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By Jonathan Liss

One of my favorite things about state and local taxation (SALT) is how it is constantly changing. Politics, the economy, and judicial decisions all significantly impact the formulation of tax policy. As I’ve always enjoyed monitoring the constant changes taking place in the SALT world, I thought it would be interesting to highlight some of the more significant trends SALT practitioners have grappled with over the years.

Mandatory Unitary Combined Reporting

Despite taxpayers’ efforts to challenge the scope of unitary combined reporting, the courts have consistently upheld the tax authorities’ broad application of the unitary method.

By 2001, 16 states had adopted mandatory unitary combined reporting as a corporation income tax filing methodology. Today, 28 states and the District of Columbia have implemented it. Some separate reporting states, like South Carolina, use their alternative apportionment rules to forcibly combine companies, effectively becoming combined reporting states.

The term “unitary combined reporting” itself is intimidating, even for those of us who understand the concept of unity. Unitary combined reporting has its roots in 19th century railroad taxation, with the question of whether a state could tax only the value of a transcontinental railroad company’s property physically located within its borders or whether it could tax an apportioned share of the entire value of the transcontinental railroad system. The unitary business principle was first applied in the 1940s to multicorporate businesses in the Butler Brothers and Edison California cases. In 1980, the U.S. Supreme Court held in Mobil Oil Corp. v. Commissioner of Taxes of Vermont¹ that the linchpin of apportionability is the unitary business principle.

For years, mandatory unitary combined reporting has been used to counter state tax planning strategies that shifted income to passive investment companies (PICs) or Delaware holding companies (DHCs) through intercompany transactions. Mandatory unitary combined reporting has been proposed in Pennsylvania in many previous legislative sessions. Gov. Tom Wolf proposed it in his budget address for fiscal year 2021 along with an incremental reduction in the corporate net income tax (CNIT) rate. Senate Bill 1032, introduced by state Sen. Christine Tartaglione (D-Philadelphia) on March 3, 2020, would implement MUCR and reduce the CNIT rate from 9.99% to 6.99% over several years. This bill is currently pending in the Senate Finance Committee.

Sales and Use Taxation of Cloud Computing

Some readers might recall that computer software was once delivered in a physical form to customers. Taxability was a relatively straightforward determination – canned software was clearly tangible personal property subject to sales tax. But when end users were able to download software from a vendor’s website directly, questions began to arise. Then, as web-based infrastructure was developed, more firms began hosting their software and licensing subscriptions to access software remotely.

Software-as-a-service (known as SaaS) is a cloud computing model in which a customer is given access to an application that is owned, operated, and maintained by a provider. The customer typically purchases access from the vendor on a subscription basis and accesses the software over the internet. The software is not transferred to the customer, and the customer is not given the right to download, copy, or modify it.

The taxability of SaaS continued to evolve as states began to address the issue through private letter rulings, tax department pronouncements, court cases, and the adoption of statutes specifically addressing SaaS transactions. Currently, more than 20 states tax SaaS explicitly as an enumerated service or within the definition of an existing taxable service, such as software, information services, or data processing. Taxpayers should not rely on one particular state’s treatment of SaaS to be uniform with the treatment in other states.

The Pennsylvania Department of Revenue’s guidance on the sales and use tax consequences of cloud computing² provides that SaaS is taxable in Pennsylvania to the extent that the users of the service are located in Pennsylvania. The department’s position is that the charge for electronically accessing taxable software is taxable because computer software is tangible personal property, and the user is “exercising a license to use the software.”³ The exercise or right or power incidental to the ownership of tangible personal property constitutes a taxable “use.”

Gross Receipts Taxes

It seems that some anticipated trends don’t materialize … or at least not as quickly as presumed.

Gross receipts taxes became popular in the late 1920s and early 1930s. As a result of the Great Depression, states were looking for a stable source of revenue. The first states to adopt broad-based gross receipts tax were Delaware (1913), West Virginia (1921), Washington (1933), and Indiana (1933). Ohio enacted its commercial activity tax (CAT) in 2005 as part of sweeping tax reform. Four other states adopted gross receipts taxes and subsequently repealed them.

At present, only six states impose a tax based on gross receipts: Delaware, Washington, Ohio, Texas (2008), Nevada (2015) and, most recently, Oregon (2020). When the Ohio CAT was enacted, many practitioners expected other states to follow suit and propose similar taxes. After all, gross receipts taxes are less volatile than other tax types. Perhaps the states recognized the policy arguments against gross receipts taxes, such as their complexity and the effects of “tax pyramiding” - taxing the same economic value multiple times in the production process.

Many municipalities and school districts in Pennsylvania impose a business privilege or mercantile tax that is based on gross receipts. The Philadelphia business income and receipts tax (BIRT) has two components: a tax on net income and a gross receipts tax.

As states grapple with the economic fallout of the COVID-19 pandemic, policymakers are searching for new taxes to close the resulting budget deficits and provide stable, long-term revenue sources. Going forward, perhaps gross receipts taxes will once again receive attention from legislators in considering new options for raising revenue.

These are just a few of the trends that have kept the SALT world fully occupied for many years. I look forward to what the future has in store.

¹ Mobil Oil Corp. v. Commissioner of Taxes of Vermont, 445 U.S. 425 (1980)
² Pennsylvania Sales and Tax No. SUT-12-001 Cloud Computing (May 31, 2012)
³ 72 P.S. Section 7201(o)(1)

Jonathan Liss is senior revenue policy analyst for the City of Philadelphia. He can be reached at jonathan.liss@phila.gov.

For more coverage of all things tax, clear your schedule and plan to attend PICPA’s Tax Con on Nov. 10-11.

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