iTaxpayers with activities in Pennsylvania or Delaware should take note of the following recent tax legislative changes, official guidance and potential refund opportunities.
Pennsylvania issues guidance on related-party intangible expense addback provision
In mid-2013, applicable to tax years beginning after December 31, 2014, Pennsylvania enacted legislation disallowing the deduction of intangible expenses and related interest payments to affiliates. The addback applies to payments such as royalties, license fees, management fees, leases, and other similar payments, whether paid to an affiliate directly or indirectly through an intermediary.[1] Earlier this year the Pennsylvania Department of Revenue (“the Department”) prepared an Information Notice to provide taxpayers with additional guidance on the mechanics of the addback, and this Information Notice was first issued in “draft” form and circulated to various taxpayer and taxpayer-advocate groups for comment. Despite harsh comments from practitioners and the taxpayer community, concerned that the Information Notice went far beyond the statutory addback provision itself, the Information Notice was issued in final form with few substantive changes made to the initially released draft.
The Information Notice clarifies that the addback applies to a broad range of expenses, including those related to “franchise rights, know-how, trade secrets, goodwill, and contract rights” in addition to the examples provided in the statute, which include “patents, patent applications, trade names, trademarks, service marks, copyrights and mask works.”
Many taxpayers likely think of related-party expense addback provisions as applying to payments to an affiliate where the affiliate continues to hold the intangible. However, the Information explains that Pennsylvania interprets its addback provision as applying to any amortization expense the taxpayer would otherwise be entitled to if an intangible asset is purchased by a Pennsylvania taxpayer from an affiliate.
Further, it appears that the Department will be scrutinizing management fees and services charges to determine whether there are “embedded” intangible expenses within such fee charged to a Pennsylvania taxpayer by an affiliate.
With respect to interest payments, the Information Notice explains that the Department will presume such payments to be related to an intangible if the Pennsylvania taxpayer has incurred any sort of intangible expenses with any affiliated entity in that same tax year. The Notice even goes so far as to conclude that there would be no deduction permitted for interest payments to a third-party bank if, in the same year, payments were made by the Pennsylvania taxpayer to an affiliate related to intangible assets.
The addback statute provides three categories of exceptions which, if applicable, allow deduction for otherwise non-deductible expenses: (i) principal purpose/arm’s length transaction, (ii) foreign treaty exception, and (iii) conduit exception. Important for taxpayers to keep in mind with respect to the addback exceptions is the Department’s newly stated requirement that the taxpayer have contemporaneous documentation to support the exception. In other words, later-dated documentation and mere statements or assertions by company representatives would not be deemed acceptable.
Finally, the Information Notice provides examples of how a taxpayer may compute the credit available against the addback when its payee affiliate pays income-based taxes in Pennsylvania or other separate-company liability computation states.
The Department’s interpretation of the newly applicable intangible expense addback in the Information Notice is quite aggressive, and in some instances, likely exceeds the statutory provisions. If taxpayers see a significant impact from the addback when preparing their corporate net income tax return(s), they should consider taking a position or filing a refund claim, particularly if a plain read of the statutory provision arguably would not require an addback in the particular facts and circumstances.
Pennsylvania refund claim opportunity
Taxpayers are reminded to review their previously filed returns to see if a refund claim is warranted based on the pending the Nextel litigation.[2] In late 2015 the Pennsylvania Commonwealth Court held that the state’s net operating loss cap violated the Uniformity Clause of the Pennsylvania Constitution, and this decision has since been appealed to the Pennsylvania Supreme Court. Many taxpayers have filed protective refund petitions pending the outcome of Nextel—this may be done quite simply by filing a Board of Appeals refund claim and completing the relevant section to have the refund claim placed on hold pending the on-going litigation.
Although the Department’s historic policy has been that refund petitions related to a particular tax year are due by three years from the return’s original due date (or April 15, 2016, for calendar-year companies), regardless of whether the company filed on extension, taxpayers that filed their 2012 returns on extension may still be able to take advantage of this refund opportunity if they file their refund petition within three years of the date the return was filed on extension. This is based on the recent decision in Mission Funding Alpha v. Commonwealth, 129 A.3d 614 (2015), where the court recently held that the three-year time-frame within which a taxpayer must file a refund claim ran from the date of the filing of the return, not from any earlier date even if an estimated payment was made with the extension request. This decision is currently pending appeal at the Pennsylvania Supreme Court (Docket No. 2 MAP 2016).
Pennsylvania amnesty period
Pursuant to Act 84 of 2016, the Pennsylvania Department of Revenue is administering an amnesty program from April 21, 2017 through June 19, 2017. The program covers all taxes administered by the Department, and taxpayers may take advantage of the waiver of all penalties and one-half of the interest for any liability due and owing as of December 31, 2015 whether or not the liability is known to the Department. Moreover, if a taxpayer is eligible for the amnesty program but does not participate, a 5% non-participation penalty will be added to the delinquency.
Delaware enacts single sales factor apportionment
Following a growing state tax trend, Delaware has enacted legislation adopting single sales factor apportionment for corporate income tax purposes.[3] Delaware is currently a three-factor apportionment state, and this will continue through the end of 2016. However, for tax years beginning in 2017, the sales factor will be weighted at 50 percent and will increase incrementally through 2020 when apportionment will be based solely on sales. Note that although the phase-in of a single sales factor is mandatory for most business, it is elective for telecommunications companies and certain “worldwide headquarters corporations” based in Delaware.
Service providers should pay particular attention to Delaware’s sourcing rules—for apportionment purposes Delaware sources services based on where such services are performed, which, although a market-driven approach, differs from the more typical market-based sourcing in place in many other states.[4] Given the upcoming shift in apportionment factor weighting, companies should take time to review their Delaware corporate income tax receipts sourcing for opportunities as well as exposures.
[1] L. 2013, H.B. 465.
[2] Nextel Communications of the Mid-Atlantic, Inc. v. Commonwealth, Commw. Ct. Docket No. 98 F.R. 2012 (Nov. 23, 2015), appealed filed Dec. 20, 2015.
[3] L. 2016, H.B. 235.
[4] Delaware Form 1100 Instructions.
