July 18, 2022
Pennsylvania enacts corporate income tax rate reduction and other tax changes
On July 8, 2022, Pennsylvania Governor Tom Wolf signed into law HB 1342 (Act 53), which includes a long-sought-after reduction to the corporate income tax rate. The law also applies market-based sourcing rules to receipts from sales of intangibles, codifies the Pennsylvania Department of Revenue's economic nexus standard for corporate income taxes, conforms to select Internal Revenue Code (IRC) provisions, imposes sales and use tax on peer-to-peer car sharing, and modifies various tax credit and economic development zone provisions.
Gradual reduction of corporate income tax rate
Starting in 2023, the current 9.99% corporate income tax rate will decrease to 4.99% over nine years. The rate reductions are as follows:
Market-based sourcing for intangible
Prior law sourced receipts from sales of intangibles (e.g., receipts from patents, royalties, franchise agreements, securities, loan interest) based on a costs-of-performance method. Effective for tax years beginning after December 31, 2022, these receipts will be sourced using the market-based sourcing method. This change aligns the sourcing method for sales of intangibles with the method already being used for sourcing sales of services, tangible personal property and real property.
Specifically, gross receipts from the following will be sourced to Pennsylvania:
Intangible property not otherwise described is excluded from the sales factor numerator and denominator. Under this provision goodwill arising from the sale of a business and gross proceeds/gains from hedging transactions will be excluded from the sales factor numerator and denominator.
For purposes of these sourcing provisions, an "unaffiliated entity" is defined as any entity that is not an affiliated entity, as defined under section 401(10).
The law directs the Pennsylvania Department of Revenue (PA DOR) to adopt regulations necessary to implement these provisions.
Corporate income tax nexus
The law codifies the PA DOR's economic nexus standard for corporate net income taxes, which was announced in response to the U.S. Supreme Court's decision in South Dakota v. Wayfair, Inc.1 In Corporation Tax Bulletin 2019-04 (revised August 6, 2020), the PA DOR said it will deem there to be a rebuttable presumption of a filing requirement for corporations without physical presence in Pennsylvania if they have $500,000 or more of Pennsylvania-sourced gross receipts. The new law includes a rebuttable presumption that a corporation with $500,000 or more of sales sourced in the current tax year to Pennsylvania under section 401 has substantial nexus in Pennsylvania without regard to physical presence in Pennsylvania.
Under the new law, corporate net income tax applies to corporations that have "substantial nexus" with Pennsylvania. The law defines "substantial nexus" as "a direct or indirect business activity that is sufficient to grant the commonwealth authority under the [US] Constitution … to impose tax … and for which a basis exists … to apportion or allocate the corporation's income to [the] commonwealth." Business activities include (1) leasing or licensing intangible property that is used in the commonwealth, (2) regularly engaging in transactions with in-state customers involving intangible property (such as loans), or (3) selling intangible property that was used by a corporation in the commonwealth.
The newly added nexus provisions do not apply to affiliated entities domiciled in a foreign nation that has entered into a comprehensive income tax treaty with the US providing for the allocation of all categories of income subject to tax, or withholding of tax, on royalties, licenses, fees and interest in order to prevent double taxation of the foreign entity.
These changes apply to tax years beginning after December 31, 2022. A potential refund opportunity may exist for corporate taxpayers that filed Corporate Net Income Tax reports beginning in 2020, in accordance with Corporate Tax Bulletin 2019-4.
As a result of the rules for sourcing interest received from an unaffiliated entity, an out-of-state domiciled affiliated finance company should not have nexus with Pennsylvania through its lending activities with an affiliate based or operating in the commonwealth.
IRC conformity — personal income tax
For personal income tax purposes, the law conforms to the following IRC provisions:
Both these changes apply to property placed in service/transactions occurring in tax years beginning after December 31, 2022, respectively.
The law also makes a technical change, codifying in the Pennsylvania Tax Reform Code the personal income tax treatment of forgiven Paycheck Protection Program (PPP) loans, which follows the federal tax treatment of exempting forgiven PPP loans from income tax and allowing a deduction for expenses paid with forgiven PPP loan proceeds. The law repeals similar provisions that were added to the Fiscal Code by Act 1-2021.
Other tax changes
The new law makes other tax changes, including the following:
After many years of considering corporate net income tax rate reductions, Pennsylvania corporate net income taxpayers will see the rate reduced over the next nine years. Unlike other states that have recently enacted reductions in their income tax rate, Pennsylvania's rate reductions are scheduled and do not depend on revenue thresholds being met in order to take effect.
The reduction in the corporate income tax rate generally aligns with Governor Wolf's budget proposal released in February, albeit accomplished on a different timeline. The enacted legislation does not include changes to the commonwealth's related-party addback provisions, which the governor had sought.
Taxpayers required to collect and remit the tax on peer-to-peer car-sharing programs will need to update their systems and processes to account for the tax.
1 South Dakota v. Wayfair, Inc., 138 S.Ct. 2080 (2018).