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Pennsylvania is now attempting to join the list of states which have challenged the use of the so-called Delaware Loophole. In the past, other states have challenged the Delaware Loophole by litigation or by legislation. The legislative remedies involved enacting either combined reporting or disallowing the deduction for the royalty payments. OnWednesday January 25th, House Bill 2150, Printer’s No. 3019 (“Bill 2150”), was introduced into the Pennsylvania Legislature. If enacted,Bill 2150 would amend the Pennsylvania Corporate Net Income Tax and address, among other thing, theso-called Delaware Loophole by disallowing the deduction that the parent operating corporation claims for the royalty payments made to its Delaware Holding Company (“DHC”).
More specifically, Bill 2150 would add-back certain intercompany expenses paid to a DHC. Effective for tax year 2013, the legislation would disallow deductions for, “an intangible expense or cost paid, accrued or incurred in connection with one or more transactions with an affiliated entity.” However, there are two (2) exceptions pursuant to which the deduction will be allowed. The first is where the transaction in question was directly related to a valid business purpose. A valid business purpose is defined as, “[a] purpose, other than the avoidance or reduction of taxation, which alone or in combination with other purposes constitute the primary motivation for a business activity or transaction which changes in a meaningful way, apart from a reduction of taxation, the economic position of the taxpayer.” Furthermore, an arm’s length transaction is presumed to be directly related to a valid business purpose. The second instance forwhich the deduction will be allowed is where a taxpayer is engaged in one or more transactions with an affiliated entity subject to tax in Pennsylvania or another state where the tax is determined upon a base that includes the intangible expense as income. In such instances,the taxpayer shall receive a credit against tax due in an amount equal to the tax paid by the affiliated entity with regard to the portion of its income that represents the parent’s/affiliate’s intangible expense.
Apart from the Bill 2150’s attempt at closing the Delaware Loophole, it also proposes certain corporate tax reductions. First, Bill2150 gradually reduces the corporate net income tax rate from 9.99% to 6.99% during a six-year period.
|Tax Year||Corporate Net Income Tax Rate|
As illustrated above, beginning with tax year 2014, the corporate net income tax rate would be gradually reduced, ultimately reaching its 6.99% low for tax year 2019.
Bill 2150 also phases out the net operating loss tax deduction cap. The cap is increased during nine years, commencing in 2014.
|Tax Year||Cap on Credit for Net Operating Loss|
|2013||Greater of 20% of taxable income or $3,000,000|
|2014||Greater of 29% of taxable income or $4,000,000|
|2015||Greater of 38% of taxable income or $5,000,000|
|2016||Greater of 47% of taxable income or $6,000,000|
|2017||Greater of 56% of taxable income or $7,000,000|
|2018||Greater of 64% of taxable income or $8,000,000|
|2019||Greater of 73% of taxable income or $9,000,000|
|2020||Greater of 82% of taxable income or $10,000,000|
|2021||Greater of 91% of taxable income of $11,000,000|
As illustrated above, beginning with tax year 2014, the cap will be increased annually. This will culminate in an uncapped amount for tax years 2022 forward.
Finally, for tax years 2013 forward, Bill 2150 changes the business income apportionment factors for Corporate Net Income Tax purposes from 90% sales, 5% property and 5% payroll to 100% sales. However, for the apportionment of capital stock value – for Capital Stock Tax and Foreign Franchise Tax purposes - the apportionment factors remain the standard equally weighted three-factor (property, payroll and sales factor) apportionment method.