Corporate Net Income Tax; Application Benefits-Received Method for Sale of Services to Out-of-State Customers
Synthes USA HQ, Inc. v. Commonwealth, 236 A.3d 1190 (Pa. Cmwlth. 2020) (en banc), original jurisdiction, appeal docket 11 MAP 2021
In this original jurisdiction appeal the Supreme Court will consider the Board of Finance and Revenue decision to deny Synthes USA HQ, Inc. (Synthes) a corporate net income tax refund based on its application of a benefits-received method to Synthes’s sales of services to out-of-state customers.
In Pennsylvania, a corporation with taxable business activities in more than one state must apportion its income among the applicable states for income tax purposes, using a formula provided in the Tax Code, which includes a property factor, a payroll factor, and a sales factor. Only the sales factor is at issue in this case. The taxpayer’s income from sales of services is taxed based on the proportion of its sales that occur in Pennsylvania.
Under the Tax Code as it applies to this case, a sale of a service occurs in Pennsylvania if:
(A) The income-producing activity is performed in this State; or
(B) The income-producing activity is performed both in and outside this State and a greater proportion of the income-producing activity is performed in this State than in any other state, based on costs of performance [ (costs-of-performance method) ].
72 P.S. § 7401(3)2.(a)(17) (Subparagraph 17). The Tax Code does not define either “income-producing activity” or “costs of performance.”
Pennsylvania’s legislature enacted a recommended amendment to Subparagraph 17 effective January 1, 2014. For calculation of the sales factor, service receipts are now expressly sourced to Pennsylvania “if the service is delivered to a location in this State. If the service is delivered both to a location in and outside this State, the sale is in this State based upon the percentage of total value of the service delivered to a location in this State.” 72 P.S. § 7401(3)2.(a)(16.1)(C)(I). However, the 2014 amendment does not apply to Synthes’s 2011 refund request.
Commonwealth Court summarized the factual background and arguments as follows:
Synthes, a Pennsylvania-based corporation, provides research, development, and management services to affiliates located outside Pennsylvania. In calculating its 2011 Pennsylvania corporate net income tax, Synthes determined its percentage of out-of-state sales of services by applying an interpretation of the Tax Reform Code of 19713 (Tax Code) that differed from the interpretation the Department had consistently applied for many years. Synthes later requested a refund because the Department’s interpretation of the Tax Code would have resulted in a lower tax. The Department denied the refund request because it found Synthes failed to present sufficient evidence to demonstrate where its sales occurred.
Synthes appealed to the Board, which upheld the Department’s refund denial, agreeing that Synthes did not satisfy its burden of proof. See Br. of Resp’t at 10; Stipulated Facts ¶¶ 66, 68, Ex. D at 95, Ex. E, Ex. F at 101-02. Synthes then petitioned for review in this Court.
The Commonwealth acknowledges that Synthes eventually established the evidence needed to support its refund claim under the Department’s interpretation of the Tax Code, once its claim had reached this Court. See Br. of Resp’t at 10; Stipulated Facts ¶¶ 12, 15-16, 18-20, 24-33, 63-64. The Department does not contend otherwise. The Commonwealth argues, however, that the Department’s interpretation of the Tax Code was in error and is not entitled to any deference from this Court. Thus, the Commonwealth contends Synthes is not entitled to a tax refund, but for a different reason from that found by the Department and the Board.
The Department, as putative intervenor, maintains that its interpretation of the Tax Code concerning calculation of Synthes’s Pennsylvania sales was correct. Indeed, that interpretation was not placed at issue until the Commonwealth raised it before this Court. The Department therefore seeks to intervene and be heard on the issue along with the parties.
Synthes argues that regardless of which calculation method was correct, Synthes is entitled to the same tax break other taxpayers received from the Department.
Slip op. at 2-3 (footnotes omitted). In essence, the Department and Synthes argued that Synthes’s sales of services should be apportioned according to where customers received the benefits of Synthes’s services (“benefits-received method”), not where Synthes incurred costs of performing those services. The Commonwealth (as Respondent represented by the Attorney General) countered that the Department was not entitled to deference in its interpretation of Subsection 17 and that the Department’s interpretation of the pre-2014 statute is contrary to legislative intent as evidence by, inter alia, the subsequent 2014 amendment to Subparagraph 17.
The Commonwealth Court majority granted the Department’s motion to intervene, criticizing the Attorney General’s advocating for a position contrary to the Department, noting:
The Commonwealth appears in this action through the Attorney General. Section 204(c) of the Commonwealth Attorneys Act, Act of October 15, 1980, P.L. 950, as amended, requires the Attorney General to represent a Commonwealth agency in any action brought by or against the agency. 71 P.S. § 732-204(c). We note with dismay the Attorney General’s assertion in this case of a legal position directly adverse to that of its client, the Department. Rather than advocating the Department’s longstanding construction of a tax statute, a matter peculiarly within the Department’s expertise, the Attorney General has forced the Department to seek intervention in order to defend its interpretation of the tax provision at issue.
We are unaware of any constitutional or statutory authorization or mandate for such conduct. Section 204 of the Commonwealth Attorneys Act requires an agency to follow the advice of the Attorney General when sought, or seek a declaratory judgment from this Court if the agency disagrees with the advice in question. 71 P.S. § 732-204(a)(1), (2). Here, however, neither the Department nor the Board sought the Attorney General’s advice concerning the proper interpretation of Subparagraph 17. Moreover, to the extent the Attorney General believed itself entitled to control the position to be advocated in this Court, and upon reaching a legal interpretation contrary to that of the Department, the Attorney General should have so advised the Department. The Department could then have initiated a request for a declaratory judgment as anticipated by Section 204(a).
Additionally, Section 204(c) of the Commonwealth Attorneys Act (Act of October 15, 1980, P.L. 950, as amended), provides that “[t]he Attorney General may, upon determining that it is more efficient or otherwise is in the best interest of the Commonwealth, authorize the General Counsel or the counsel for an independent agency to initiate, conduct, or defend any particular litigation or category of litigation in his stead.” 71 P.S. § 732-204(c). Here, rather than acting directly adversely to its client’s position, the Attorney General could have authorized counsel for the Department or the Board to litigate this matter before this Court, thereby avoiding this unseemly conflict between the Commonwealth and its own agency concerning a statutory construction issue within the agency’s expertise.
Slip op. at n.12 (emphasis in original).
On the merits, the majority deferred to the Pennsylvania Department of Revenue’s interpretation that the “benefits-received method” should apply to Snythes’s sales made in the 2011 tax year to Pennsylvania for purposes of the sales factor for corporate net income tax. The majority concluded that, given the ambiguity of the pre-2014 statute, the Department’s interpretation was not contrary to legislative intent, explaining that Department consistently interpreted provision to apply benefits-received method to sales of services to out-of-state customers, rather than alternative method listed in the statute, and the legislature subsequently amended statute to match the Department’s interpretation and eliminate the ambiguity in the pre-2014 version of the statute. Having found that Synthes is entitled to the tax refund it seeks, the majority avoided addressing the Uniformity Clause constitutional argument.
Judge (now Justice) Brobson in a concurring opinion agreed with the majority’s conclusion and wrote separately “to emphasize my agreement with the majority’s conclusion that the Pennsylvania Office of Attorney General overstepped its authority under the Commonwealth Attorneys Act (CAA) by assuming the mantles of both counsel and client.” Slip op. at PKB-1 (footnote omitted). Judge Brobson reasoned that:
It would be incongruous to construe the Attorney General’s duty under Section 204(c) to “represent” the Commonwealth in legal proceedings as authority for the Attorney General to override, as it has done in this matter, the voice of the legislatively designated Commonwealth agency on a particular subject matter.
Slip. op at PKB-3. Thus, Judge Brobson would not have “entertain[ed] the Office of Attorney General’s collateral attack on the Commonwealth’s longstanding construction of the Tax Code provision.” Id.
In a concurring and dissenting opinion joined by Judge Cohn Jubelirer, Judge Wojcik expressed his strong disagreement “with the majority’s assertion that the Attorney General, while representing the interests of the Commonwealth, the Treasury Department, and the Department of Revenue in this matter, acted inappropriately by presenting a legal argument that conflicts with the position of the Department of Revenue below or that of the Office of General Counsel in its representation of the Department of Revenue on appeal,” reasoning that :
The CAA clearly and explicitly confers upon the Attorney General the primary authority to determine and present to this Court what he perceives those interests to be, in spite of what the Department of Revenue or the Treasury Department may perceive them to be, and specifically contemplates dual representation of the agencies where those perceived interests are conflicting. The majority’s contrary conclusion is patently incorrect.
Slip op. at MHW-3 – MHW-4 (footnote omitted). However, Judge Wojcik agreed that, based on the conflicting legal positions, the majority correctly granted the Department of Revenue’s application to intervene to represent its own legal interests. On the merits, Judge Wojcik would find, contrary to the majority, that the Department was not entitled to deference because its interpretation was contrary to legislative intent, opining that:
I believe that the Attorney General has presented a convincing argument that although the Department of Revenue erred in its pre-amendment application of the Tax Reform Code of 1971 (Tax Code) in disposing of Synthes USA HQ, Inc.’s (Taxpayer) petition for a refund of its corporate net income tax (CNIT) paid for the 2011 tax year, the Board of Finance and Revenue’s (F&R) order denying Taxpayer’s petition for review of the Department of Revenue’s Board of Appeal’s order should be affirmed nonetheless. Taxpayer calculated its CNIT for the 2011 tax year based, in part, on the definition of “Taxable income” provided in Section 401(3)2.(a)(17) (Subparagraph 17) of the Tax Code,6 which was applicable before the General Assembly amended the Tax Code in 2013 by adding Section 401(3)2.(a)(16.1)(C) (Subparagraph 16.1). On its return, Taxpayer properly applied Subparagraph 17 for apportioning income, including a sales factor among the three factors, and sourced all receipts to Pennsylvania because the greatest proportion of the costs of performing the services at issue was incurred here. This computation method, the “costs-of-performance” method, is inconsistent with the Department’s interpretation of Subparagraph 17, applying the “benefits-received” method for these services, as subsequently provided for in Subparagraph 16.1 and applicable to Taxpayer’s CNIT following its enactment. See generally Honigman Miller Schwartz and Cohn LLP v. City of Detroit, ––– N.W.2d ––, ––, 2020 WL 2530162 (Mich., Dkt. No. 157522, filed May 18, 2020), slip op. at 8-10 (outlining the evolution from the application of the costs-of-performance method to the benefits-received method of calculating CNIT for income derived from providing multistate services under the relevant Michigan tax statute); University of Phoenix, Inc. v. Indiana Department of State Revenue, 88 N.E.3d 805, 811-13 (Ind. T.C. 2017) (analyzing a number of states’ interpretation of similar provisions and applying the costs-of-performance method under the relevant Indiana tax statute).
To my mind, the General Assembly’s 2013 enactment of Subparagraph 16.1, while keeping Subparagraph 17 intact, demonstrates a legislative intent to alter the calculation of CNIT for income received for the sale of services from the costs-of-performance method to the benefits-received method by specifically adding this provision to the Tax Code, and by specifically excepting the application of Subparagraph 17 to income within the ambit of Subparagraph 16.1. See, e.g., Masland v. Bachman, 473 Pa. 280, 374 A.2d 517, 521 (Pa. 1977) (“A change in the language of a statute ordinarily indicates a change in legislative intent.”); Haughey v. Dillon, 379 Pa. 1, 108 A.2d 69, 72 (Pa. 1954) (“A change of language in subsequent statutes on the same matter indicates a change of legislative intent. Commonwealth v. Lowe Coal Co., [296 Pa. 359, 145 A. 916, 918-19 (Pa. 1929)]. Why else would the legislature change the language?”). See also Section 1921(c)(5) of the Construction Act, 1 Pa. C.S. § 1921(c)(5) (“When the words of the statute are not explicit, the intention of the General Assembly may be ascertained by considering, among other matters … [t]he former law, if any, including other statutes upon the same or similar subjects.”); Section 1928(b)(3) of the Construction Act, 1 Pa. C.S. § 1928(b)(3) (“All provisions of a statute of the classes hereafter enumerated shall be strictly construed: … (3) Provisions imposing taxes.”).
As a result, the Department of Revenue’s grant of Taxpayer’s refund application for the 2011 tax year would be void because its interpretation of Subparagraph 17 as requiring an assessment based on the benefits-received method of allocation is not supported by the express language of the applicable Tax Code provision in effect at that time. See 72 P.S. § 7401(3)2.(a)(17) (“Sales … are in this State if … [t]he income-producing activity is performed in this State; or … [it] is performed both in and outside this State and a greater proportion … is performed in this State than in any other state, based on costs of performance.”) (emphasis added).
Slip op. at MHW-4 – MHW-7 (footnotes omitted).