01 November 2018 Pennsylvania Supreme Court addresses sales and use tax treatment of non-separately stated charges and royalty payments On October 25, 2018, the Supreme Court of Pennsylvania (Court) held in Downs Racing, LP v. Commonwealth1 (Downs Racing) that royalty payments for intellectual property associated with video poker machines were not subject to sales tax because intellectual property is not tangible personal property. The Court also held that charges for non-taxable components must be both separately stated from taxable components and sufficiently detailed in order to be treated as non-taxable. In Downs Racing, the taxpayer purchased video poker machines from International Gaming Technologies, PLC (IGT) and paid sales tax on those purchases. In addition, the taxpayer purchased under separate agreements with IGT: (1) software; and (2) "intellectual property [consisting] of legal rights to use trademarks, copyrights and patented methods of play[.]"2 IGT was located outside of the US and did not (and was not then) required to collect Pennsylvania sales tax. The taxpayer self-assessed and remitted use tax on the royalty fees and subsequently sought a refund. The Pennsylvania Commonwealth Court rejected the taxpayer's request for a refund of the use taxes paid on the royalty fees it paid to IGT and the taxpayer appealed to the Court. The taxpayer argued to the Court that the royalty fees were billed separately from the purchase of the poker machines and thus, were for the right to use intellectual property in the form of trademarks, copyrights and patented methods of play owned by third parties and not for the use of the machines or computer software. The Pennsylvania Department of Revenue (Department) did not directly contradict the taxpayer's assertion but instead relied upon a more generalized contention that the "full consideration paid" for a product, such as a video poker machine, includes fees for ancillary items (i.e., the intellectual property at issue in this case). In finding that the royalty fees constituted non-taxable payments for license to use intangible property, the Court rejected the argument that intangible property was included by implication within the definition of "corporeal personal property." It also rejected the Department's argument that the trademarks, copyrights and patented methods of play were incidental to the taxpayer's purchase of the gaming machine and, as such, were taxable as part of the machines' purchase price. The Court looked to the fact that the taxpayer executed separate agreements with IGT (one for the software and the other for the use of intellectual property). It also considered the facts that: (i) the royalty fee charges were incurred on a daily basis separately from the initial purchase of the machines and associated software; (ii) the intellectual property was not necessary to the function of the machines, but the taxpayer had to purchase it to obtain the right to offer certain poker styles or games; and (iii) decisions regarding which intellectual property to purchase were often made after the initial purchase of both the machine and software. The Court also considered the taxability of charges of a service contract with respect to which the vendor supplied equipment, such as screens, satellite dishes and closed circuit television feeds used to simulcast racing events to off-track wagering sites across the country. While charges for equipment were separately stated from labor charges, charges for taxable labor (such as servicing the equipment) were not separately stated from charges for non-taxable labor (labor charges associated with operating the equipment provided). The Commonwealth Court upheld the Department's assessment of tax upon the service contract, finding that the taxpayer had not presented documentary evidence specifying which portions of the billed amounts were taxable vs. non-taxable as required by Departmental regulations. The Court agreed with the lower court's finding on the grounds that, because the vendor had not separately identified which portions of the labor charges were non-taxable, the taxpayer had not proven that the cost of labor to operate the equipment was "separately stated" as required by 72 Pa. Stat. Ann. Section 7201 (g)(4). Taxpayers that have paid Pennsylvania sales or use tax on "royalty fees" or other intangible property that is separately stated in separate contracts or invoices should consider filing a refund claim for any such tax paid to the Commonwealth in light of this decision. An important lesson learned from the decision is that taxpayers purchasing services consisting of both taxable and non-taxable labor components should be sure that invoiced charges for non-taxable labor are separately stated from charges for taxable labor (rather than bundled in a single "labor" charge).
Document ID: 2018-2191 | |||||||||
