- Pennsylvania Enacts “Delaware Loophole” Closer and Other Significant Tax Changes
- July 22, 2013 | Author: David M. Kuchinos
- Law Firm: Blank Rome LLP - Philadelphia Office
On July 9, 2013, Pennsylvania’s governor signed House Bill 465 into law, making changes to Pennsylvania’s taxation of corporations, partnerships, and individuals; extending the phase-out of the capital stock tax, fundamentally changing the Bank Shares Tax; and eliminating a common planning technique involving the realty transfer tax, among other modifications. Unless otherwise noted, these changes are effective for tax years beginning after December 31, 2013.
Corporate Net Income Tax (“CNIT”)
Delaware Loophole Closer. For tax years beginning after December 31, 2014, and with a few important exceptions, no deduction is allowed for an intangible expense or a related interest expense paid to an affiliated entity. The disallowance applies to amounts paid for the acquisition, use, maintenance, management, ownership, and sale or exchange of patents, trade names, trademarks, service marks, copyrights and similar expenses, and to interest expenses that are directly related to such intangible expenses.
The disallowance does not apply to a transaction (1) that did not have tax avoidance as its principal purpose and was done at arm’s length rates and terms, (2) where the affiliate is domiciled in a foreign country with which the United States has a comprehensive income tax treaty providing for the allocation of all categories of income, or withholding on royalties, license fees and interest, or (3) where the affiliate directly or indirectly paid the amount at issue to an unaffiliated entity. Further, if the affiliate receiving the payment was subject to any state tax on a tax base that included the intangible or interest receipt, the payor receives a credit against its CNIT based on a formula provided in the statute.
Net Operating Losses. The net loss deduction has been increased from the lesser of 20% of taxable income or $3 million to the lesser of 25% of taxable income or $4 million for 2014, and thereafter to the lesser of 30% of taxable income or $5 million.
Market-Based Sourcing. For apportionment purposes, income related to the sale of services and certain property is assigned to Pennsylvania based on where the service is delivered and where the property is located (realty) or where the customer takes possession (rented or leased tangible personal property). Rules are provided for services delivered in more than one state and for rented or leased tangible personal property subsequently removed from Pennsylvania, and default rules are provided if the state of assignment cannot be determined based on the new rules. The existing rules remain in effect for the sourcing of sales of tangible personal property (to Pennsylvania if delivered or shipped to the purchaser in this state) and all other sales not described above (to Pennsylvania if the greater proportion of the income producing activity is performed here).
Capital Stock Franchise Tax
Extension of Phase-Out. For the third time in the last decade, the phase-out of this tax has been extended. Previously scheduled to expire at the end of 2013, the tax will now continue through 2015 with expiration now scheduled for the end of 2015. The tax rate will be reduced from its current 0.89 mills of capital stock value to 0.67 mills in 2014, and 0.45 mills in 2015.
Bank Shares Tax
Complete Reform. Due in part to the questionable constitutionality of the current Shares Tax as it applies to merged banks, the new law completely revamps the tax effective for the calendar year beginning January 1, 2014 and thereafter. The current tax base, which is computed under a six-year moving average value of shares, is replaced with single-year value, thereby returning the tax base to its pre-1990 calculation. This change is intended to eliminate the constitutional problem of taxing mergers involving out-of-state banks by excluding the historical value of such a bank when it merges into a Pennsylvania bank, but not extending the same treatment to mergers involving in-state banks. Blank Rome is litigating this constitutional issue in a case that is pending in the Supreme Court of Pennsylvania.
The new law reduces the tax rate from 1.25% to 0.89% and changes the tax base by including only bank equity capital, not total equity capital as under present law. Further, three-factor apportionment based on a bank’s payroll, receipts, and deposits is replaced by a single receipts factor (the application of which is detailed in more than ten pages of the new legislation). The new law also expands the definition of “doing business” in Pennsylvania, the touchstone for being subject to the Shares Tax. A bank will be subject to the Shares Tax if it generates more than $100,000 in gross receipts apportioned to Pennsylvania and meets any one of seven tests, which include holding a security interest, mortgage, or lien on Pennsylvania personal property or real estate.
Realty Transfer Tax
Second-Tier Transfers. The realty transfer tax (“RTT”) exemption for second-tier entity transfers is eliminated. This popular planning technique allows an owner that had the foresight to own real estate through a two-tiered entity structure to escape the RTT on the sale of all the interests in the top-tier entity (not a “real estate company” as presently defined) that owns 100% of the interests in the bottom-tier real estate owning entity (a “real estate company” as presently defined). The new law eliminates this exemption by defining the term “real estate company” to include an entity that owns, as 90% or more of the value of its assets, “a direct or indirect interest in a real estate company.” An “indirect ownership interest” is defined as an interest in an entity “whose purpose is the ownership of a real estate company.” This change will make Pennsylvania’s law on this subject similar to that in Philadelphia.
Acquired Company. The RTT amendments also change the definition of an “acquired company,” which is a real estate company in which there is a transfer of 90% or more of the interests within a period of three years. The RTT is imposed when a real estate company becomes an acquired company. The amendment provides that a transfer is “deemed to occur” within three years of another transfer when “the transferring party provides the transferee a legally binding commitment or option, enforceable at a future date, to execute the transfer.”
Sales and Use Tax
Internet Sales. The new law includes implementation provisions should the U.S. Congress enact legislation permitting the sales taxation of Internet sales without regard to physical presence. That federal legislation is now stalled in the House of Representatives.
Aircraft Parts and Services. Effective October 9, 2013, sales and use tax will no longer be due on the sale or use of aircraft parts, services to aircraft, and aircraft components. The law already excludes from the tax the sale of helicopters and repair and replacement parts for helicopters. Note that the sale of aircraft (excluding helicopters) remains subject to sales and use tax in Pennsylvania.
Philadelphia Sales Tax Rate Remains at 8%. The 1% component of Philadelphia’s sales and use tax that was due to expire next year has been extended. The law provides a pathway for dedicating a significant amount of the related revenues to the School District of Philadelphia.
Personal Income Tax
Pass-Through Entity Assessments. The Department of Revenue will be allowed to assess tax at the partnership or S Corporation level if the entity underreported its income by more than $1 million in any year. While the assessment at the entity level will not relieve the entity owners of liability for their share of the additional tax, they will receive a credit for their share of the tax paid by the entity. This provision applies to partnerships with 11 or more partners who are natural persons (and those with less than 11 natural person partners that elect to have the provision apply), and those with at least one partner which is a corporation, LLC, partnership or trust, but not to publicly traded partnerships. It also applies to S Corporations with 11 or more shareholders and any other electing S corporation. All appeals involving assessments at the entity level must be filed by the entity and reassessments are binding on the entity owners.
Start-Up Expenses. In determining the net income from the operation of a business, taxpayers will be able to deduct start-up expenses to the same extent they are deductible for federal income tax purposes.
Credit for Taxes Paid to Other States. The credit available to resident taxpayers for taxes paid to other jurisdictions will no longer be available for taxes paid to foreign countries.
Intangible Drilling Costs. An option is provided for capitalizing and recovering intangible drilling costs over 10 years, or expensing up to one-third of the costs in the year incurred and recovering the remaining costs over 10 years.
Compliance Changes. Partnerships, estates, and trusts having a Pennsylvania resident owner or beneficiary, whether or not they have Pennsylvania source income, are required to file Pennsylvania returns (with a copy of their federal returns) and statements (K-1s) showing each owner’s or beneficiary’s share of income, gain, loss, etc. Further, estates, trusts, partnerships, and Pennsylvania S corporations must maintain a list of their owner or beneficiary names, addresses, and taxpayer identification numbers as of the end of each year. Failure to do so can make a general partner, tax matters partner, corporate officer, or trustee liable for the entity’s unpaid tax, interest, and penalties. Further, the requirement that pass-through entities withhold tax on their non-resident owners’ Pennsylvania source income has been extended to estates and trusts.
Qualified Family-Owned Business. For estates of decedents dying after June 30, 2013, the transfer of a qualified family-owned business to members of the same family will not be subject to inheritance tax if the business continues to be owned by a qualified transferee for at least seven years after death. The tax will be due, with interest, if the business is not so held for at least seven years. Qualified transferees for this purpose are a spouse, lineal descendants, siblings and their lineal descendants, and ancestors and their siblings.
A qualifying business is a proprietorship engaged in a trade or business with less than 50 full-time equivalent employees, having a net book value of assets of less than $5 million, and having been in existence for at least five years, all measured at the date of death. An entity meeting these tests that is wholly owned by the decedent or by the decedent and qualified transferees also qualifies unless the principal purpose of the business is the management of investments or income producing assets.
Amendments. Changes have been made to the existing Film Production Tax Credit and Job Creation Tax Credit, generally adding flexibility to the application of these credits.
Additions. New credits—an Innovate in PA Tax Credit and Mobile Telecommunications Broadband Investment Tax Credit—have been enacted, the former providing credits against the insurance premiums tax and the latter against the CNIT with the ability to be transferred to pass-through entity owners if not usable against the CNIT. Finally, a City Revitalization and Improvement Zones credit has been enacted for the benefit of third-class cities that meet the statutory requirements.
Board of Finance and Revenue
Effective April 1, 2014, practice before the Board of Finance and Revenue (“BF&R”) will change significantly. Presently, an appeal from a decision of the Board of Appeals is to the BF&R, which is a board of six agency representatives, including delegates of the Secretary of Revenue and Attorney General. Only the taxpayer or taxpayer representative presents the appeal and argues the issues. There is no interaction with the Department of Revenue (“DOR”) and the BF&R has no settlement authority.
Under the new rules, the BF&R will have three members, one appointed by the State Treasurer, and two nominated by the governor and approved by the senate. The DOR will be permitted to present evidence and the BF&R may compromise an appeal if the parties agree.