PA Tax Law News – Spring 2016
May 3, 2016
In This Issue: Tax Increases Part of Governor Wolf’s 2016-2017 Proposed Budget l Lease Receipts Subject to Business Privilege Taxes After All l Department of Revenue Issues Guidance Regarding the Act 52-2013 Add-Back Provision l The End of (New) Limited Partnerships in Pennsylvania? l SALT Group Out and About
by Randy Varner
On February 9, amidst the Commonwealth’s longest-ever budget standoff over the 2015-2016 budget, Governor Wolf presented his 2016-2017 budget address to the General Assembly with combative and pointed remarks. While there are tax increases and revenue enhancements in his new budget, the new changes do not come close to the drastic tax overhaul that was contained in his proposal last year.
Major proposed tax and revenue changes are as follows:
Personal Income Tax
The proposal would raise the Commonwealth’s flat Personal Income Tax rate from 3.07% to 3.4%, effective January 1, 2016. The proposal includes a 40% increase in the Tax Forgiveness program to lessen or eliminate the Personal Income Tax burden on low income taxpayers. The proposal would also subject Pennsylvania Lottery winnings to tax. The administration estimates the net revenue increase for 2015-2016 to be nearly $555 million and for 2016-2017, nearly $1.3 billion.
Sales and Use Tax
Unlike last year, the proposal does not involve an increase in the 6% tax rate. The proposal involves expanding the tax base to include movie tickets and basic television, and clarifying that items delivered or accessed electronically or digitally, including books, music, video, and photographs, are subject to tax. These changes would be effective April 1, 2016. The administration estimates a net revenue increase for 2015-2016 to be roughly $66 million and for 2016-2017 to be nearly $415 million.
The governor has once again included a severance tax as part of his budget proposal. This proposal would impose a 6.5% tax on the value of natural gas severed through unconventional means (fracking). There would be a credit issued against the tax for amounts paid as part of the existing Impact Fee. This tax would be effective on July 1, 2016 and is estimated to provide nearly $218 million in revenue in the 2016-2017 year.
Bank Shares Tax
The proposal would increase the Bank Shares Tax rate from 0.89% to 0.99%, effective January 1, 2016. The revenue estimate for this increase is $37.4 million in 2015-2016 and $39.2 million in 2016-2017.
Insurance Premiums Tax
The proposal includes a 0.5% surcharge on property, casualty, and fire premiums, for a total tax rate on the premiums at 2.5%. This change would be effective January 1, 2016. This is estimated to raise an additional $80.7 million in 2015-2016 and an additional $100.9 million in 2016-2017.
The per-pack tax on cigarettes would be raised from $1.60 to $2.60, effective April 1, 2016. This will generate an additional $122 million in 2015-2016 and $468 million in 2016-2017.
Other Tobacco Taxes
Effective May 1, 2016, a 40% tax will be imposed on the wholesale price of other tobacco products, including cigars, smokeless tobacco, and e-cigarettes. A 40% tax on loose tobacco is effective July 1, 2016. Revenue estimates are $10.6 million for 2015-2016 and $136 million for 2016-2017.
The proposal includes an 8% tax on promotional plays of slots and table games, effective January 1, 2016. This is estimated to raise $21 million in 2015-2016 and $50.9 million in 2016-2017.
The governor’s package includes total spending of $32.7 billion, which includes nearly $1.6 billion in mandated spending increases for debt obligations, corrections, human services, and pensions. The
governor argues that this proposed budget would fully fund pension and debt obligations and eliminate the structural deficit.
What is the outlook? Over the long months of the 2015-2016 budget standoff, the only thing that ever seemed certain about the situation was uncertainty. Only time will tell how Governor Wolf’s current proposals will fare. For specific questions, please feel free to contact me at email@example.com or another member of the SALT team.
The Pennsylvania Supreme Court recently reversed a 2014 Commonwealth Court decision in which the Commonwealth Court had ruled that the Local Tax Enabling Act (“LTEA”) bars local taxing jurisdictions from imposing business privilege taxes on receipts from leases or lease transactions. See Fish, Hrabrick and Briskin v. Township of Lower Merion, 29 MAP 2015 (Pa., December 21, 2015). Many taxpayers had filed protective refund claims for business privilege taxes paid on lease receipts pending final disposition of the appeal in the Fish case. Unfortunately, those refund claims are no longer viable.
The LTEA provides the authority and limitations for all taxing jurisdictions other than the City of Philadelphia to impose taxes. While the LTEA allows for the imposition of business privilege taxes, the LTEA expressly excludes the power to impose tax “on . . . leases or lease transactions.” In Fish, the township argued that its tax was actually imposed on the privilege of doing business in the township and was not a direct tax on leases. The Commonwealth Court flatly rejected this argument and held that the LTEA prohibits “any tax—i.e. privilege, transactional, or otherwise—on leases and lease transactions.” In reaching its conclusion, the Court stated that the LTEA must be read in a way “that most restricts the taxing authority….”
The Supreme Court applied prior precedent establishing that business privileges and transactions are separate and distinct subjects of taxation. Therefore, a business privilege tax that encompasses all businesses offering services within a local taxing jurisdiction may be imposed on receipts derived from leases, even though a tax directed specifically to lease transactions would constitute a prohibited tax. The Court further clarified that this rule applies even if a taxpayer’s revenues are derived exclusively from “untaxable transactions,” such as lease transactions.
On February 19, 2016, the Pennsylvania Department of Revenue (“Department”) released Information Notice Corporation Taxes 2016-1 (“Notice”) regarding the Act 52-2013 add-back provision that disallows corporate net income tax deductions for transactions between affiliated members for tax years beginning after December 31, 2014.
According to the Notice, deductions for royalties, licensing, or other fees paid, accrued, or incurred by a corporate taxpayer to an affiliated entity are disallowed. The provision refers to direct or indirect costs or expense deductions claimed by a corporate taxpayer as a result of transactions with an affiliated entity. The Notice explains direct and indirect intangible expenses and costs, including amortization of intangible property and embedded intangible costs, and provides examples.
The add-back provision also disallows interest expenses that are directly related to an intangible expense or cost. Interest paid to an affiliated entity is presumed to be directly related to the acquisition or use of an intangible asset if the corporate taxpayer and the affiliated entity engage in any intangible transaction during the tax year in which the interest was paid. Tracing the source and application of funds among the affiliated entities is not necessary.
The add-back provision disallows all intangible costs or expenses paid by a corporate taxpayer to an affiliated entity unless a statutory exception applies. The exceptions to the add-back provision are:
- the principal purpose and arm’s length exception,
- the foreign treaty exception, and
- the conduit exception.
For the principal purpose and arm’s length exception to apply, a corporate taxpayer must establish that the transaction did not have a principal purpose of avoiding the corporate net income tax and the transaction was conducted at arm’s length rates and terms.
The foreign treaty exception applies to transactions between a corporate taxpayer and an affiliated entity that is domiciled in a foreign nation that has in force a comprehensive income tax treaty with the United States. The treaty must provide for the allocation of all categories of income subject to tax, or the withholding of tax, on royalties, licenses, fees and interest for the prevention of double taxation of the respective nations’ residents and the sharing of information.
Under the conduit exception, intangible expenses or costs are not disallowed where, and to the extent that, the affiliated entity pays expenses to an unaffiliated entity for the same intangible asset.
Corporate taxpayers must maintain contemporaneous documentation to support an exception and must produce it at the Department’s request.
The Notice is based upon the Georgia, Alabama, and Connecticut’s statutes and regulations regarding add-backs. These statutes and regulations are much broader than the Act 52 add-back provision. Accordingly, the add-back guidance issued by the Department goes beyond what the statute requires or what the General Assembly arguably intended.
Please bear in mind that the Notice is not the law. It is just the Department’s interpretation of the add-back provision. Thus, because we believe the Department’s guidance overreaches the provisions of the statute, it may lead to Department applications that are unreasonable.
If you have any questions regarding the Notice or are experiencing a situation in which the Department is asserting its interpretation of the add-back provision upon your company, please contact one of our SALT attorneys for advice.
by Shaun R. Eisenhauer, McNees Corporate & Tax Group
On December 31, 2015, after a 15-year phase-out (originally intended to last only nine years), Pennsylvania’s 171 year-old capital stock tax finally expired.
While few will mourn its passing, that expiration may take with it the formation of new limited partnerships in Pennsylvania. Let’s see why.
The capital stock tax was an annual charge based on a combination of an entity’s income and assets. It applied to corporations and limited liability companies but not to partnerships. A purchaser of real estate or other significant assets who also wanted limited liability was therefore faced with a difficult calculation: Would avoiding the annual cost of the capital stock tax justify acquiring the assets in the complicated limited partnership structure? For every other purpose, the more user-friendly limited liability company would do just fine.
To limit the effect of the capital stock tax, an acquirer would use a limited partnership where the limited partners could own 99% (or more) of the limited partnership and a limited liability entity like a corporation or LLC would own the remaining 1% (or less) of the general partnership interest. In this way, only the general partner’s percentage of the limited partnership’s assets would be affected by a capital stock tax. All ultimate owners would be insulated from liability by virtue of their status as either (i) limited partners of the partnership or (ii) stockholders/members of the general partner.
Unfortunately, this locked the assets into the limited partnership model. That model requires maintenance of two separate entities: the limited partnership itself and the general partner entity. This necessitates dual filings, meetings, reporting, ownership tracking and potentially licensing. Because many states have no capital stock tax on limited liability companies, out-of-state investors were often surprised by this complication.
Absent the capital stock tax, acquiring assets in a new limited liability company provides limited liability to its owners and pass-through taxation in a single, flexible, customizable entity.
Are there ANY remaining reasons to form a limited partnership in Pennsylvania? Four have been suggested and each are rebuttable.
Point: There is a much more robust body of common law demonstrating the limited liability features of limited partnerships and corporations than for limited liability companies, which have existed in the United States only since 1977. Counterpoint: While that is certainly true, it is also semantically evident that limited liability companies are designed to provide, well…limited liability!
Point: For leveraged limited partnerships, partnership taxation generally allows for higher basis to the general partner, and therefore more deductions. Counterpoint: Members of a limited liability company can achieve the same result through express guaranties by designated members.
Point: If the capital stock tax is resurrected, it may be better to own property in a limited partnership once again. Counterpoint: Yes, the capital stock tax could be resurrected. But if it is, there is no telling which entities will be affected under a new tax regime.
Point: A limited partnership allows for active control by a general partner and passive investment by limited partners. While that same dichotomy can be achieved through good drafting of an operating agreement with a strong manager-managed overlay, this last reason may prove to be the limited partnership’s salvation. Just as the corporate entity has survived the advent of limited liability companies thanks to historical comfort with the familiar officer/director/shareholder structure, a limited partnership provides an off-the-shelf active management/passive investment structure. That hard-wired result avoids the necessity of negotiating the many details of a limited liability operating agreement. Counterpoint: When a thorough consideration of those details is embraced, the limited liability operating agreement provides many planning opportunities, which allows for all the benefits and is burdened with virtually none of the limitations or complications of a limited partnership.
In sum, when determining how to acquire assets in 2016 and beyond, the limited partnership offers few remaining advantages in Pennsylvania. As a result, the long-awaited expiration of the capital stock tax makes limited liability companies king of the entity-formation hill.
We are often asked to speak on Pennsylvania tax law at conferences and seminars across the state and the country. Currently, our attorneys are scheduled for the following engagements:
- May 16, 2016 (Sharon R. Paxton) “Pennsylvania Tax Law Update” PBI Seminar, Philadelphia, PA. and webcast and simulcast locations.
- May 18, 2016 (Sharon R. Paxton) “Pennsylvania Tax Law Update” PBI Seminar, Mechanicsburg, PA.
- June 28, 2016 (Randy L. Varner and Paul R. Morcom) “Pennsylvania Property Tax Update” Lorman Webinar
- July 18, 2016 (Randy L. Varner and Paul R. Morcom) “Assessment Law and Procedure in Pennsylvania” PBI Seminar, Mechanicsburg, PA.
- July 22, 2016 (Randy L. Varner and Paul R. Morcom) “Assessment Law and Procedure in Pennsylvania” PBI Seminar, Philadelphia, PA.
- July 28, 2016 (Randy L. Varner and Paul R. Morcom) “Assessment Law and Procedure in Pennsylvania” PBI Seminar, Pittsburgh, PA.
For more information on these items, please contact any member of our SALT team.
We are proud to announce that the 15th Edition of the PBI treatise Assessment Law and Procedure in Pennsylvania will be released this spring! Authored by SALT Group Chair Randy L. Varner and SALT Group attorney Paul R. Morcom, the book is regarded as the “go-to” guide for Pennsylvania property tax issues by members of the bench and bar as well as property owners. In conjunction with the release of the book, Randy and Paul will be presenting three PBI seminars this summer.
HOLD THE DATE!
The McNees SALT Group will be holding its annual fall seminar on October 25th in Lancaster. This full-day event is well attended every year and features timely information and guest speakers addressing Pennsylvania tax issues that are important to your business or clients. Mark your calendars now and watch for more information in this newsletter!
© 2016 McNees Wallace & Nurick LLC
PA TAX LAW NEWS is presented with the understanding that the publisher does not render specific legal, accounting or other professional service to the reader. Due to the rapidly changing nature of the law, information contained in this publication may become outdated. Anyone using this material must always research original sources of authority and update this information to ensure accuracy and applicability to specific legal matters. In no event will the authors, the reviewers or the publisher be liable for any damage, whether direct, indirect or consequential, claimed to result from the use of this material.