United States: Pennsylvania Municipality Can’t Keep it All. Business Privilege Tax Fails to Meet External Consistency Test

In Northwood Construction Co. v. Township of Upper Moreland, Pa., No. 12, M.D. Appeal Docket 2003 (Sept. 2, 2004) 2004 Pa. LEXIS 2055, the Supreme Court of Pennsylvania found a municipal business privilege tax ("BPT") unconstitutional because the taxing scheme failed to apportion the taxpayer’s interstate revenues.

State and local governments cannot tax 100 percent of revenues or receipts from a taxpayer’s interstate activities. A taxing state must apportion the revenues attributable to the state and then only impose the tax on the state’s portion of the revenues. Even if other states do not tax the revenue, the taxing state cannot impose its tax on more than its allocated portion.

The Supreme Court in Complete Auto Transit, Inc. v. Brady, 430 U.S. 274, 1977 U.S. LEXIS 56 (1977), set forth a four-part test for determining the constitutionality under the Commerce Clause of a state tax imposed on the interstate activities of a taxpayer. One part of that test, the fair apportionment prong; comprises two tests; the external consistency test; and the internal consistency test.

The external consistency test requires the tax to be fairly apportioned by the state so that the portion of the value reached by the state is attributable to economic activity within the taxing state. The internal consistency test requires that if, in theory, every state imposed an identical tax to the one being tested, the taxes would not place interstate commerce at a disadvantage compared to intrastate commerce.

The Township of Upper Moreland imposed its BPT on 100 percent of the receipts of Northwood Construction Co., a company with its principal place of business in the township. Northwood Construction conducted construction management and general contracting activities in the township but also in other jurisdictions of Pennsylvania and also in Delaware, New Jersey and Maryland.

According to the court, the Township violated the Commerce Clause by imposing a tax on income "‘out of all appropriate proportion to’ the business transacted in the Township and [that] has no ‘rational relationship’ to Northwood’s business in the Township." (Northwood Construction Co. v. Township of Upper Moreland, Pa., No. 12, M.D. Appeal Docket 2003, 2004 Pa. LEXIS 2055, at *37 (Sept. 2, 2004).)

The BPT, which taxes gross receipts of parties conducting business in the Township, provided an exclusion for gross receipts which were taxed by another political subdivision. In practice, the Township applied the exclusion to receipts taxed by other political subdivisions within Pennsylvania but did not apply the exclusion to Northwood Construction’s receipts that were taxed by other states. The court relied upon the exclusion’s application to political subdivisions both within and without Pennsylvania in its decision.

The Commonwealth’s Local Tax Enabling Act (Local Tax Enabling Act, 53 P.S. sections 6901- 6924) permits the Township to tax receipts generated outside the Township’s limits. However, the court rejected the Commonwealth Court’s conclusion that the Township could tax 100 percent of Northwood Construction’s interstate receipts on the basis that the company maintains its primary business office in the Township. The Commonwealth Court had concluded that the BPT only taxed in-state activity because the tax was imposed on the privilege of maintaining an office in the Township.

Under the Commerce Clause, courts must examine where the activities that generate receipts occur. A gross receipts tax may only apply to in-state activities, the court stated.

The Township argued its exclusion provision, which excluded receipts already taxed under a business privilege tax in another political subdivision, eliminated the necessity to apportion the BPT. The Township reasoned that the exclusion prevented any risk of multiple taxation.

The court rejected the Township’s arguments. "[T]he Township essentially ignores Supreme Court precedent that the ‘central purpose behind the apportionment requirement is to ensure that each state taxes only its fair share of an interstate transaction," the court stated. Northwood Construction Co. v. Township of Upper Moreland, Pa., No. 12, M.D. Appeal Docket 2003, 2004 Pa. LEXIS 2055, at *41 (Sept. 2, 2004)(quoting Goldberg, 488 U.S. at 260.).

The Supreme Court of Pennsylvania found the BPT did meet the internal consistency test. The Court held that the Township’s exlusionary provision prevents multiple taxation if the same taxing scheme were applied in multiple jurisdictions. The provision requires the Township to exclude from taxation receipts already taxed by another political subdivision if that tax is imposed because the receipts were generated by the performance of services or by business conducted in the taxing political subdivision.

Northwood Construction made two additional but unsuccessful challenges to the Township’s BPT. The company claimed the Township could not impose the taxes under its own ordinance and regulations. The company also challenged the Township’s authority to impose the tax under Pennsylvania’s Local Tax Enabling Act. The state supreme court found the Township had authority under both its ordinance and regulations and under Pennsylvania’s Enabling Act to impose the taxes.

If the Township amends its BPT scheme to apportion the tax and impose the tax over only the in-state portion of the taxpayer’s gross receipts, the BPT should withstand constitutional scrutiny. The Township is already allowed to impose the BPT on gross receipts of activities outside the Township’s jurisdiction but within Pennsylvania.

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