The Last Hurrah for Pennsylvania’s Capital Stock and Foreign Franchise Tax

by Vito A. Cosmo Jr., CPA, CGMA | Aug 31, 2017
Pennsylvania CPA Journal
Barring a cataclysmic event, such as the Pennsylvania legislature reinstating the Capital Stock and Foreign Franchise Tax (CSFFT), this may be my last article on this most complex and often maligned tax. For what it’s worth, I loved this tax. No tax had so many nooks and crannies in the areas of book income and apportionment methods. I pored over statutes, regulations, and a plethora of cases over the past 30 years. Now, it’s (almost) gone.

The CSFFT was phased out of existence as of Dec. 31, 2015, but there may still exist refund opportunities before the general three-year statute of limitation lapses or where the general statute of limitations has been held open pursuant to an audit. 

Pennsylvania imposed the CSFFT on corporations that were either incorporated in Pennsylvania or that conducted business in the state. The tax was imposed upon taxable capital, which was determined under a fixed formula using an average of capitalized history of earnings and net worth. Multistate taxpayers could use either single-asset factor apportionment or three-factor apportionment.

Several exemptions apply. For instance, corporate taxpayers may lower their CSFFT three-factor apportionment by claiming an exemption for property and payroll used directly and indirectly for manufacturing, processing, or research and development (R&D) activities.2 The exemption permits a taxpayer to reduce its property and payroll numerators by the amount of property and payroll attributed exclusively to manufacturing,3 processing, or R&D (exempt activities). Property and payroll that are partially or indirectly involved in the exempt activities can also qualify for the exemption. They include, but are not limited to, headquarters and administrative payroll and property that oversee manufacturing conducted both within and without Pennsylvania. This is an important distinction (i.e., payroll and property within Pennsylvania overseeing manufacturing activities conducted outside Pennsylvania) and came about from the 2001 decision of PPG Industries Inc. v. the Commonwealth of Pennsylvania. Gross receipts attributable to these activities are not exempt by statute. (Prior to the PPG decision, and subsequent law changes, manufacturing sales were exempt.)

As discussed above, a taxpayer can use administrative/other property and payroll that are indirectly involved in manufacturing, processing, and R&D activities to increase the manufacturing exemption. The increase is limited to the portion of the property and payroll that is attributable to exempt activities, often measured by total manufacturing sales divided by total sales. Pennsylvania allows the piece of indirect property and payroll in the exemption, because the manufacturing exemption is a business-based exemption and is not activity-based.

Clients that have a presence in Pennsylvania and are engaged in exempt activities may not be aware of this broader classification.

If it is determined that a client is not including all of its exempt property and payroll in the manufacturing exemption, a refund petition should be filed with the Pennsylvania Department of Revenue Board of Appeals. Because of the Pennsylvania statute of limitations, petitions can only be filed within three years from the date the return was filed. The returns from the open years should be examined to determine the tax benefit of filing a petition versus the costs. 

Single-Asset Factor Opportunities 

A similar analysis may be conducted for corporations using the single-asset factor for apportionment. This formula takes into account a ratio of taxable Pennsylvania assets to total assets found in the entity’s separate-company balance sheet. Therefore, intangible assets are also used in this formula.5 In addition, under this methodology, the following items should be examined to maximize the exemption:
  • U.S. and state/municipal obligations, which are exempt assets under this formula.
  • Investments in subsidiaries, including limited liability companies, calculated under the equity method of accounting, are exempt under this formula. Any percentage investments in Pennsylvania corporations are exempt, and more than 50 percent investment in non-Pennsylvania corporations are exempt. This rule may violate the commerce clause of the U.S. Constitution because investments in domestic corporations appear to be treated more favorably than investments in non-Pennsylvania corporations.
  • Pennsylvania holding company exemption, which provides for a flat 10 percent apportionment if the 60 percent asset test and the 90 percent income test are met.6 This analysis is critical. I personally helped a company lower its apportionment percentage by half through employing a careful analysis of their facts. 

Transactional-Based Opportunities

In addition to the above opportunities, here are some lesser-known transactional-based opportunities:
  • Internal Revenue Code (IRC) Section 338(h)(10), Gains – The CSFFT calculation, including the average net income and net worth amounts,7 does not specifically adhere to items reported pursuant to the IRC. Instead, a taxpayer is generally required to report these amounts “per books on the income tax return filed by the entity with the federal government for such taxable year, or if no such return is made, as would have been set forth had such a return been made.” Accordingly, gains from IRC Section 338(h)(10) transactions should not be included in the five-year history of earnings section of the Pennsylvania corporate tax report in order to calculate average net income.8 Rather, book gain on the actual sale of stock should be included in this calculation. If such book gain is significantly lower, a refund opportunity may exist.
  • Book income – While Pennsylvania’s adherence to book concepts under the CSFFT usually means generally accepted accounting principles (GAAP), it is not always GAAP. If a company keeps its books on another comprehensive basis of accounting, or if it is able to do so, a comparison of the gains on dispositions pursuant to these different types of methods should be made to determine whether the gain can be reported at a lower value than previously envisioned.
  • Distortion – If the disposition or extraordinary event results in a distortive capital stock value as compared to other valuation methods, distortion can be argued against the use of the CSFFT “fixed formula.”9 Cases such as Complete Auto Transit v. Brady and Hans Rees’ Sons Inc. v. North Carolina can be referenced as support.10 However, to succeed on this argument, a burden of proof “plainly rests with the taxpayer,” according to Justice Leadbetter in her concurring opinion in the Shawnee Development Inc. v. Commonwealth of Pennsylvania decision.11
You may be thinking, “Vito, the rate dropped to .45 mills in the final year of the tax, down from a high of 13 mills 20 years ago. What real opportunity exists here?” Fair comment, but I continue to see some big numbers (any rate applied to a big number can still be a big number), and I would not discount that there could be an opportunity.  

1 All Pennsylvania taxpayers may use the single-asset factor apportionment formula, even those that would not normally have a “right to apportion.” 
2 Pennsylvania Reform Tax Code, Sec. 602(a), (b) Act of March 4, 1971, P.L. 6, [72 P.S. Section 7602].
3 “Manufacturing” is not defined by statute, but the courts have generally construed manufacturing as a process that brings about the production of some new article by the application of skill and labor to the original material out of which such new product emerges. “Processing” is defined by statute, and a number of processes are enumerated.
4 The CSFFT manufacturing exemption is broader than the activity-based exemption found in the Pennsylvania sales and use tax statutes. See PA TRC Code Sec. 201(a) and 602(a).
5 Under this formula, even a company domiciled outside Pennsylvania will be treated as a domestic entity and will be required to include all intangibles in its Pennsylvania numerator, unless an exemption applies.
6 The 60 percent asset test is met if at least 60 percent of the entity’s assets consist of stock, securities, or indebtedness of subsidiary corporations, and the 90 percent income test is met if at least 90 percent of an entity’s gross income consists of dividends, interest, gains from the sale of stock or securities, or management fees from subsidiary corporations.
7 72 Pa. Cons. Stat. Section 7601(a) (“average net income”), (“net worth”).
8 Id.
9 See Pennsylvania Tax Update No. 93, Pennsylvania Department of Revenue, May/June/July 2001.
Complete Auto Transit v. Brady, 430 U.S. 274 (1977); Hans Rees’ Sons Inc. v. North Carolina ex rel. Maxwell, 283 U.S. 123 (1931).
11 799 A.2d 882 (Pa. Commw. 2002).

Vito A. Cosmo Jr., CPA, CGMA, is a managing director, state and local taxes, with Grant Thornton LLP in Philadelphia. He can be reached at
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