Synthes USA HQ, Inc. v. Commonwealth

CourtCommonwealth Court of Pennsylvania
Citation236 A.3d 1190
Docket NumberNo. 108 F.R. 2016,108 F.R. 2016
Parties SYNTHES USA HQ, INC., Petitioner v. COMMONWEALTH of Pennsylvania, Respondent
Decision Date24 July 2020

Frank J. Gallo, Philadelphia, for petitioner.

Neil P. McConnell, Senior Deputy Attorney General, Harrisburg, for respondent.

Kenneth L. Joel, Deputy General Counsel, Harrisburg, for intervenor.



Synthes USA HQ, Inc. (Synthes) petitions for review from a decision of the Board of Finance and Revenue (Board). The Board affirmed a decision of the Department of Revenue (Department) denying a corporate net income tax refund sought by Synthes for the 2011 tax year.1

The Commonwealth, through the Attorney General (Commonwealth), is the respondent before this Court.2 The Commonwealth has taken a position before this Court that would alter drastically the Department's longstanding interpretation of a corporate net income tax provision applicable to pre-2014 tax years. The Department has therefore applied to intervene. This Court listed the application to intervene for disposition with the merits.

After thorough review, we grant the Department's application to intervene, reverse the decision of the Board, and remand to the Board for a further remand to the Department to issue an appropriate tax refund to Synthes.

I. Background

Synthes, a Pennsylvania-based corporation, provides research, development, and management services to affiliates located outside Pennsylvania. In calculating its 2011 Pennsylvania corporate net income tax, Synthes determined its percentage of out-of-state sales of services by applying an interpretation of the Tax Reform Code of 19713 (Tax Code) that differed from the interpretation the Department had consistently applied for many years. Synthes later requested a refund because the Department's interpretation of the Tax Code would have resulted in a lower tax. The Department denied the refund request because it found Synthes failed to present sufficient evidence to demonstrate where its sales occurred.

Synthes appealed to the Board, which upheld the Department's refund denial, agreeing that Synthes did not satisfy its burden of proof. See Br. of Resp't at 10; Stipulated Facts ¶¶ 66, 68, Ex. D at 95, Ex. E, Ex. F at 101-02. Synthes then petitioned for review in this Court.4

The Commonwealth acknowledges that Synthes eventually established the evidence needed to support its refund claim under the Department's interpretation of the Tax Code, once its claim had reached this Court. See Br. of Resp't at 10; Stipulated Facts ¶¶ 12, 15-16, 18-20, 24-33, 63-64. The Department does not contend otherwise. The Commonwealth argues, however, that the Department's interpretation of the Tax Code was in error and is not entitled to any deference from this Court. Thus, the Commonwealth contends Synthes is not entitled to a tax refund, but for a different reason from that found by the Department and the Board.

The Department, as putative intervenor, maintains that its interpretation of the Tax Code concerning calculation of Synthes's Pennsylvania sales was correct. Indeed, that interpretation was not placed at issue until the Commonwealth raised it before this Court. The Department therefore seeks to intervene and be heard on the issue along with the parties.

Synthes argues that regardless of which calculation method was correct, Synthes is entitled to the same tax break other taxpayers received from the Department.

II. Issues

Synthes asserts two arguments before this Court. First, Synthes contends the Department's interpretation of the Tax Code was correct regarding calculation of the sales factor for apportioning corporate net income tax among multiple states. Like the Department, Synthes argues its sales of services should be apportioned according to where customers received the benefits of Synthes's services, not where Synthes incurred costs of performing those services.

Second, Synthes asserts it is entitled to a tax refund based on the Department's interpretation of the Tax Code, even if the Department's interpretation was incorrect and Synthes used the correct calculation method at the time it paid the tax. Synthes insists the Department must accord Synthes the same tax break it gave other corporate taxpayers, as required by the Uniformity Clause of Article VIII, Section 1 of the Pennsylvania Constitution.5

III. Discussion

A. Tax Code – Subparagraph 17

In Pennsylvania, a corporation with taxable business activities in more than one state must apportion its income among the applicable states for income tax purposes, using a formula provided in the Tax Code. The statutory formula includes a property factor, a payroll factor, and a sales factor. See Sections 401(3)2.(a)(2) and 401(3)2.(a)(9)(A)(iv) of the Tax Code, 72 P.S. §§ 7401(3) 2.(a)(2), 7401(3)2.(a)(9)(A)(iv). Only the sales factor is at issue in this case.6

The taxpayer's income from sales of services is taxed based on the proportion of its sales that occur in Pennsylvania. The sales factor is expressed as a fraction. The numerator is the dollar amount of the taxpayer's sales in Pennsylvania for the applicable tax year. The denominator is the taxpayer's total sales everywhere for the tax year. 72 P.S. § 7401(3) 2.(a)(15).

Synthes sells services to customer affiliates located in other states. Thus, the question here is whether sales of services by Synthes, a Pennsylvania corporation, to businesses outside Pennsylvania constitute sales in Pennsylvania or sales where the purchasing businesses are located, for purposes of calculating the sales factor.

Under the Tax Code as it applies to this case,7 a sale of a service occurs in Pennsylvania 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 [ (costs-of-performance method) ].

72 P.S. § 7401(3) 2.(a)(17) (Subparagraph 17). The Tax Code does not define either "income-producing activity" or "costs of performance."

B. Intervention by the Department

In support of its application for intervention, the Department points out that it is the agency charged with settling and collecting taxes for the Commonwealth, as well as issuing refunds when appropriate.8 See Br. of Intervenor at 4-5 (citing Sections 201 – 203 and 206 of the Fiscal Code,9 72 P.S. §§ 201 - 203, 206 ; Sections 201-212, 401(7), 407.1, 407.3(d), 407.5, and 3003.1 of the Tax Code, 72 P.S. §§ 7201-12, 7401(7), 7407.1, 7407.3(d), 7407.5,10 and 10003.111 ). The Department also observes that it is a party to proceedings before the Board. Br. of Intervenor at 5 (citing Section 704(d.1)(2) of the Fiscal Code, 72 P.S. § 704(d.1)(2) ). As such, the Department was entitled to intervene as of right within 30 days after notice of filing of the petition for review, or thereafter by obtaining permission to intervene. Pa. R.A.P. 1531(a). However, the Department asserts it was not subject to the 30-day requirement because Synthes failed to name the Department as a Respondent and include a Notice to Participate directed to the Department. Br. of Intervenor at 6 (citing Lautek Corp. v. Unemployment Comp. Bd. of Review , 136 Pa.Cmwlth. 79, 583 A.2d 7, 9-10 (1990) ).

Alternatively, the Department argues that even if it needs permission to intervene, this Court should grant such permission. The Department contends it did not become fully aware of the Commonwealth's position concerning interpretation of Subparagraph 17 until the Commonwealth filed its brief in January 2020.12

The Commonwealth has not taken a position either supporting or opposing the Department's application for intervention. Synthes initially opposed the Department's request for intervention, but withdrew its opposition at oral argument.

The Department has a clear interest in the Tax Code issue presented in this case. The Department was entitled to intervene as of right within 30 days after notice of the petition for review. No other party contends that any prejudice would arise from allowing the Department to intervene at this point. For these reasons, we grant the Department's application for intervention.

C. Synthes's Refund Request

The parties have stipulated that Synthes's customers received the benefits of Synthes's services outside Pennsylvania. See Stipulated Facts, ¶ 63, Ex. C. However, Synthes incurred costs in performing its services for its affiliate customers, and most of those costs were incurred in Pennsylvania. Thus, whether Synthes must calculate its sales factor using the costs-of-performance method or the benefits-received method has a major impact on the determination of its sales factor, and consequently on the amount of state income tax it must pay.

Although the Department never issued a regulation or formal policy concerning its construction of Subparagraph 17, it interpreted and enforced Subparagraph 17 consistently for decades, including during the tax years relevant to Synthes's refund claims.13 The Department treated each sales receipt as a separate income-producing activity. It then deemed each income-producing activity as having occurred at the location where the customer received the benefit of the service (benefits-received method). Stipulated Facts, ¶ 37. In its brief before this Court, the Department asserts this same interpretation of Subparagraph 17.

Synthes originally calculated and paid its 2011 corporate net income taxes using the costs-of-performance method of determining the sales factor. Synthes subsequently sought a refund from the Department on the basis that the Department...

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