Pennsylvania recently enacted a wide variety of tax changes as part of its recent budget process. A summary of the more significant changes is set forth below.
Jeff Kessel chairs the firm’s state and local tax group and is available to discuss any questions that you might have concerning the new legislation. Jeff can be reached at firstname.lastname@example.org
CNI Tax: Closing the Delaware Loophole (Sort of…)
Many corporations have established passive investment companies (“PICs”) as a vehicle for reducing their Pennsylvania corporate net income tax liability. The PICs are often incorporated in Delaware and are commonly called Delaware Holding Companies. The PICs typically hold intangible assets and earn income by charging royalty or interest expense to affiliated entities. The expense is deducted by the affiliate for Pennsylvania CNI purposes, while the PIC typically doesn’t pay state income tax on the income because it’s located in a state that exempts the income (e.g. Delaware) or does not have a state CNI tax (e.g. Nevada).
Many states have nullified the state tax savings associated with PIC arrangements by requiring the in-state corporation to add-back the intercompany charge in computing state taxable income. Effective for tax years beginning after 2014, Pennsylvania has followed this approach with respect to the corporate net income tax. Its approach is unique, however, in that it only applies if (1) the intercompany charges do not reflect arm’s length pricing; or (2) the [emphasisadded]principal purpose of the transaction was tax avoidance. Also note that the provision only applies to entities that are taxed as C corporations.
Taxpayers that use PIC arrangements should make sure that their transfer pricing is documented and current. It would also be prudent to review any documents related to the establishment of the PIC and/or the intercompany transactions in order to assess if exposure exists with respect to tax avoidance being the principal purpose for the intercompany transactions.
Capital Stock/Franchise Tax: Extended
The capital stock/franchise tax had been scheduled to expire at the end of 2013. It has been extended for two more years at the following rates:
- 2013: .89 Mills
- 2014: .67 Mills
- 2015: .45 Mills
Inheritance Tax: Family Business Exclusion
Transfers of qualifying family businesses will now be excluded from the Pennsylvania Inheritance Tax. The exclusion will apply to the estates of decedents who die on or after July 1, 2013.
In order to qualify, the business must have been owned by the decedent, or the decedent and his family, for at least five years. The business must have a net book value of $5 million or less, and have fewer than 50 employees. The principal purpose of the business cannot be the management of investments or income producing assets. Also, the business must be transferred to a qualified family member and remain in the family for seven years.
Income Tax Apportionment: Sales of Services
Effective for tax years beginning after December 31, 2013, sales of services will generally be sourced to the state in which the customer is located (i.e. market state approach). Although the provision is part of the CNI tax, it should also apply to other businesses (e.g. S corporations, partnerships).
Realty Transfer Tax: Changes in Definitions
The Pennsylvania Realty Transfer Tax generally applies to transfers of real estate. It also applies to transfers of 90% or more of the ownership in a real estate company. The new legislation includes two changes, effective January 1, 2014, pertaining to the definition of a real estate company.
In determining whether an entity is a real estate company, assets owned directly and indirectly will be considered. Thus a top tier entity will have to take its subsidiaries’ assets in to account.
The legislation also provides that a legally binding commitment or option to transfer ownership in a real estate company, enforceable at a future date, is treated as a transfer of an ownership interest.
Individual Tax Changes
The following changes will take effect for tax years beginning in 2014:
- Foreign tax credits will not be available.
- Deductions will be available for start-up expenditures.
- Intangible drilling costs will receive more favorable treatment.
The legislation establishes some new tax credits and modifies some existing credits, including the following:
- Educational Opportunity
- City Revitalization and Improvement Zone
- Keystone Special Development Zone
- Job Creation
- Film Production
- Innovate in PA
The legislation also includes the following changes:
- The NOL deductions for CNI Tax were increased. For tax years beginning in 2014, the NOL deduction will be limited to the greater of 25% of taxable income or $4 million. For tax years beginning after 2014, the deduction will be limited to the greater of 30% of taxable income or $5 million.
- A new sales tax exemption was created for the retail sale or use of aircraft parts and services to aircraft and aircraft components.
- Several changes were made to the Bank Shares Tax, effective January 1, 2014.
- Board of Finance and Revenue reform was enacted.