Devil’s in Details of PA Governor’s Tax Proposals
March 16, 2015
Devil’s in Details of PA Governor’s Tax Proposals
On March 3rd, when Governor Wolf submitted his budget and tax proposals for FY 2015-16, it was widely understood that the Sales & Use Tax Manufacturing Exclusion would be retained. What was not said was that he would redefine “manufacture” to reject more than fifty years of legal precedent interpreting the term and redefine it to deprive recyclers and presumably many other companies of the exclusion. This would be accomplished by removing the words “other operations” from the statutory definition of “manufacture.” The term “other operations” was key when the Pennsylvania Supreme Court decided Commonwealth v. Sitkin’s Junk in 1963, granting exclusion to what would now be called a metal recycler.
The draft text of the Governor’s tax bill was posted Thursday, March 13th on the Commonwealth’s website. It is full of interesting provisions expanding on the Governor’s big picture proposals, and includes a number of surprising changes that clearly were not advertised in advance. As the old saying goes – “the devil’s in the details!”
While most of the surprises are found in the sales and use tax provisions, there also are a few surprises and many interesting details in the corporate net income tax, personal income tax, bank shares tax, cigarette and other tobacco products taxes and severance tax provisions. We will try to cover the most important changes.
Sales & Use Tax
In addition to increasing the state sales and use tax rate from 6% to 6.6%, Governor Wolf’s proposal would broaden the tax base (and we do mean broaden!). We break these changes down into three groupings: numerous enumerated services that would be newly taxed; repealed exemptions; and, changes to existing definitions and rules.
Miscellaneous Services. The Governor’s proposal would tax numerous enumerated services not currently subject to tax. These “Miscellaneous Services” would be taxed by Pennsylvania if delivered to a Pennsylvania location. If delivered to multiple states, the charge would be allocated. If the point of delivery could not be determined, the service would be taxable if the billing address were in PA. If the billing address were not known, then tax would be based on the location from which the services were ordered in the ordinary course.
Subject to certain exceptions discussed below, taxable “Miscellaneous Services” would include the following (note that each of these general categories is defined to include numerous sub-categories):
- Scenic and sightseeing transportation services
- Motor vehicle towing, storage and emergency road repair
- Information services, including packaged software design, documentation, installation, maintenance, support and publishing (includes games)
- Motion picture and video production, distribution and display
- Investment advice and financial planning services
- Legal, accounting, architectural, engineering, building inspection, surveying and mapping services
- Physical, chemical and other analytical services
- Interior design
- Industrial design
- Graphic design
- Other specialized design services
- Custom computer programming
- System design
- Computer facilities management
- “Other” computer-related services
- Administrative management
- General consulting
- Human Resources ConsultingMarketing consulting
- Process, distribution and logistics consulting
- Other management consulting
- Environmental consulting
- Other scientific and technical consulting
- R&D services
- Advertising and public relations services
- Market research and polling
- Translation and interpreting
- Veterinary services
- “Other” professional, scientific and technical services
- Office administration services
- Facilities support services
- Professional employment services
- Business support services
- Travel arrangements and reservation services
- Packaging and labeling services
- Convention and trade show organizing
- Other support services
- Waste collection
- Services other than tuition and housing provided by colleges, universities and other schools
- Home health care services
- Other ambulatory health care services
- Nursing care facility services
- Residential, intellectual and developmental disability, mental health and substance abuse facility services
- Continuing care retirement community and assisted living facility services for the elderly
- Other residential care facility services
- Individual and family services
- Community food and housing and emergency and other relief services
- Vocational rehabilitation services
- Child day-care services
- Performing arts company, group or theater services
- Sports teams or club services
- Promoting performing arts, sports, and similar events
- Agency or management for artist, athlete, entertainer and other public figure
- Museum, historical site and similar institution services (admission taxed)
- Amusement park and arcade services
- Other amusement and recreation industry services
- Recreational vehicle park and recreational camp services
- Personal care services
- Death care services
- Drycleaning and laundry services
- Uniform rental services
- Other personal services
- Real estate agent and broker services
Exemptions – Miscellaneous Services. While the newly taxed “miscellaneous services” would be eligible for some of the existing exemptions (e.g., purchase by governmental entity or by charitable organization) certain of the “miscellaneous services” would be singled out specifically for exemption:
Tuition charges (apparently without limitation as to type of institution)
Legal Services relating to family law or criminal law
Services provided by individuals under 18 years of age, not on behalf of another person
Services provided by employees to their employers in the ordinary course
Services (and tangible personal property) transferred to a patient and paid for by Medicare Part B
The following services when performed by a business and rendered to another business:
Architectural, engineering and related services
Accounting, auditing and bookkeeping services
Specialized design services
Advertising , public relations and related services
Services to buildings and dwellings
Scientific, environmental and technical consulting services
Scientific research and development services
Custom programming, design and data processing services
Receipts from that part of a contract for services predating the January 1, 2016 effective date of the expanded tax; proration would be on the basis of the length of term before the effective date, compared to the total term of the contract.
Repealed Exemptions. Following are a number of the exemptions that would be repealed, and tax would apply after January 1, 2016, under the Governor’s proposal:
Disposable diapers, incontinence products, toilet paper, sanitary napkins, toothpaste, toothbrushes, dental floss, etc.
Basic local phone service and subscriber line charges; pay phone calls
Returnable pallets and other returnable, unenumerated wrapping supplies not already taxed
Nonprescription medicines and drugs
Prescription medicines, if any, not qualifying as “drugs”
Therapeutic, prosthetic or artificial devices, not limited to use of one person (except that hospital beds, iron lungs, kidney machines, crutches and wheelchairs would continue to be generally exempt)
Sales of food or beverages at or from a school not qualifying as a primary or secondary school
Candy & Gum, regardless of where sold
Caskets & burial vaults
Flags of the United States or the Commonwealth of Pennsylvania
Mail order catalogs and direct mail advertising literature or materials, including mailing lists
Rail transportation equipment other than rail cars and locomotives
Horses sold at in-state sales, even though shipped or delivered to out-of-state location
Supplies and materials used by tourist promotion agencies
Materials used by nonprofit organizations in construction and erection of historical memorials
Race horses and related farrier services, portable stalls, sulkies, feed, bedding and other supplies
Purchase of food and beverages by airlines
Separately stated commercial code filing fees
Construction materials used by contractor in construction or reconstruction of public schools as a result of a natural disaster
Investment metal bullion and investment coins
Changes to Existing Rules & Definitions. In addition to narrowing the scope of the Manufacturing Exclusion by removing words from the definition of “manufacture,” the Governor’s proposal would make the following changes by amending definitions and existing statutory rules:
- Flavored water to be taxed as “soft drink”
- Alteration, pressing, etc. of new clothing or shoes in preparation for sale to be taxed
- Standard (not just premium) cable and video programming services would be taxed as “tangible personal property.”
- Digital Goods would be treated as “tangible personal property.” Tax would apply to electronically or digitally delivered or accessed video, photos, books, magazines, newspapers, mailing lists, apps, games, music, software, etc.
- Data processing and medical transcription services would be taxed as “Secretarial or editing services.”
- Changes to the definition of “building machinery and equipment” would preclude a contractor on a job for a governmental or charitable organization from claiming exemption for furniture, medial devices, light poles, bridge and road drainage equipment and other foundations or supports for BME.
- Unless an invoice would separately state the charge for taxable property and services, the entire bill would be taxable.
- Tax would apply to discounts applicable at the time of sale unless the item was named both on the line for the sale price and the line showing the discount.
- The “Special Resale” exclusion would be narrowed to apply only to materials transported outside the state for use in a construction contract.
- Otherwise taxable services would qualify for the regular resale exclusion if resold without modification or if they were “an integral, inseparable part of services that are taxable.”
- Online hotel reservation services would be treated as “vendors” required to collect hotel occupancy tax.
- The time period for assessing corporate officers or other responsible persons for collected and unremitted tax would be set at ten years from the date of collection.
- Vendor Discount would be reduced from 1% of the collected tax to the lessor of 1% or: $25 for monthly returns, $75 for quarterly returns and $150 for semiannual returns.
- Revenue Department would be allowed to issue, within two years, an assessment to recover a refund where the refund was “erroneously made or allowed for any reason.” (Statute currently restricts to where refund was “erroneously made or allowed.”)
- Refunds of tax paid erroneously on a construction contract would have to be obtained from the construction contractor by filing a claim within one year. The contractor would not be required to refund the money. If the contractor chose to refund the tax, the contractor would claim a credit on its return for the refunded tax, net of the use tax due on materials used in the contract. If the tax were erroneously refunded by the contractor, the Department could later assess either the contractor or the customer.
- Where Revenue Dept. has granted a refund, it would be authorized to assess the other party to the transaction within three years of the refund date – making an extension of the statute of limitations for the other party dependent on an action of the refund claimant.
Criminal violations are expanded to include possession, sale, purchase, transfer, installation or use of “an automated sales suppression device or zapper or phantomware with the intent to defeat or evade” tax.
Personal Income Tax
In addition to increasing the rate from 3.07% to 3.7%, state lottery winnings would become taxable and the baseline for special tax relief would increase from $6,500 to $8,700 for single claimants and from $13,000 to $17,400 for married claimants. The additions of $9,500 per dependent remain the same and the discounts for income exceeding the baseline remain the same (e.g. relief discounted 50% if income exceeds baseline by more than $1,000 but not more than $1,250).
Corporate Net Income Tax
Governor Wolf’s proposal would reduce the Corporate Net Income Tax rate from 9.99% to 5.99% effective for taxable years beginning on or after January 1, 2016 (5.49% effective 1/1/2017; 4.99% effective 1/1/2018). Combined reporting would be required. Effective for tax years beginning after December 31, 2015, the cap on net loss deductions would be reduced from the greater of 30% of income or $5,000,000 to the greater of 12.5% of income or $3,000,000.
One significant Sourcing Surprise. In addition to fleshing out the details of combined reporting, the Governor surprisingly proposes a new rule for sourcing receipts from licensing of intangibles. Under the sales factor changes made by Act 52 of 2013, receipts from the sales of services were made subject to destination sourcing (loosely referred to as “market sourcing”) rather than the classic UDITPA income producing activity / costs of performance rule, and receipts from sales of intangibles remained subject to the income producing activity / costs of performance rule. In December, the Department of Revenue published a notice on its website purporting to interpret the classic income producing activity / costs of performance rule in a manner so as to, essentially, make it into a market sourcing rule. The governor’s current proposal would explicitly source receipts from the licensing of intangibles to the state in which the intangible property is used by the licensee (allocated if used in multiple states).
Combined Reporting. Under Pennsylvania’s version of combined reporting:
- Business Income from unitary business to be apportioned on a waters edge basis; Nonbusiness Income to be allocated on traditional rules.
- Each member of unitary business to apportion combined business income from unitary business using single sales factor – member’s PA sales divided by combined sales of all members of unitary business.
- Excluded from sales factor: intercompany transactions; business income of banks, mutual thrift institutions, title insurance companies, insurance companies, S corps; dividends from one member to another if paid from payee’s business income.
- Members eligible for special apportionment (railroad, truck, bus, airline, pipeline, natural gas, water transportation and satellite TV companies) would convert special apportionment formulas to a single sales fraction, as prescribed by Revenue Department.
- Secretary of Revenue to make adjustments to insure corporation does not incur unfair penalty or realize unfair benefit under combined reporting.
- Secretary of Revenue given Section 482 powers.
- No inference to be drawn from IRS failure to audit international transactions.
- Each member of unitary business to have common taxable year.
- “Unitary Business” defined with reference to being “sufficiently interdependent, integrated and interrelated through their activities so as to provide a synergy and mutual benefit that produces a sharing or exchange of value among [the members] and a significant flow of value ….”
- “Commonly controlled group” determined on 50% ownership basis.
- “Water’s-edge basis” defined to include:
- entities incorporated in US or formed under laws of any state, District of Columbia, any territory or possession of the US, or Commonwealth of Puerto Rico.
- Members incorporated or formed elsewhere if average of property, payroll and sales factors in US is 20% or more.
- Domestic international sales corporations, foreign sales corporations and export trade corporations as defined in IRC provisions.
- Members of unitary business not described in 1, 2 or 3 to be included to extent of business income derived from or attributable to sources within US, per IRC, without regard to Federal treaties.
- Member that is “controlled foreign corporation,” to extent of Subpart F income (not excluding lower-tier subsidiaries’ distributions of the income which were previously taxed); income to be excluded if subject to foreign income tax meeting IRC threshold.
- Any other member of unitary business doing business in a tax haven (unless meeting foreign tax threshold).
- “Tax Havens” would include:
- Jurisdiction identified as tax haven by Organization for Economic Cooperation and Development.
- Cayman Islands.
- Bailiwick of Jersey.
- Grand Duchy of Luxembourg.
The safeharbor for estimated tax for tax years beginning in 2016 or 2017 would be based on the combined tax of all of the members of the unitary business in the base year, adjusted for the rate differential
Bank Shares Tax
As advertised, the governor’s bank shares tax proposal would increase the tax rate from 0.89% to 1.25%, retroactive to tax years beginning after December 31, 2013. “Receipts” are re-defined by reference to the income statement of the institution’s Reports of Condition (or based on GAAP if no Report of Condition is filed).
Cigarette & Tobacco Products Taxes
The cigarette tax increase from eight to thirteen cents per cigarette, and the new 40% Tobacco Products Tax would take effect October 1, 2015. The “tobacco products” subject to the new tax would include cigars, cigarillos, pipe tobacco, roll-your-own tobacco, snuff, chewing tobacco and e-cigarettes. The new tax would be collected by manufacturers and wholesalers, on the wholesale price. If not paid to the manufacturer or wholesaler, the retailer would be responsible for paying the tax. Any user acquiring untaxed tobacco products from out of state, or otherwise, would be subject to tax on the purchase price. Manufacturers, wholesalers and retailers would be required to obtain licenses. The usual regime of regular reporting and interest, penalties and criminal sanctions for various infractions would apply.
As promised during his campaign, Governor Wolf has proposed a natural gas severance tax on producers. The tax consists of two parts: (1) an imposition of a 4.7 cents tax on each unit (one thousand cubic feet) of natural gas severed measured by the well head meter; and (2) an imposition of 5% tax on the gross value of gas severed as shown by the gross proceeds derived from the sale by the producer. The proposal would have the Department of Revenue publish an average market price quarterly, to be used in computing the tax. That value would be subject to a minimum floor price of $2.97 per unit. Exemptions from the tax include gas severed from a lease for no consideration, gas severed from a stripper well, and gas severed from a storage field. Importantly, the legislation would forbid producers from “passing through” this tax as an obligation, indebtedness or liability to a landowner, leaseholder or other person in possession of real property upon which the removal or extraction occurs.
The severance tax proposal also resurrects the current impact fee which contains an automatic sunset should a severance tax be enacted. The proposal outlines how the impact fee would be distributed to state and local governments.