PA Court OKs tax refund over location issue

In a case that could have far-reaching implications for corporate taxpayers, the state’s highest court has awarded a $2.1 million tax refund to a Pennsylvania-based arm of Johnson & Johnson.

  • Reached last week, the decision hinged on what sounds like a simple question: Whether the company owed taxes in Pennsylvania based on services produced in this state but sold to customers in other states.
  • The answer was clarified in 2014 under a change to Pennsylvania’s corporate tax code.
  • However, the answer had been murky in previous years due to dueling interpretations of the code, according to tax attorneys who spoke with biznewsPA.
  • It was those interpretations at play in the decision favoring the J&J unit, a company called Synthes USA HQ Inc

What’s the difference: It rests on whether companies should be taxed where a service is produced – called the costs of performance method – or where it’s delivered – called the benefit-received method. 

  • Synthes initially paid Pennsylvania’s corporate net income tax under the costs of performance method. It produced services here, but the services were consumed in other states and countries. 
  • The company later sought a $10.7 million refund for three tax years — 2010, 2011 and 2012 — arguing that it should have been taxed based on where services were delivered. 
  • Most states have lower corporate taxes than Pennsylvania, so they would prefer to pay taxes in those other states.
  • In a 56-page opinion covering an appeal for the 2011 tax year, a majority of justices on the Pennsylvania Supreme Court agreed that Synthes was due for a refund — and that the benefit-received method should have applied.
  • An attorney for Synthes, Frank Gallo of law firm Reed Smith, declined to comment.
  • A spokesperson for the Pennsylvania Attorney General’s office, which handled the case, declined to comment.
  • A spokesperson for the Pennsylvania Department of Revenue said the agency is reviewing the decision

Why was this an issue: In 2014, changes to the Pennsylvania tax code clarified that companies should be taxed based on where services are delivered, the benefit-received method.

  • Before that, companies and state tax collectors often interpreted the law in whatever way was most beneficial to them, tax attorneys said.
  • Disputes arose, but the state and taxpayers usually settled their differences before reaching the court system, the attorneys said. 
  • “This case blew that all up,” said Paul R. Morcom, a member and chair of the state and local tax group at Harrisburg law firm McNees Wallace & Nurick.  

Why does it matter: Other companies have similar appeals pending, all based on tax years before 2014.

  • The Synthes decision is likely to benefit those that produced services in the state but sold them elsewhere. Those firms may be able to lessen their tax burden.
  • However, it could harm out-of-state companies that delivered services to Pennsylvania but produced them in other states, tax attorneys said. They could end up owing Pennsylvania tax.
  • In fact, a majority of the pending claims likely were filed by out-of-state companies, said Richard Botwright, co-chair of the state and local tax group at Reading law firm Stevens & Lee
  • “The amount of companies that are going to benefit from this decision is very small,” he said.

Were all justices on board: No.

  • Justice Kevin Dougherty took issue with how the majority construed the laws at stake in the case.
  • He argued that the pre-2014 law clearly dictated that companies should be taxed based on where services were produced — the costs of performance method.
  • “The majority’s arguments to the contrary are not persuasive,” Dougherty wrote in an 11-page dissent.

Were there other issues: Yes.

  • The Supreme Court considered a relatively unusual situation in which the attorney general’s office clashed with a state agency.
  • The Revenue Department sided with Synthes’s interpretation of the tax code, applying the benefit-received method — the one the court chose.
  • The attorney general’s office backed the alternative interpretation favoring the costs of performance method.
  • The question for the court was whether the AG could take a legal position that conflicted with the agency it was supposed to represent.
  • Justices said yes, the AG could go its own way.

The bottom line: The Synthes case applies to companies that filed appeals over corporate net income taxes paid in 2013 and earlier.

  • However, it could have implications for pass-through entities — such as LLCs, LLPs and S corporations — whose profits flow through to the personal income-tax returns of their owners.
  • They wrestle with similar questions of how and where to tax services, said Michael Bannasch, state and local tax practice leader at Lancaster-based accounting and consulting firm RKL LLP
  • The Synthes ruling could help clarify matters for partnerships that have some members outside of Pennsylvania, he said.
  • Those non-PA partners could use the benefit-received method to reduce the taxes they owe in Pennsylvania, Bannasch said.
  • “There are significant refund opportunities for flow-through entities who have non-resident owners,” Bannasch said. “The flip side of it is, for a company that is not in Pennsylvania that has Pennsylvania customers, arguably the department now has more teeth to go try to pursue them, if it were to choose to do so.”


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