Exclusion of certain receipts from the sales factor
The newly enacted market-based sourcing statute categorizes certain types of receipts from intangible income and sets forth rules for sourcing those receipts. The statute also provides a catch-all throwout rule stating that receipts received from goodwill or intangible property not otherwise described in the statute should be excluded from the numerator and denominator of the sales factor. Bulletin 2024-01 clarifies that the sales factor exclusion includes but is not limited to: “workforce in place, contracts in place, going concern value, patents and copyrights, customer lists, and any covenant not to compete entered into in connection with the acquisition of an interest in a trade or a business.” Such receipts should be excluded from both the numerator and denominator of a taxpayer’s Pennsylvania sales factor for tax years beginning on or after Jan. 1, 2023. The exclusion of goodwill from the sales factor could have a significant impact on apportionment for taxpayers divesting a portion of their business in a given year.
Sourcing receipts from intangibles
The statute provides that receipts from lease or license of intangible property are sourced to Pennsylvania if the intangible is used in the state. This ‘use’ rule also applies to a sale or exchange of property where the receipts from the sale or exchange derive from payments that are contingent on the productivity, use or disposition of the property. However, the statute does not define what constitutes ‘use’ of an intangible. Bulletin 2024-01 provides illustrative examples of certain activities that the department will consider to be in-state use. These include receipts from royalties for the use of trademarks, receipts from the use of patents in the production and manufacturing process, and receipts from the use of intellectual property in advertising.
For example, the department provides an example whereby a Delaware holding company receives royalty income from a related company in Pennsylvania for the use of trademarks owned by the Delaware holding company. In this case, all royalty revenue received from the Pennsylvania affiliate is sourced to Pennsylvania. Bulletin 2024-01 also provides examples for sourcing the sale of intangible property where the property sold is a contract right, government license or similar property that authorizes the holder to conduct a business activity in a specific geographic area, which is another category of intangible property contemplated by the statute. For example, a Virginia based company receiving payment from a customer for the exclusive right to bake and distribute bread within Pennsylvania is sourced entirely to Pennsylvania under the guidance within Bulletin 2024-01.
Sourcing receipts from securities
The statute provides that receipts from securities that are held primarily for sale to customers are included in the Pennsylvania sales factor if the taxpayer’s customers are located in the state. A comment in Bulletin 2024-01 clarifies that the department considers “held by the taxpayer primarily for sale to customers” as requiring greater than 50% of the taxpayer’s total receipts be from these transactions. Bulletin 2024-01 also provides that, in the case of an individual, the taxpayer’s customer will be considered located in Pennsylvania if they are a resident of this state.
Sourcing of interest
The statute provides rules for sourcing interest received from loans by companies regularly engaged in lending funds to unaffiliated entities. Bulletin 2024-01 clarifies that ‘unaffiliated’ applies to entities only, and interest received from individuals should be sourced under a separate rule. Bulletin 2024-01 also provides explanatory examples for how to source interest from 1) loans related to real property, 2) loans related to the sale of tangible property, and 3) loans not otherwise described. Additionally, the statute has a catch-call provision that other receipts from interest not described in the statute are in this state if the commercial domicile of the lender is in the state. A comment in Bulletin 2024-01 clarifies that this catch-all provision applies to entities that regularly lend funds and to entities that do not regularly lend funds.
Takeaways
Bulletin 2024-01 offers taxpayers additional clarity as to how the department plans to apply the new sales factor sourcing rules. Many examples from Bulletin 2024-01 are similar to the manner in which the department interpreted the sales factor sourcing statute prior to 2023. Taxpayers and practitioners should keep in mind that Pennsylvania also adopted an economic nexus threshold of $500,000 in Pennsylvania sourced sales under the legislation enacted in 2022. The application of the new sales factor sourcing rules and guidance issued in Bulletin 2024-01 could trigger income tax nexus for out-of-state companies when combined with this economic threshold.
Taxpayers with questions about the application of Bulletin 2024-01 should contact their Pennsylvania corporate income tax advisors.
