In a regulatory proposal published this month, Pennsylvania tax collectors are offering up a revised definition of business income, a move that sounds innocuous on its face. But observers question whether the new definition would do more than just clarify which corporate profits are subject to state taxation.
The proposed changes, the observers say, could open the door to combined reporting, a tax system with a record of stirring up controversy in Pennsylvania.
A combined reporting system is not explicitly authorized in the proposal, which are open for public comment. But language in the proposal seems to pave the way, the observers note.
“This, to me, sends a signal: ‘Look, we’ve already worked out the details. All we need is the enacting legislation,'” said Michael Bannasch, local tax practice leader for accounting and professional services firm RKL LLP.
Peter Calcara, vice president of government relations for the Pennsylvania Institute of CPAs, described the proposal as a potential “backdoor approach” to implementing combined reporting.
PICPA is not opposed to combined reporting. But much depends on the details, and the proposal from the Pennsylvania Department of Revenue appears to exceed the agency’s statutory authority, he said.
What’s the proposal: It comes from the Department of Revenue, and it focuses on defining business and nonbusiness income for the purpose of assessing Pennsylvania’s corporate net income tax, which is 8.49% this year.
But a chunk of the rule’s preamble dwells on the concept of unitary business income and lays out several tests for determining when separate corporate entities should be taxed as one.
To Bannasch, the discussions seem to be more than what is needed to distinguish between business and nonbusiness income.
“That’s what leads me to believe that it is potentially setting up combined reporting down the road,” he said.
What’s combined reporting: A system under which companies are required to report income from subsidiaries and related entities as part of a single, or unitary, business, provided certain conditions are met.
Critics argue that companies use subsidiaries and affiliates to shift income to states with lower tax rates.
By forcing multipart companies to report as “unitary” businesses, states can, in theory, capture more tax revenue.
About 30 states use combined reporting. Pennsylvania is not one of them. But the idea crops up whenever elected officials debate corporate tax cuts.
Last fall, the Democratic-controlled House approved a bill to accelerate cuts to the state’s corporate net income tax and allow businesses to deduct more of their past losses. But the legislation also would have enacted combined reporting.
The Pennsylvania Chamber of Business and Industry applauded the tax cuts but described combined reporting as a “poison pill.”
In a position paper last fall, the chamber said, “While combined reporting is one way to address tax avoidance, it also has several negative attributes, including: increased cost and complexity to filing tax returns, increased tax appeals and litigation, and creating an overall disincentive to do business in Pennsylvania.”
The bill was referred to a Senate committee but has not moved since last fall.
What’s the feedback: No one has filed formal comments yet on the current proposal, which has been submitted to the Independent Regulatory Review Commission, an independent panel that scrutinizes proposed state rules.
But the revenue department received feedback after circulating a similar proposal four years ago.
In a letter to the agency in early 2020, PICPA identified a range of issues with the proposal, one being that certain provisions were inconsistent with Pennsylvania statute and case law.
In a separate letter around the same time, the Philadelphia Bar Association raised three main concerns, including a presumption in the regulation’s preamble that businesses are unitary unless they can prove otherwise. The same presumption is made in the latest version.
“This presumption does not reflect the statutory language and is not part of the proposed regulatory text,” wrote Cheryl Upham, then-chair of the bar’s tax section. “It is not appropriate to use a regulatory preamble to make a substantive change to the law.”
A department spokesperson referred to the proposal and its preamble when asked about its potential impact.
The text suggests the department aims to head off disputes over what counts as business income but also to prevent companies from sheltering income in other jurisdictions.
“The application of the unitary business principle to this income assures that income over which the Commonwealth has Constitutional authority to tax does not escape taxation,” the department wrote. “Determination of the scope of the unitary business being conducted in the Commonwealth is without regard to the extent to which the Commonwealth requires or permits combined reporting.”
What’s next: The public comment period on the proposal is scheduled to close June 24, with comments from the review panel due by July 24.
