Testimony

Testimony Before the Pennsylvania Senate Special Session Committee on Legislation

Presented by J. Andrew Weidman, CPA, and
William R. Lazor, CPA/PFS, CSEP
Representing the Pennsylvania Institute of Certified Public Accountants

January 18, 2006

Good morning, Chairman Wenger, Chairman Wozniak and members of the Senate Special Session Committee on Legislation. Thank you for the opportunity to present testimony on behalf of the 19,000 members of the Pennsylvania Institute of Certified Public Accountants. My name is Andy Weidman, and I am the president-elect of the PICPA and managing partner of Reinsel Kuntz Lesher, a CPA firm headquartered in Wyomissing, Pennsylvania.

The PICPA represents CPAs in business and industry, public practice, government, and education. Our members advise clients on federal, state, and international tax matters, and prepare income and other tax returns for thousands of Pennsylvania taxpayers. They provide services to individuals, not-for-profit organizations, small and medium-sized employers, as well as Pennsylvania's largest employers. It is from this broad perspective that we offer our thoughts today.

Joining me this morning is Bill Lazor, a CPA and partner with Kronick Kalada & Berdy, located in Kingston, Pennsylvania. Bill also is a past president of the PICPA.

The PICPA opposes the expansion of the sales and use tax base to fund property tax relief, as currently proposed by Senate Bill 854, Printer's Number 1429. This legislation violates a number of principles of good tax policy, including certainty, simplicity and neutrality, which I will discuss in greater detail.

First, let me say that this is not an issue, in the PICPA's view, that should pit business against consumer. It is fundamentally about having a tax policy in Pennsylvania that will enhance economic growth and efficiency, not impede or reduce its productive capacity.

The PICPA is a strong proponent for tax simplification. As you may know, we have been working with Sen. Scarnati on Senate Bill 292, legislation streamlining the local earned income tax collection system.

Senate Bill 854 is not tax simplification. It can easily be called a full employment act for Pennsylvania CPAs and attorneys, but I believe with some certainty that most of our members don't want to earn their livelihood trying to interpret the provisions of this legislation.

I would now like to review the tax principles we believe Senate Bill 854 violates.

Certainty
Tax policy should specify when a tax is to be paid, how it is to be paid, and how the amount to be paid is to be determined. A tax system's rules must enable taxpayers to determine what is subject to tax, i.e., the tax base. Taxpayers should be able to determine their tax liabilities with reasonable certainty based on the nature of their transactions. If the transactions subject to tax are easily identified and valued, the principle of certainty is more likely to be attained. On the other hand, if the tax base is dependent on subjective valuations or transactions that are difficult to categorize, the principle of certainty might not be attained. As currently drafted, Senate Bill 854 does not provide certainty. The legislation does not clearly tell us what is subject to the tax. The definition of 'management consulting services" is extremely broad and poorly defined. In fact, one could make the argument that under this bill "financial planning" could include some accounting services. But the services that would be taxable is unknown to us.

Simplicity
Tax law should be simple so taxpayers can understand the rules and comply with them correctly and in a cost-efficient manner. Simplicity in the tax system is important both to taxpayers and to the Department of Revenue. Complex rules lead to errors and disrespect for the system, which can reduce compliance. Simplicity is also important both to improve the compliance process and to enable taxpayers to better understand the tax consequences of transactions in which they engage in or plan to engage.

With taxation of services as proposed in Senate Bill 854, a service provider may be located in one taxing jurisdiction while the customer of the service is located in another taxing jurisdiction. Taxation of services must take into account not only what services to tax, but also where the transaction is to be held taxable. General sourcing rules and definitions do not work for services, because such services frequently involve--but are not limited to--multiple points of delivery/use; multiple points of creation; multiple sub-service providers; multiple delivery dates of partial products; and, multiple taxing jurisdictions. The legislation violates this principle by not providing guidelines on where the service should be taxed.

Neutrality
The effect of the tax law on a taxpayer's decisions as to how to carry out a particular transaction or whether to engage in a transaction should be kept to a minimum. That is, taxpayers should not be unduly encouraged or discouraged from engaging in certain activities, or taking certain courses of action, primarily due to the effect of the tax law on the activity or action. The primary purpose of a tax is to raise revenue for governmental activities, rather than to influence business and personal decisions.

Related to neutrality is the principle of economic growth and efficiency. The tax system should neither discourage nor hinder economic growth, capital formation, and competitiveness. Senate Bill 854 violates this principle.

For example, small and emerging businesses are especially disadvantaged under Senate Bill 854. These businesses generally must purchase services that larger businesses may provide internally. These small businesses will bear not only the higher cost of an externally provided service but the tax on that service as well. Further, the additional compliance costs associated with such a tax are proportionally greater for small businesses and make up a higher percentage of their total purchases. A tax on services also creates an incentive for larger business not to contract-out services to small businesses or independent contractors because of the additional cost burden of the tax.

Cash flow could be impacted particularly for new start-up entities as well. For example, suppose I provide a "management consulting service" to a client, and the cost of that service is $1,000. After adding 6 percent sales tax, I bill the client $1,060. I remit the $60 as part of my next quarterly sales tax payment to the Commonwealth, but my client doesn't pay me for three months. This requires the taxpayer to float its sales tax payment until payment is actually received.

Also, sometimes in today's business world, the $1,000 invoice may be adjusted after the initial bill is sent. I have already paid the full sales tax due, but the sales tax base is less than the original transaction base.

Now, I would like to hand over this discussion to Bill Lazor, who will detail specific problems found in Senate Bill 854.

Thank you. Good afternoon senators.

One aspect of Senate Bill 854 that has not been widely discussed is the definition of "Purchase price." This definition states, in part, that "In determining the purchase price on the sale or use of taxable tangible personal property or a service where, because of affiliation of interest between the vendor and purchaser, or irrespective of any such affiliation, if for any other reason the purchase price declared by the vendor or taxpayer on the taxable sale or use of such tangible personal property or service is, in the opinion of the Department of Revenue, not indicative of the true value of the article or service or the fair price thereof, the department shall … determine the amount of constructive purchase price upon the basis of which the tax shall be computed and levied."

The definition goes on to say, "There shall be a rebuttable presumption, that because of such common interest such transaction was not at arms-length."

We read this language as giving vast and unfettered new powers to the Department of Revenue that mirror the Internal Revenue Service's 482 powers. Section 482 of the Internal Revenue Code (IRC) authorizes the IRS to reallocate income among commonly controlled corporations when necessary to prevent the evasion of taxes or to properly reflect the income of related parties. Congress enacted 482 to ensure that commonly controlled corporations report and pay tax on their actual share of income arising from related party transactions. The IRS has a vast array of personnel with expertise in many areas of tax law and related matters to properly and fairly evaluate these transaction.

Moreover, our reading of Senate Bill 854 leads us to conclude that inter-company transactions would be subject to a 6 percent sales tax. It is common practice in today's business world to push down administrative or management functions at cost to inter-company affiliates. There are legitimate business reasons to do this. This would be a significant economic burden to many employers in the state of Pennsylvania.

Another issue that has not gained a lot of attention is the impact Senate Bill 854 would have on senior citizens. Consider a 65-year old who retires the day that these sales tax changes take effect. While she worked, her income exceeded her consumption, and she paid income taxes. Now in retirement-when her consumption will exceed income-she will be asked to pay more in consumption taxes. Senate Bill 854 will penalize these individuals.

There's also the issue of federal tax deduction. For those individuals or couples who itemize their federal tax returns, their overall tax liability may actually increase because, in most cases, sales taxes paid would not be enough to offset their state tax payments.

In closing, the PICPA applauds the commitment each member of the Senate and the House have shown on this complex and politically challenging issue; however, property tax relief should not be paid for on the back of Pennsylvania's already over-taxed business community.

Thank you for the opportunity to share our thoughts on this important issue. We will be happy to answer your questions.