of-state sellers without a physical presence in the state to collect sales and use tax if the seller has $100,000 of sales in the state or at least 200 separate transactions in the state on an annual basis. In upholding the South Dakota law, the Supreme Court overturned the physical presence requirement reaffirmed in Quill Corp. v. North Dakota.3 Reasoning that Quill was wrongly decided and that the physical presence test no longer applied to sales and use taxes, the Court upheld the South Dakota law as constitutional, finding that it satisfied the substantial nexus requirements of the Commerce Clause under the U.S. Constitution.

Evolution of Pennsylvania sales and use tax economic nexus Prior to the Wayfair decision, Pennsylvania enacted Act 43 of 2017, which required remote sellers with at least $10,000 in taxable Pennsylvania sales to file an election to either: (i) register to collect and remit sales tax; or (ii) comply with detailed notice and reporting requirements.4 Following Wayfair, the Department issued Sales and Use Tax Bulletin 2019-01, which was not intended to replace the provisions of Act 43, but established a sales and use tax filing and collection obligation for remote sellers and marketplace facilitators exceeding a $100,000 annual gross sales threshold.5 After the issuance of the bulletin, the Pennsylvania legislature responded with budget legislation enacted as Act 13 of 2019, which in part codified the $100,000 gross sales threshold and also eliminated the collection or reporting option for sellers having $10,000 or more in taxable sales as set forth in Act 43.6

Pennsylvania CNIT nexus landscape Unlike current Pennsylvania sales and use tax statutory provisions, CNIT is imposed on any corporation: (i) doing business in Pennsylvania; (ii) carrying on activities in Pennsylvania, including solicitation activities not protected under Public Law 86-272 (P.L. 86-272);7 (iii) having capital or property employed in Pennsylvania; or (iv) owning property in Pennsylvania.8 “Doing business” is not statutorily defined, but the Department has historically considered a corporation to be doing business in Pennsylvania or engaging in activities in the Commonwealth where it had a physical presence in the state.

Corporation Income Tax Bulletin 2019-04 Recognizing the longstanding dispute over whether the physical presence standard in Quill applied to corporate income taxes, the Department determined that the Wayfair decision confirmed there is no longer a physical presence standard limiting the ability of a state to impose a net income tax on an out-of-state taxpayer, “so long as the constitutional requirements under the Due Process Clause and Commerce Clause of the U.S. Constitution are satisfied.” Analyzing the CNIT nexus statutory provisions, the Department reasoned that it would consider out-of-state corporations to be doing business in Pennsylvania “to the extent they are taking advantage of the economic marketplace of the Commonwealth,” regardless of whether they are physically present in the state. The Department will therefore require any corporation meeting the minimum constitutional nexus thresholds to file a Pennsylvania CNIT report.

Although the Department broadly stated that all taxpayers having nexus under the U.S. Constitution are required to file a CNIT tax report, for tax years beginning on or after Jan. 1, 2020, the Bulletin establishes a rebuttable presumption that all corporations having $500,000 or more of direct or indirect gross receipts sourced to Pennsylvania per year under existing Pennsylvania sales factor sourcing rules are subject to a CNIT filing requirement.9 The gross receipts threshold consists of gross receipts from: (i) the sale, rental, lease, or licensing of tangible personal property; (ii) sales of services; and (iii) sales or licensing of intangibles, including franchise agreements. The Department clarified that the new economic nexus standard would not apply to taxpayers claiming exemption from the imposition of CNIT under P.L. 86-272. Regardless of whether they are exempt from CNIT under P.L. 86-272, taxpayers having economic nexus in Pennsylvania will be required to file a CNIT report. Taxpayers claiming P.L. 86-272 protection are directed to file a Pennsylvania CNIT report and complete the necessary schedules to claim the exemption.10

Commentary Bulletin 2019-04 presents multiple issues regarding the Department’s implementation and enforcement of a CNIT economic nexus standard. The Department has once again chosen to adopt an economic nexus policy through a bulletin instead of deferring to the state legislature to amend the existing statute. The Department’s authority to enforce its $100,000 sales and use tax economic nexus threshold was in doubt until the state legislature later codified this standard under Act 13. Therefore, the question remains whether the Department is authorized to impose a CNIT economic nexus standard without statutory authority or the promulgation of a formal regulation.

While the Department has indicated that it is interpreting existing law by applying the Wayfair decision to existing CNIT nexus rules, there are several issues with this approach. Although the Department has set a $500,000 bright-line gross receipts threshold for determining whether an out-of-state corporation has a CNIT filing requirement, the Bulletin states that any taxpayer meeting the minimum nexus thresholds under the constitution technically has nexus for CNIT purposes. In other words, all corporations utilizing Pennsylvania’s economic marketplace are considered to be doing business in the state, meaning that the $500,000 gross receipts threshold is not intended as a safe harbor for small businesses. As a result, the Department may consider an out-of-state corporation making any sales into the state to have CNIT nexus.

With the release of Bulletin 2019-04, Pennsylvania becomes the latest state to take an expansive reading of Wayfair and adopt an economic nexus standard for corporate income tax purposes, following a statutory rule in Hawaii11 and proposed regulations in Texas.12 The Department’s action also follows Philadelphia’s regulatory adoption of an economic nexus gross receipts threshold of $100,000 for the Business Income and Receipts Tax.13 With Pennsylvania’s threshold being greater than Philadelphia’s, the question remains whether local jurisdictions imposing post-Wayfair economic nexus standards will always adopt lower thresholds than their state counterparts for sales and use tax or income/franchise tax purposes. It also remains to be seen whether the approximately 300 Pennsylvania municipalities imposing local business privilege taxes based on gross receipts will attempt to enforce a Wayfair economic nexus standard, although it does not appear that these localities currently have the authority to impose such a standard under Pennsylvania law.14

It should be noted that the Bulletin applies for CNIT purposes only and does not appear to have any application to personal income tax or other Pennsylvania taxes. However, certain taxpayers may still be subject to the new standard, including legal entities electing to be treated as C corporations for Pennsylvania purposes, or even S corporations with built-in gains tax. Despite the Bulletin’s focus on CNIT nexus rules, it is unclear whether the Department will attempt to broadly enforce the standard beyond traditional C corporation taxpayers, such as lower tier pass-through entities with corporate partners. It is likely that the Bulletin also applies to international corporations having Pennsylvania sales, given that the Department interprets the CNIT imposition statute to apply regardless of whether a corporation is subject to federal income tax.

Several aspects of the Bulletin present challenges in terms of specific implementation. For example, the Bulletin does not mention estimated payment requirements for those taxpayers subject to CNIT beginning in January 2020, such as the base year that may be used for determining safe harbor payments.15 Further, the Bulletin merely states that the $500,000 gross receipts threshold will be determined “per year,” without specifying whether it will be based on the previous or current calendar year or fiscal year, or whether it would apply to a short-year taxpayer. Finally, calculation of the gross receipts threshold based on current Pennsylvania sales factor sourcing rules may create confusion for taxpayers, as services are sourced according to market-based sourcing rules created through a Department notice, while intangibles are still sourced based on cost of performance sourcing rules.16 The Department has informally indicated that regulations interpreting the statutory market-based sourcing rules for sales of services are forthcoming, estimating that draft regulations would be issued in early 2020. In the meantime, the Department intends to enforce its economic nexus standard based in part on sourcing rules that have been announced through an information notice.

It is also possible that the Bulletin may be challenged on uniformity grounds, given that the Uniformity Clause of the Pennsylvania Constitution has been strictly construed by Pennsylvania courts.17 Under the Bulletin, a taxpayer having $499,999 in Pennsylvania sales would not have the rebuttable presumption of a CNIT filing obligation, while a similar business having $500,000 of sales into the state will be subject to tax. Applying Pennsylvania uniformity case law, two similarly situated taxpayers are arguably treated differently solely based on their levels of taxable income, thus creating a uniformity violation.18

Despite the current confusion surrounding the implementation of the Bulletin, there are some potential tax savings opportunities to consider. For example, corporations with prior year federal losses and subject to the Bulletin’s nexus standard may be able to file prior year CNIT reports and generate Pennsylvania net operating losses to offset future income, if the case could be made to apply the Bulletin to tax years preceding Jan. 1, 2020. Although the Bulletin states otherwise, taxpayers may argue for retroactive treatment, as the Department maintains that the Bulletin is an interpretation of existing Pennsylvania law. Finally, corporate taxpayers having sales outside of Pennsylvania may apportion income outside the state using Pennsylvania’s apportionment rules to limit their CNIT liability.

Plenty of questions remain about the Department’s implementation of the Bulletin. Additional guidance is likely expected to determine the extent of the Bulletin’s application to impacted taxpayers. With the release of the Bulletin on September 30, these important changes may be treated as a 2019 third-quarter event for tax accounting purposes.


 
1 Corporation Tax Bulletin 2019-04, Nexus for Corporate Net Income Tax Purposes, Pennsylvania Department of Revenue, Sept. 30, 2019.
2 138 S. Ct. 2010 (2018). For an in-depth discussion of this case, see GT SALT Alert: Wayfair Ruling Overturns Quill Physical Presence Requirement.
3 504 U.S. 298 (1992).
4 Act 43 (H.B. 542), Laws 2017. For a more detailed explanation of the evolution of Pennsylvania’s sales and use tax nexus rules, see GT SALT Alert: Pennsylvania Enacts Budget Legislation Updating Post-Wayfair Requirements for Remote Sellers and Marketplace Facilitators.
5 Sales and Use Tax Bulletin 2019-01, Maintaining a Place of Business in the Commonwealth, Pennsylvania Department of Revenue, Jan. 8, 2019, revised Jan. 11, 2019.
6 Act 13 (H.B. 262), Laws 2019.
7 15 U.S.C. 381 et seq. P.L. 86-272 prevents states from imposing net income tax on taxpayers engaged in selling tangible personal property if the taxpayer’s activities in the state are limited to the solicitation of such sales.
8 72 PA. STAT. § 7402.
9 The Bulletin refers to the statutory sales factor sourcing rules under 72 PA. STAT. § 7401.
10 Taxpayers claiming P.L. 86-272 protection should attach PA Form REV-986, Schedule to Support Claim of Exemption from Corporate Net Income Tax under P.L. 86-272, to their CNIT report.
11 Hawaii enacted legislation in July establishing thresholds of $100,000 in gross income or 200 separate transactions to establish corporate income tax nexus. Act 221, Laws 2019.
12 Texas released proposed regulations that would apply an economic nexus threshold of $500,000 in annual gross receipts to create a franchise tax filing requirement. Proposed amendments to TEX. ADMIN. CODE § 3.586, Texas Comptroller’s Office, Sept. 27, 2019.
13 For further discussion of Philadelphia’s economic nexus standard, see GT SALT Alert: Philadelphia Enacts Various Tax Changes Addressing Economic Nexus Standard, Responses to Federal Tax Reform Provisions, and NOL Carryforwards.
14 Pennsylvania municipalities other than Philadelphia derive their taxing powers from the Local Tax Enabling Act of 1965. P.L. 1257, No. 511, 53 PA. STAT. § 6924.301 et seq.
15 Under current law, corporate taxpayers are required to make estimated payments equal to 90 percent of the current year’s tax liability or 100 percent of the tax liability applied to the tax base for the safe harbor base year. 72 PA. STAT. § 10003.3(b), (d). “Safe harbor base year” means the taxpayer’s second preceding taxable year, unless the taxpayer has filed only one previous CNIT report, in which case the safe harbor base year is the first preceding taxable year. 72 PA. STAT. § 10003.2(b)(4.4).
16 Under Act 52 of 2013, Pennsylvania enacted market-based sourcing rules for sales of services that became effective for tax years beginning on or after Jan. 1, 2014. The Department subsequently released an information notice discussing its interpretation of the market-based sourcing rules for sales of services. Information Notice Corporation Taxes 2014-01, Pa. Department of Revenue, Dec. 12, 2014.
17 PA. CONST. ART. VIII, § 1. The Uniformity Clause requires that taxes be applied uniformly across the same class of taxpayers.
18 See Nextel Communications of the Mid-Atlantic, Inc. v. Pennsylvania, 171 A.3d 682 (Pa. 2017).



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