SALT Blawg – State and Local Tax Blog
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During July, the Commonwealth Court handed down its decision in Synthes v. Commonwealth of Pennsylvania, 108 FR 2016, which was a closely watched case dealing with differing interpretations of Pennsylvania’s costs of performance (“COP”) statute. Prior to 2014, the statute required services to be sourced to the location of the “income-producing activity.” Where the income-producing activity occurred both within and without Pennsylvania, receipts were required to be sourced to the state where the greater proportion of income-producing activities occurred, based on COP. Effective for tax years beginning in 2014, Pennsylvania adopted market-based sourcing for services – but maintained COP sourcing for sales of intangibles.
Arguably, the legislative history was clear – there was an intent to move from COP to market-based sourcing for services. However, the Pennsylvania Department of Revenue (“Department”) took a different position. The Department issued assessments for COP years applying a market-based sourcing interpretation whereby the location of the income-producing activity was the location where the benefit was received – i.e., the location of the customer. Many taxpayers challenged the Department’s interpretation, but all COP cases settled prior to Synthes. Thus, Synthes represented the first time that a Pennsylvania court was asked to address the Department’s position related to COP.
Synthes was a Pennsylvania-based company that had filed based on a standard understanding of COP, thereby sourcing its sales to Pennsylvania. It filed a petition for refund asserting that it wished to have the Department’s market-based sourcing interpretation of COP applied to it, essentially arguing that a failure to do so would result in a violation of the Uniformity Clause of the Pennsylvania Constitution. Losses at the Board levels resulted in an ultimate appeal to Commonwealth Court, where the case was assigned to the Office of Attorney General (“OAG”), which is tasked with handling such appeals – with the Department essentially acting as its client. In defending against the refund claim, the OAG took a position contrary to the Department’s market-based sourcing interpretation of the COP statute and consistent with the standard understanding of COP. The Department then sought to intervene, arguing that the OAG was not representing its interests.
This strange procedural posture seemed to irritate the court during oral argument, and its disdain was also reflected in its opinion in which it essentially asserted that the OAG was a rubber stamp for the Department. In upholding the Department’s position, the court cited to the Department’s “long-standing position” and the deference that should be afforded to the agency charged with interpretation of the statute. The court remanded the case to the Board for a calculation of the refund.
On August 24th, both parties filed exceptions with the Commonwealth Court. The taxpayer sought to preserve its Uniformity Clause argument and to point out that the case need not be remanded to the Board for a calculation of the credit, since both parties had agreed what the proper credit amount should be if the Department’s position was upheld.
Meanwhile, the OAG filed exceptions to essentially the entire decision. The OAG took exception to a number of aspects of the Majority’s decision, which can be grouped into two categories – first, a disagreement regarding the interpretation of the COP statute; and second, a disagreement regarding the OAG’s role. Regarding the first category of exceptions filed, the OAG filed a litany of exceptions. Among them, the OAG took exception to the fact that: (1) the Department’s market-based sourcing interpretation was correct; (2) the OAG was bound by the Department’s interpretation of COP; (3) the correct interpretation of the COP statute was not in dispute prior to this case and that the Department was not aware of the OAG’s position; (4) the legislature intended market-based sourcing for COP years; and (5) the opinion ignored important history and case law from other jurisdictions. In the second category of exceptions, the OAG took exception to the fact that: (1) the court overlooked the OAG’s role as an independent agency; (2) Commonwealth agencies are no different from the Commonwealth itself; and (3) the Department, as opposed to the Commonwealth as a whole, is the OAG’s sole client.
Many practitioners took issue with the court’s decision based on the same grounds that the OAG raised in its exceptions. The OAG’s position is not only supported by the legislative history, but also by the historical evolution of COP. Further, the court’s assertion that the Department was unaware of the OAG’s position prior to this case is baseless. While the OAG’s exceptions raise a number of valid points, whether any of those points will change the court’s mind is yet to be seen. Stay tuned for the next part of this riveting saga.