Pennsylvania’s Agency Deference Bait and Switch: Synthes USA

This article was originally published by Tax Notes State.

The Pennsylvania Commonwealth Court released its decision in the much-anticipated Synthes USA HQ Inc. v. Commonwealth case July 24. The case addressed the proper interpretation of Pennsylvania’s sales factor sourcing statute in effect for tax years before 2014, which sourced service receipts to the location where the “income-producing activity” occurred. The commonwealth court deferred to the Pennsylvania Department of Revenue’s interpretation, which construed income-producing activities to occur where the service provider’s customer receives the benefit of the services (benefits-received sourcing method).

The proper application of Pennsylvania’s sourcing statute has been the subject of considerable controversy. Before 2014 Pennsylvania law incorporated the former Uniform Division of Income for Tax Purposes Act model apportionment statute’s service receipts sourcing provision, which sourced service receipts to Pennsylvania:

• if the income-producing activity is performed in Pennsylvania; or
• if the income-producing activity is performed both in and outside Pennsylvania and the greater proportion of income-producing activity is performed in Pennsylvania than in any other state, based on costs of performance.

The provision has been broadly interpreted to refer to the taxpayer’s activities and costs, thus sourcing receipts on an “origination” basis to the taxpayer’s location. However, before the commonwealth court, the DOR asserted its interpretation that the provision required the benefits-received sourcing method, which sources receipts on a “destination” basis to customers’ locations. The DOR had never formally adopted this position in published guidance or a properly issued regulation, and Pennsylvania’s administrative tax forums had not provided definitive guidance. Accordingly, the commonwealth court’s decision is the first authoritative guidance taxpayers have addressing service receipt sourcing in Pennsylvania.

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