• Pennsylvania Supreme Court Decision Provides Tax Refund and Planning Opportunities
  • August 19, 2004 | Author: George F. Nagle
  • Law Firms: Buchanan Ingersoll, Professional Corporation - Philadelphia Office ; Buchanan Ingersoll, Professional Corporation - Pittsburgh Office
  • The Pennsylvania Supreme Court recently affirmed the Commonwealth Court's decision in Canteen Corporation that gain recognized as the result of a Section 338(h)(10) election qualifies for treatment as non-business income. This decision provides both a planning opportunity, as well as a potential refund opportunity, for taxpayers who have sold or acquired all of the stock of a corporation and elected the federal tax benefits of Section 338(h)(10) of the Internal Revenue Code.

    Pennsylvania allows corporations that are engaged in business in more than one state to apportion their business income by using the following 3 factor formula:

    Total Payroll


    _PA Property 
    Total Property


    PA Sales 
    Total Sales

    Business income is generally defined as income arising from transactions and activities in the regular course of the taxpayer's trade or business. If, however, income is deemed to be non-business income, the gain and loss from the sale or disposition of real and tangible personal property is allocated to the state where the assets are located. On the other hand, gain from the sale of intangible assets, such as goodwill, is allocated to the taxpayer's commercial domicile -- the state in which its business is directed or managed.

    For over a decade the Pennsylvania courts have held that if a corporation sells all of its assets and liquidates, the gain realized from that sale should be treated as non-business income. As a result corporations that do business in Pennsylvania but have their corporate domicile outside of Pennsylvania could minimize their burdensome Pennsylvania corporate net income tax liability by treating the gain from a sale of all of their assets as non-business income. The tax savings would be substantial if a large portion of the purchase price was allocated to goodwill and if the corporation was domiciled in a state with a lower corporate tax rate than Pennsylvania's.

    The question presented in Canteen was whether this same result would apply in the case of a transaction in which the parties made an election under Section 338(h)(10) of the Internal Revenue Code. Section 338(h)(10) elections arise when one corporation acquires all of the stock of another corporation. Section 338(h)(10) permits the seller and buyer to elect to treat the stock acquisition as if it were an asset acquisition -- a sale of the acquired corporation's assets followed by the liquidation of the acquired corporation. This deemed sale of assets results in a step up in the basis of the assets of the acquired corporation based upon the purchase price paid for the stock of the acquired corporation.

    In Canteen the Pennsylvania courts agreed that gain arising from the deemed sale of assets as a result of a Section 338(h)(10) election should be treated in the same manner as the actual sale of assets.

    Corporations that have engaged in Section 338(h)(10) elections should consider filing refund claims for Pennsylvania tax based on the position that the gain recognized as a result of the election was non-business income.