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Jennifer Karpchuk’s recent SALT article, “The Top Three Takeaways from Pa.’s New Corporate Tax Laws”
Reprinted with permission from the August 3, 2022, edition of The Legal Intelligencer © 2022 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited, contact 877-257-3382 or reprints@alm.com.
On July 8, 2022, after years of attempted tax cuts, the Pennsylvania legislature finally adopted a change to Pennsylvania’s Corporate Net Income Tax (CNIT) and adopted other provisions targeted at reaching out-of-state companies doing business in the Keystone State. See H.B. 1342. This article will discuss the top 3 corporate tax takeaways from the new bill.
CNIT Reduction
Pennsylvania has long been criticized for its growth-inhibiting high tax rate of 9.99%. Pennsylvania’s CNIT rate has consistently ranked it at the very top among the states with the highest corporate income tax rates nationwide. The new bill lowers the CNIT rate incrementally, until it bottoms out at 4.99% in 2031. Upon being fully phased-in, Pennsylvania’s CNIT rate will rank among the lowest nationwide. The lower CNIT rate could make it more attractive to businesses looking to relocate, given that all of its neighboring states have significantly higher tax rates. This should also help Philadelphia as it hopes to attract more businesses. Philadelphia has been impacted by its own high Business Income & Receipts Tax rate, the effect of which has only been exacerbated by the high CNIT rate.
Economic Nexus
While the CNIT rate is going down, the number of taxpayers the CNIT applies to should be increasing. The bill creates a $500,000 economic nexus threshold for purposes of the CNIT and codifies the following business activities as establishing substantial nexus: (1) leasing or licensing intangible property utilized in Pennsylvania; (2) regularly engaging in transactions with Pennsylvania customers involving intangible property, including lending to unaffiliated entities or individuals; and (3) selling intangible property that was used by the taxpayer in Pennsylvania.
While the economic nexus provision is a new law, the threshold is not a new concept. During 2019, the economic nexus threshold was originally announced by the Pennsylvania Department of Revenue (Department) in Corporation Tax Bulletin 2019-04 (TB 2019-04). Many have questioned the Department’s authority to administratively create an economic nexus threshold – and that ability may still be questioned for pre-2023 tax years. However, taxpayers that have $500,000 in sales in Pennsylvania beginning with 2023 are on notice to evaluate their potential CNIT liability.
Intangibles Sourcing
For almost a decade in Pennsylvania, intangibles have been sourced based on costs-of-performance, while services have been sourced based on market-based sourcing. The new legislation brings the two into harmony – both services and intangibles will now be sourced based on market-based sourcing. The types of gross receipts of intangibles that the legislation calls out includes: (1) the lease or license of intangible property; (2) the sale of intangible property where the property sold is a contract right, government license or similar intangible property that authorizes the holder to conduct business activity in a specific geographic area; (3) the sale, redemption, maturity or exchange of securities that are held by the taxpayer primarily for sale to customers in the ordinary course of its trade or business; (4) interest, fees and penalties from credit card receivables; and (5) interest, fees and penalties imposed in connection with loans.
Although there is disagreement from the Pennsylvania Department of Revenue regarding how the costs-of-performance language should be interpreted, as an oversimplification, costs-of-performance tends to be the location of the headquarters of the business in question. Conversely, market-based sourcing instead looks to the location of the customer. Thus, an in-state company with the bulk of its sales outside of Pennsylvania could see a drop in its CNIT liability. On the other hand, an out-of-state company with a number of customers in Pennsylvania may find itself now subject to CNIT. Coupled with the economic nexus threshold provision, the change in intangibles sourcing could lead to another group of taxpayers that will now find themselves subject to CNIT in Pennsylvania.
Jennifer Karpchuk is the co-chair of the State and Local Tax (SALT) Controversy and Planning practice at Chamberlain Hrdlicka. She may be reached at jennifer.karpchuk@chamberlainlaw.com.