Effects of New Phila. Business Privilege Tax Legislation

January 20, 2012Articles The Legal Intelligencer

On Nov. 14, 2011, Mayor Michael Nutter signed legislation intended to provide relief to Philadelphia businesses subject to the city's business privilege tax. In follow-up legislation, the name of the BPT was changed to business income and receipts tax. The BPT has long been viewed as an impediment to Philadelphia's economic growth and sustainability since it often results in Philadelphia-based businesses paying a significantly higher amount of tax than similar businesses located outside of the city.

The BPT is imposed on any person who engages in a taxable activity in Philadelphia or attributable to Philadelphia, whether or not such person is a resident and whether or not such person has a permanent place of business in Philadelphia. For purposes of the BPT, a "person" is defined to include any individual, partnership, limited partnership, corporation, estate or trust. The presence of a taxable activity in the city for purposes of the BPT is essentially a factual determination made on a case-by-case basis. The city has been extremely aggressive in determining what constitutes the presence of a taxable activity in Philadelphia for purposes of imposing the BPT.

The BPT has two components — a tax on gross receipts and a tax on net income. For this purpose, "receipts" is defined to include cash, credits or property received from conducting any business or by reason of the sale or leasing of goods or the provision of services. Receipts from the sale of goods delivered to a location regularly maintained by the purchaser outside of Philadelphia are generally not counted as receipts subject to this component of the BPT. Special rules are also provided for the taxation of banks and other regulated industries. The tax rate on the gross receipts component of the BPT is .1415 percent.

With respect to the net income component of the BPT, alternative methods are provided for the calculation of such net income. Only that portion of net income attributable to doing business in Philadelphia is subject to this component of the BPT. The regulations promulgated under the BPT provide a methodology to apportion income between taxable activities within Philadelphia and nontaxable activities outside of Philadelphia. This methodology utilizes a three-factor test that measures the amount of business property located within or outside of Philadelphia, the amount of the payroll attributable to employees located within Philadelphia or outside Philadelphia and the amount of gross receipts attributable to activities within or outside Philadelphia. Currently, the tax rate on the net income component of the BPT is 6.45 percent.

Under the new legislation, the gross receipts tax will remain at its current level of .1415 percent. The net income tax rate will remain at 6.45 percent through 2013 and will then be slightly phased down over the subsequent 10 years to 6 percent in 2023. This incremental reduction in the net income tax rate actually represents a slower reduction in that tax rate than previously scheduled but is offset by more generous exclusions to the tax, discussed below.

Beginning in 2014, taxpayers will be able to exclude the first $50,000 of gross receipts from the gross receipts component of the BPT. This exclusion increases to $75,000 in 2015 and to $100,000 in 2016 and thereafter. A deduction is also provided for the pro-rata portion of net income attributable to the gross receipts exclusion. It is anticipated that these exclusion amounts, when fully phased in, will result in a significant number of small and startup companies being exempt from any tax liability under the BPT.

Perhaps the most meaningful aspect of the new legislation is that it directs the Philadelphia Department of Revenue to implement a single sales factor method for the apportionment of net income. Under a single sales factor method of apportionment, local businesses that sell tangible goods outside of Philadelphia would not have to pay any net income tax on such sales. Under the prior three-factor apportionment methodology, some portion of net income attributable to sales outside of Philadelphia would still have been taxed if the business maintained property and an employee-payroll base within the city. For example, it is anticipated that under the single sales factor method, a business based in Philadelphia that sells and delivers goods to California will now avoid a tax on its net income attributable to such sales just as would a similar business located in a suburban county that sells and delivers goods to California.

Another series of reforms contained in the new legislation grant significant tax relief to new businesses. Under this legislation, a "new business" would be exempt from the BPT for the first two years of operations. In general, a business will qualify for this exemption if it was not subject to the BPT at any time during the five tax years preceding 2012. As a condition of maintaining its "new business" status for purposes of tax relief, the business must also satisfy an employment requirement. As of the 12-month anniversary of becoming subject to the BPT and continuously thereafter through the 18-month anniversary of becoming subject to the BPT, the new business must maintain at least three full-time employees who are not family members and who work in the city at least 60 percent of the time. For the period commencing as of the 18-month anniversary of becoming subject to the BPT and continuously thereafter through the 24-month anniversary of being subject to the BPT, the new business must have at least six full-time employees who are not family members and who work in the city at least 60 percent of the time.

In addition to the two-year exemption from the BPT, a new business will also be exempt from all licensing and permit fees otherwise charged by the city during this initial two-year period. These fees include the one-time $300 business privilege license fee, zoning and planning fees and a variety of vending fees. The business privilege license fee will be eliminated for all businesses commencing in 2014.

The new legislation, when fully implemented, will put many small businesses and businesses selling a significant amount of their goods or services outside of the city on more competitive footing with businesses located outside of Philadelphia. In addition, new businesses otherwise planning to locate within Philadelphia will receive significant immediate tax relief.

Reprinted with permission from the January 20 issue of The Legal Intelligencer. (c) 2011 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.