Synthes U.S. HQ, Inc. v. Commonwealth

Decision Date22 February 2023
Docket Number11 MAP 2021,J-16-2022
CourtUnited States State Supreme Court of Pennsylvania

ARGUED: March 10, 2022

Appeal from the Order of Commonwealth Court at No. 108 FR 2016 dated July 24, 2020, Judgment Entered January 21, 2021, Reversing the decision of the PA Board of Finance and Revenue at No 1409195 dated January 13, 2016 and Remanding.



In this corporate income tax case, we are presented with two discrete questions of law. First, we consider a threshold issue questioning the authority of the Pennsylvania Office of the Attorney General ("OAG") to represent the Commonwealth in this litigation, where it asserts an interpretation of the relevant tax provision contrary to the reading forwarded by the Pennsylvania Department of Revenue ("Department"). The second question requires our interpretation of a provision of the Tax Reform Code of 1971 ("Tax Reform Code") allocating a corporation's sales of services between Pennsylvania and other states for purposes of calculating the corporation's income that is taxable in Pennsylvania. After review, we conclude that the Commonwealth Attorneys Act permits the OAG to take a position on behalf of the Commonwealth that is inconsistent with the position adopted by the Department, but we ultimately reject the OAG's reading of the relevant tax provision in favor of the interpretation presented by the Department. Accordingly, we affirm the order of the Commonwealth Court remanding this case to the Board of Finance and Revenue for calculation and issuance of a tax refund by the Department to the corporate taxpayer, Appellee Synthes USA HQ ("Synthes"), for the 2011 tax year.

As explained in detail below, this case centers upon how Synthes should apportion its income between Pennsylvania and other states in order to calculate its Pennsylvania corporate net income tax. To determine the Pennsylvania income tax for a corporation doing business in multiple states, the Tax Reform Code for the 2011 tax year employed an "apportionment factor," which in turn derives from three other factors: sales, property, and payroll. 72 P.S. § 7401(3)2. (a)(9)(A). As is relevant to the case at bar, the "sales factor" is the ratio of "total sales of the taxpayer in this State" compared to the "total sales of the taxpayer everywhere." 72 P.S. § 7401(3)2. (a)(15).[1] Accordingly, the Tax Reform Code necessitates categorization of which sales are "in this State," or in the parlance of the parties, which sales should be "sourced" to Pennsylvania.

The Tax Reform Code provides separate instructions for different types of sales. The dispute before this Court relates to the allocation of Synthes' sales of services. As applicable to sales of services for the 2011 tax year, the Tax Reform Code instructed,

(17) Sales, other than sales of tangible personal property, are in this State if:
(A) The income-producing activity is performed in this State; or
(B) The income-producing activity is performed both in and outside this State and a greater proportion of the income-producing activity is performed in this State than in any other state, based on costs of performance.

72 P.S. § 7401(3)2. (a)(17) (amended 2013) (hereinafter "Subparagraph 17").

Neither the Tax Reform Code nor the Department's regulations define "income-producing activity" or "costs of performance." To fill this void, the parties offer interpretations of these terms in support of categorizing sales based either upon the location where the taxpayer produces the service, as advocated by the OAG, or conversely the location where the customer receives the benefit of the service, as proffered by the Department. The parties refer to the OAG as employing a "Cost of Performance Method" and the Department as utilizing a "Benefit-Received Method."[2]

While the parties contest the interpretation of the Tax Reform Code, they stipulated to the relevant facts set forth herein. For purposes of the 2011 tax year, the parties agreed that, while Synthes had business activity and paid taxes in multiple states, it was headquartered and maintained its principal place of business in Pennsylvania. Synthes sold research and development services ("R&D services") and management services to its affiliates. The management services included "(1) information technology support service; (2) accounting service; (3) human resource service; (4) legal support service; and (5) purchasing service." Stipulation of Facts at 5-6, ¶ 21.

In 2011, Synthes sold its R&D services to only one customer, Synthes USA LLC, which is a medical device manufacturer. The parties stipulated that "Synthes USA LLC received the benefit of R&D Services at locations in Pennsylvania, Colorado, New York, and in foreign countries where third-party contract manufacturers are located." Id. at 4, ¶ 15. To produce its R&D Services, Synthes incurred costs in the form of "wages paid to employees and other employee-related costs; costs to purchase and maintain equipment and supplies; costs to operate and maintain research labs; and overhead costs (administrative costs, lighting, building systems, etc.)." Id. at 4, ¶ 13. While these costs were incurred in multiple states, "the greater proportion of [Synthes'] costs for providing R&D Services to Synthes USA LLC was incurred in Pennsylvania ... ." Id. at 4, ¶ 14.

For its management services, Synthes had three customers in 2011: Synthes USA LLC; Synthes USA Sales LLC; and Synthes Canada, LTD. The parties agree that these customers received the benefit of Synthes' management services in every state, including Pennsylvania, and in Canada. Synthes incurred the same categories of costs in producing its management services as listed for its R&D services (other than research lab costs), the greater portion of which were incurred in Pennsylvania.

In its initial 2011 tax return, Synthes calculated its sales factor by applying the Costs of Performance Method, sourcing all of its sales of services to Pennsylvania. In April 2014, Synthes timely filed a petition to the Board of Appeals for refund of a portion of its 2011 corporate income tax.[3] Synthes sought to recalculate the sales factor by employing the Benefit-Received Method. Specifically, Synthes sought to exclude from the sales factor numerator the sales of services where the benefit was received by its customers outside of Pennsylvania. Synthes petitioned for a refund of approximately $2 million plus interest. Stipulation of Documents at 23 (Exhibit G: Board of Appeals Petition, unnumbered).

The Board of Appeals sought additional documentation to support Synthes' petition. In April 2015, after reviewing the documents submitted by Synthes, the Board of Appeals denied the refund. While the Board of Appeals agreed with Synthes' use of the Benefit-Received Method, it nevertheless denied the petition concluding that Synthes failed to provide the necessary evidentiary support for its asserted allocation of its sales of services.

In May 2015, Synthes appealed the Board of Appeals' decision to the Board of Finance and Revenue, reasserting its claim to a refund based upon use of the Benefit-Received Method. Synthes argued, inter alia, that the Uniformity Clause of the Pennsylvania Constitution required application of the Benefit-Received Method, given the Department's long-standing practice of applying that sourcing method to other corporate taxpayers.[4]

The Board of Finance and Revenue denied Synthes' petition for refund in January 2016.[5] Without speaking to the proper sourcing method or the merits of Synthes' Uniformity Clause claim, the Board of Finance and Revenue concluded that Synthes failed to meet its evidentiary burden to demonstrate that its receipts derived from income-producing activities in states outside Pennsylvania, as was required to trigger application of Subparagraph 17(B).

In February 2016, Synthes filed a petition for review of the Board of Finance and Revenue's order in the Commonwealth Court, naming the Commonwealth of Pennsylvania as respondent as required by Pa.R.A.P. 1571(c).[6] As before the other tribunals, Synthes sought to exclude from the sales factor numerator all receipts from sales of services "where the benefit was received outside Pennsylvania." Petition for Review ¶ 10(c)(ii). It reiterated that failure to grant recalculation would violate the Uniformity Clause as its income would be "apportioned to Pennsylvania in a greater concentration than other similarly situated taxpayers."[7] Id. at 10(d)(iv)(B).

Following various proceedings and Synthes' submission of additional information, Synthes and the Commonwealth, as represented by the OAG, filed a joint stipulation of facts and stipulation of documents in November 2019. [8] The parties stipulated that, if the Benefit-Received Method applied, then Synthes would be entitled to a refund of $2,138,271.00 for the 2011 tax year but that no refund would be issued if the Costs of Performance Method applied. Stipulation of Facts at 18 ¶ 70-71.

The parties agreed that the Department has utilized the Benefit-Received Method as a "consistent and deliberate policy and practice," explaining that the Department interpreted the term "'income-producing activity' in Subparagraph 17 as the receipt of the benefit of the taxpayer's service," which it deemed to occur "at the customer's location." Id. at 9, ¶ 37. While recognizing the practice the parties stipulated that the Department did not publish formal guidance on the use of the method until 2014. Id. at 10, ¶ 40; 14, ¶ 54; see Pa. Dep't of Revenue, Information Notice - Corporation Taxes 2014-01. Moreover, the parties detailed that the...

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